Thousands of Tax Returns From Northeast Lost or Destroyed

As many as 40,000 federal tax returns and tax payment checks totaling more than $800 million from the Northeast have been lost or destroyed at a processing center operated by a Pittsburgh bank for the Internal Revenue Service, Senate Finance Committee Chairman Max Baucus said Wednesday.

It is unclear whether the missing documents will be found. The IRS is advising taxpayers who sent payments to Pittsburgh and whose checks have not cleared to stop payment on them. An IRS spokesman said the agency would pick up bank fees for the stop-payments.

The affected taxpayers, from upstate New York and several New England states, will have any penalties waived and replacement returns and checks credited as on time, IRS officials said.

The Pittsburgh contractor, Mellon Bank, has not explained what happened, other than to say it does not appear to be a case of identity theft, stolen checks or disclosure of sensitive taxpayer information.

Sources here said it appeared the IRS contract penalized Mellon for unprocessed returns and checks rather than rewarding it for those it did process.

“The system was flawed,” one said. “It gave them incentive to stick the payments in a drawer. It was almost cost-effective for Mellon to do that. There was no reward for timely processing.”

The situation is reminiscent of an episode at the IRS’ own Philadelphia Service Center in the mid-1980s in which overwhelmed IRS workers stuffed returns into the trash because they could not keep up with the workload.

When the latest problem was disclosed earlier this year, it was thought to involve about 1,800 returns. But Baucus said Wednesday that IRS Commissioner Charles O. Rossotti had “acknowledged that possibly 40,000 or more taxpayers from the Northeast may have had their federal tax returns and tax payments concealed or destroyed” at the Pittsburgh facility.

Baucus (D-Mont.) said the IRS and the Treasury Inspector General for Tax Administration, which is conducting an investigation, told him that “the number of phone calls regarding uncashed checks has increased to 21,000 and the dollar impact has escalated to $810 million.” He added that “it may be six months or more before the scope and magnitude of this problem is fully known.”

IRS officials said they have been working for several months to track down missing documents from the Mellon processing center.

Historically, the IRS has directed taxpayers to send their returns and payments to IRS offices around the country, where the checks were pulled out and deposited and the returns processed. As the economy has grown and the IRS has not, the agency has increasingly contracted with banks to receive returns and checks. The banks are supposed to pull the checks out, credit them to the IRS and then forward the returns to the agency for processing.

Mellon has been doing this since 1993 for taxpayers whose returns are processed at the IRS’ Andover, Mass., service center.

Mellon’s contract has been canceled and the bank has fired some workers and laid off others. In an e-mail to employees last week, Mellon Chairman Marty McGuinn said the bank lost the contract “after we found that a significant number of taxpayer submissions had been hidden, and in some instances, destroyed.”

“After an investigation, we promptly terminated several employees,” he said, adding, “tragically, the loss of the IRS contract also meant the shutdown of the Pittsburgh IRS Processing Unit and the displacement of 74 full-time and 32 part-time positions.”

About 50 workers have been reassigned to other jobs, a spokesman said.

Affected taxpayers are from Connecticut, Maine, New Hampshire, Vermont, Massachusetts, Rhode Island and New York, except for New York City and suburban Nassau, Rockland, Suffolk and Westchester counties, who submitted federal tax returns and payments to the Pittsburgh address in April.