The IRS is Downsizing — What Taxpayers Can Expect

Recent IRS downsizing efforts have posed challenges for taxpayers attempting to resolve issues with the agency. Over recent months, thousands of IRS employees have left the IRS through the administration’s deferred resignation programs, comprehensive layoffs of probationary employees, and retirements. Reductions not only affect processing and service centers but also impact personnel who are part of the IRS’s Taxpayer Experience Office, Taxpayer Advocate Service, IRS Office of Appeals, and IT modernization staff — all departments that exist to assist taxpayers with navigating complex U.S. tax compliance issues and IRS controversies. As of the current date, it remains unclear whether the IRS will be safe from further staffing cuts. What’s more, IRS employees are voluntarily resigning, often as a result of increasing uncertainty within the agency. 

While the ultimate goal of the downsizing is to enhance the IRS’s efficiency through automation and streamlined operations, taxpayers should be prepared to encounter administrative and logistical challenges when dealing with the agency as it settles into new processes with fewer personnel. These challenges include:

•     Processing backlogs 

•     Unapplied tax payments

•     More correspondence exams

•     Appeals resolution issues

•     Delayed determination letters

•     Taxpayer Advocate Service delays

Routine processing backlogs. Processing of routine tax filings such as original and amended returns, refund claims, and requests for appeals consideration may be delayed due to fewer IRS staff. These backlogs may also lead to delays in the IRS issuing much needed tax refunds to taxpayers. 

Longer processing times may also expose certain taxpayers to operational disruptions. The IRS may, for example, delay the processing of a business taxpayer’s request to change its legal entity name by several months. As a result, the taxpayer’s customers and vendors might be reluctant to remit payment to the newly named entity because its entity name for legal purposes does not match IRS records.

Unapplied tax payments and payments made by consolidated subsidiaries. In certain cases, the IRS is failing to apply or is misapplying taxpayers’ payments. A taxpayer may, for example, remit payment to the IRS to offset its 2024 income tax liability, then later determine the IRS never withdrew the funds from its account or applied the payment to the wrong year. The IRS may fail to apply or misapply a taxpayer’s payment without notification to the taxpayer, causing late payment penalties and interest to accrue without the taxpayer’s knowledge.  

Recently, tax payments made by a consolidated subsidiary on behalf of its parent corporation have triggered automatic notices from the IRS demanding the associated tax return. In these cases, the IRS apparently has not associated the payment with the parent’s consolidated return, even though the subsidiary and the payment are properly reported on Form 851. As a result, consolidated filers must dedicate resources to clearing IRS requests for income tax returns from subsidiaries with no filing requirements.

More correspondence exams. As part of the agency’s recent downsizing, the IRS has lost approximately one-third of its auditors. Although fewer auditors may lead to fewer in-person audits, it also may mean more audits are conducted entirely via computer system and by mail, with taxpayers unable to speak directly to a live revenue agent. This type of audit, known as a correspondence exam, often leads to a lack of clarity for the taxpayer and the IRS incorrectly adjusting items on a taxpayer’s return even when the taxpayer has the relevant documentation to support the return as filed. In these cases, the only resolution may be for the taxpayer to file a petition with the Tax Court, which is expensive and often more costly than the tax adjustment itself.

Appeals resolution issues. The IRS Office of Appeals has lost hundreds of employees in the downsizing, all while dealing with an increasingly complex workload. The number of Appeals cases is expected to further increase due to errors and disputes resulting from the loss of qualified personnel in other areas of the IRS. 

As a result, taxpayers can anticipate the Appeals process will take longer. Unfortunately, this may result in more taxpayers taking issues to litigation, thus burdening the federal court system. Taxpayers that need to take issues to Appeals should consider the benefits of engaging a professional advisor to assist and advocate for them throughout the Appeals process.

Delayed determination letters. Entities applying for tax-exempt status may have to wait longer periods to receive their IRS determination letters. These entities, which are required to electronically file Form 990, will not be able to properly file Forms 990 until the determination letter is issued, resulting in IRS-assessed late filing penalties.  

Contacting the Taxpayer Advocate Service. The Taxpayer Advocate Service (TAS) is also dealing with the separation of hundreds of employees. TAS is an independent office within the IRS that helps taxpayers resolve errors the IRS processing centers cannot or will not resolve on their own. An increase in errors made by the IRS due to the downsizing has also led to an increase in taxpayer assistance requests of TAS. Although traditionally effective at expediting the resolution of errors, TAS representatives may become increasingly difficult to reach due to the recent reduction in qualified personnel along with the increase in requests for assistance. This may mean issues require more time to resolve or even go unaddressed, with taxpayers potentially requiring assistance from professional advisors to reach a resolution.