Late-year changes, cancelled debt income pose concerns.(DEALING WITH THE IRS)

Late-year tax code changes may mean that taxpayers are missing out on tax deductions to which they are entitled, National Taxpayer Advocate Nina E. Olson wrote in her 2007 Annual Report to Congress.

Each year, the National Taxpayer Advocate is required by statute to submit a report to Congress discussing at least 20 of the most serious problems encountered by taxpayers. The 2007 report addresses 26 problems, makes seven "key" and six "additional" legislative recommendations and identifies the top 10 litigated tax issues.

Olson identified the impact of late-year tax law changes and the tax consequences of cancellation of debt income as the two most serious problems facing taxpayers.

Late-Year Tax Law Changes

In December 2006, Congress reauthorized deductions for state and local sales taxes, educator expenses and post-secondary tuition and fees (i.e., the so-called extenders legislation). A year later, in December 2007, Congress approved an extension of the alternative minimum tax (AMT) "patch."

Enacting tax law changes so late in a year poses challenges for taxpayers and the IRS for the next filing season, according to Olson. For 2006, taxpayers made about 1.4 million fewer claims for state and local sales taxes, educator expenses and post-secondary tuition and fees compared to 2005, she reported. Olson attributed that drop to the fact that the IRS typically publishes Form 1040 and its accompanying instructions in early November--around the same time that tax software companies finalize their shrink-wrapped software products.

"Because of systematic limitations and to minimize taxpayer confusion, the IRS generally does not update Form 1040 or its accompanying instructions after initial publication," Olson wrote. "As a result, taxpayers filing paper returns are particularly likely to complete their returns without taking into account late-year changes. Taxpayers who purchase shrink-wrapped software have the option of downloading a 'patch' to update their software, but some taxpayers do not do so. As a result, some taxpayers who prepare their returns electronically also do not take late-year changes into account."