IRS faces major management challenges in FY 2026

The Internal Revenue Service is confronting a daunting array of management and performance challenges in fiscal year 2026, according to a new report from the Treasury Inspector General for Tax Administration.

The report, released Monday by TIGTA, discusses challenges such as the IRS’s reduced workforce and budget, operational efficiencies (and inefficiencies), taxpayer data protection, tax law changes, taxpayer services and taxpayer rights, information technology improvements and tax compliance.

In terms of the reduced IRS staffing and budget, the report noted that between January and May 2025, the number of IRS employees dropped by about 25%, from approximately 103,000 to 77,000, as previously reported. The employees either separated or accepted a Deferred Resignation Program offer from the IRS or other incentive to leave. The employees who departed represented all experience levels, and their departures affected each function within the IRS.  

In addition, various proposed FY 2026 budgets, if enacted, would reduce IRS’s annual funding by approximately 20%. While the Inflation Reduction Act previously provided the IRS nearly $80 billion in supplemental funding over a 10-year period, Congress later slashed IRA funding to $37.6 billion. 

As of March 2025, the IRS has spent $13.8 billion, or 37%, of its IRA funds. 

“Completing IT modernization projects, providing quality service to taxpayers, and enforcing tax laws with a reduced workforce and budget will be challenging for the IRS,” said the report. “Despite numerous ongoing automation projects, the IRS still needs skilled and experienced employees to interpret tax law changes, investigate criminal activity, prevent fraudulent refunds, and implement complex coding changes for its information systems.”

The report noted that the IRS had lost 25% of its IT employees as of May 2025, and the IRS’s Return Integrity and Compliance Services function, which detects and prevents fraudulent refunds, had lost 18% of its staff as of May 2025. TIGTA estimates that may result in nearly $360 million in fraudulent refunds that are not stopped during next year’s tax filing season. 

These staff and budget cuts preceded the recent government shutdown, which has hit the IRS with extensive furloughs.

The IRS is also facing challenges in terms of improving operational efficiencies such as the transition away from paper checks. Under an executive order signed in March by President Trump, the IRS and the Treasury began phasing out paper checks on Sept. 30.

“The agency plans to begin this transition on  October 1, 2025,” said the report. “While most taxpayers receive refunds via direct deposit, IRS data shows that more than 6 million taxpayers received a paper check refund during the 2025 tax filing season. The IRS will need to educate taxpayers — especially those without bank accounts — about the change and help them understand and navigate alternative electronic payment options.”

Another big hurdle faced by the IRS involves tax law changes, especially the passage of the One Big Beautiful Bill Act in July. The OBBBA will complicate the IRS’s processing of tax returns, the report noted, as it requires the agency to update its computer programming; create or revise tax forms, instructions or guidance for taxpayers and tax professionals; and increase or revise its enforcement strategies. 

“Taxpayer uncertainty around new tax law changes can affect voluntary compliance, and errors (caused by computers and employees) in the IRS’s tax return processing systems may delay refunds, affect the accuracy of taxpayer accounts and result in incorrect taxpayer notices,” said the report.

The version of the OBBBA that was ultimately passed by the Senate and the House did not completely end the IRS’s Direct File free tax program (although an earlier version of the bill passed by the House would have done that), but the report suggests it may end Direct File anyway.

“We are also evaluating whether the IRS met all legislative requirements to terminate Direct File (an IRS-developed free tax return preparation tool) and report to Congress on a potential replacement system,” said the report.