Dealing with Identity Theft, Debt and Tax Collection Issues

Tuesday July 22, 2008

National Taxpayer Advocate Nina Olson highlights the top five tax issues for taxpayers dealing with the IRS in her semi-annual report to Congress. The five top issues are

complex procedures for responding to identity theft cases,
identifying how canceled debt income from foreclosures will be processed by the IRS,
trends towards more aggressive collection activities by the IRS,
whether outsourcing collection services to third-party firms has created inefficiencies, and
concerns over lingering tax debts caused by incentive stock options.

At the top of her list, Olson says that identity theft is a growing problem for both taxpayers and for the Internal Revenue Service. Cases where Social Security numbers have been used by someone else to obtain employment have increased 129% from 2002 to 2006. Over the same period, cases where someone other than the taxpayer filed a tax return and claimed a tax refund increased 396%. Current IRS procedures result in time-consuming and confusing delays in issuing refunds, in processing tax returns, even in establishing eligibility for various tax credits. Determining which taxpayer is entitled to use a Social Security number "can take in excess of a year," according to the report. Olson noted that the IRS is in the process of developing a centralized unit to deal with identity theft cases, with a special hotline for taxpayers to call if they suspect their identity has been stolen. This hotline should be available by October 2008.

Individuals can learn more about how to protect themselves from identity theft by monitoring their credit reports and safeguarding their tax data, including Social Security numbers. It is important to report cases of identity theft, as that can be the key to speeding up a tax refund with the IRS.

When debts and loans are canceled, a taxpayer might have to report canceled debts as taxable income. With the dramatic increase in foreclosures, settlements, and short sales, many people will have to navigate through the rather confusing laws regarding canceled debts to figure out if there are any tax consequences. The Advocate highlighted the new lawed passed by Congress to exclude mortgages secured by a main home from tax treatment, and discussed efforts by the Taxpayer Advocate Service to educate consumers and tax professionals about the rules for handling canceled debts. The Taxpayer Advocate Service has developed video broadcasts to highlight the canceled debts and other tax issues.

Canceled mortgage debt for a primary residence is excluded from taxable income, whether the forgiven debt is from a foreclosure or short sale or by renegotiating the mortgage for a lower principal amount. Some types of mortgages, however, will qualify for exclusion only if the taxpayer is considered insolvent.

Nothing is more stressful than owing the IRS, yet three of the top five tax problems concern how tax is collected. The Taxpayer Advocate has noticed trends for IRS agents to take aggressive efforts to collect taxes owed, including pressure to seize a person's assets or to levy funds from a person's retirement savings. At the same time, the IRS has not been using alternatives to these more severe actions, such as entering into long-term partial payment agreements.

The IRS outsources some of its debt collection services to third-party agencies, which has created a whole range of questions about taxpayer privacy and the whether the outside collection agents could collect money more efficiently than the IRS. Nina Olson has consistently pointed out that collecting taxes is one of the core functions of the IRS, and in this report Olson expands her critique of the private debt collection program. Private collection agencies raise less money than the IRS would if it managed these cases itself, unresolved cases are being left with private agencies longer than necessary, and existing reports do not capture enough information to accurately evaluate the performance of the third-party agencies.

The fifth most important tax problem are lingering tax debts created by the tax treatment of incentive stock options. Incentive stock options can generate a tax liability in the year the option is exercised but not sold. If the stock suffers a decrease in value after exercising the option, a taxpayer can be left with a tax bill under the alternative minimum tax rules. Olson urges Congress and the IRS to consider a wide range of administrative remedies to alleviate this tax burden.

Individuals with outstanding tax debts should review the various options available to them. There are five ways to handle tax debts, all of them are far less severe than the IRS taking possession of a house or tapping into retirement savings.

The Taxpayer Advocate Service is an independent, ombudsman service within the IRS that reports directly to Congress twice a year. Taxpayers can contact their local advocate to receive help in dealing with the IRS.

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