5 serious taxpayer problems

National Taxpayer Advocate Nina Olson submits her annual report to Congress, criticizing the AMT, the tax gap, IRS use of private debt collectors and more.

By Jeanne Sahadi, CNNMoney.com senior writer

NEW YORK (CNNMoney.com) -- The most serious problem facing taxpayers today is complexity, and no tax represents that complexity better than the Alternative Minimum Tax, according to National Taxpayer Advocate Nina Olson in her annual report submitted to Congress on Tuesday.

The National Taxpayer Advocate is appointed by the Treasury Secretary and is charged with representing taxpayer interests before the IRS and Congress.

Olson's report outlines for lawmakers what she considers to be 21 of the most serious taxpayer problems - not a conclusive list by any means, as she notes in her report.

Here are five that Olson details:

Alternative minimum tax

First imposed in 1969, the AMT was intended to ensure that the wealthy few paid their fair share of tax by preventing them from exercising too many loopholes, many of which have since been closed.

Today, because its income exemption levels were never adjusted for inflation and because it disallows key breaks allowed under the regular tax code, the AMT threatens to capture millions of primarily married couples with kids and incomes in the middle- to upper-incomes range.

Now, Olson writes, "the AMT is left to punish taxpayers for engaging in such 'classic tax avoidance behavior' as having children or living in a high-tax state."

To make matters worse, it's hard for taxpayers to figure out if they owe AMT, which imposes a higher bill than they would pay under the regular income tax code. And if they find out they do, they may also be subject to a penalty for failure to pay sufficient estimated tax if they didn't count on having to pay AMT.

"'Gotcha' taxation is not good for taxpayers or the tax system," Olson writes. She recommends that lawmakers repeal the AMT as it pertains to individuals.

Leading tax writers in the House and Senate have said they would make AMT a priority issue this year, but given the high cost of repeal - estimated in the neighborhood of $1 trillion over 10 years - repeal is a tall order.

More likely, but in no way guaranteed, are possible reforms to the AMT - such as indexing income exemption levels for inflation. (Here's a closer look at the AMT and whether you may be subject to it.)

Tax gap

Every year, $290 billion in federal taxes owed are not collected. The biggest reason for this "tax gap" is the under-reporting of income, but not all of it intentional. The IRS has noted that confusion over how to comply with complex tax laws also contributes to the gap.

"It is a problem for taxpayers because the average taxpayer is paying thousands of dollars in extra tax each year to subsidize noncompliance by others," Olson writes.

To close the gap, she recommends a number of things, including a move toward fundamental tax simplification, greater third-party information reporting, and better IRS compliance efforts that respect taxpayer rights.

Costs and benefits of private debt collection

Olson has come out strongly against the IRS's recently instituted practice of farming out some of its past-tax-owed debt collection cases to private agencies.

The initiative was intended to be cost-effective, but Olson writes that the IRS has acknowledged it can deal with delinquent accounts more efficiently than private companies, and the Taxpayer Advocate Service has found a high number of complex cases assigned to private companies, instead of the less complex ones which they were originally intended to get.

"The IRS has a nearly $2 billion collection budget with thousands of collection employees. In contrast, (private collection agencies) PCAs at this stage of the initiative are using 75 employees to collect on these accounts , and the IRS is using 65 employees to monitor them," Olson writes.

What's more, she says, the Taxpayer Advocate Service has observed "poor customer service to multilingual taxpayers, (private collection agencies') operational plans being withheld from public disclosure, and PCA collection scripts through which PCA employees attempt to manipulate taxpayers."

Her recommendation to lawmakers: Repeal the IRS's authority to use private debt collectors.

In a six-page response to Olson's charges on private debt collection printed in the report, the IRS noted that two of the three private companies it uses have bilingual staff and the third is in the process of arranging assistance for non-English callers.

In general, the agency said, "Given the backlog of IRS receivables and our limited collection resources, [this] initiative allows the IRS to ensure that more delinquent taxpayers are personally assisted in meeting their obligations. ... [A]nd we will continue to make program decisions to protect the privacy and security of taxpayers while collecting outstanding government debt."

Transparency of the IRS

The IRS needs to do a better job of disclosing to the public its updates to procedures and IRS guidance, and the agency needs to make sure its employees as well as taxpayers and practitioners are aware of what is most current, Olson contends.

"Transparency in tax administration is essential to assure taxpayers that the tax laws are being administered fairly," she writes.

The IRS, in a written response to Olson's critiques, said it is "committed to improving the way it manages instructions to staff. We acknowledge we have experienced growing pains as we have moved towards electronic creation and delivery of the plethora of instructions to staff we produce."

Early intervention in IRS collection cases

Not dealing with delinquent accounts early enough "contributes to long-term financial problems for many taxpayers and costs the government billions of dollars in lost revenue," Olson writes.

And cases are left pending even when taxpayers have tried to settle their debts through installment agreements or offers in compromise, she notes.

Olson recommends that the IRS improve the way it prioritizes cases, initiate more personal contact with taxpayers and become more flexible in the way it provides realistic payment options for taxpayers who owe back taxes.

In its written response to Olson's critiques, the IRS said it agrees that early intervention is important, noted that it is analyzing the rates at which cases are deemed "currently not collectible," and stressed that "all of our processes are designed to reduce personal burden by directing taxpayers to the right treatment at the fastest possible time."

The full annual report to Congress from the National Taxpayer Advocate can be found here on the IRS Web site.

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.