United States General Accounting Office

GAO Report to the Ranking Minority Member,

Committee on Government Affairs,

U.S. Senate

October 1995 TAX

ADMINISTRATION

Electronic Filing

Falling Short of

Expectations

GAO/GGD-96-12

GAO United States

General Accounting Office

Washington, D.C. 20548

General Government Division

B-260137 

October 31, 1995

The Honorable John Glenn

Ranking Minority Member

Committee on Governmental Affairs

United States Senate

Dear Senator Glenn:

Electronic filing is a cornerstone of the Internal Revenue Service’s (IRS)

plan to move away from the traditional paper-based return filing. In

May 1993, IRS established a goal of receiving 80 million tax returns

electronically in 2001—about 36 percent of all the tax returns it expects to

receive that year. Our July 1995 report on IRS’ multibillion dollar

modernization effort, known as Tax Systems Modernization, included a

discussion of the need for IRS to develop a strategy to maximize electronic

filing.1

 This report, prepared under our basic legislative authority, builds

on that message by assessing (1) IRS’ progress in broadening the use of

electronic filing, (2) the availability of data needed to develop an

electronic filing strategy, and (3) the implications for IRS if it does not

significantly reduce its paper-processing workload.

Background IRS is in the midst of a major modernization effort, which, if implemented

as intended, will change the way IRS receives, processes, stores, and

retrieves information needed to administer the tax system and change the

way taxpayers and IRS interact. As part of this effort, IRS plans to (1) shift

from a paper-based to an electronic tax-processing system, (2) consolidate

fragmented telephone assistance into fewer centrally managed locations to

handle almost all taxpayer calls, and (3) develop a database that contains

all pertinent taxpayer account information and make that information

readily available to all employees who need it. These plans are all part of

what IRS calls its new business vision.

IRS is making organizational changes to accommodate this new vision by

(1) moving responsibility for processing electronic returns from 5 service

centers to 3 computing centers; (2) consolidating in 5 submission

processing centers, the paper-processing activities now done in 10 service

centers; and (3) consolidating in 23 sites, the customer service activities

now done in over 70 sites.

1

Tax Systems Modernization: Management and Technical Weaknesses Must Be Corrected If

Modernization Is To Succeed (GAO/AIMD-95-156, July 26, 1995).

Page 1 GAO/GGD-96-12 Electronic Filing
B-260137 

Electronic filing is one of IRS’ first ventures into a more modern

environment. This alternative to the traditional filing of paper returns

started as a test in 1986 and became available nationwide in 1990. Some

taxpayers can file electronically by telephone, but most electronic filing is

done through a tax return preparer or an electronic return transmitter.

Once received by IRS, electronic returns are automatically edited,

processed, and stored—functions that are performed manually for paper

returns.

Electronic filing benefits taxpayers. The benefits include receipt of their

refunds several weeks sooner than if they had filed paper returns and

greater assurance that (1) IRS has received their returns, (2) the returns are

mathematically accurate, and (3) information on the returns has been

accurately posted to the taxpayers’ accounts in IRS’ records.

Compared with IRS’ current procedures for processing paper returns,

electronic filing has several benefits for IRS. These benefits include

reduced costs of processing, storing, and retrieving returns and faster,

more accurate processing of returns and refunds. Also, with electronic

filing, IRS gets 100 percent of the return information in its computers

compared with the approximate 40 percent IRS inputs from paper returns.

As part of its future business vision, IRS plans to capture 100 percent of the

information on paper returns using new scanning technology. However,

the cost of scanning the data from paper returns will most likely be higher

than the cost of obtaining it electronically because (1) manual labor will

still be required to prepare the paper documents for scanning and (2) IRS

test indicate that scanning cannot always correctly read the information

on paper returns, thus requiring rework and manual intervention.

Therefore, electronic filing would continue to provide a more efficient way

of obtaining tax return data than having taxpayers submit paper returns.

Results in Brief Since IRS first offered electronic filing in 1986, its marketing has been

targeted primarily at professional tax return preparers. That approach has

not resulted in the level of electronic filing needed to achieve IRS’

long-term goal nor has it attracted those taxpayers who file the kinds of

returns that contribute most to IRS’ paper-processing workload and costs.

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If electronic filing continues to grow at its recent pace, IRS will fall far

short of 80 million electronic returns in 2001.2

 From 1992 through 1994, the

number of returns filed electronically grew from 12.6 million to

16.4 million, an annual growth rate of 14 percent. In 1995, the number of

electronic returns is expected to drop to about 14.8 million, which IRS

attributes to various actions it took to crack down on refund fraud. It is

impossible to accurately predict how the number of electronic returns will

change in future years. For illustrative purposes, however, if 1995 is

considered an aberration, as IRS believes, and the 14 percent annual

growth rate of the preceding 2 years is resumed, we estimate that only

about 33 million returns will be filed electronically by 2001.

Most of the electronic returns IRS received in 1994 were individual income

tax returns that could have been filed on Form 1040A or 1040EZ—forms

that are among the least costly paper returns to process. Individual tax

returns that would have otherwise been filed on the more costly to

process Form 1040 accounted for only about 20 percent of the individual

tax returns filed electronically, although 59 percent of all individual

income tax returns (paper and electronic) filed in 1994 were on Form

1040. In addition, IRS has made little headway in increasing the number of

electronically filed business returns, which are generally more complex

and thus more costly to process on paper than individual returns. In 1994,

about 2.4 million, or 6 percent of the approximate 42 million business

returns were filed electronically.

A major impediment to the expansion of electronic filing is its cost to the

general public. Taxpayers must generally file an electronic return through

a preparer or electronic filing transmitter and pay from $15 to $40 for such

services. In January 1993, we reported that electronic filing appealed

primarily to taxpayers who most needed their refunds and that other

taxpayers saw little reason to incur the filing cost.3

According to the American Institute of Certified Public Accountants

(AICPA), many preparers are also concerned about the costs associated

with preparing and transmitting electronic returns. One aspect of IRS’

current electronic filing program that contributes to this cost is the need

2

Since establishing its electronic filing goal, IRS has modified its definition of electronic returns to

include returns filed on magnetic media (tape and computer diskette). IRS has said that returns filed

on magnetic media will be mostly business returns. To be consistent with IRS’ definition, further

reference to electronic returns in this report will include, unless otherwise noted, returns filed on

magnetic media.

3

Tax Administration: Opportunities to Increase the Use of Electronic Filing (GAO/GGD-93-40, Jan. 22,

1993).

Page 3 GAO/GGD-96-12 Electronic Filing
B-260137 

for taxpayers to submit a paper signature document to affirm that the

information on the electronic return is accurate.

The fact that less complex returns comprise a disproportionate share of

electronic filing may be due, at least in part, to IRS’ goal of 80 million

returns. Focusing solely on this goal could cause IRS to target its efforts at

groups of taxpayers or types of returns that provide the greatest

opportunity to increase the number of electronic returns but not the

greatest opportunity to reduce IRS’ paper-processing workload and

operating costs. Although a marketing strategy that focuses on reducing

paper and costs may generate less than 80 million returns, it could have a

more significant impact on IRS’ overall operations.

Although business returns and returns filed on Form 1040 would appear to

offer the greatest opportunity to reduce IRS’ costs if filed electronically, IRS

does not have enough data to make that determination. Although IRS has

some comparative data on the cost to process electronic and paper

returns, it does not have comparative data on other costs (such as storage

and retrieval) that can vary depending on how a return is filed. IRS also

does not have (1) adequate data on why taxpayers do not file

electronically and what it would take to get them to do so and

(2) estimates of the number of electronic returns IRS can expect to receive

from those taxpayers after some market intervention. IRS awarded a

contract in May 1995 that may provide at least some of this information.

With this information IRS could (1) identify those groups of taxpayers that

offer the greatest opportunity for reducing operating costs and (2) develop

an appropriate marketing strategy for those groups.

Assumptions about increases in electronic filing and decreases in paper

return filing were critical factors in several of IRS’ modernization decisions,

such as deciding on the number of sites and staff needed to process paper

returns and provide customer service. Without a significant change in the

trends in electronic filing, IRS’ paper-processing and customer-service

workloads will exceed expectations, and IRS may have to alter various

aspects of its modernization. IRS does not have contingency plans for this

eventuality.

Objectives, Scope,

and Methodology

Our objectives were to assess (1) IRS’ progress in achieving its electronic

filing goal, (2) the availability of data needed to develop an electronic filing

strategy, and (3) the implications for IRS if it does not reach its electronic

filing goal and reduce its reliance on paper.

Page 4 GAO/GGD-96-12 Electronic Filing
B-260137 

To accomplish our objectives, we did the following:

• We analyzed IRS data for calendar years 1990 through 1994 on the number

and composition of electronic filings. For calendar year 1995, we analyzed

such data through May 1995.

• We determined IRS’ potential shortfall in meeting its 80-million goal for

2001 by using the annual growth rates for 1993 and 1994. We did not use

the 1995 growth rate because IRS officials believe the 1995 rate is an

aberration, and they expect the growth of electronic filing to resume in

1996.

• We used IRS data on the average cost to process electronic returns and

various types of paper returns in 1993 (the latest available)4

, along with

data on the number of returns filed in 1994, to estimate (1) the potential

savings if all forms 1040, 1040A, and 1040EZ had been filed electronically

in 1994 and (2) the portion of potential savings that IRS realized, given the

number of returns that were actually filed electronically in 1994. We did

not assess the reliability of IRS’ data on average processing costs for paper

and electronic returns.

• We interviewed officials and staff who had electronic filing responsibilities

in IRS’ National Office; 2 of its 7 regional offices (Central and Mid-Atlantic);

5 of its 63 district offices (Baltimore, Cincinnati, Cleveland, Indianapolis,

and Richmond); and 4 of its 10 service centers (Andover, Cincinnati,

Memphis, and Philadelphia). We judgmentally selected IRS field offices that

were involved with unique electronic filing initiatives and/or were

convenient to our audit staff.

• We reviewed information related to the electronic filing program,

including IRS’ electronic filing strategy, related legislative proposals, and

surveys of preparers and taxpayers done by the AICPA and other

organizations.

• We reviewed IRS’ modernization plans, including documents on the sizing

of submission processing centers and discussed with returns processing

and information systems managers in IRS’ National Office, IRS’ plans in the

event electronic filing falls short of expectations.

We did our work between April 1994 and May 1995 in accordance with

generally accepted government auditing standards. We requested

4

As computed by IRS, processing costs for paper returns include the costs incurred for such things as

opening and sorting the mail, preparing the returns for data transcription, keypunching data from the

returns into the computer, and correcting errors made by taxpayers in preparing the returns and by

IRS in processing them. Processing costs for electronic returns include those costs IRS incurs after the

return is received. (Processing costs do not include the telecommunications costs associated with

receiving the return because they are currently incurred by the taxpayer/preparer.) These costs

include upfront validity checks and other costs associated with preparing return data so they can be

merged with data from paper returns on magnetic tape.

Page 5 GAO/GGD-96-12 Electronic Filing
B-260137 

comments on a draft of this report from the Commissioner of Internal

Revenue or her designee. On July 27, 1995, IRS’ Executive for Electronic

Filing and the Site Executives for IRS’ Computing Centers and Submission

Processing provided oral comments. Those comments and our evaluation

are summarized on pages 17 to 20 and are incorporated in this report

where appropriate.

IRS’ Electronic Filing

Strategy Has Not

Produced the Kind of

Results Needed to

Meet IRS’ Goal

Since the inception of electronic filing, IRS’ marketing strategy has been

targeted primarily at professional tax return preparers. That strategy has

not resulted in the level of electronic filing that will bring IRS to its

long-term goal nor has it attracted those taxpayers who file the kinds of

returns that contribute most to IRS’ paper-processing workload and costs.

One impediment to the growth of electronic filing that IRS has yet to

adequately address is its cost to taxpayers and preparers.

Focus of IRS’ Marketing

Efforts Has Not Changed

Much Since Electronic

Filing Began

When electronic filing started in 1986, IRS’ marketing approach was to

encourage tax return preparers to provide electronic filing in hope that

they would market the service to the general public. IRS’ rationale for this

approach was based primarily on the large number of returns prepared by

professional preparers—about 57 million for tax year 1993.

Because we saw the need for IRS to expand the appeal of electronic filing,

we recommended, in January 19935

, that IRS identify additional market

segments and specify national strategies for attracting those market

segments to electronic filing. To that end, an IRS task group, in May 1993,

presented a strategy that encompassed 21 initiatives for increasing the

number of electronically filed returns.

A few of the 21 initiatives have been implemented and have resulted in

modest increases in the number of electronic returns. For example, one

initiative called for expanding TeleFile—a program that allows taxpayers

who meet certain criteria to file 1040EZ returns by telephone. About

680,000 taxpayers in 10 states filed returns using this method in 1995

compared with 149,000 in 1 state in 1993, and IRS plans to expand the

program nationwide in 1996. Another initiative called for expanding

cooperative arrangements with states that would allow electronic filers to

jointly file their federal and state tax returns. As of June 9, 1995, about

1.5 million taxpayers in 29 states had used this program compared with

about 635,000 taxpayers in 15 states in 1993.

5

GAO/GGD-93-40.

Page 6 GAO/GGD-96-12 Electronic Filing
B-260137 

However, other initiatives included in the 1993 strategy have been delayed

or dropped. According to the IRS task group, several of these initiatives

required legislation. For example, the task group had estimated that IRS

could obtain 37 million electronic returns by legislatively mandating that

tax return preparers who prepare a large number of individual returns

offer electronic filing. That initiative was dropped because, according to

IRS and Treasury officials, there was little chance that Congress would pass

such legislation. Appendix I provides additional information on those

initiatives that the task group said would require legislation.

Because several initiatives that were designed to attract large numbers of

taxpayers to electronic filing have not been implemented, IRS’ default

strategy has been to continue marketing electronic filing to tax preparers.

However, that strategy has resulted in a program that primarily attracts

individuals who file simple tax returns, are due refunds, and are willing to

pay the fees associated with electronic filing to get those refunds sooner.

Number of Taxpayers

Using Electronic Filing

Relatively Low Compared

With IRS’ Goal

As shown in figure 1 on page 8, the number of electronic returns increased

from about 4.9 million returns in 1990, when electronic filing became

available nationwide, to a high of 16.4 million returns in 1994, before

dropping to an estimated 14.8 million returns in 1995.

IRS attributes the decrease in electronic filing in 1995 to steps it took to

prevent refund fraud. As a result of these steps, refunds for millions of

taxpayers were delayed, thereby reducing the major appeal of electronic

filing. IRS officials believe that the decrease is temporary.

Even if electronic filing begins growing again, IRS will be hard pressed to

reach its electronic filing goal. We estimate that electronic filing, including

returns filed on magnetic media, would need to grow at an annual rate of

about 32 percent to reach 80 million returns in 2001. That rate contrasts

with the 14 percent annual growth rate IRS achieved in 1993 and 1994. As

shown in figure 1, if annual growth were to continue at 14 percent, we

estimate that only about 33 million returns would be filed electronically in

2001.

Page 7 GAO/GGD-96-12 Electronic Filing
B-260137 

Figure 1: Number of Returns Filed

Electronically in Calendar Years 1990

Through 1995 and Estimated Shortfall

in Meeting 80-Million Goal for Calendar

Year 2001

Shortfall in meeting 80-million goal


Estimate based on 14 percent annual growth


Actual number of returns received

1990 1991 2001 1992 1993 1994 1995

33

80

16.4

14.3 12.6

8.6

4.9

14.8

80


70


60


50


40


30


20


10


0


Number of returns (millions)

Processing year

Note 1: The 1995 figure is an estimate.

Note 2: These data include business returns filed mostly on magnetic media and, for 1994 and

1995, include an estimated 2.4 million and 3 million such returns, respectively.

Source: GAO computations using IRS data.

The More Complex Tax

Returns Are Not Being

Filed Electronically

Not only is the number of electronic returns relatively low, but the returns

being filed electronically are generally those that contribute least to IRS’

paper-processing workload and operating costs. Electronic filing has not

yet attracted a representative number of taxpayers who file individual

income tax returns on the more complex Form 1040 and business returns.

Since electronic filing began, IRS has focused its marketing efforts on

individual income tax returns. Accordingly, those returns, which

accounted for about 56 percent of all returns filed in 1994, accounted for

86 percent of those filed electronically. Despite the focus on individual

returns, electronic filing is not attracting those taxpayers who represent

the largest segment of individual filers and those who file the most costly

Page 8 GAO/GGD-96-12 Electronic Filing
B-260137 

individual income tax form to process on paper. As a result, potentially

significant cost savings may be going unrealized.

On the basis of IRS’ 1993 service center processing cost estimates (the

latest available), it cost IRS $4.53 to process a paper Form 1040, $3.95 to

process a paper Form 1040A, and $3.36 to process a paper Form 1040EZ.6

The most costly of the three (Form 1040) accounted for about 59 percent

of all individual returns (paper and electronic) processed in 1994, yet

Form 1040 accounted for only about 20 percent of the individual returns

filed electronically.

On the basis of IRS’ processing cost estimates for paper returns and its

estimated average cost of $3.08 to process each electronic individual

return, we estimated (1) the total potential processing savings that could

have been achieved if all individual income tax returns had been filed

electronically in 1994 and (2) the portion of those potential savings that

went unrealized.7

 Figure 2 shows that the greatest amount of unrealized

savings, about $90 million, was for returns filed on Form 1040.

6

The 1040A and 1040EZ are less costly to process because they generally contain fewer pages than the

1040 and thus less data for IRS to input and less opportunity for taxpayers or IRS to err. The 1040EZ

has one page with no supporting schedules. The 1040A has two pages, like the 1040, but generally has

fewer supporting schedules because of limitations as to who can file a 1040A. A 1040A filer, for

example, cannot claim itemized deductions, self-employment income, rents and royalties, or capital

gains. According to IRS data, it takes an average of 89 and 159 keystrokes, respectively, to enter data

into the computer from a paper 1040EZ and 1040A compared with 247 keystrokes for an average 1040.

7

The savings from electronic filing would be even more if IRS did not have to process the paper

signature document (Form 8453) that electronic filers are required to send to IRS. IRS data show that

it costs 30 cents to process each of those forms, or about $4.3 million in 1994.

Page 9 GAO/GGD-96-12 Electronic Filing
B-260137 

Figure 2: Estimated Savings That

Could Have Been Realized If All

Individual Income Tax Returns Were

Filed Electronically in 1994 and

Estimated Amount That Went

Unrealized

Savings in dollars (millions)

0

10

20

30

40

50

60

70

80

90

100

1040 1040 A & EZ

Type of tax form

95

90

21

14

Potential savings

Unrealized savings

Source: GAO computations using processing cost data in IRS’ Service Center Costing Handbook

for 1993 and return filing data from IRS’ Management Information System for Top Level

Executives.

Because paper returns filed by businesses are more expensive to process

than paper returns filed by individuals, according to IRS data, they would

seem to represent a potential source of significant savings if filed

electronically. IRS estimated, for example, that in 1993 it cost $6.97 to

process each partnership return (Form 1065), $6.95 to process each

corporate income tax return (Form 1120), and $6.19 to process each

Employers Quarterly Federal Tax Return (Form 941).

In 1994, about 6 percent of all business returns were filed electronically

(2.4 million out of 42 million), while the participation rate for individual

returns was about 12 percent (14 million out of 115 million). Of the

Page 10 GAO/GGD-96-12 Electronic Filing
B-260137 

2.4 million electronically filed business returns, all but about 46,000 were

filed on magnetic media.8

IRS officials said that the lower participation rate for business returns

reflects, in part, the priority IRS has attached to increasing the number of

electronically filed individual returns. That priority is reflected in IRS’

May 1993 strategy. The more traditional marketing aspects of IRS’ strategy

were focused on getting individual returns filed electronically. For

business returns, IRS’ strategy was to rely on legislative mandates. More

specifically, the 1993 strategy included an initiative that called for

developing a legislative proposal that would (1) mandate electronic filing

of many business returns, including those filed by fiduciaries (Form 1041),

partnerships, and corporations and (2) require the electronic transmission

of Employers Quarterly Federal Tax Returns by businesses with 10 or

more employees. IRS has since decided to pursue mandates only as a last

resort but has not developed an alternative strategy for getting large

numbers of business returns filed electronically.

Cost Is a Major

Impediment to the Growth

of Electronic Filing

IRS has not been successful in dealing with a major impediment to greater

taxpayer and preparer participation in electronic filing, i.e., its cost.

For most taxpayers, the only way to file electronically is through a tax

return preparer or electronic filing transmitter at a cost of from $15 to $40.

This cost is in addition to any costs associated with preparing the return.

In January 1993, we reported that electronic filing appealed primarily to

taxpayers who most needed their refunds and that other taxpayers due

refunds were unwilling to pay the going fees for that benefit.9

 Cost is even

more of an impediment to taxpayers owing money because those

taxpayers see little, if any, benefit to filing electronically. We know of little

that has changed since 1993 to alter that opinion. As a result, less than

2 percent of the individual income tax returns filed electronically in 1995

were from taxpayers owing money.

In response to a recommendation in our January 1993 report and one of

the initiatives in IRS’ May 1993 strategy, IRS has (1) increased the number of

8

Although returns filed on magnetic media are less costly to process than returns filed on paper, IRS

does not achieve all the benefits from magnetic media that it does from electronic filing. For example,

errors on magnetic media returns are printed out on paper and mailed back to the sender. The

electronic filing system, however, includes filters that check for such errors as mathematical mistakes

and incorrect Social Security numbers. If an error is identified, the system is designed to reject the

return and electronically notify the sender of the problem.

9

GAO/GGD-93-40.

Page 11 GAO/GGD-96-12 Electronic Filing
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walk-in sites that offer free electronic return preparation and transmission

and (2) provided additional support for similar services at sites staffed by

volunteers. As of April 29, 1995, about 246,000 taxpayers had availed

themselves of these free services.

The free electronic filing at IRS and volunteer sites is generally available to

low-income taxpayers who file less complex returns. Cost is at least one

factor that deters electronic filing by a potentially more lucrative market

of individual taxpayers—those with home computers. Since 1992,

taxpayers using tax preparation software could file returns from home

computers and transmit them from home through an approved computer

service. However, these filers must pay a fee of about $15 and must still

send paper, including a signature document (Form 8453) and wage and

withholding statements (Forms W-2), to IRS. Only about 1,400 taxpayers

had filed their returns through this program as of May 5, 1995.

For those taxpayers who prepare their returns on computers but are

unwilling to pay to transmit the returns electronically, the result is

inefficient and counterproductive. The taxpayer prepares the return on a

computer and then converts it to paper for mailing to IRS, which then

employs a labor intensive, error prone process to input that information

back into a computer.

IRS has completed a draft strategy for increasing the number of taxpayers

filing from home computers. Part of the strategy focuses on eliminating

the fees these taxpayers incur for having a third party transmit their

returns to IRS.

Cost also deters some preparers from participating in the electronic filing

program. In September 1994, the Chairman of the AICPA’s Tax Practice and

Procedures Committee provided us with summary information on

members’ experiences with electronic filing. He said that some

practitioners have been filing electronically for several years with positive

experiences, while others discontinued doing so because IRS’ current

electronic filing program “did not fit into their ‘office routine’ or because

they or their clients did not receive any additional benefit from the

program to offset the additional cost.” He said that many practitioners are

concerned with the additional input, transmitting, and monitoring time

required with the current electronic filing program and the fact that

electronic filing is not yet a paperless system. Among the paper

documents, the most problematic, according to the AICPA, is the signature

document. That document, which is used to affirm that the information on

Page 12 GAO/GGD-96-12 Electronic Filing
B-260137 

the electronic return is accurate, must be signed by the taxpayer and filed

with IRS within 24 hours after IRS has acknowledged acceptance of the

electronic return.10

IRS has recognized for years the potential benefit of paperless electronic

filing but thought that legislation was needed to authorize an alternative to

the paper signature document. Information on IRS’ efforts to obtain such

legislation is presented in appendix I. In April 1995, however, IRS’ Office of

Chief Counsel concluded that IRS had regulatory authority to prescribe

signature alternatives. An IRS official said that IRS plans to test signature

alternatives in 1996.

IRS Does Not Have

Adequate Data to

Focus Its Electronic

Filing Strategy

IRS recognizes that it needs to increase the appeal of electronic filing to

attract more taxpayers. IRS also recognizes that it does not have unlimited

staff or funds to apply to that effort. However, IRS’ ability to effectively

target its limited resources is hampered by inadequate data on the relative

costs and benefits of processing different types of returns electronically

versus on paper. Business and complex individual returns would seem to

offer opportunities for significant cost reductions if filed electronically.

However, IRS does not have sufficient data to determine (1) what it would

cost to get those returns filed electronically, including the costs of any

incentives that might be needed to prompt certain groups of taxpayers to

file electronically and (2) how that cost compares to the expected benefits

from electronic filing.

As discussed earlier, IRS has data on some of the costs incurred in

processing returns. However, IRS does not have data on other costs that

can vary depending on how a return is filed. Those costs include (1) costs

to store and retrieve returns and to administer certain fraud controls, such

as those established to assess the suitability of preparers and transmitters

who apply to participate in the electronic filing program and (2) certain

nonservice center costs incurred in resolving taxpayer account errors that

are made during IRS’ manual processing of paper returns (such as the costs

associated with handling the extra telephone calls generated by those

errors). Without better data on the relative costs and benefits of electronic

filing as well as data on why taxpayers do not file electronically and what

it would take to get them to do so, IRS cannot make sound decisions on

10The AICPA mentioned that another big obstacle to practitioner participation in electronic filing is

that many of the returns prepared by its members involve forms that cannot be filed electronically.

Thus, a firm would have to incur the costs of two processes—one for paper returns and one for

electronic returns.

Page 13 GAO/GGD-96-12 Electronic Filing
B-260137 

such things as the feasibility of offering incentives (such as a tax credit) to

encourage greater participation in the program.

IRS awarded a contract in May 1995 that may provide at least some of the

needed cost/benefit data. Among other things, the contract calls for a

systematic analysis of the costs and benefits of each step in the electronic

filing process. We believe this aspect of the contract is critical to helping

IRS focus its resources on those taxpayers or returns that provide the

greatest opportunity for reducing overall operating costs. Data on the cost

and benefits of electronic filing versus paper filing for various taxpayers or

returns, coupled with estimates of the number of electronic returns IRS can

expect to receive from these market segments, should provide IRS with a

foundation for focusing future electronic filing marketing strategies.

It is not clear whether the contractor will be doing any taxpayer focus

groups or surveys to determine what changes IRS needs to make to better

motivate taxpayers to participate in electronic filing. IRS’ most recent

taxpayer opinion data on electronic filing were collected in 1991 and those

did not include data from businesses. Unless IRS obtains more current

information from taxpayers, it may have difficulty reliably estimating the

number of electronic returns it can expect to receive from different

market segments.

A complicating factor in any cost/benefit analysis is IRS’ plan to change the

way it processes paper returns in the future. Instead of the current

manually intensive process by which tax return data are keypunched into

the computer, IRS plans to scan paper returns. If scanning reduces the cost

of processing paper returns, as expected, it could alter any analysis of the

relative costs and benefits of electronic filing.

IRS Does Not Have

Contingency Plans in

Case Electronic Filing

Goals Are Not

Reached

In deciding on 5 submission processing centers and 23 customer service

centers and in determining the number of persons needed to staff those

centers, IRS relied, in large part, on expectations that it would be receiving

a minimum of 61 million electronically filed returns by 2001. Using IRS’

return filing projections for 2001, we estimated that submission processing

centers would thus be expected to process about 163 million paper

returns.

If fewer returns are filed electronically or if the returns filed electronically

do not substantially decrease IRS’ paper-processing workload, IRS will have

to process more paper, which would decrease productivity and increase

Page 14 GAO/GGD-96-12 Electronic Filing
B-260137 

costs. The need to process more paper could also cause IRS to revise its

plans for the submission processing centers. Staffing and equipment needs

could be expected to increase at the sites if more paper returns have to be

processed. A National Office official told us that if another submission

processing site is needed, site preparation costs alone would amount to

more than $17 million.

A substantial increase in the number of paper returns could also affect IRS’

plans for its 23 customer service centers and the availability of staff to

work in compliance positions. The customer service centers are

responsible for handling taxpayer telephone and correspondence contacts,

many of which are a byproduct of questions that arise from processing

taxpayers’ returns. Because of the substantially higher error rates

associated with paper returns, according to IRS data (23 percent versus

2 percent for electronic returns), customer service centers would likely

need to field more questions if IRS receives more paper returns than it has

projected. And, if IRS needs more staff to process paper returns and

provide customer service, it may have fewer staff to redeploy to

compliance positions, thus decreasing the amount of additional tax

revenue anticipated from such a redeployment.

IRS National Office officials told us that they had not developed

contingency plans for the possibility that electronic filing will fall short of

expectations. They believe that IRS will be successful in achieving the level

of electronic filing needed to support the projected workloads for the

submission processing and customer service centers. In the event of a

shortfall, they believe IRS will have time later to develop alternative plans.

IRS has developed a contingency plan for the document imaging system

that is to eventually replace IRS’ current paper-processing system. The

purpose of that plan is to ensure that the project office overseeing

implementation of this automated system can help submission processing

centers process tax documents if the automated system does not meet

prescribed efficiency rates. The plan does not indicate how IRS’ plans for

the new imaging system would have to be revised if IRS receives more

paper returns than the system is being designed to handle. The plan, given

its focus on submission processing, also does not address the impact of a

shortfall in electronic returns on IRS’ plans for customer service.

We believe that contingency plans are needed now. IRS is beginning to

implement its customer service vision and is preparing to pilot the imaging

system. In conjunction with those efforts, IRS needs to identify and take

into account the impact of possible shortfalls in electronic filing. The

Page 15 GAO/GGD-96-12 Electronic Filing
B-260137 

longer IRS waits, the fewer its options become and the less time it will have

to fully consider alternatives.

Conclusions IRS’ ability to effectively process tax returns and assist taxpayers in the

future largely depends on how successful IRS is in converting to an

electronic environment and reducing its reliance on paper. Electronic

filing of tax returns is a critical part of that conversion. However, without

some dramatic changes in IRS’ current electronic filing program over the

next 6 years, many of the benefits available from electronic filing could go

unrealized.

The number of electronic returns has been growing at a pace that will

leave IRS far short of its 80-million goal in 2001. Even more important to

the ultimate success of electronic filing, in our opinion, is the fact that the

returns being filed electronically are generally the less complex returns

that are the least costly for IRS to process when filed on paper.

The heavy representation of less complex returns may be influenced, at

least in part, by IRS’ goal of 80 million returns. Focusing solely on this goal

could cause IRS to expend its limited resources on initiatives that are

directed toward groups of taxpayers or types of returns that provide the

greatest opportunity to increase the number of electronic returns but not

the greatest opportunity to reduce IRS’ paper-processing workload and

operating costs. Although a marketing strategy that focuses on reducing

paper and costs may generate fewer than 80 million returns, it could have

a more significant impact on IRS’ overall operations. The contract IRS

awarded in May 1995 may provide cost/benefit data IRS can use to reassess

its strategy. That information may help IRS identify effective steps to make

electronic filing more attractive to those taxpayers and tax return

preparers who are now put off by its cost.

If the growth and impact of electronic filing fall short of expectations, IRS’

paper-processing workload will increase. More paper means more errors,

which, in turn, would create a need for more taxpayer contacts.

Depending on the extent of the electronic filing shortfall, IRS may need to

increase the number and/or size of submission processing and customer

service centers and adjust plans for equipping and staffing the centers.

However, IRS is not prepared to make those adjustments because it has no

contingency plans.

Page 16 GAO/GGD-96-12 Electronic Filing
B-260137 

Recommendations to

the Commissioner of

Internal Revenue

To help better ensure the success of IRS’ modernization, we recommend

that the Commissioner do the following:

• Identify those groups of taxpayers who offer the greatest opportunity to

reduce IRS’ paper-processing workload and operating costs if they were to

file electronically and develop strategies that focus IRS’ resources on

eliminating or alleviating impediments that inhibit those groups from

participating in the program, including the impediment posed by the

program’s cost.

• Adopt goals for electronic filing that focus on reducing IRS’

paper-processing workload and operating costs. These goals could be used

in addition to the existing electronic filing goal to assess IRS’ progress in

achieving the intended benefits of electronic filing.

• Prepare contingency plans for the possibility that the electronic filing

program will fall short of expectations.

Agency Comments

and Our Evaluation

We requested comments on a draft of this report from the Commissioner

of Internal Revenue or her designated representative. Responsible IRS

officials, including IRS’ Electronic Filing Executive and Site Executives for

Computing Centers and Submission Processing, provided IRS’ comments in

a July 27, 1995, meeting. These officials provided a few factual

clarifications that we have incorporated in this report where appropriate.

The officials also said that they generally agreed with our report

recommendations. They stated that they recognized that much work

needed to be done to increase the number of electronic returns and

identified plans or actions that were under way that they believe address

the recommendations. We agree that IRS has developed plans and is taking

action to increase the number of electronic returns. However, we remain

concerned that unless those actions or plans are supported by the type of

analysis and goal setting that we are recommending, IRS may not be

effectively targeting its limited resources for marketing the electronic

filing program.

On our first recommendation on identifying taxpayers who offer the

greatest opportunity to reduce IRS’ paper-processing workload and costs,

IRS officials said that (1) they strongly believe that the electronic filing

program already focuses on those taxpayers who offer the greatest

opportunity to reduce IRS’ paper-processing workload—essentially

individual taxpayers—but had not yet prepared a business case to support

that belief, (2) they were expanding TeleFile nationwide for the 1996 filing

season to make electronic filing available to more individual taxpayers,

Page 17 GAO/GGD-96-12 Electronic Filing
B-260137 

and (3) research was under way to help make electronic filing more

appealing to taxpayers and to help IRS expand the program to more

individual taxpayers. In addition, IRS believes its current focus on

individual taxpayers is appropriate because the bulk of its processing

costs stem from having to process large numbers of individual returns in a

short time period. IRS officials also said they are working with some large

businesses on electronic filing of employment tax returns. These returns

represent a large portion of all business returns filed.

Although the actions IRS mentioned may help expand the electronic

program, we believe the second and third items discussed above will most

likely have an effect on those taxpayers that are already attracted to IRS’

electronic filing program—those individual taxpayers who file relatively

simple returns. The expansion of TeleFile in 1996, for example, will have

no impact on those individual taxpayers that file more complex tax

returns. As we discuss on page 6, the expansion IRS refers to is a

geographic one—going from 10 states to all states in the 1996 filing season.

The TeleFile program will continue to focus on those taxpayers who file

the simplest individual tax return (Form 1040EZ).

IRS’ comment regarding research to make electronic filing more appealing

refers to analysis being done to profile (1) those taxpayers who currently

file electronically and (2) those who could file electronically, but currently

do not. IRS believes this profiling will assist in marketing electronic filing to

those individual taxpayers who do not currently use electronic filing. We

agree that such an analysis may be helpful as a marketing tool for district

offices. However, it is uncertain how this analysis will help alleviate some

of the current impediments to electronic filing for many individual

taxpayers, such as the cost to the taxpayer.

With respect to our second recommendation on adopting goals for

electronic filing that focus on reducing IRS’ paper-processing workload and

costs, IRS officials provided several examples of actions that they believed

indicated that they have adopted such goals. These examples included

(1) the contract to conduct cost and marketing analyses that we discuss on

page 14, (2) another contract that was awarded to develop a strategy to

reach taxpayers who could file from home computers, and (3) IRS’ plans to

eliminate processing of signature documents for electronic returns.

We agree that some of the actions IRS mentioned may reduce

paper-processing workload and costs. However, these actions are steps IRS

is taking to achieve its existing performance goal of 80 million returns. The

Page 18 GAO/GGD-96-12 Electronic Filing
B-260137 

intent of our recommendation is for IRS to develop other performance

goals based on the analysis done in response to the first recommendation.

IRS’ current performance goal provides little incentive to identify and

pursue opportunities for reducing the paper-processing costs associated

with more complex returns that may not represent a large number of

returns. The analysis called for in our first recommendation would put IRS

in a better position to develop specific goals for receiving certain types of

returns electronically based on the their contribution to reducing overall

paper-processing costs. For example, goals such as “receive 75 percent of

all corporate returns electronically by 2001” or “reduce the number of

paper returns processed (in terms of number of pages rather than number

of returns) by 50 percent,” might result in different decisions on how IRS

should focus its limited marketing resources than those decisions

currently being made.

On our third recommendation regarding contingency planning, IRS agreed

that it needed to prepare for the eventuality of receiving fewer electronic

returns in 2001. However, IRS representatives said that contingency

planning is not the only way to prepare for this eventuality. IRS officials

said IRS is using a program management approach to phase in operations

under its new business vision. IRS officials expected this approach to

provide the flexibility for adjusting program plans to address any

significant shortfall in the number of electronic returns received. In

addition, IRS officials said that the contract for procuring new scanning

equipment for paper returns is flexible. Therefore, IRS expects to have an

option to buy additional equipment if it needs to process more paper

returns than it originally estimated.

We reviewed a November 29, 1994, memorandum from IRS’ Modernization

Executive to the heads of offices that are involved in IRS’ modernization

program. That memorandum described the program management

approach that IRS refers to above and a program control process for

helping to ensure that IRS achieves its modernization goals. According to

the memorandum, the program control process will include risk

assessments that are to (1) identify impediments to delivering various

aspects of IRS’ business vision and (2) prompt the development of

mitigation strategies to address identified risks.

IRS would be responsive to our recommendation if it succeeds through its

program management approach in (1) promptly developing mitigation

strategies if more paper tax returns have to be processed in future years

Page 19 GAO/GGD-96-12 Electronic Filing
B-260137 

than IRS currently expects and (2) specifying alternative actions for

processing paper returns and implementing its customer service vision.

As agreed with your staff, unless you publicly announce the contents of

this report earlier, we plan no further distribution for 30 days. At that time

we will send copies to the Secretary of the Treasury, the Commissioner of

Internal Revenue, and other interested parties. We will also make copies

available to others on request.

The major contributors to this report are listed in appendix II. If you or

your staff have any questions about this report, you can reach me at

(202) 512-8633.

Sincerely yours,

Lynda Willis

Associate Director, Tax Policy and

 Administration Issues

Page 20 GAO/GGD-96-12 Electronic Filing
Page 21 GAO/GGD-96-12 Electronic Filing
Contents

Letter 1

Appendix I 

Legislative Needs

Cited in IRS’ May 1993

Electronic Filing

Strategy

24

Permit Payment of Taxes by Credit Card 24

Mandate Electronic Filing by Certain Tax Return Preparers and

Businesses

24

Eliminate Requirements for Paper Submissions in Electronic

Filing

25

Institute a Promotional Campaign 25

Propose Tax Incentives 26

Appendix II 

Major Contributors to

This Report

27

Figures Figure 1: Number of Returns Filed Electronically in Calendar

Years 1990 Through 1995 and Estimated Shortfall in Meeting

80-Million Goal for Calendar Year 2001

8

Figure 2: Estimated Savings That Could Have Been Realized if All

Individual Income Tax Returns Were Filed Electronically in 1994

and Estimated Amount That Went Unrealized

10

Abbreviations

AICPA American Institute of Certified Public Accountants

IRS Internal Revenue Service

Page 22 GAO/GGD-96-12 Electronic Filing
Page 23 GAO/GGD-96-12 Electronic Filing
Appendix I 

Legislative Needs Cited in IRS’ May 1993

Electronic Filing Strategy

In May 1993, the IRS Electronic Filing Strategy Task Group issued a report

that included 21 initiatives directed at increasing the use of electronic

filing. Five of those initiatives cited the need for legislation. As discussed

below, none of that legislation has been enacted and, in some cases, IRS

has decided not to seek legislation.

Permit Payment of

Taxes by Credit Card

One of the 21 initiatives was directed at increasing the number of balance

due returns filed electronically. Critical to the success of this initiative,

according to the task group, was legislation that would allow credit card

payments of tax obligations. Such a provision was included in section 4122

of H.R. 11, the Revenue Act of 1992, which was passed by both houses of

Congress but vetoed by the President. A similar provision was included in

other bills, none of which were enacted. Most recently, IRS included this

proposal in a package of legislative initiatives sent to the Assistant

Secretary of the Treasury for Tax Policy in January 1995. In February 1995,

Treasury’s Office of Fiscal Assistant Secretary raised several questions

about the potential costs associated with this proposal and how those

costs would be funded. As of June 26, 1995, IRS and Treasury had not

resolved these cost issues.

Mandate Electronic

Filing by Certain Tax

Return Preparers and

Businesses

The task group estimated that 46 million more electronic returns would be

received if (1) preparers of 100 or more individual returns were required to

offer electronic filing and (2) businesses with 10 or more employees were

required to file their returns electronically. The business returns

specifically identified by the task group were Form 1041 (U.S. Fiduciary

Income Tax Return), Form 1065 (U.S. Partnership Return of Income),

Form 1120 (U.S. Corporation Income Tax Return), Form 1120S (U.S.

Income Tax Return for an S Corporation), forms 5500 and 5500 C/R

(Annual Return/Report of Employee Benefit Plan), and Form 941

(Employer’s Quarterly Federal Tax Return).

In a November 1993 testimony before a subcommittee of the then House

Committee on Government Operations, the Assistant Secretary of the

Treasury for Tax Policy made the following comments:

“The Service has proposed that the Secretary be given regulatory authority to require that

tax returns be filed other than in paper form, including electronically or by magnetic

media. . . . Broad regulatory authority to require that returns be filed other than in paper

form is appropriate and essential to the Service’s ability to modernize its systems,

streamline its operations and, in general, deliver quality services at the least cost. However,

Page 24 GAO/GGD-96-12 Electronic Filing
Appendix I 

Legislative Needs Cited in IRS’ May 1993

Electronic Filing Strategy

in view of the potential burdens on taxpayers and preparers in complying with electronic

or magnetic media filing requirements, we currently are considering whether legislative

refinements to this proposal may be necessary to clarify the intended scope and timing of

the conversion to a non-paper based system.”

The proposal was eventually dropped because IRS and Treasury officials

believed that Congress would not pass legislation that would enable IRS or

Treasury to dictate who would have to file electronically.

Eliminate

Requirements for

Paper Submissions in

Electronic Filing

The task group noted that “In virtually every study conducted on

electronic filing, the issue of processing paper documents has been

identified as impacting negatively upon IRS’ ability to realize electronic

filing’s full savings potential.” The task group further said that “Eliminating

the requirement to prepare and submit paper documents could have a

significant impact on reducing the cost electronic filers pass on to their

customers.”

This initiative called for eliminating the paper documents associated with

electronic filing by proposing legislation that would (1) allow alternatives

to the paper signature document and (2) eliminate the submission of paper

attachments to the electronic return. H.R. 11, referred to earlier, included a

provision (section 4933) that would have addressed the first of those two

legislative needs by authorizing the Secretary of the Treasury to prescribe

alternative methods of verifying returns on a trial basis. IRS’ latest

proposal, included in its January 1995 submission to the Assistant

Secretary for Tax Policy, was broader. It would have authorized the

Secretary of the Treasury to permit alternative methods of (1) verifying,

signing, and subscribing returns and other statements and (2) submitting

written declarations, statements, or other documents required by the

Internal Revenue Code.

In April 1995, IRS’ Office of Chief Counsel concluded that IRS had regulatory

authority to prescribe alternative methods for signing and submitting tax

returns and other written documents. An IRS official said that IRS plans to

test signature alternatives in 1996.

Institute a

Promotional

Campaign

The task group determined that “a full scale, high-powered promotional

campaign” was needed to “maximize the number of electronic returns.”

Because of the anticipated scope of the promotional campaign, the task

group recommended that IRS obtain an appropriations rider for paid

Page 25 GAO/GGD-96-12 Electronic Filing
Appendix I 

Legislative Needs Cited in IRS’ May 1993

Electronic Filing Strategy

advertising. IRS has taken no action to get such a rider because of concerns

that a paid advertising campaign might jeopardize current free public

service advertising.

Propose Tax

Incentives

To encourage greater participation in electronic filing, the task group

proposed that IRS initiate legislative action to provide tax incentives for

businesses and preparers. The group suggested consideration of such

incentives as a more accelerated depreciation schedule for electronic

filing equipment and a higher percentage of investment tax credit. IRS has

decided not to pursue such legislation. As noted in this report, IRS does not

have the data needed to determine what kind of incentives would be most

effective and what level of incentives makes sense given the benefits of

electronic filing.

Page 26 GAO/GGD-96-12 Electronic Filing
Appendix II 

Major Contributors to This Report

General Government

Division, Washington,

D.C.

David J. Attianese, Assistant Director

Monika Gomez, Evaluator

John Lesser, Senior Evaluator

Sherrie Russ, Senior Evaluator

Cincinnati Regional

Office

Daniel J. Meadows, Evaluator-in-Charge

Linda Standau, Senior Evaluator

Laurie Housemeyer, Evaluator

Robert I. Lidman, Regional Assignment Manager

(268636) Page 27 GAO/GGD-96-12 Electronic Filing
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