Jonathan W. Benowitz, CPA
Associate Editor
Loyola University Chicago School of Law, JD 2019

The IRS suspended its Automatic Substitute for Return (ASFR) Program for lack of resources, Tax Analysts and others report.  The ASFR program has long provided an avenue for the IRS to assess taxes on delinquent filers after requests to file returns were ignored by having its computer system automatically calculate the tax due based on Forms 1099 and other information reports that had been filed with the IRS.  The IRS could then assess the taxes and attempt to collect based on these substitute returns.  However, since deductions were ignored, the tax amounts tended to be inflated, sometimes incredibly so, and significant IRS time was required to respond to contested assessments and collection efforts that were sometimes highly unrealistic.

The High Cost of Computerized Returns is in Human Labor

The IRS has been greatly expanding the use of automation in the assessment of taxes for decades.  Automation especially expanded after Congress cut the IRS budget for years since 2010.  The ASFR program, however, was cut in half in 2012, after increasing eight-fold from 2002 to 2011.  Since 2012, the program has been decreased an additional 86 percent.  The culprit for the failing program may be something as simple as basic math.

The Taxpayer Advocate, the taxpayers’ ombudsman within the IRS, has repeatedly criticized the IRS program in its annual report to Congress as an inefficient use of resources.  The IRS reports that the program generated revenue of $89.5 million in pre-collection revenue in 2015, while costing $39.8 million. Those numbers, however, do not factor in the substantial costs involved in failed collection attempts, sending out notices and abating liabilities.  IRS claims that, in the end, revenue of $2.25 is made on every $1 spent on the program, but acknowledges that the amounts spent on collection efforts are difficult to determine.  In comparison, the 2015 Taxpayer Advocate annual report noted that other IRS programs produce returns ranging from 6 to 1 to even 20 to 1.

An Illustration: Automatic Returns Produce Unproductive Debt

Illustrative of the sort of uncollectible accounts produced by the ASFR program is the case of Marcos Esparza Bofill, who was sent a $172 million tax bill by the IRS on an alleged $500 million of income.  Contrary to the IRS’ view of Bofill’s extravagant finances, Bofill was a Spanish émigré who dabbled in day-trading in 2006, lost money on day trading, couldn’t afford rent in New York, and moved back home to Spain.  Bofill may have had no income in 2006, but since he filed no tax return, the IRS assumed every time he sold stock he made 100 percent profit.  Bofill’s first question, when he learned of his incredible tax debt, was “[w]ho’s the IRS?”

Bofill’s case may have been an extreme, but the fundamentals of his situation are not that unusual.  Because the IRS is not generally provided information on inventory costs and other cost of revenues except in a filed tax return, the agency therefore assumes that any self-employed taxpayer’s revenues are not offset by any expenses.  In addition, the IRS ignores additional deductions, such as the mortgage interest deduction, even though the IRS has third-party documentation supporting the deduction.  The Taxpayer Advocates’ 2015 report specifically criticizes the practice of ignoring potential deductions, claiming the inflated amounts reduces collection potential, wastes IRS resources, and harms the taxpayer.

Conclusion: ASFR Program Turns Non-Filers Into Non-Debt Payers

In essence, the program amounts simply to responding to non-filers with known sources of revenue by automatically assessing tax on the gross amount.  This response seems reasonable under the circumstances.  Requiring employee auditors to decide every case would almost certainly be more expensive.  One tax professional, Frank Agostino, described the unfiled tax returns as “low-hanging fruit.”  Indeed, if a taxpayer doesn’t file a tax return, but has substantial credit card sales or investment income, it seems like it should be relatively straightforward for the IRS to collect the tax.  However, given the low rate of return to the IRS from the ASFR program, apart from the intangible, but unmeasurable benefit of encouraging taxpayers to file accurate returns, it appears that non-filers may not represent so much low-hanging fruit as rotten fruit.  ASFR debts risk tainting IRS collection efforts from more responsive taxpayers by bogging down collection agents chasing phantom income determined by ghost returns.