IRS Mistakenly Mails 90,000 Tax Warnings

In a bureaucratic snafu that started with a political scandal and ended with an apology, the Internal Revenue Service has mistakenly warned 90,000 Americans that they had erred on their taxes.

The IRS notified taxpayers across the nation in recent months that they were subject to penalties and interest on back taxes for failing to file proper tax returns for their nannies and other household employees.

But the IRS letters--all 90,000 of them--were a huge mistake, the agency said. The taxpayers had already correctly followed IRS rules in using a new, “simplified” form for paying taxes for their household employees.

IRS spokesman Steve Pyrek said the letters were the result of a software error in the agency’s outdated and error-prone computers. The IRS is now issuing new letters apologizing to taxpayers, Pyrek said.

The letters rank among the silliest and at the same time most far-reaching mistakes ever made by the agency. They come after more than a year of disclosures about the agency’s obsolete computer system, parts of which date back to the mid-1960s.

“It is inexcusable,” said Sen. Bob Kerrey (D-Neb.), a leader in the congressional efforts to overhaul the IRS. “Nobody in the private sector would make this mistake.”

The whole incident might also be described as blow-back from “Nannygate,” the scandal that erupted in 1993 when a series of Clinton administration nominees, notably Zoe Baird, Clinton’s first choice for attorney general, admitted that they had illegally failed to pay employment taxes for their nannies.

After the controversy quieted, Congress decided the problem was not so much with unethical taxpayers as with the complexity of the tax code. In an effort to simplify tax filing for upper-income families with domestic help, Congress passed the Social Security Domestic Employment Reform Act of 1994--sometimes known as the Zoe Law.

Previously employers were required to pay Social Security taxes on household employees who earned as little as $50 every three months, but the Zoe Law raised that threshold to $1,000. And it allowed employers to pay all the Social Security taxes at the end of the year by using Schedule H of Form 1040, instead of paying quarterly on the old Form 940.

But getting the IRS’ creaky computer system--one of the oldest in the federal government--to go along with the changes was not so easy. The main body of the IRS’ tax software was written in the 1960s in a computer language known as machine assembly code, which few programmers even understand today.

The software in the past has kicked out a notice to every taxpayer who has employees and did not file Form 940. Under the new law, IRS programmers had to write a patch on the older software that “suppressed” the computer from issuing notices to taxpayers who filed Schedule H.

It worked in 1996, but the IRS’ suppression system went haywire this year.

“It was a programming error, in effect,” Pyrek said.

The letter told 90,000 taxpayers that the IRS had not received their Form 940s and ordered them to “send it to us today.” It advised taxpayers to send payment for any taxes due and to expect to get a bill from the IRS later for interest and penalties.

“There is a lack of information technology that allows the right hand to know what the left hand is doing,” observed Rep. Rob Portman (R-Ohio), co-chairman of a commission to restructure the IRS.

Indeed, Pyrek said there was no way for the IRS to know whether the erroneous letter caused taxpayers to actually file unnecessary Form 940s and pay additional taxes.

The letters were sent from seven of the IRS’ 10 service centers across the nation. Three of the service centers, including the one in Fresno, detected the errors before sending any of the letters, Pyrek said.

Phil Brand, former IRS compliance chief and now an executive at KPMG Peat Marwick, said the computer snafu “can’t help” the IRS’ troubled public image.

The IRS made a similar blunder three or four years ago when its software was unable to handle complex tax law changes and sent out another round of incorrect notices threatening taxpayers.

“Here you go again,” Brand said, noting that most of the people affected by the recent error are high-income individuals who tend to have influential opinions.

“The age of [the agency’s computer equipment] is the root cause of it,” Brand said.