Late tax law changes cause filing pain-IRS advocate

By David Lawder

WASHINGTON, Jan 9 (Reuters) - Last-minute U.S. tax law changes such as Congress' alternative minimum tax "patch" can inflict financial pain through filing delays and missed deductions, the Internal Revenue Service's ombudsman said on Wednesday.

More than a million taxpayers may not have claimed deductions to which they were entitled in 2006 due to late-year extensions that kept them from expiring, National Taxpayer Advocate Nina Olson said in her annual report.

The extensions were too late for publication of the tax filing Form 1040 or for inclusion in shrink-wrapped tax preparation software for the 2006 tax year.

Thus, many taxpayers did not know they were still available and made 1.4 million fewer deduction claims for state and local sales taxes, educator expenses and post-secondary tuition and fees for 2006 than for 2005.

"When taxpayers do not claim tax benefits because they do not know about them, Congress' intent in providing the tax benefits is undermined and taxpayers understandably question the fairness of the tax system," Olson wrote.

REFUND DELAYS

The AMT patch, passed by Congress just days before the end of 2007 will prevent millions of middle-income taxpayers from being ensnared by a tax originally designed for millionaires.

While that may be welcome news for families making up to $150,000 a year, it will place a burden on low-income taxpayers by delaying the start of the tax filing season by three weeks until Feb. 11, Olson said.

The IRS needed the time to reprogram its computers to reflect the tax law changes.

This will delay badly needed refunds to low-income taxpayers, particularly those who claim the earned income tax credit.

"For some taxpayers, a delay of two to four weeks in receiving their refunds could mean eviction, inability to pay the high heating bills that arise during the winter or defaulting on credit card bills from the holiday season," Olson wrote.

The average refund for taxpayers who claim the earned income tax credit is more than $3,000 -- about 20 percent of their yearly income, according to the report.

APOLOGY PAYMENTS

The report also urged Congress to enact a comprehensive taxpayer "bill of rights" and to authorize "apology payments" in cases where the IRS excessively burdens or harms taxpayers. She advocated that the payments could range from $100 to $1,000 as an acknowledgment of an IRS error in a "tangible way."

"I believe taxpayers and tax administration will benefit from an explicit statement of what taxpayers have a right to expect from their government and what the government has a right to expect from its tax system," Olson said.

In addition, she also called for the IRS to develop a comprehensive strategy to address tax noncompliance in the "cash economy" which, which accounts the for the largest portion of the tax gap -- the estimated difference between taxes legally owed and those actually paid.

Estimates for the gap range from $290 billion to $345 billion, with the largest portion accounted for by cash payments to service contractors who do not report the income to the IRS.

Olson said the IRS's current efforts to close the gap are inadequate and it needed a more coordinated approach to improve tax compliance. "Ad-hoc measures will not get the job done," she wrote. (Reporting by David Lawder; Editing by Diane Craft)