Few taxpayers will be upset to see the unloved Internal Revenue Service going through its worst crisis in decades -- although tax experts and lawyers say they probably should be.
The agency runs on the trust and cooperation of taxpayers in raising revenue for the U.S. government, and its widening scandal and use of invasive tactics is undermining that role at a critical time as budget concerns mount. A prolonged political battle over what to do about the agency could be a costly problem. And taxpayers will foot the bill.
"We all know what's going on with the IRS today. How can we trust an entity like that?" said Rep. Charles Boustany, the Louisiana Republican who heads the House Ways and Means subcommittee that oversees the IRS, in a hearing committee comment reported by The Wall Street Journal.
"We have to trust them," says Edward Zelinsky, a tax law expert and professor at Benjamin N. Cardozo School of Law and Yale Law School who has handled federal tax appeals. "Their ability to do their work depends on public trust and confidence, and they have violated it. The secretive way they have gone about their work is the most disturbing part of this. It's certain to undermine them in their mission, and that hurts all taxpayers."
There will also be direct costs related to lawsuits and the many investigations already launched. The Internal Revenue Service Restructuring and Reform Act of 1998 lets taxpayers sue for up to $1 million over tax grievances. Already, a number of groups from the loosely affiliated wings of the Tea Party have said they will.
Congress is also likely to take a much harder look at how the IRS uses technology and automatic screening of returns as it identifies possible audits, a critical cost-saver aimed at collecting more of the estimated $400 billion in tax dodges missed each year. The agency has declined numerous requests from U.S. News to explain how it uses technology to screen tax returns, and denied suggestions that such screenings were used inappropriately to target any groups. The IRS's lack of openness in providing guidelines has made the agency "their own worst enemy," says Zelinsky.
Investigators are now looking into the use of keywords to review an estimated 60,000 applications for tax-exempt status by a small staff of workers in Cincinnati, the hub for reviewing nonprofits. Initial government reports do not disclose how technology may have been used, but the agency did automate such filings over the past five years to simplify the process of screening.
"There is going to be a lot more digging to see how this happened," says tax attorney and former IRS revenue officer Elizabeth Atkinson of LeClairRyan in Virginia Beach, Va. "The lack of transparency and guidance is the fundamental problem at the root of this scandal. As they move into data mining, it shows the dangers. You just cannot run an agency with such an important role off the cuff like this."
U.S. Treasury Inspector General for Tax Administration J. Russell George, in a report on the alleged abuses, said the agency failed in its stated mission to help Americans "understand and meet their tax responsibilities and enforce the law with integrity and fairness to all." In hearings Friday, the Associated Press quoted House Ways and Means Committee Chairman David Camp, (R-Mich.), as saying, "This is a problem of the IRS being too large, too powerful, too intrusive and too abusive of honest, hardworking taxpayers."
The Republican-controlled Ways and Means committee blames the Obama administration for the abuses. But the inspector general's report blamed "ineffective management" and lack of proper oversight, not political pressure. The Cincinnati group screening the applications was told at numerous points to stop using explicit search terms like "Tea Party" and "patriot" that profiled a group's political beliefs, according to the report.
Instead, the group quickly substituted more vague terms to circumvent restrictions on specifying political groups, replacing it with "limiting government" and "educating on the Constitution and Bill of Rights," according to the report, which notes the groups did not seek higher approval for the change.
The use of computer screening allows such quick changes in tactics without additional funding or staff. The report says the "Determinations Unit," as the group was known, set its own criteria notifying high-level administrators. The report also says the guidelines and management controls were not in place to prevent the unit from doing it, and through the use of search terms in a database, Atkinson says, "it's the kind of thing that can be done easily with use of technology."
The cost to taxpayers. The final cost could be felt far beyond Washington as a crippled IRS tries to regroup to serve its central role in the U.S. budget crisis, both as a provider of information and the collector of tax revenue. In a statement, the White House said President Obama's nominee, Daniel I. Werfel, the controller of the Office of Management and Budget, "has the experience and management ability necessary to lead the agency at this important time."
His experience has been as a front-line administration official in working with Congress to manage the impact of sequestration, the cuts mandated at the start of the year to head off a total shutdown of the government as the U.S. borrowing limit approached.
The last budget showdown two years ago resulted in a cut in the U.S. credit rating by Standard & Poor's, which cited the Washington stalemate as a key reason for the loss of status. Its rival agency, Moody's, has also put the U.S. debt rating on a credit watch. The credit-rating companies declined comment for this article.
At the same time, IRS duties are expanding. The agency has begun using third-party data from a wide range of public and private sources it has not used in the past. It is also taking on the chore of managing the implementation of health care reforms, which add a range of tax credits and charges that will complicate taxes for millions of returns.
In a statement, Obama said Werfel "will lead efforts to ensure the IRS implements new safeguards to restore public trust and administers the tax code with fairness and integrity."
A high-tech crackdown on tax-exempts. The first victim of the IRS shakeup, acting director Steven Miller, had a long history of involvement in policing misuse of tax-exempt filings. He vowed to Congress to act as the "cop on the beat" to ensure "charities behave in accordance with their charter and the privilege of tax exemption." He created an electronic processing form that could screen filings. He told Congress in 2007 that there were more than 1.6 million tax-exempt groups with assets totalling $3 trillion, excluding churches, and pushed for more professionalism and accountability in nonprofits.
Miller moved through the ranks of the IRS in a 25-year career, with much of his recent time spent as commissioner of the agency's tax exempt and government entities division - the division in the midst of the scandal. He stepped up enforcement and screening of groups seeking tax-exempt status and pushed for more transparency from nonprofits to document their social welfare goals and to account for their spending and donations. Critics say he was less forthcoming about the IRS's enforcement policy.
IRS unshackled puts agency in jeopardy. Miller brought the same commitment to the top of the agency. But the inspector general's report blamed his "shortcuts" as part of the problem. The agency's more aggressive tax collection and use of snooping technology without restraint has drawn criticism from both sides of the political spectrum. The American Civil Liberties Union has pushed for the release of IRS documents that show the agency was allowed by its counsel to open emails without warrants, and how it instructs agents on using information on Facebook and other sites. The IRS denied it opens emails without a warrant, but has not outlined the limits and guidelines for other uses of personal data.
As for the partisan nature of the latest scandal, Atkinson, who spent years as a compliance officer and lawyer for the agency, sees the problem not as one of political agenda, but rather as an agency caught in the middle of a deeply divided Washington that lacks the expertise and resources to manage all of the competing interests. The IRS's "over-reliance on technology to solve human problems" and its "insular culture" are hurting the agency, she says.
"I feel sorry for the IRS. There are a lot of good people there just doing their jobs and not understanding how to do them," Atkinson says. "It's more of a mess than a conspiracy."
More From US News & World Report