August 4, 2022 – Throughout my tenure as the National Taxpayer Advocate, I have appreciated the ongoing exchange of ideas and information with my IRS colleagues as we work collaboratively to improve the taxpayer experience, including accelerating the payment of tax refunds to taxpayers entitled to receive them. But we don’t always agree on the same approach or priorities.

On March 29, I issued a Taxpayer Advocate Directive (TAD) to the IRS directing it to implement scanning technology to machine read paper-filed tax returns in time for the 2023 filing season. Specifically, the TAD directed the IRS to (1) implement technology to automate the processing of paper-filed returns prepared with tax software (known as “v-coded” returns) by the start of the 2023 filing season and (2) automate the processing of handwritten paper returns by the start of the 2023 filing season if possible or, if not, by the start of the 2024 filing season. I explained the issue in detail in a previous blog.

On July 18, the IRS’s Deputy Commissioners responded to the TAD. The response said the IRS is testing several pilot programs, and its goal is to accelerate the “V-Coded Return Pilot” described in the response for 2022 returns. Notably, however, the response declined to make a commitment to implement scanning technology to machine read v-coded returns, and it expressly rejected implementing scanning technology to machine read handwritten returns. The response further stated the IRS would not implement any single option until it is confident in the delivery system.

I fully agree the IRS should choose an efficient and reliable delivery system, but the TAD response does not provide specifics regarding its ongoing efforts, a timeline to apply a delivery system to process paper returns, or the percentage of 2022 returns it anticipates scanning. I appreciate the IRS’s efforts with the “Lockbox Scanning Service Pilot” and encourage moving forward with scanning returns. But that pilot involves returns with which the taxpayer is making a payment. Processing delays primarily harm taxpayers who are due refunds, and I would like to see the IRS prioritize its efforts to paper-filed refund returns.

On Tuesday, due to the magnitude of this issue and the unprecedented backlog of paper returns, I took the unusual step of appealing the Deputy Commissioners’ decision to the Commissioner for reconsideration.

In this blog, and in the interest of transparency, I will explain why. Before I get into the details, I want to take a moment to acknowledge and thank the IRS employees in Submission Processing, the IRS employees working on the surge teams, and IRS management for their tireless efforts during the last three filing seasons aimed at overcoming the numerous challenges paper filings have presented. During my visits to the campuses, it was inspiring to observe the work ethic of the employees and local management. Although their daily efforts may not be observable to the public, they have worked diligently to confront the daunting and massive mountain of paper awaiting processing. That said, our taxpayers and employees deserve a 21^st century tax administration that utilizes technology to streamline tax administration, most notably by delivering timely tax refunds. I believe IRS executives and employees wholeheartedly agree with this statement. As such, I was disappointed in the Deputy Commissioners’ response to my TAD.

Since the start of the COVID-19 pandemic, tens of millions of taxpayers have experienced significant delays in receiving their tax refunds – some waiting 10 months or more. In 2021, about 17 million individual taxpayers filed original paper returns (Forms 1040), and about 4 million individual taxpayers filed amended paper returns (Forms 1040-X), which are processed like paper returns regardless of whether they are paper-filed or e-filed. Millions of business taxpayers have also filed paper tax returns, with many employers waiting far too long to receive Employee Retention Tax Credits.

I have previously said that paper is the IRS’s Kryptonite and the IRS is buried in it. Paper returns remain the IRS’s Achilles heel because the IRS still – in the year 2022 – has not implemented technology to machine read paper-filed returns. As a result, employees must manually keystroke into IRS systems each digit on every paper return. Not only does manual data transcription delay refunds, but data transcription errors were made on 22 percent of paper-filed returns processed last year, which causes rework and additional frustration for taxpayers and the IRS itself.

I believe there are two possible solutions to accelerate the processing of paper-filed tax returns: (1) automate the data intake process or (2) hire a lot more employees and/or outsource clerical tasks. Automating the data intake process is unquestionably the better and more efficient solution. The IRS’s antiquated technology is well known, and its failure to automate the processing of paper tax returns is a prime example of how the IRS lags behind other tax administrators. As we have previously reported, 17 state tax agencies were using scanning technology to machine read paper-filed tax returns – 22 years ago!

In fiscal year 2017, the IRS requested that Congress appropriate $8.4 million so it could implement 2-D barcoding. Congress didn’t appropriate the funding, so the IRS let the proposal drop. It is not clear why the IRS, managing a budget that at that time exceeded $11 billion, could not reallocate funding to cover the $8.4 million implementation cost. Had it done so, the technology would have paid for itself many times over. In its efforts to work through the tax return processing backlog this year, the IRS has set a goal of hiring almost 5,500 employees in its Submission Processing function. Many of these hires wouldn’t be necessary if the data intake process were fully automated. If you assume for illustrative purposes that the cost of a “fully loaded” Submission Processing employee is around $40,000 (including salary, benefits, and overhead), it becomes clear that the annual cost of paying employees to transcribe paper tax returns substantially exceeds the previously projected $8.4 million cost of 2-D barcoding implementation. Not to mention that the IRS has had difficulty hiring Submission Processing employees, so far just reaching 55 percent of its goal.

More importantly from a taxpayer’s perspective, the IRS has set a goal of working through its backlog of paper tax returns by the end of the year, but it’s far from clear it will succeed. At this writing, there remains a significant imbalance between the number of paper-filed returns the IRS must process and the IRS’s processing pace. The IRS carried over a backlog of 4.7 million paper-filed Forms 1040 from 2021 to 2022, and it was not able to complete the processing of these returns until late June 2022.  For 2022, the IRS has projected it will receive about 13.2 million paper-filed Forms 1040 (including returns filed on extension between now and October 15), 4.2 million amended individual income tax returns (Forms 1040-X), and millions of business tax returns. With more returns still projected to be filed later in the year, the IRS’s total paper-filed processing backlog stood at 17.4 million as of July 1.

Just focusing on Forms 1040, that means the IRS will have to process a projected 13.2 million paper Forms 1040 during the second half of 2022 – almost triple its pace during the first half of the year. Put differently, the IRS will have to process an average of about 525,000 paper-filed Forms 1040 per week during the second half of 2022 to eliminate the backlog. The IRS continues to explore options to apply additional resources to increase the number of processed returns by year-end. As of July 15, however, it had processed a weekly average of paper-filed Forms 1040 over the prior four weeks of just 295,000. While we all hope the IRS can work through the backlog this year, I often say that hope is not a business plan.

From a taxpayer perspective, working through the paper processing backlog and paying timely refunds must be Job One for the IRS. Many of the IRS’s information technology priorities will necessarily take years to develop and implement. Scanning technology need not be one. Immediate implementation of scanning technology will achieve four goals: (1) accelerate the processing of tax returns; (2) deliver timely refunds to taxpayers; (3) substantially reduce or eliminate data transcription errors that burden both taxpayers and the IRS itself; and (4) allow the IRS to reassign Submission Processing employees to other tasks that cannot be automated, such as answering taxpayers’ telephone calls or processing taxpayers’ correspondence.

I look forward to a continuing dialogue and exchange of ideas with my IRS colleagues as we work to eliminate the paper processing challenges and provide taxpayers with the service they expect and deserve.