Hoyle Says Law Requires State to Hang Onto Tax Refunds

The N.C. Department of Revenue says it will need new legislation from the General Assembly before it can send out the final tax refunds linked to a controversy that hit the headlines last summer. A top Democratic senator blamed Revenue staff for causing the controversy in the first place.

“There are about 7,000 of those refunds worth $2.3 million waiting for legislative action by the General Assembly to allow us to send them out,” said David Hoyle, recently appointed as state Revenue secretary, during a presentation this morning to the legislature’s Revenue Laws Study Committee. “We will send those just as soon as the law allows. By the way, they will be accruing interest at 5 percent. That’s a whole lot more than you can get from a bank.”

“When we do send these 7,000 out, that will clear up all of our individual returns that remain to be reviewed,” said Hoyle, who joined the Revenue Department after serving 18 years as a Democratic state senator from Gaston County. Hoyle had co-chaired the Revenue Laws committee before taking the new job. “A total of $20 million in individual income [tax] refunds have already gone out the door during this process.”

The review Hoyle mentioned stirred up controversy in August, when The News & Observer reported that a backlog of 230,000 unresolved tax returns from as far back as 1994 had led to an internal Revenue Department debate about whether some of those returns included refunds that never would be repaid.

The controversy surrounded the department’s interpretation of when Revenue officials knew that a tax refund was owed. Each of the unresolved returns — Hoyle reported a figure of 240,000 during the meeting — had been flagged by the department’s computers.

Each flagged return requires a manual review from a Revenue Department staffer. For years, the department had considered the computer action as the trigger that designates that a tax refund has been “discovered.”

But the summer newspaper reports showed Revenue officials debated whether the discovery should be tied to the computer’s flagging of a return or to a Revenue staffer’s manual review. If the department chose option No. 2, any return reviewed more than three years after the filing period would fall outside the statute of limitations. Taxpayers would be paid no refunds.

Three days after the initial newspaper report highlighting this debate, Gov. Beverly Perdue promised that the backlog would be cleared and that any taxpayer owed money would receive a refund — regardless of the time delay between the return’s filing and the resolution of the case.

More than a month later, the Revenue Department released a document contending that lawyers for Perdue and for N.C. Attorney General Roy Cooper had signed off on the policy change. When Perdue and then-Revenue Secretary Kenneth Lay offered reporters different stories about the details of the policy debate, Lay ended up resigning.

“To my knowledge and to the knowledge of those in the department — we have searched — we have had no written or longstanding policy regarding refunds that are out of statute [beyond the statute of limitations],” Hoyle told lawmakers. “In actuality, I think a few of our administrative staff had a longstanding practice — their way of doing things. That practice was not used universally among the entire agency. And that’s probably one of the problems we’ve got here today. There was inconsistency among different divisions within the agency. It was not a policy change.”

Hoyle won praise from several lawmakers for his efforts to resolve the controversy, but one singled out unnamed Revenue Department staff for criticism.

“To be honest about it, calling something a practice rather than a policy is just a dodge — I mean, they’re the same thing,” said Sen. Dan Clodfelter, D-Mecklenburg, who co-chaired the Revenue Law Study Committee with Hoyle until Hoyle took the Revenue job. “A practice that is honored over decades and decades and decades is a policy.”

“[This] is a sudden flip in longstanding policy and practice that catches taxpayers unaware and without notice,” Clodfelter continued. “That’s the issue for the General Assembly to have to deal with.”

The Revenue Department decided in October 2009 to reverse the policy of considering a tax refund to be discovered once the computer flagged the tax return, Clodfelter said. “This problem really was created by an internal decision by the department that the way they would manage the backlog … was by simply flushing these returns out and just canceling them and saying they were out of statute. That was not a responsible action.”

Clodfelter raised a more general concern about the Revenue Department. “What concerns me most about this issue is that is not an isolated situation,” he said. “It is part of another practice and a pattern that has developed in the department over recent years under a number of secretaries — not any one individual, and therefore I don’t think it’s been the secretary-driven policy — but it has been a policy and practice of sudden changes in longstanding ways of doing business without any statutory compulsion to do so, that catch taxpayers short, that create confusion, and always mean that it lands back in this body’s lap for us to have to fix the problem. That’s not stable tax administration.”

Another lawmaker, Rep. Larry Womble, D-Forsyth, questioned the need to have any statute of limitations for taxpayers to collect refunds when the Revenue Department caused the delay in the first place.

While Hoyle promised to resolve the current backlog by Dec. 22, he contended there’s “not an easy fix” for the problem that created the backlog in the first place.

The backlog resulted from the fact that Revenue Department computers flag hundreds of thousands of returns each year, Hoyle said. That includes 910,000 returns in 2009 alone. “One out of every 10 tax returns that was filed would be required to be worked by a live person,” and he said. “The department worked 898,000 of these 910,000 items in that year. Can you imagine how time-consuming and costly it is to have employees review each of these cases? It costs the state millions and millions of dollars each year.”

Hoyle labeled the number of computer-flagged returns a “tsunami” that will require additional staffing in the years ahead. He suggested that more than 300 department positions cut and frozen in recent years would help prevent future problems with tax-return backlogs.

Mitch Kokai is an associate editor of Carolina Journal.