Report to the Chairman and Ranking

Minority Member, Committee on

Finance, U.S. Senate

United States General Accounting Office

GAO

June 2002 TAX

ADMINISTRATION

New Compliance

Research Effort Is on

Track, but Important

Work Remains

GAO-02-769
Page i GAO-02-769 New Compliance Research Effort

Letter 1

Results in Brief 2

Background 4

Scope and Methodology 5

NRP’s Design and Major Components 7

NRP Is on Track To Meet Objectives, but Critical Cadre

Development and NRP Testing Steps Remain 13

Conclusions 19

Recommendations for Executive Action 20

Agency Comments 20

Appendix I GAO Products Related to Measuring Voluntary

Compliance 22

Appendix II NRP Sample 23

Appendix III Comments from the Internal Revenue Service 26

Table

Table 1: National Research Program Sample Design 24

Figure

Figure 1: Estimated NRP Sample by Level of Taxpayer Contact 11

Abbreviations

EITC Earned Income Tax Credit

GPRA Government Performance and Results Act

IRS Internal Revenue Service

NRP National Research Program

RGS Report Generation Software

TCMP Taxpayer Compliance Measurement Program

Contents
Page 1 GAO-02-769 New Compliance Research Effort

June 27, 2002

The Honorable Max Baucus

Chairman

The Honorable Charles E. Grassley

Ranking Minority Member

Committee on Finance

United States Senate

The U.S. tax system is based on taxpayers voluntarily complying with the

tax laws. However, the Internal Revenue Service (IRS) last measured

taxpayers’ rate of compliance with the tax laws using 1988 tax returns. IRS

uses the compliance rate to help understand the effectiveness of its

programs to promote and enforce compliance. IRS also uses the

information from its compliance studies as the basis for its audit selection

formulas. The intent of the formulas is to target noncompliant returns for

audits while avoiding audits of compliant returns. As time has passed since

the last compliance study, IRS has become concerned that its ability to

understand the effectiveness of its programs and target audits on

noncompliant returns has deteriorated, potentially resulting in poorer

service to taxpayers, reduced confidence in the fairness of the tax system,

and unnecessary audits of compliant taxpayers.

IRS has not conducted more recent studies of compliance because of

concerns about the burden such studies impose on taxpayers. Past

compliance studies relied on intensive, line-by-line audits of a randomly

selected sample of tax returns. A study proposed in 1994 would have

included about 150,000 taxpayers in the sample. Taxpayers, Congress, and

the media all criticized the proposal because of the demands that would

have been placed on compliant taxpayers to produce records verifying

every line of their tax returns.

Recognizing the need for current compliance data, IRS is now planning a

new compliance study called the National Research Program (NRP). As

we reported earlier this year, NRP is intended to produce compliance data

United States General Accounting Office

Washington, DC 20548
Page 2 GAO-02-769 New Compliance Research Effort

useful for management and targeting of enforcement audits while

minimizing the burden on taxpayers selected for the study.1

In order to identify potential design or implementation problems with

NRP, you asked us to assess IRS’s plans for the program. Accordingly, this

report (1) describes NRP’s overall design and major components and (2)

assesses whether it is likely to produce the compliance data IRS needs, be

conducted in a manner that minimizes taxpayer burden, and be

successfully implemented.

To describe and assess IRS’s plans to measure compliance and assess its

progress towards implementing those plans, we reviewed documents

describing NRP in general and documents related to specific program

elements. We also held frequent discussions with the IRS officials

designing the program. We examined IRS’s plans to conduct NRP and

compared them to IRS’s own objectives, government program planning

principles, and general research design guidance. As NRP was largely still

under development throughout the time of our review and key documents

were still in draft at the time this report was prepared, our assessment of

NRP should be considered preliminary, pending the program’s final design.

The NRP descriptions and other information in this report were current as

of May 2002.

NRP is designed to review about 49,000 individual tax returns randomly

selected from the population of over 129 million such returns (Form

1040s). According to the NRP plan, IRS will review each sampled return to

determine whether the taxpayer has complied with statutory income,

expense, and tax reporting requirements. Unlike past compliance studies,

not all of the reviews will include contacting taxpayers. The reviews will

be conducted by specially trained IRS examiners who will first use IRS

and third-party databases to verify as much information as possible on the

sampled returns. IRS estimates that it will be able to verify the information

on about 8,000 of the sampled returns without contacting taxpayers. For

line items that could not be verified from available databases, IRS will ask

taxpayers for supporting information. IRS estimates that about 9,000 of

these contacts will cover one or two simple issues and be handled through

correspondence. The remaining contacts will require face-to-face audits

 1

 U.S. General Accounting Office, Tax Administration: Continued Progress Modernizing

IRS Depends on Managing Risks, GAO-02-715T (Washington, D.C.: May 14, 2002).

Results in Brief
Page 3 GAO-02-769 New Compliance Research Effort

but, unlike past compliance studies, most of these audits will cover only

lines IRS was unable to otherwise verify. Generally, the face-to-face audits

will involve self-employed and high-income taxpayers. To determine and

correct any bias resulting from its plan not to subject all sampled returns

to audits, IRS plans to conduct full line-by-line audits of 1,683 returns in

the NRP sample.

Based on our assessment of NRP in light of government guidance on

performance measurement and data reliability, research design guidelines,

and IRS’s goals for the program, we found that NRP’s design is likely to

yield the sort of detailed information that IRS needs to measure overall

compliance, develop formulas to select likely noncompliant returns for

audit, and identify compliance problems for the agency to address. The

sample is adequately sized for these tasks, and IRS has designed NRP

processes and procedures in such a way that they are likely to meet the

goals the agency has set for NRP. IRS has included quality checks in NRP

and has developed a plan for using the data that NRP generates.

One key goal for IRS has been to minimize the burden that NRP poses for

the 49,000 taxpayers with returns in the sample. IRS’s plan meets this goal

by eliminating the need for some taxpayers to be contacted at all, by

limiting the amount of information other taxpayers will have to provide to

verify the information on their returns, and by limiting the scope of most

of the audits that will be carried out under NRP. IRS’s proposal to develop

a specially trained cadre of examiners to carry out NRP audits will also, if

implemented, serve to minimize the burden on taxpayers.

IRS has made substantial progress towards fully implementing NRP later

this year, though important tasks remain. Although IRS may not meet its

scheduled October 1, 2002, date for the start of taxpayer contacts under

NRP, extending that date to later in the year will not likely cause problems

for the program as a whole, according to IRS officials. IRS has completed

work on both the NRP sample and most of the procedures the program

will employ. However, IRS may not have given itself enough time to

complete several important steps before determining which returns need

to be audited and the level of audit needed. These steps include testing

and modifying NRP procedures and selecting the cadre of examiners to

carry out NRP. Accordingly, we are recommending that IRS complete

testing of NRP procedures before training the NRP cadre, determining the

scope of audit needed, if any, or making any taxpayer contacts. We are

also recommending that IRS select and appropriately train the cadre of

examiners before starting to determine which returns to audit.
Page 4 GAO-02-769 New Compliance Research Effort

In written comments from the Commissioner of Internal Revenue and

subsequent discussions with IRS’s Director of Research, Analysis and

Statistics, IRS agreed with our recommendations. IRS’s comments are

discussed later in this report. The Commissioner’s letter is reprinted in

appendix III.

The Government Performance and Results Act (GPRA) of 1993 requires

federal agencies to establish measures to determine the results of their

activities. Such measures are a prerequisite for making informed decisions

on allocating scarce resources to areas likely to attain results that advance

the agency’s mission and achieve its goals. One of IRS’s strategic goals is

to ensure taxpayer compliance, but the agency lacks current measures of

taxpayers’ voluntary compliance. Having such measures would give IRS an

understanding of current compliance levels and help to identify steps that

are likely to lead to improved compliance.

There are three types of voluntary compliance measures: filing

compliance, which measures the percent of taxpayers who file returns in a

timely manner; payment compliance, which measures the percent of tax

payments that are paid in a timely manner; and reporting compliance,

which measures the percent of actual tax liability that is reported

accurately on returns. Although IRS’s NRP plans include reviews of all

three types of compliance, the majority of their efforts have been devoted

to the development of reporting compliance measurement procedures.

Reporting compliance is also the only aspect of NRP that will include

audits of taxpayers.

For many years, IRS has periodically used random audits of tax returns to

measure the level of voluntary reporting compliance. However, IRS last

measured voluntary reporting compliance over a decade ago when it did

line-by-line audits of about 50,000 individual tax year 1988 tax returns. IRS

planned to measure reporting compliance using 1994 returns in an

ambitious effort involving over 150,000 randomly selected returns,

including 92,000 individuals (including sole proprietorships and farmers)

as well as corporations, partnerships, and S-corporations. Before

beginning the audit process, however, IRS cancelled the study because of

its cost and because of criticism from Congress, the media, tax

community, and taxpayers about the size of the sample and the burden

imposed by the audits on compliant taxpayers.

IRS’s compliance research studies provided more than just a measure of

voluntary compliance. They have also been used by IRS to identify

Background
Page 5 GAO-02-769 New Compliance Research Effort

compliance trends and to allow IRS to suggest changes in tax laws and

regulations to improve voluntary reporting compliance.

Voluntary reporting compliance study results have also been the basis for

formulas to help IRS select returns for enforcement audits. IRS conducts

hundreds of thousands of enforcement audits each year as part of its

overall enforcement efforts. Unlike compliance study audits, enforcement

audits are not random. IRS targets enforcement audits on likely

noncompliant returns—those returns with a high probability that an audit

would detect improperly reported tax liability. According to IRS, return

selection formulas—first used to select 1968 tax returns for audit—have

reduced the number of audits that resulted in no change to tax liability. No

change enforcement audits are a burden on compliant taxpayers and use

scarce IRS resources. In the year before the formulas were first used, the

no change rate was 46 percent. For returns filed in 1994, the no change

rate was about 19 percent. These formulas were last updated using 1988

tax return data, however, and as they become more out of date, the

percentage of formula-identified enforcement audits resulting in no

change has increased. IRS reports that 24 percent of enforcement audits of

1998 returns resulted in no change, and the agency projects that this rate

will grow to 27 percent for returns filed in 2005.

We have previously reported on the need for IRS to conduct new

compliance research. In 1996, we recommended that IRS develop a costeffective, long-term strategy to ensure the continued availability of reliable

compliance data and reiterated the need for new compliance research

studies in subsequent reports and testimonies. (See app. I for a list of

reports we have issued relating to compliance measurement.) Others,

including the IRS Commissioner and the IRS Oversight Board, recognize

the need for IRS to measure voluntary compliance. The IRS Commissioner

has said that measuring voluntary compliance is a critical part of IRS’s

overall organizational transformation. In its fiscal year 2001 annual report,

the IRS Oversight Board supports the National Research Program and

requested congressional support for the program.

To describe NRP, we have been in frequent contact with representatives of

IRS’s NRP Office and other IRS officials as they have designed the

program and planned for its implementation. We reviewed IRS’s draft

prospectus and the detailed plans that act as a blueprint for the NRP

processes and components. These documents describe the program’s

objectives and the steps needed to implement the program. We also

received briefings from the program’s designers and discussed the

Scope and

Methodology
Page 6 GAO-02-769 New Compliance Research Effort

program with other IRS officials, including representatives of the Office of

Research and the Large and Mid-Sized Business, Small Business/Self

Employed, and Wage and Investment operating divisions. The NRP

descriptions and other information in this report were current as of May

2002.

We assessed NRP’s design and progress towards implementation in light of

several criteria. We considered how well NRP addresses government

guidance on performance measurement and data reliability. GPRA, for

example, requires agencies to establish meaningful performance goals

aligned with their mission and measure progress using sound, objective

performance data.2

 In addition, the Office of Management and Budget

issued guidelines in February 2002 that require agencies to ensure that

information they generate be objective and reliable.3

 We also considered

how well NRP meets general research design guidelines, such as GAO’s

draft guidelines for ensuring the reliability of computer-based data. We

also reviewed past taxpayer compliance research efforts and discussed the

program with former IRS commissioners. Furthermore, we assessed how

well the program meets the design principles IRS has defined, assessed

whether NRP appears suited to accomplish IRS’s stated objectives for

voluntary reporting compliance research, identified key steps in IRS’s NRP

implementation plans and schedules, and assessed IRS progress towards

meeting those milestones. As NRP was largely still under development

throughout the time of our review and key documents were still in draft at

the time this report was prepared, our assessment of NRP should be

considered preliminary pending the program’s final design.

At the time of our study, IRS was also having its sample design reviewed

by two outside contractors. These reviews were not complete at the time

we were preparing this report. In light of these reviews, we did not

independently replicate calculations for the overall NRP sample or the

sizes of individual strata. With respect to the NRP sample, we held detailed

discussions with the IRS officials responsible for developing the sample

design and discussed with them the rationale for their decisions regarding

 2

 GPRA and how federal agencies comply with it is described in detail in our report,

Executive Guide: Effectively Implementing the Government Performance and Results

Act, GAO/GGD-96-118 (Washington, D.C.: June 1996).

3 Guidelines for Ensuring and Maximizing the Quality, Objectivity, Utility, and

Integrity of Information Disseminated by Federal Agencies; Notice; Republication, U.S.

Office of Management and Budget, February 22, 2002.
Page 7 GAO-02-769 New Compliance Research Effort

the sample. We also reviewed statistical analyses and other studies done

by IRS to justify sample design decisions.

We conducted our work between September 2001 and May 2002 in

accordance with generally accepted government auditing standards.

The purpose of NRP is to produce data that IRS can use to measure overall

reporting compliance, update existing audit selection formulas, and

identify potential ways to improve voluntary compliance. Under NRP, IRS

will review randomly selected individual tax returns to determine whether

the taxpayer has complied with statutory income, expense, and tax

reporting requirements. The major components of the program include (1)

a random sample of individual tax returns large enough to meet program

objectives; (2) a specially trained cadre of examiners; (3) an assortment of

casebuilding tools to verify as many items reported on tax returns as

possible without contacting the taxpayer; (4) a tax return classification

process for determining the level of audit, if any, a return warrants and

which items must be verified; and (5) an examination process that uses

structured procedures and managerial reviews. IRS has also developed a

data analysis plan that describes how it plans to use the data to address

each of the program objectives.

According to IRS, the NRP sample is designed so that the results are

representative of the population of individuals and self-employed

taxpayers who filed tax year 2001 Form 1040 tax returns. The sample is

intended to produce estimates of noncompliance and potential tax change

as well as capture differences in reporting compliance levels between this

study and subsequent ones.

The NRP sample consists of a total of about 49,000 returns representing

the population of about 129 million individual Form 1040 filers.4

 These

filers include sole proprietor business owners who file schedule C (Profit

or Loss From Business – Sole Proprietorship) and farmers who file

schedule F (Profit or Loss From Farming), as well as taxpayers whose

income consists solely of wages and investment income. The NRP sample

 4

 The NRP sample was based on tax year 1999 data with projections of tax year 2001 return

population estimates. The NRP sample design shows 124,519,129 Form 1040 returns in tax

year 1999 and projects 129,411,510 Form 1040 returns in tax year 2001.

NRP’s Design and

Major Components

NRP Sample Design and

Return Selection
Page 8 GAO-02-769 New Compliance Research Effort

is stratified or divided by type of Form 1040 filer and by income level. The

sample includes some substratification of higher-income taxpayers, which

was done at the request of the IRS business operating divisions that will be

key users of NRP data. The purpose of the stratification is to permit IRS to

develop audit selection formulas and other information specific to

different types of taxpayers. Returns in each strata will be weighted to

make the sample representative of the overall population. See appendix II

for a description of the NRP sample.

IRS plans to select a cadre of examiners and other staff from its current

employees and train them to implement the program. IRS estimates that it

will have over 1,000 full-time equivalent staff working on the program

during the peak examination phase, which is expected to be in fiscal year

2003. Most of the cadre will consist of revenue agents from the Small

Business/Self Employed operating division, but the cadre will also include

correspondence examiners from the Wage and Investment operating

division.5

 According to NRP’s plans, the cadre will undergo substantial

training designed to ensure consistency and quality in NRP

implementation. IRS plans state that the extensively trained cadre

represents a sizeable investment in human capital and an attempt to

develop lasting institutional knowledge for subsequent NRP studies.

The NRP proposal includes using casebuilding tools to aid examiners in

determining whether IRS needs to have any contact with taxpayers to

verify the accuracy of information reported on their tax returns. The

casebuilding tools consist of data from both IRS and third-party sources.

IRS’s internal casebuilding tools include return information from the prior

3 years, audit history, payment and filing history, information return data

reported by third parties (banks, lending institutions, and others), and

bank reports on large cash transactions. Use of these data is intended to

rule out compliance issues that can be verified without contacting

taxpayers. Casebuilding tools also include data from two third-party

sources. The first is ChoicePoint, an external public database containing

real estate and other asset ownership information (e.g., motor vehicle

registrations and ownership of luxury items like watercraft and aircraft).

 5

 IRS has four business operating divisions: Wage and Investment, Small Business/Self

Employed, Large and Mid-Sized Business, and Tax Exempt and Government Entities.

NRP Cadre Selection and

Training

NRP Casebuilding Process

and Data Sources
Page 9 GAO-02-769 New Compliance Research Effort

For NRP purposes, ChoicePoint is to enable examiners to confirm basic

asset information. The other third-party data source is the Dependent Data

Base, which is a combination of Department of Health and Human

Services and the Social Security Administration data. These data are to

provide custody information that can be used to help determine the

validity of dependent and Earned Income Tax Credit (EITC) claims.

According to IRS, although information from IRS and other databases will

help NRP classifiers determine whether or not a return warrants an audit,

the data will only be used to validate return items or identify potential

problems and not to make changes to tax liability. IRS officials stressed

that NRP-recommended changes to tax liability will always be based on

information obtained by audit.

IRS plans for NRP cadre members to use the data compiled during

casebuilding to classify the returns in the sample according to the level of

audit, if any, they should be given. IRS plans to train about 100 members of

the NRP cadre to classify returns according to NRP guidelines. These

specially trained staff are to classify returns as either accepted as filed

(i.e., all line items are verified without any taxpayer contact) or as needing

some form of audit. IRS’s preliminary estimates are that about 8,000

returns will be accepted without any taxpayer contact, most of them

coming from nonbusiness income returns. For returns needing an audit,

classifiers will also specify which line items need verification and

determine whether the additional information needs to be obtained

through correspondence or a face-to-face audit.6

For correspondence examinations, the returns are to contain no more than

two simple tax issues, such as those dealing with filing status, exemptions

and dependent claims, various tax credits besides the EITC (e.g.,

education credit, fuel tax credit) and alimony deductions.7 IRS’s

preliminary estimates are that about 9,000 returns will be classified into

the correspondence audit category.

 6

 Classification will place returns into one of three categories – accepted as filed,

correspondence audit, and face-to-face audit. However, where classifiers identify small

discrepancies on the sampled return, the taxpayer will not be contacted through either a

correspondence or a face-to-face audit, but the noncompliance will be noted in the NRP

database. IRS refers to these returns as accepted as filed with adjustments.

7

 Generally, EITC-related issues, such as those dealing with filing status and exemptions

and dependent claims, are to be considered as one tax issue.

NRP Classification

Process
Page 10 GAO-02-769 New Compliance Research Effort

If a classifier determines that some line item information cannot be

verified with casebuilding materials or simple correspondence, the line

items will be noted on a check sheet along with a brief explanation and

sent for a face-to-face audit. IRS will require taxpayers whose returns fall

into this category to verify information on their returns in person with an

examiner from the NRP cadre. IRS’s preliminary estimates are that about

30,000 returns, including most self-employed taxpayers and high-income

individuals, will fall into the face-to-face audit category.

IRS plans to have NRP managers review many classification decisions. A

supervisory review team will review all “accept as filed” classification

decisions throughout NRP. This team will also review a sample of

classification decisions indicating the need for an audit.

As part of the classification process, IRS plans to select about 1,683

returns—561 from each of the three classification categories—that would

otherwise have been accepted as filed or sent for correspondence or faceto-face audits to undergo intensive line-by-line audits. IRS determined that,

since it plans to accept return information as accurate without getting

additional information from taxpayers, the study results might misstate

compliance levels. Therefore IRS developed this subsample of classified

returns to compare NRP study results with what might have been detected

by comprehensive line-by-line audits. According to IRS, this is to provide it

with some insights as to the accuracy of the casebuilding and

classification processes, the bias (if any) introduced by the NRP approach,

a basis for correcting any bias in the aggregate NRP measures, and

indications of where future studies might be improved. IRS has termed this

comparison a “calibration” of the study results.

Figure 1 is a breakdown of the NRP sample by the level of IRS contact that

taxpayers with returns in the NRP sample will experience. The number of

returns in the face-to-face audit, correspondence audit, and no contact

categories are IRS’s preliminary estimates and may change based on the

results of upcoming tests of NRP processes. The actual number of returns

in each of these categories will depend on the results of the NRP

classification process. The number of returns to be selected for line-by-line

audits, however, has been predetermined and, according to IRS, will not

change.
Page 11 GAO-02-769 New Compliance Research Effort

Figure 1: Estimated NRP Sample by Level of Taxpayer Contact

Note: Except for line-by-line audits, numbers are IRS’s preliminary estimates.

Source: IRS’ NRP office data.

Returns that cannot be fully verified using casebuilding data will be sent

for examination – either through correspondence or face-to-face audits.

Correspondence audits will be done with relatively simple returns that

have potential underreporting or unverifiable information in one or two

areas. In a correspondence audit, IRS will request that the taxpayer send

documentation verifying the line items in question.

According to IRS, in many ways, NRP face-to-face audits (with the

exception of those in the calibration sample) will resemble IRS’s

enforcement audits.8

 Examiners will determine whether the information

reported on the return is accurate or adjustments need to be made. If they

determine that a taxpayer’s tax liability is understated, the additional tax

will be assessed. In other ways, however, NRP audits will differ from

enforcement audits. For example, examiners use classification check

sheets to guide their enforcement audits, but they are not limited to the

line items flagged during classification. IRS has established examination

guidelines for NRP examiners to follow that require justification to audit

unclassified line items. IRS officials have said that these guidelines help

ensure that research consistency and the promise of minimizing taxpayer

burden are not compromised. IRS officials also say that NRP guidelines

will require examiners to record all tax changes, regardless of amount,

 8

 Enforcement audits are targeted on returns where IRS suspects noncompliance, often

based on a computerized screening of returns that looks for indicators of noncompliance.

NRP Examination

Procedures and Data

Collection Mechanism

Face-to-face

audits

Correspondence

audits

No contact

Most will cover 

schedule C, E, or F

filers

Questions limited to one

or two line items

Most will cover wage 

and investment returns

Line-by-line

audits

1,683 returns - 561 from each of 3 categories; face-to-face audits,

correspondence audits, and no contact

0 5,000 10,000 15,000 20,000 25,000 30,000
Page 12 GAO-02-769 New Compliance Research Effort

though taxpayers will not be asked to pay additional taxes uncovered by

an NRP audit that fall below a predetermined limit.

IRS’s plans state that the examination component of NRP will be subject

to reviews both while the examinations are underway and after the

examinations are complete. NRP managers will review ongoing

examinations periodically. Also, all cases will be subject to IRS’s regular

quality review steps for all examinations, as well as a special review

conducted by NRP managers.

IRS will use the Report Generation Software (RGS) system to capture NRP

results. Included in the database of NRP results will be examiners’

determinations of the reasons for any noncompliance that they found. IRS

examiners will use the RGS menu of 46 reason codes to categorize reasons

for taxpayer noncompliance.9

 NRP examiners will also prepare electronic

workpapers that will be attached to each RGS case file to aid researchers

using the NRP database. The RGS case files, including these workpapers,

will be archived in a database.

The NRP Office has drafted a plan to guide the usage of data gathered in

NRP classification and examination. IRS specifies how NRP data will

allow the agency to conduct the following four broad categories of

analysis that IRS describes as both critical to the IRS mission and not

possible using alternative data sources:

• Measure overall compliance (the voluntary reporting rate10 and the

underreporting portion of the tax gap).

• Update existing audit selection and resource allocation systems and

develop new ones.

• Estimate impact on compliance and revenue of legislative and

administrative changes.

• Identify potential ways to improve voluntary compliance.

 9

 Reason codes are used by examiners to identify the causes of incorrect information on

tax returns. The 46 codes are divided into six categories and include codes for

computational mistakes, bad information from a tax preparer, and intentional

misrepresentation.

10 IRS describes the voluntary reporting rate as the accuracy of the information taxpayers

report on their timely filed returns. IRS defines it as equal to 100 multiplied by the total tax

reported on timely filed returns divided by the sum of the total tax reported plus the

estimate of tax misreported.

NRP Data Analysis Plan
Page 13 GAO-02-769 New Compliance Research Effort

The plan also outlines specific uses of NRP results by IRS’s Office of

Research and by the business operating divisions. For example, the Office

of Research will focus on the development of compliance measures for the

taxpayer population as a whole while the operating divisions will use NRP

data to look at compliance issues for their specific customers. These

measures are essentially based on a comparison of misreported amounts,

by line item, with what the amounts should have been. In another

example, IRS expects the operating divisions to be able to use information

about the characteristics of specific pockets of noncompliance, including

the causes of the noncompliance, to identify solutions. For example, if a

large number of problems appear to be due to ignorance of IRS rules, the

affected operating division could consider developing a new taxpayer

education program.

The analysis plan also describes how the Small Business/Self-Employed

division will use NRP data, for example, to identify differences in

compliance in dissimilar geographical areas, by industry and by type of

business organization. The Wage and Investment division plans to focus on

other NRP data, such as the relationship between Earned Income Tax

Credit returns that are filed on time and paid in full and those that are not.

Based on our assessment of NRP in light of government guidance on

performance measurement and data reliability, IRS appears likely to meet

the objectives the agency has set for NRP. IRS has designed NRP to meet

the agency’s need for up-to-date reporting compliance data, including

overall compliance rate information, data to support updating audit

selection formulas, and information on specific pockets of noncompliance.

At the same time, IRS has included several features in NRP that will meet

the important goal of minimizing NRP’s intrusiveness and the burden on

taxpayers whose returns are in the NRP sample. IRS has made substantial

progress towards the implementation of NRP, though important steps

remain to be completed.

IRS designed NRP to address its need for up-to-date reporting of

compliance research data. The sample is of sufficient size to meet both

IRS’s need for information about the Form 1040 filing population in

general and specific information about particular types of filers. The data

IRS plans to capture includes the sort of detailed information that the

agency will need to determine overall compliance levels, update selection

formulas, and identify specific compliance problems. IRS has developed

appropriate quality assurance mechanisms for NRP data collection, and its

NRP Is on Track To

Meet Objectives, but

Critical Cadre

Development and

NRP Testing Steps

Remain

Successful NRP

Implementation Should

Provide the Data IRS

Needs
Page 14 GAO-02-769 New Compliance Research Effort

data analysis plan appropriately shows how IRS is to use the data it

collects. If implemented as planned, NRP should produce sound, objective,

and reliable performance data in accord with government guidance on

performance measurement and data reliability.

We evaluated the NRP sampling plan and found that the design is

appropriate to meet IRS’ goals of producing a measure of voluntary

compliance and development of return selection formulas. The sample of

about 49,000 returns is designed to be representative of the population of

about 129 million Form 1040 returns. The sample is stratified by type of

return and amount of income, and we found that the sample is reasonably

designed for making compliance measures for the taxpayer population as

a whole and for subgroups of taxpayers. Also, the sample is stratified to

provide adequate data for developing return selection formulas for

examinations of Small Business/Self Employed returns and high-income

Wage and Investment returns.11

The amount of data IRS plans to capture should be sufficient to identify

specific compliance issues. NRP plans include capturing information

about discrepancies between amounts reported on returns and what those

amounts should have been, regardless of the size of the difference. The

plans also specify that examiners are to determine the reasons for any

noncompliance that they find – an improvement over past compliance data

that could prove very useful to users of NRP data. IRS also plans to ensure

that all workpapers developed by NRP examiners be prepared in

electronic format and included in the NRP database. This represents

another improvement over past compliance research efforts and should

provide a valuable source of information for researchers and other users

of NRP data.

IRS has also included quality assurance mechanisms in NRP to help ensure

that the data collected is complete and accurate. For example, IRS will

have supervisors review all “accept as filed” classification decisions and a

sample of decisions to send returns for either correspondence or face-toface audits, providing assurance that classification decisions will be made

accurately and consistently. This corresponds with both IRS’s NRP goal of

 11 We have evaluated IRS sample design by reviewing the documentation of its goals and

plans for sampling as of May 2002. Contractor reviews may result in further adjustments to

either overall or stratum-specific sample sizes. While some changes might be made, we do

not expect the changes to the final size or fundamental design of the sample to be

substantial.
Page 15 GAO-02-769 New Compliance Research Effort

getting accurate data as well as general research design principles. NRP’s

use of line-by-line audits to calibrate the program’s results also provides a

useful check on the accuracy of the classification process. The NRP

guidelines also include procedures to check the quality of examination

decisions, including the use of the Examination Quality Management

System, which IRS uses for enforcement audits, and additional quality

review steps developed specifically for NRP.

One characteristic of good research designs is that they have a detailed

analysis plan ensuring that study objectives are met with appropriate data.

The NRP data analysis plan meets this criterion because it describes IRS’s

goals for this research and how it will make appropriate use of the data

NRP generates. The plan describes how NRP data will enable IRS to meet

each of the four objectives it has laid out — measure overall reporting

compliance, update existing audit selection and resource allocation

systems and develop new ones, estimate impact on compliance and

revenue of legislative and administrative changes, and identify potential

ways to improve voluntary compliance. The plan includes specific

questions that the Office of Research and the business operating divisions

will be able to answer using the data generated by NRP. For example, the

plan describes how IRS will be able to use NRP data to identify potential

causes of noncompliance, which can be used to develop programs to

reduce the incidence of noncompliance. Such research into the causes of

noncompliance should be enhanced by NRP’s inclusion of reason codes

and electronic workpapers in the NRP database.

IRS has included important features in NRP that will minimize the time,

expense, and overall intrusiveness associated with taxpayer contacts

under the program. IRS has set minimizing taxpayer burden as one of the

guiding principles of NRP, and its plans show that it has met that goal

through (1) the use of IRS and third-party information to minimize the

amount of information requested of taxpayers, (2) the development of

classification guidelines to ensure that taxpayer contacts are limited to

auditing only those line items on returns that cannot be verified without an

audit, and (3) the development of a specially trained cadre of examiners to

carry out NRP audits.

By using information it has in its own files plus data from third-party

sources, IRS has taken a substantial step towards minimizing the

intrusiveness of the audits that will take place under NRP. By reviewing as

much information as is available without taxpayer contact, IRS will

eliminate the need for some taxpayers to be contacted at all, while others

As Planned, NRP

Implementation Should

Entail Minimal Taxpayer

Burden
Page 16 GAO-02-769 New Compliance Research Effort

only will be asked to verify information that cannot be verified any other

way. To ensure that casebuilding tools are used properly, IRS has drafted

training materials and Internal Revenue Manual sections that describe the

various casebuilding tools and their uses. We reviewed these documents

and found that they meet the overall NRP design concept and goals set by

IRS to minimize taxpayer burden.

The decision not to audit every line on every return but, instead, classify

the returns in the NRP sample to determine what needs to be verified also

represents a substantial change from past compliance research efforts and

an important step towards IRS’s goal of minimizing the impact on

taxpayers in the NRP sample. Our assessment of IRS’s quality review

procedures, draft training material, and draft Internal Revenue Manual

sections on the processes and procedures to be used in classifying returns

showed that, if properly implemented, they should aid classifiers in

correctly determining which of the three-taxpayer contact categories

returns should be placed. These decisions are vital to minimizing taxpayer

burden.

The NRP cadre is another important element of IRS’s ability to minimize

the burden associated with taxpayer contacts under NRP. IRS has defined

what it wants from a cadre of examiners – specifically that these staff be

experienced, well-trained, and supplied with appropriate information,

tools, and management support. The NRP cadre training materials and

plans that we reviewed are sufficiently detailed to meet the goals IRS has

spelled out for NRP, in particular that the cadre be prepared to keep the

intrusiveness of NRP audits to a minimum and otherwise make the

necessary distinctions between regular enforcement audit procedures and

procedures specific to NRP.

IRS’s progress so far indicates that the agency is on track to complete its

development of NRP and begin auditing taxpayers under the program in

late 2002, though not necessarily by the currently scheduled date of

October 1, 2002. However, important work remains for IRS to complete

before the agency can be confident that NRP will successfully generate the

reporting compliance data it needs. Specifically, IRS needs to select and

train a cadre of examiners to conduct NRP, complete testing NRP

classification processes before they are implemented, and test the

suitability of existing IRS information systems to capture and store NRP

data.

IRS Has Made Progress

Towards Successfully

Implementing NRP, but

Important Steps Remain
Page 17 GAO-02-769 New Compliance Research Effort

IRS met its goal to finalize its sample design by early February 2002. The

agency needed its sample defined by that date in order to make sure that

returns in the NRP sample were not selected for enforcement audits or for

other research efforts, and to be able to separate returns after they were

processed normally but before they were shipped off to storage. IRS met

this deadline and is currently identifying and setting aside returns for NRP.

The remaining work for IRS related to the NRP sample is for the agency to

continue identifying and retrieving the returns selected for NRP.

IRS has substantially completed the tasks associated with developing

guidelines and training materials for casebuilding, classification, and

examination of returns in the NRP sample. We assessed these guidelines

and training materials and found that they meet the overall NRP design

concept and goals set by IRS and general research design and data quality

standards.

According to IRS, plans for how it will identify the cadre of examiners to

conduct NRP are complete but have not been implemented. However,

important deadlines requiring a trained cadre are quickly approaching. The

current NRP plan indicates that, as of May 2002, selecting the cadre should

already be complete and cadre training should already be underway, but

IRS has not met these milestones. Having the right people to perform NRP

classification and examination tasks is very important. IRS’s plans for NRP

and general research program design principles point to the importance of

consistency and accuracy in all aspects of a research program like NRP,

and the experience and commitment of the NRP cadre is an important part

of ensuring this consistency and accuracy. Taxpayer contacts will also be

of critical importance to how this program is perceived by the public and,

again, having the right people in the examiner cadre will have much to do

with the public’s acceptance of NRP.

IRS now plans to begin training the NRP cadre in August 2002. This may

impact IRS’s ability to begin classifying returns in August 2002. This may

also mean that IRS may not meet the currently scheduled date of October

1, 2002, to begin taxpayer contacts. IRS officials pointed out both that this

date may not be met, but also that the overall goals of the program will not

suffer if taxpayer contacts start later in the year. The officials noted that it

is more important to make sure that the design, testing, and

implementation of NRP be complete before taxpayers are contacted than

it is that IRS meet a self-imposed deadline.

IRS recognized that it needs to test its NRP procedures, particularly as

they relate to casebuilding and classification, and to modify procedures

IRS Has Made Substantial

Progress Towards

Implementation

Examiners Not Yet Selected

and Trained

Casebuilding and Classification

Testing Not Yet Completed
Page 18 GAO-02-769 New Compliance Research Effort

based on what those tests show. IRS has completed two tests of NRP

casebuilding and classification procedures, but has extended the date of

an important pre-implementation test to a date close to the start of the

actual implementation of these steps.

IRS has conducted two tests of NRP casebuilding and classification

procedures. In October 2001, IRS conducted a preliminary classification

process test to aid in the development of classification guidelines,

including the use of casebuilding tools. The test consisted of two phases—

one making classification decisions without the use of casebuilding tools

and the other using casebuilding tools. The test results indicated that

casebuilding tools were useful in detecting misreported income, but that

specific guidelines were needed for using the tools and for making

classification decisions regardless of the amount of misreporting found. A

second test, conducted in early May 2002, was done on 30 previously

audited returns that were part of a tax year 1999 EITC compliance study.

This test was to assess draft classification guidelines and to test for

consistency among classifiers. The test resulted in changes to training

materials and classification guidelines.

IRS plans to do additional pre-implementation evaluations of the NRP

casebuilding and classification process, but only a very limited evaluation

of this process using actual audited returns. The agency plans to conduct

an additional test in July 2002 using unaudited returns as was done in the

October 2001 test, as well as some previously audited EITC returns. The

July 2002 test will involve actual NRP processes in order to provide IRS

with an opportunity to make final adjustments to those processes prior to

NRP implementation. One of the purposes of this test is to determine

whether the classification guidelines will result in consistent classification

decisions among classifiers. To test the guidelines, more than one

classifier will classify each return and the results will be compared. IRS

expects that this test will allow it to make changes to the guidelines so that

more consistent classification decisions are made. Since most of the

returns used in the test will have not been previously audited, the results

give IRS little assurance that, even collectively, the classification decisions

are correct but only that the decisions were consistent. Testing the NRP

classification process using previously audited returns would allow a

comparison of classification results with actual audit findings. As in the

May 2002 test, such a test using a small number of recently audited returns

would give IRS more assurance that NRP classification will result in

correct decisions.
Page 19 GAO-02-769 New Compliance Research Effort

Another part of the July 2002 test will entail classifying a larger group of

the previously audited EITC compliance study returns that were used in

the May test. The primary purpose of this test will be as a pre-test of an

analysis planned for later in the year when final NRP processes are applied

to a sample of previously audited EITC returns. That analysis will provide

a basis for a decision whether NRP will be a suitable substitute for

separate EITC compliance research studies and, if so, what adjustments

need to be made to NRP results to make them comparable to the EITC

compliance studies. The July 2002 pre-test will also provide a check on

classification accuracy for this particular type of return, but these only

represent a small portion of the NRP sample.

Until IRS completes its July classification test, it cannot update its

classification guidelines and procedures or train the staff who are to

classify the returns. Depending on the results of the test and the number

and types of changes that may have to be made to the classification

procedures, IRS may not be in a position to begin classifying returns in

August, as planned.

IRS plans to use its existing information systems to capture and store the

data generated by NRP. Modifications to these systems—RGS and the

Examination Operational Automated Database—are planned in order to

support NRP. IRS plans to evaluate the suitability of these systems for

these purposes, but has not yet completed these evaluations. Identifying

information system issues early enough to deal with them before NRP is

implemented will permit the rest of NRP’s processes to run more smoothly

than if problems are encountered later. IRS management told us that they

have made implementing any information system changes needed to

support NRP a top priority for the agency.

IRS needs accurate and up-to-date information on taxpayers’ compliance

with the tax laws in order to help it understand the effectiveness of its

programs to promote and enforce compliance and target its enforcement

audits on noncompliant returns. The design of NRP addresses this need

while limiting the burden imposed on taxpayers selected for NRP reviews.

IRS has been taking steps to implement NRP and, while it may not meet

the October 1, 2002, date in its current schedule, it is currently on track to

begin contacting taxpayers, when necessary, in late 2002. Because of the

risk of increasing taxpayer burden, we agree with IRS that it is more

important that design, testing, and implementation of NRP be complete

before taxpayers are contacted, than it is that the agency meet a selfInformation Systems Testing

Not Yet Completed

Conclusions
Page 20 GAO-02-769 New Compliance Research Effort

imposed deadline. While IRS has shown flexibility about the date to begin

taxpayer contacts, the interim milestone for beginning to classify returns

remains fixed at August 2002. Adhering to this milestone may pose

problems because NRP plans call for several sequential steps to be

completed before classification begins. Although IRS’s plans call for

completing these steps, there may not be sufficient time to complete them,

in their proper sequence, before August 2002. Specifically, testing and

modifying casebuilding and classification procedures must be finished

before NRP examiners can be trained in the finalized procedures. Such

tests will be most useful if they include the classification of some recently

audited returns. In addition, IRS must select and then train the cadre of

NRP examiners. While completing these steps before classification begins

will not guarantee successful NRP implementation, it would provide added

assurance that implementation will proceed smoothly.

We recommend that the Commissioner of Internal Revenue:

• Ensure that testing and modification of NRP casebuilding and

classification procedures is complete before IRS begins cadre training,

classifying NRP returns, or making any taxpayer contacts. IRS should

use some previously audited, non-EITC tax returns to evaluate NRP

classification procedures and classifier training; and

• Implement plans to select and appropriately train the cadre of

examiners and other staff before NRP classification begins.

On June 18, 2002, we received written comments on a draft of this report

from the Commissioner of Internal Revenue (see app. III). The

commissioner agreed with our recommendations as they concern the

completion of NRP process testing, cadre selection, and cadre training

prior to the start NRP casebuilding and classification. He expressed IRS’s

commitment to not compromising the quality of the program in order to

meet the agency’s scheduled date for commencement of taxpayer contacts

under NRP. The commissioner also noted that draft reports from the two

contractors evaluating the NRP sample indicate that the sample is valid for

IRS’s goals of precision and workload selection development.

The commissioner expressed concern with our recommendation that IRS

use previously audited, non-EITC returns in the final stages of NRP

casebuilding and classification testing. Specifically, he noted that IRS

would not be able to produce all of the casebuilding data that relate to

previously audited, non-EITC returns, and that IRS would not have a clear

understanding of why the non-EITC returns were selected for audit and

Recommendations for

Executive Action

Agency Comments
Page 21 GAO-02-769 New Compliance Research Effort

what guidance the examiners were given in conducting the audits. We

agree that these are issues that a full-scale evaluation of NRP using

previously audited returns would have to address. In subsequent

discussions with IRS’s Director of Research, Analysis and Statistics, the

senior IRS official responsible for NRP, we pointed out that our

recommendation was not for IRS to conduct a full-scale evaluation of

NRP, but for a smaller review of some previously audit returns. As we note

in the report, a small test, such as the one IRS conducted in May 2002

using 30 previously audited EITC returns, would give IRS more assurance

that NRP classification will result in correct decisions. The Director of

Research, Analysis and Statistics agreed that such a test using non-EITC

returns would be feasible and useful and that IRS will conduct the test

before beginning taxpayer contacts.

As agreed with your office, unless you publicly announce its contents

earlier, we plan no further distribution of this report until 30 days after its

date. At that time, we will send copies of this report to the Secretary of the

Treasury, the Commissioner of Internal Revenue, and other interested

parties. The report is also available at no charge on the GAO web site at

http://www.gao.gov.

If you or any of your staff have any questions, please contact Ralph Block

at (415) 904-2150 or me at (202) 512-9110. Key contributors to this

assignment were Wendy Ahmed, Jeffrey Baldwin-Bott, and David Lewis.

James R. White

Director, Tax Issues
Appendix I: GAO Products Related to

Measuring Voluntary Compliance

Page 22 GAO-02-769 New Compliance Research Effort

GAO report Summary

Tax Administration: IRS’ Plans to Measure Tax Compliance

Can Be Improved. GAO/GGD-93-52. (Washington, D.C.: April 5,

1993)

Summarizes uses of Taxpayer Compliance Measurement Program

(TCMP) data and outlines who uses the data. Identifies weaknesses

of proposed changes and establishes criteria for evaluating proposed

changes to measures of voluntary compliance.

Tax Compliance: Status of the Tax Year 1994 Compliance

Measurement Program. GAO/GGD-95-39. (Washington, D.C.:

December 30, 1994)

Summarizes IRS’s plans for the 1994 TCMP and discusses

promising changes. Identifies several weaknesses in the plan that

the Internal Revenue Service (IRS) needs to fix before implementing

the project.

Tax Compliance: 1994 Taxpayer Compliance Measurement

Program. GAO/T-GGD-95-207. (Washington, D.C.: July 18,

1995)

Testimony on 1994 TCMP before the House Subcommittee on

Oversight, Committee on Ways and Means. Discusses uses of

TCMP data and status of planned 1994 TCMP effort. Discusses

some of the criticisms of TCMP. Identifies GAO reports where TCMP

data were used.

Letter to the Commissioner on TCMP Errors. GAO/GGD-95-

199R. (Washington, D.C.: July 19, 1995)

Summarizes errors in audits for 1988 TCMP and suggests changes

to codes to be used to categorize the cause of noncompliance for the

planned 1994 TCMP project.

Tax Administration: Information on IRS’ Taxpayer Compliance

Measurement Program. GAO/GGD-96-21. (Washington, D.C.:

October. 6, 1995)

Follow-up on issues raised in our December 1994 report concerning

timeliness and the types of data IRS planned to gather for TCMP

audits. Also, briefly discusses other sources of data on voluntary

compliance and the relevance of TCMP data for alternative tax

system proposals. Indicates how IRS responded to our

recommendations.

Tax Administration: Alternative Strategies to Obtain

Compliance Data. GAO/GGD-96-89. Apr. 26, 1996.

(Washington, D.C.: April 26, 1996)

Summarizes the problems caused by cancellation of the 1994 TCMP

project. This report also identifies sampling strategies that will reduce

the sample size and still provide some data.

Tax Administration: Status of IRS Efforts to Develop Measures

of Voluntary Compliance. GAO-01-535. (Washington, D.C.:

June 18, 2001)

Describes IRS’s efforts to develop new voluntary compliance

measures. Also discusses how federal agencies besides IRS assess

compliance with the rules and regulations governing their programs.

Appendix I: GAO Products Related to

Measuring Voluntary Compliance
Appendix II: NRP Sample

Page 23 GAO-02-769 New Compliance Research Effort

The Internal Revenue Service (IRS) designed a sample of 49,251 returns

from the population of Form 1040 tax returns filed for tax year 2001. These

include returns from wage earners and from self-employed individuals

filing Schedule C and farmers filing Schedule F. IRS developed a

representative sample, then added returns to increase the precision of

NRP results. Included with these additional returns are about 18,000 added

to increase the likelihood that there would be enough returns to provide a

basis for developing new audit selection formulas. The NRP sample

designers used past reporting compliance research results to derive an

estimate of the percentage of returns that will likely need to be audited in

each of the strata. The designers then used those estimates to add returns

to the sample, intending to have at least 500 sufficiently high tax change

returns in each grouping of strata that will likely require the development

of a unique audit selection formula. Officials explained that the 500-return

standard was used in past reporting compliance studies to develop audit

selection formulas. The designers also said that they considered it

important to apply the same standard in NRP.

The NRP sample is detailed in table 1.

Appendix II: NRP Sample
Appendix II: NRP Sample

Page 24 GAO-02-769 New Compliance Research Effort

Table 1: National Research Program Sample Design

NRP Sample design for individual taxpayers

SB/SE Form 1040 filers

Taxpayer description

Sample size to achieve

precision requirement

Additional sample

size to meet other

IRS requirements

Total

sample size

TPIa <$100,000, no Schedule C 4,103 96 4,199

TPI <$100,000, with Schedule C 2,901 452 3,353

TPI $100K under $250K, no Schedule C 2,208 51 2,259

TPI $100K under $250K, with Schedule C 1,037 244 1,281

TPI $250K under $1,000K, no Schedule C 1,110 344 1,454

TPI $250K under $1,000K, with Schedule C 436 2,112 2,548

TPI $1000K and over, no Schedule C 479 257 736

TPI $1000K and over, with Schedule C 138 228 366

Schedule C – TGRb < $25K, AGIc < $10K 353 130 483

Schedule C - TGR < $25K, AGI >= $10K 294 2,551 2,844

Schedule C - TGR $25K under $100K, AGI < $25K 499 2,292 2,791

Schedule C - TGR $25K under $100K, AGI >= $25K 1,095 26 1,120

Schedule C - TGR $100K under $250K, AGI < $50K 308 3,852 4,159

Schedule C - TGR $100K under $250K, AGI >=

$50K 637 15 652

Schedule C - TGR $250K under $1,000K, AGI <

$100K 221 2,068 2,290

Schedule C - TGR $250K under $1,000K, AGI >=

$100K 342 18 360

Schedule C - TGR $1,000K and over 321 7 329

Schedule F - TGR <$1,000K and AGI <$25K 73 654 727

Schedule F - TGR <$1,000K and AGI >=$25K 193 2,758 2,951

Schedule F - TGR >= $1,000K 12 156 168

Total SB/SE returns 16,760 18,311 35,069

Wage and investment Form 1040 filers

1040A Type, TPI < $25K, AGI <$10K 557 835 1,392

1040A Type, TPI < $25K, AGI >=$10K 1,346 218 1,563

Non-1040A Type, TPI < $25K, AGI <$10K 340 41 380

Non-1040A Type, TPI < $25K, AGI >=$10K 543 72 614

TPI $25K Under $50K, AGI < $25K 22 1 22

TPI $25K Under $50K, AGI >= $25K 3,102 72 3,174

TPI $50K Under $100K 2,938 68 3,006

TPI $100K Under $250K 1,023 219 1,242

TPI $250K Under $1,000K 172 1,899 2,071

TPI $1,000K and over 29 686 716

Total wage and investment returns 10,070 4,111 14,182

Total—All Form 1040 filers 26,830 22,421 49,251

Note: Some row and column totals do not add up due to rounding.

a

TPI= Total Positive Income (sum of positive income amounts reported by the taxpayer)
Appendix II: NRP Sample

Page 25 GAO-02-769 New Compliance Research Effort

b

TGR = Total Gross Receipts (sum of Schedule C and Schedule F gross receipts amounts).

c

AGI = Adjusted Gross Income.
Appendix III: Comments from the Internal

Revenue Service

Page 26 GAO-02-769 New Compliance Research Effort

Appendix III: Comments from the Internal

Revenue Service
Appendix III: Comments from the Internal

Revenue Service

Page 27 GAO-02-769 New Compliance Research Effort (440089)

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