An information box accompanying a front-page story Sunday about overpayments to the state Revenue Department should have said that so far the department has gone through 68,000 inconsistencies that its computer system had flagged from tax returns. The figure represents roughly a third of a backlog of 230,000 inconsistencies flagged by the computer system since 1994 that the department is trying to clear by the end of this year.
A newly released document from the state Department of Revenue says that attorneys for Gov. Bev Perdue and Attorney General Roy Cooper signed off on a new policy that made it harder for taxpayers who unknowingly overpaid their taxes to get refunds.
The document raises questions about how much two of North Carolina's top officials knew about a policy prompted by an undisclosed backlog of unprocessed tax returns involving 150,000 taxpayers. Cooper's office said it cannot respond to questions, citing attorney-client privilege, while an attorney for Perdue said he may have been briefed in passing about the policy but did not share it with the governor.
Late last year, revenue officials struggling with that backlog seized upon the idea to dismiss those overpayment cases if the taxpayers had not requested a refund within a three-year statute of limitations. The policy ended a previous practice that considered confirmed overpayments refundable at any time if they had been flagged by the department's computer system, which reviews every return shortly after it is filed.
The News & Observer learned of the policy change when revenue officials turned over e-mail messages under a public records request. The messages showed an internal dispute within the department about the change.
Perdue said that she did not know about the policy change or the backlog until The N&O received the messages and that she was "incensed" by it, according to her communications director, Chrissy Pearson. Two days after The N&O's report, Perdue announced that revenue officials would clear the backlog by the end of the year and that anyone owed money would get it back.
But a report that Revenue Secretary Kenneth Lay delivered to Perdue shortly before her announcement indicates that months earlier, the Attorney General's Office gave her lawyers an opinion backing the change - and that they supported it.
"It is our understanding that this legal opinion was later shared with lawyers in the governor's office, who agreed with the guidance offered," Lay's report said. "It is that guidance that has now become agency policy."
'A narrow legal question'
Lay was appointed by Perdue. In an interview, he said he did not talk to the governor about the policy change. He said he could not explain how she did not know.
"I really can't speak for the governor," he said. "You're going to have to ask the governor's staff about that one."
Lay said the legal opinion came from Kay Hobart, a deputy attorney general who handles revenue matters. He said she shared her opinion with the governor's lawyers.
Eddie Speas, Perdue's chief legal counsel, said he doesn't remember that conversation, but he said Hobart recently told him about it and he has no reason to doubt her recollection. He said the conversation, as Hobart recounted it, happened in the spring and was limited to when the Revenue Department "discovered" an overpayment and did not get into the ramifications of that distinction. Speas said he had no further discussions about the issue with anyone.
"She said we talked about it in passing; I'm willing to accept that," Speas said. "But she said it was just a narrow legal question. I certainly had no discussions of broad policy issues with her."
Speas also said Hobart, in recounting the earlier conversation, told him her opinion on the overpayments was that the statute of limitations didn't begin until an auditor discovered it. That would have been far more favorable to taxpayers, but that's not what the Department of Revenue did, nor is it what the report says Hobart recommended. Efforts to reach Hobart for comment were unsuccessful.
Hobart later wrote an e-mail message and an advisory opinion that said The N&O's request for documents related to unprocessed overpayments could not be fulfilled. She said the information was protected by taxpayer privacy laws. The N&O appealed her opinion to the Attorney General's Office and later received the e-mail messages.
Changing the law
Lay said the backlog involves the returns of about 150,000 taxpayers stretching as far back as 1994, when the Revenue Department purchased its current computer system. The department wants to move to a new computer system that would more quickly resolve questions regarding returns.
Lay said the intent was to clear up the backlog, not to keep money the department isn't entitled to at a time when the state is straining to pay its bills. He said items often flagged by the computer system - once reviewed - did not involve refunds.
As of this week, the department had whittled the backlog by about 68,000 flagged items and found that 3,300 taxpayers had overpaid their taxes by a combined $949,000.
But only 100 of those taxpayers will receive refunds immediately, totaling $32,000, because their overpayments were within the statute of limitations. The other 3,200 taxpayers, who overpaid their taxes by a combined $917,000, are outside of the statute, and the refunds are being set aside. They can't be paid until state lawmakers revisit a 2007 law that revenue officials say eliminated their responsibility to make refunds thatweren't discovered by a staff member within the three-year period.
"The governor says she would get a legislative change if that's required, and it looks like that's going to be required," Lay said.
Lawmakers said they were unaware of the long-standing backlog of unprocessed returns and didn't know about the policy change. They say the 2007 law was not intended to allow revenue officials to keep taxpayer overpayments. Rep. Pryor Gibson, an Anson County Democrat and a chief House tax writer, said he expects lawmakers to address the problem when they return to Raleigh in January.
"That's an unintended consequence, and we would change it so quick your head will pop off your shoulders," he said.
Lay said it was not a set policy that required the department to refund long-standing overpayments that had been flagged by its computer system. "What we had was inconsistent practice," he said.
Revenue correspondence shows the practice of giving the money back was in place at least as far back as 1999. In a case from that year, the computer system had discovered an overpayment, but an auditor did not look at it until the statute of limitations had expired.
"The overpayment was discovered at the time the payment was posted, and the system reflected an overpayment," wrote Gregory Radford, a department supervisor. "Can't penalize the taxpayer for our workload."
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