“…Nothing is certain except death and taxes” – Benjamin Franklin
BLOG VIEW: The IRS recently announced it was overhauling the Income Verification Express Service (IVES) program. While this should have been welcome news to the mortgage industry, which relies on IVES for verification of borrowers’ incomes through historic tax records (commonly called transcripts), the reality is that these changes aren’t really making the process that much better, at least initially.
Anyone who has been in the mortgage business probably has a less-than-positive view of IVES. It was inefficient before the pandemic, and during the pandemic it ground to a halt. IRS processing was at such a standstill that our industry stopped requiring transcripts on all mortgage files for underwriting and verification purposes, despite the value of gleaning indisputable historic income derived from the transcripts. You may remember the 2008 financial crisis when lenders were originating loans with stated income and no income verifications.
What’s Changing
Five years ago, Congress enacted the Taxpayer First Act, which, among other things, created funding and a mandate for the IRS to overhaul its systems to create real-time capabilities and more user-friendly processes. The first step was to introduce a new request form, the 4506-C, and to put in place procedures to better control who has access to the data and ensure the taxpayer has authorized the party pulling the transcripts to do just that.
Fast forward, and the IRS is finally adding technology to replace an internal manual process that has historically been used and which contributed to the pandemic challenges the IRS experienced.
Historically, the process worked as follows:
- The lender or servicer would send a blank or partially completed 4506-C form – a type of limited power of attorney – to the borrower who must handwrite in the missing information and execute it. If the borrower filed joint tax returns with their spouse, both taxpayers had to sign the form.
- The lender and/or IVES vendor authorized to request tax transcripts then validated that the document was completed and signed correctly and, often times, overlayed other data on the form, such as the tax records and years being requested and the requesting party (the IVES vendor).
- The IVES vendor then faxed the completed 4506-C to one of the three IRS fulfillment centers. A few days (or sometimes a few weeks) later, the transcript data would be available via the IRS site, but only in HTML form (i.e. as a website page).
- The IVES vendor scraped the HTML of the website and then converted this to a PDF for delivery to the lender.
- Some IVES vendors built the capabilities to convert this information to usable XML or JSON files so that lenders could automate certain processes, but ultimately, the procured transcript was just a big PDF image.
What Happens Now?
Unfortunately, not much has changed to make this process better. The new process is still highly inefficient for the lender or servicer, the IVES vendor and the IRS. What follows are a few reasons why:
- The IRS rules regarding how to properly complete the 4506-C result in no less than a 40% rejection rate on all submissions, either as part of the IVES vendors’ quality assurance (QA) measures or as a result of IRS review. As an example, one requirement is that the taxpayer who is listed first, must also sign the first signature line. If the IRS thinks the signature on the first line doesn’t match the first listed taxpayer or that they signed the second line, they reject the request, and the lender/servicer must start again. Historically, this has been one of the primary reasons for rejections.
- The taxpayer’s listed address must match the address used when that taxpayer filed the taxes for the transcript year being requested. Thus, if the borrower moved after they filed their 2021 taxes, the lender or servicer needs to ensure it’s that address that is populating the “previous address” field on the form. This is one of the other main reasons for rejections, but very hard for the lender or servicer to assess in their QA efforts.
- The IVES vendor is usually unknown to the borrower, resulting in many questions to the lender/servicer when the vendor follows the IRS requirements by inserting the vendor’s name in the “Client Name” line on the form before the taxpayer signs it. The form can’t be altered after signature, so most lenders and servicers populate this with their vendor.
- Unless the form is completed online during a digital application or process, most lenders and servicers send the form to their borrowers with key fields and non-public information blank (like the social security number), especially when they are relying on mail or other unsecure means of delivery to the borrower.
- The IRS still receives the 4506-C via fax, immediately reducing the legibility of the form. As noted, they then queue these to their human processing teams to review and, if the form is correctly completed, fulfill the order. The new API-driven process has, to date, only been released to authorized tax accountants (more on that below).
- The 4506-C only lets the lender/servicer order past tax records. It does not authorize the lender to view any future returns once the taxpayer files them. As such, the transcript is only a historic view and cannot be used to predict future potential loan-level risks if their borrower were to incur a negative life event such as loss of job, underemployment, or divorce/death resulting in reduced income.
The good news is that the IRS is deploying its Optical Character Recognition (OCR) technology to better automate the review. They are also overhauling their applications so that fax lines will no longer be the ingestion point for orders, but rather the fulfillment of orders will become digital and data-driven. For approved tax accountants, this system has been in place for a while.
The IRS also introduced ID-ME which allows taxpayers to self-fulfill transcripts after setting up an account. Tax accountants have already used ID-ME as a means to look at historic records and, with the 8821 tax form, these accountants can pull historic and up to three years of future tax year filings as transcripts instantaneously, all with a single taxpayer signature. Today, the 8821 process can immediately fulfill about 50% of tax transcript requests.
Ultimately, the new IRS system will become nearly instantaneous for all requests. Enterprising IVES vendors have partnered with tax accountants to leverage the new 8821 process, bypassing the legacy, slow process of the 4506-C.
The less good news is that as part of the overhaul the IRS has made several announcements about changes required immediately as well as upcoming changes expected when the new technology is implemented. Some of these requirements will complicate the process rather than address some of the issues that could make the process more inefficient. These requirements include the following:
- No handwritten data, other than the signatures and dates – OCR reading handwriting is an imperfect science, so presumably the IRS is reasoning that if they eliminate handwriting, they will have better accuracy. However, in the mortgage process, not all applications are digital. So, a lender now must have a process to populate the form with accurate data before it’s signed and, at the same time, protect the personally identifiable information and nonpublic personal information within the form. As a result, mailing a 4506-C to borrowers is no longer a viable (or safe) option.
- One type of transcript per form – previously a lender could choose to receive transcripts, a record of account (payment history), or both, and could do so for 1040, 1065, or 1120 returns. Now if the lender needs any type of transcripts for the 1040 and the 1065, they actually need two completed 4506-Cs.
- No mobile phone pictures of the form and it must not be reduced in size – so a borrower can no longer upload a picture of their 4506-C into the lender or servicer’s digital portal, meaning unless the lender/servicer gives the borrower a means to eSign the document, the form must be scanned and be its original size. This really means the borrower either must have a full-size scanner or mail the completed form back to the lender, again creating additional PII/NPI risks.
How does a lender or servicer solve for these issues under the new IRS requirements? Well, the IRS has delayed the handwriting requirements due, in part, because of delays in their OCR rollout. As a workaround, lenders and servicers will need to future-proof their operations by using third-party technology that exists today. The way this works is that the borrower is sent a text or an email that launches a secure means of validating requested information and then eSigns the form or multiple forms, as needed.
Old Ben would be proud.
Jim Norman is vice president, credit and verifications, for Covius.