National Taxpayer Advocate (NTA) Erin Collins formally directed the
IRS to take immediate steps toward implementing existing scanning
technology to process tax returns filed on paper.
Collins issued the directive, which is dated March 29, under her
authority pursuant to a delegation order in the Internal Revenue
Manual to mandate administrative or procedural changes by the IRS to
improve its functional operation or grant relief to taxpayers to
protect their rights or to provide them an essential service.
In an NTA blog post on the Taxpayer Advocate Service website, Collins
said the directive was necessitated by repeated warnings that
processing paper returns remain a weakness for the IRS. As she said in
her 2021 Annual Report to Congress in January, “paper is the IRS’s
Kryptonite, and the IRS is buried in it.”
She cited recent updates on paper return processing that suggest the
problem is not getting better: As of March 18, the paper return
backlog numbered nearly 15 million returns, Collins said. Representing
processing delays of 10 months or more, the backlog includes 4.7
million original individual income tax returns, 2.6 million amended
individual income tax returns, 4.9 million original business tax
returns, and 1.2 million amended business tax returns.
“Over the past year, the IRS has not made progress in reducing its
backlog,” Collins said in the directive, noting that as of a year
earlier, unprocessed original individual returns numbered slightly
fewer, 4.6 million.
If the IRS is to meet its stated goal of eliminating its backlog by
the end of 2022, it will need to adopt new ways of processing paper
returns, mostly by implementing scanning technology that itself is
hardly new, Collins said.
“If the IRS had implemented scanning technology, it is unlikely the
current processing backlog would exist,” she said.
Moreover, the current process of transcribing the returns manually by
operators typing their contents into a computer is error-prone. About
22% of transcribed returns last year contained data transcription
errors, Collins said.
2-D barcoding: Already in limited use
One of two methods Collins recommended, 2-D barcoding, is as
time-honored and ubiquitous as most retail checkout lines and the 17
state departments of revenue that used it to process returns as of 20
years ago. Just as scanning a barcode on a retail product brings up
all relevant details to a sale, one placed on a tax return by tax
preparation software and printed out by the taxpayer for mailing can
encode all information necessary for the taxing authority to process
the return.
The IRS has in fact implemented 2-D barcoding for certain forms,
including Schedules K-1, which are issued to partners of partnerships
and shareholders of S corporations, reporting their shares of the
entities’ income, deductions, credits, and other tax items.
Yet the technology’s potential for processing an entire return has
been stymied by 20 years of dithering by the Service, Collins said. In
2002, when then-National Taxpayer Advocate Nina Olson, citing the
example of the 17 states, recommended 2-D barcoding to the IRS, the
IRS demurred, saying it could undermine taxpayers’ transition to
e-filing.
A year later, however, the IRS began working with tax software
companies to implement 2-D barcoding for some tax forms, such as
Schedule K-1. The Service asked Congress in 2017 to provide its
authority to require taxpayers filing paper returns prepared with
software to use a 2-D barcode, which Congress initially included in an
early version of the Taxpayer First Act.
But before the Taxpayer First Act’s enactment in 2019 (as P.L.
116-25), “the IRS had changed its position again,” ostensibly to give
it more flexibility to use other scanning technology, and the
provision was stricken from the bill’s enacted version at the IRS’s
request, Collins said.
A Program Manager Technical Assistance memo (PMTA 2022-002) in
December 2021 advised that the IRS currently lacks authority to
require tax software developers to include barcodes, but the IRS can
include one on its own tax returns and forms. The Service also can
request that the software companies do so, Collins said. She directed
that the IRS immediately begin discussing this with the companies in
time for the 2023 filing season and if the companies decline to do so,
to ask Congress to mandate it.
OCR: A backup to barcodes
The other main technology used for scanning paper documents is known
as optical character recognition (OCR), which interprets the marks on
a document and renders them into computer characters. While OCR has
the advantage of also being able to read handwriting, it doesn’t
always do so accurately, Collins said. Even so, some states use it in
tandem with 2-D barcoding, such as when a barcode is smeared or
otherwise unreadable, Collins said. She directed the IRS to also
develop a plan to use OCR, also by the start of the 2023 filing season
or, if not feasible by then, the following season.
The directive asks the IRS to respond to it by May 13, 2022, and state
whether it plans to implement the directed actions, plans to implement
alternative actions that will achieve the same objective, or declines
to take the directed actions. If the IRS indicates it will implement
the directed actions, the directive also asks the IRS to provide a
detailed plan by May 31 to implement the two technologies for the 2023
filing season.