A kinder, gentler IRS?

National Taxpayer Advocate says IRS should ease the burden on taxpayers already struggling with harsh economic conditions.

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By Ben Rooney, CNNMoney.com staff writer

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NEW YORK (CNNMoney.com) -- The Internal Revenue Service should take steps to ease the burden on taxpayers hit by the recession, according to National Taxpayer Advocate Nina Olson.

In her annual report to Congress Wednesday, Olson said that it is "imperative" for tax collectors to consider the economic circumstances of a taxpayer before initiating "enforcement actions."

"Current IRS guidance provides little direction to help IRS employees identify taxpayers who are experiencing economic hardship and prevent undue economic burden," said Olson, who is appointed by the Treasury Secretary and is charged with representing taxpayer interests before the IRS and Congress.

On Tuesday, the IRS released a fact-sheet outlining its efforts to help distressed taxpayers. In that announcement, the agency said it would consider postponing collection actions for those with financial hardships and add flexibility for missed payments, among other things.

Some of these actions fall in line with recommendations made in the advocate's report, which maintains that enforced collection actions, such as asset seizures, do not result in "commensurate" revenue increases. Instead, the report recommends that the IRS rely more on "collection alternatives" such as installment plans.

The IRS is "walking a very thin line," said Cindy Hockenberry, tax research coordinator at the National Association of Tax Professionals. "They're getting so much pressure to close the tax gap, and the way to do that is to step up enforcement, yet they're supposed to be compassionate."

While Hockenberry calls many of efforts being touted by the IRS as "same old, same old," she said the tax credit for first-time homebuyers is noteworthy.

The credit, which was passed by Congress in September as part of the Housing and Economic Recovery Act of 2008, is essentially an interest-free loan of up to $7,500. The credit amount is based on the price of the home and must be repaid over 15 years.

"The first time homebuyer credit is huge," Hockenberry said. "If you were thinking about buying a home, it might give you some extra incentive."

For those homeowners facing foreclosures, Olson recommends a review of the tax laws governing the cancellation of debt. When a taxpayer cannot pay certain debts, including home and auto loans, and the creditor is forced to write off that debt, the canceled debt is sometimes counted as taxable income to the debtor.

On Tuesday, the IRS said it would not tax the debt forgiven on most foreclosed properties and mortgage work-outs. The agency also said it would reevaluate how it calculates home equity in determining a taxpayer's ability to pay.

"With the uncertainty in the housing market, the IRS recognizes that the real-estate valuations used to assess ability to pay may not be accurate," it said. "So in instances where the accuracy of local real-estate valuations is in question or other unusual hardships exist, the IRS is creating a new second review of the information."

The advocate report also recommends that the IRS create a "screen" to protect Social Security recipients from automated tax levies. Currently, the IRS is authorized to withhold 15% of any federal payment, including Social Security benefits, made to a delinquent taxpayer. This levy is automatically imposed, but the report estimates that one-third of the taxpayers in this group would be considered unable to pay if their cases were subject to a human review.

In addition to calling for a more compassionate IRS, the report said Congress should "substantially" simplify the tax code.

Taxpayers and business spend about 7.6 billion hours a year complying with tax-filing requirements, at an estimated cost of $193 billion annually, the report said. The complexity of the tax code imposes additional costs on taxpayers, the majority of whom spend money on accountants or tax-preparation software.

But the most troubling aspect of tax law complexity is that it produces "perverse results," according to the report.

"Taxpayers who honestly seek to comply with the law often make inadvertent errors...on the other hand, sophisticated taxpayers often find loopholes that enable them to reduce or eliminate their tax liabilities."

Tom Ochsenschlager, a CPA and vice president of taxation at the American Institute of Certified Public Accountants, agreed that the tax code should be simplified, even though it could result in lost revenue for tax accountants. Given the challenges facing the economy, however, he thinks decluttering the tax code "is going to be on the back burner."

"Simplification should be done, but it's not critical to the economy right now," Ochsenschlager said.

Among Olson's recommendations for simplifying the code: repeal the Alternative Minimum Tax, streamline the rules under which workers are classified as either employees or independent contractors, and revise the overall tax penalty structure. To top of page

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