TREASURY INSPECTOR GENERAL FOR TAX ADMINISTRATION 

The Affordable Care Act: 

An Improved Strategy Is Needed to 

Ensure Accurate Reporting and Payment 

of the Medical Device Excise Tax 

July 17, 2014 

Reference Number: 2014-43-043 

This report has cleared the Treasury Inspector General for Tax Administration disclosure review process 

and information determined to be restricted from public release has been redacted from this document. 

Redaction Legend: 

1 = Tax Return/Return Information 

2 = Risk Circumvention of Agency Regulation or Statute

Phone Number / 202-622-6500 

E-mail Address / TIGTACommunications@tigta.treas.gov

Website / http://www.treasury.gov/tigta
HIGHLIGHTS

THE AFFORDABLE CARE ACT: AN device manufacturers registered with the Food 

IMPROVED STRATEGY IS NEEDED TO and Drug Administration that are required to file 

ENSURE ACCURATE REPORTING AND a Form 720 and pay the excise tax. 

PAYMENT OF THE MEDICAL DEVICE In addition, processing controls do not ensure 

EXCISE TAX the accuracy of medical device excise tax 

figures reported on paper-filed Forms 720. Our 

Highlights analysis of 5,107 Forms 720 processed for the 

quarters ending March 31 and June 30, 2013, 

identified discrepancies in the amount of the 

Final Report issued on July 17, 2014 medical device excise tax and/or taxable sales 

amount captured from 276 paper-filed tax 

Highlights of Reference Number: 2014-43-043 returns. TIGTA identified medical device excise 

to the Internal Revenue Service Commissioners tax discrepancies totaling almost $117.8 million 

for the Small Business/Self-Employed Division when comparing the excise tax amount captured 

and the Wage and Investment Division. by the IRS from the Form 720 to the excise tax 

amount TIGTA calculated. 

IMPACT ON TAXPAYERS 

Finally, the IRS erroneously assessed The Affordable Care Act includes a tax provision 219 failure to deposit penalties totaling $706,753 that provides for an excise tax equal to against businesses filing a Form 720 for the 2.3 percent of the sales price for medical quarters ending March 31 and June 30, 2013, devices sold beginning January 1, 2013. which was designated a penalty relief period. Manufacturers, producers, and importers are The IRS had reversed 133 of the 219 penalty responsible for collecting the medical device assessments. When TIGTA alerted the IRS of 

excise tax and must file a Form 720, Quarterly the remaining 86 penalties, IRS management Federal Excise Tax Return. The Joint reversed the penalties and issued apology Committee on Taxation estimated revenues letters to the affected taxpayers. from the medical device excise tax of $20 billion 

for Fiscal Years 2013 through 2019. WHAT TIGTA RECOMMENDED 

WHY TIGTA DID THE AUDIT TIGTA recommended that the IRS continue 

refining its compliance strategy to include This audit was initiated as part of our continued actions that can be taken to identify coverage of the IRS’s implementation of key noncompliant manufacturers. TIGTA also Affordable Care Act tax provisions. The overall recommended that the IRS conduct a review of 

objective of this review was to assess the IRS the 276 tax returns TIGTA identified to 

processing of tax returns reporting the medical determine the proper excise tax owed, establish device excise tax and efforts to identify taxpayer a process to verify the accuracy of the medical noncompliance. device excise tax amount for paper-filed 

Forms 720, and initiate a process to correspond WHAT TIGTA FOUND with taxpayers to obtain missing taxable sales or 

Our review found that both the number of tax amounts. 

Forms 720 filed reporting the medical device The IRS agreed with our recommendations and excise tax and the amount of the associated plans to consider alternative strategies for revenue reported are lower than estimated. The identifying noncompliant manufacturers, identify IRS is attempting to develop a compliance programming changes needed to improve the strategy to ensure that businesses are compliant math verification for paper-filed Forms 720, and with medical device excise tax filing and implement procedures for corresponding with payment requirements and has taken several taxpayers if the changes can be accomplished measures to advise medical device within budgetary constraints. The IRS also manufacturers of the new excise tax. However, indicated that about two-thirds of the paper-filed the IRS cannot identify the population of medical tax returns TIGTA identified were reviewed. 
DEPARTMENT OF THE TREASURY 

WASHINGTON, D.C. 20220

TREASURY INSPECTOR GENERAL 

FOR TAX ADMINISTRATION 

July 17, 2014 

MEMORANDUM FOR COMMISSIONER, SMALL BUSINESS/SELF-EMPLOYED 

DIVISION 

COMMISSIONER, WAGE AND INVESTMENT DIVISION 

FROM: Michael E. McKenney 

Acting Deputy Inspector General for Audit 

SUBJECT: Final Audit Report – The Affordable Care Act: An Improved Strategy 

Is Needed to Ensure Accurate Reporting and Payment of the Medical 

Device Excise Tax (Audit # 201340332) 

This report presents the results of our review to assess the Internal Revenue Service’s processing 

of tax returns reporting the medical device excise tax and efforts to identify taxpayer 

noncompliance. This audit is included in the Treasury Inspector General for Tax 

Administration’s Fiscal Year 2014 Annual Audit Plan and addresses the major management 

challenge of Implementing the Affordable Care Act and Other Tax Law Changes. 

Management’s complete response to the draft report is included as Appendix V.

Copies of this report are also being sent to the Internal Revenue Service managers affected by the 

report recommendations. If you have any questions, please contact me or Russell P. Martin, 

Acting Assistant Inspector General for Audit (Returns Processing and Account Services). 
The Affordable Care Act: An Improved Strategy 

Is Needed to Ensure Accurate Reporting and Payment 

of the Medical Device Excise Tax 

Table of Contents 

Background .......................................................................................................... Page 1 

Results of Review ............................................................................................... Page 4 

Development of a Compliance Strategy to Identify Medical 

Device Excise Tax Nonfilers Continues to Be a Challenge ......................... Page 4 

Recommendation 1: ........................................................ Page 6 

Processing Controls Do Not Ensure the Accuracy of 

Medical Device Excise Tax Figures Reported on 

Paper-Filed Forms 720 .................................................................................. Page 7 

Recommendation 2: ........................................................ Page 9 

Recommendations 3 and 4: .............................................. Page 10 

Taxpayers Were Erroneously Assessed Failure to Deposit 

Penalties During the Penalty Relief Period ................................................... Page 10 

Processes Were Timely Developed to Review Applications 

for Medical Device Excise Tax-Exempt Registrations ................................. Page 11 

Appendices 

Appendix I – Detailed Objective, Scope, and Methodology ........................ Page 13 

Appendix II – Major Contributors to This Report ........................................ Page 18 

Appendix III – Report Distribution List ....................................................... Page 19 

Appendix IV – Outcome Measures ............................................................... Page 20 

Appendix V – Management’s Response to the Draft Report ....................... Page 22 

 
The Affordable Care Act: An Improved Strategy 

Is Needed to Ensure Accurate Reporting and Payment 

of the Medical Device Excise Tax 

Abbreviations 

BRTF Business Return Transaction File 

CY Calendar Year 

e-filed Electronically filed 

FDA Food and Drug Administration 

FTD Failure to Deposit 

IRS Internal Revenue Service 

NAICS North American Industry Classification System 

TIGTA Treasury Inspector General for Tax Administration 
The Affordable Care Act: An Improved Strategy 

Is Needed to Ensure Accurate Reporting and Payment 

of the Medical Device Excise Tax 

Background 

The Patient Protection and Affordable Care Act of 20101 and the Health Care and Education 

Reconciliation Act of 20102 that made amendments to it (collectively referred to as the 

Affordable Care Act hereafter) were both signed into law in March 2010. The Affordable Care 

Act revenue provisions are expected to generate $438 billion between Fiscal Years 2010 and 

2019.3 One such provision is Section 1405 that 

provides for an excise tax equal to 2.3 percent of the 

sales price for medical devices sold beginning 

January 1, 2013. The Joint Committee on Taxation 

estimated revenues from the medical device excise tax 

of $20 billion for Fiscal Years 2013 through 2019. 

In general, a taxable medical device is a device 

intended for humans that is listed with the Food and Drug Administration (FDA) under section 

510(j) of the Federal Food, Drug, and Cosmetic Act4 and 21 Code of Federal Regulations 

part 807. Exclusions include eyeglasses, contact lenses, hearing aids, and medical devices 

purchased by the general public at retail for individual use5 as well as medical devices exported 

outside of the United States. 

Manufacturers, producers, and importers (commonly referred to as “manufacturers” or 

“businesses” throughout the report) are responsible for collecting the medical device excise tax 

and must file a Form 720, Quarterly Federal Excise Tax Return. The medical device excise tax 

is reported on Part 1 of Form 720. Manufacturers are required to enter the total sales price 

(referred throughout as taxable sales) of all taxable medical devices sold during the quarter and 

the total tax due (2.3 percent of the taxable sales). The first quarterly tax returns reporting the 

 

1

 Pub. L. No. 111-148, 124 Stat. 119 (2010) (codified as amended in scattered sections of the U.S. Code), as 

amended by the Health Care and Education Reconciliation Act of 2010, Pub. L. No. 111-152, 124 Stat. 1029. 2

 Pub. L. No. 111-152, 124 Stat. 1029. (See Affordable Care Act, infra). 

3

 Joint Committee on Taxation, JCX-17-10, Estimated Revenue Effects of the Amendment in the Nature of a 

Substitute to H.R. 4872, the “Reconciliation Act of 2010,” as Amended, in Combination With the Revenue Effects 

of H.R. 3590, the “Patient Protection and Affordable Care Act,” as Passed by the Senate and Scheduled for 

Consideration by the House Committee on Rules on March 20, 2010 (March 20, 2010). 

4

 Pub. L. No. 75-717, 52 Stat. 1040 (1938). 

5 This is known as the retail exemption. This exemption includes devices of a type generally purchased by the 

general public at retail for individual use; regularly available for purchase and use by individuals who are not 

medical professionals; and not primarily intended for use in a medical institution or office or by a medical 

professional. The evaluation of whether the retail exemption applies is based on all the relevant facts and 

circumstances. 

Page 1

Medical devices are devices 

intended for humans, including any 

instrument, machine, or implant 

intended for the diagnosis, cure, 

treatment, or prevention of disease. 
The Affordable Care Act: An Improved Strategy 

Is Needed to Ensure Accurate Reporting and Payment 

of the Medical Device Excise Tax 

medical device excise tax were due April 30, 2013. Figure 1 shows where the medical device 

excise tax is reported on Form 720. 

Figure 1: Reporting of the Medical Device Excise Tax on Form 720 

Source: Form 720 for Tax Year6 2013.

Manufacturers are required to submit semimonthly7 payments of excise tax either by the 

Electronic Federal Tax Payment System8 or an approved alternative method9 when the tax 

liability is $2,500 or more for the quarter. However, if the tax liability is less than $2,500 for the 

quarter, then the tax is payable by the tax return due date. Manufacturers are subject to a failure 

to deposit (FTD) penalty if 95 percent of the net tax liability is not timely deposited for the 

semimonthly period. 

 

6

 A 12-month accounting period for keeping records on income and expenses used as the basis for calculating the 

annual taxes due. 

7

 A semimonthly period is the first 15 days of a month (which would be the first semimonthly period) or the 16th day 

of the month to the last day of the month (which would be the second semimonthly period). 8

 The system designed to process Federal tax deposits and other types of business and individual payments. 

9

 Alternative methods include tax professional, financial institution, payroll service, or other trusted third party. 

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The Affordable Care Act: An Improved Strategy 

Is Needed to Ensure Accurate Reporting and Payment 

of the Medical Device Excise Tax 

This review was performed at the IRS Submission Processing Site in Covington, Kentucky, and 

with information obtained from the Small Business/Self-Employed Division Headquarters in 

Washington, D.C., and the Wage and Investment Division Headquarters in Atlanta, Georgia, 

during the period June 2013 through March 2014. We conducted this performance audit in 

accordance with generally accepted government auditing standards. Those standards require that 

we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable 

basis for our findings and conclusions based on our audit objective. We believe that the 

evidence obtained provides a reasonable basis for our findings and conclusions based on our 

audit objective. Detailed information on our audit objective, scope, and methodology is 

presented in Appendix I. Major contributors to the report are listed in Appendix II. 

 

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The Affordable Care Act: An Improved Strategy 

Is Needed to Ensure Accurate Reporting and Payment 

of the Medical Device Excise Tax 

Results of Review 

Development of a Compliance Strategy to Identify Medical Device 

Excise Tax Nonfilers Continues to Be a Challenge 

The IRS is attempting to develop a compliance strategy to ensure that businesses are compliant 

with medical device excise tax filing and payment requirements. Specifically, the IRS has taken 

several measures to advise medical device manufacturers of the new excise tax during 

implementation, including: 

 Developed a communication and outreach plan for taxpayers that might owe the new tax 

on medical device sales. 

 Disseminated information regarding the new filing requirements in many different forms, 

including adding information to the IRS website and giving seminars at IRS Nationwide 

Tax Forums. 

 Prepared high-level talking points for executives and phone scripts for telephone assistors 

responding to taxpayer questions. 

 Revised Form 720 to reflect the tax and updated the associated Form 720 instructions, 

which included adding a paragraph describing the tax in the ‘What’s New’ section on the 

first page and referencing the statute and regulations associated with the new tax filing 

requirements. 

However, the IRS still cannot identify the population of medical device manufacturers registered 

with the FDA that are required to file a Form 720 and pay the medical device excise tax. 

Businesses involved in the production and distribution of medical devices intended for 

commercial distribution in the United States are required to register annually with the FDA.10 

The IRS has analyzed medical device registration data obtained from the FDA. However, this 

data cannot be used to definitively identify manufacturers subject to the medical device excise 

tax reporting and payment requirements. Specific exemptions, other safe harbors,11 and retail 

exemptions apply, and therefore not all businesses registered with the FDA are engaged in 

taxable sales of medical devices. For example, the IRS evaluated the FDA’s registration data as 

of May 21, 2013, and identified 16,370 businesses with registered medical devices but estimated 

 

10 21 Code of Federal Regulations part 807. 

11 Devices or classes of devices that are considered to be of a type generally purchased by the general public at retail 

for individual use. For example, devices that qualify as durable medical equipment, prosthetics, orthotics, or 

supplies for which payment is available on a purchase basis under Medicare Part B payment rules. 

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The Affordable Care Act: An Improved Strategy 

Is Needed to Ensure Accurate Reporting and Payment 

of the Medical Device Excise Tax 

that only 4,500 to 7,800 of these businesses may sell taxable medical devices. The IRS 

concluded that a more precise estimate of businesses selling taxable devices could not be made 

because the FDA’s requirements for registering are much different than requirements for paying 

the excise tax. In addition, the Employer Identification Number12 is not captured as part of the 

FDA’s registration process. This increases the difficulty for the IRS to compare tax returns filed 

with the FDA’s registration data to identify the population of potential nonfilers. 

The North American Industry Classification System code is unreliable for use to 

identify businesses that may be subject to excise tax reporting and payment 

The North American Industry Classification System (NAICS) is a system for classifying 

business establishments by type of economic activity. The NAICS is the standard used by 

Federal agencies in classifying business establishments for the purpose of collecting, analyzing, 

and publishing statistical data related to the U.S. business economy. Businesses are required to 

select from a list of principal business activities and enter the associated NAICS code on the 

business income tax returns (e.g., Form 1120, U.S. Corporation Income Tax Return). For 

example, businesses that are engaged in the manufacturing of medical equipment and supplies 

are supposed to enter NAICS Code 339110 (Medical Equipment and Supplies Manufacturing) on 

their tax return. However, our testing found that the use of the NAICS code does not accurately 

identify businesses engaged in the sale of medical devices. For example: 

 The NAICS Code 339110 is not the only NAICS code used by manufacturers of 

medical devices. We identified 2,007 of 2,965 businesses filing a Form 720 during 

quarters ending March 31 and June 30, 2013, for the medical device excise tax reported a 

NAICS code other than 339110. For example, the other NAICS codes reported by the 

manufacturers included NAICS Code 454390 (Other Direct Selling Establishments); 

NAICS Code 423990 (Other Miscellaneous Durable Goods); and NAICS Code 339900 

(Other Miscellaneous Manufacturing). 

 The NAICS code does not always signify a business that is engaged in taxable sales 

of medical devices. We identified 5,443 businesses filing Tax Year 2012 income tax 

returns reporting NAICS Code 339110 that did not file a Form 720 in Tax Year 2013 

reporting the medical device excise tax. 

Furthermore, a prior Treasury Inspector General for Tax Administration (TIGTA) report on the 

excise tax on indoor tanning services13 cited concerns about the reliability of NAICS codes. 

These concerns included that the IRS does not require entry of the NAICS code on filed tax 

returns and that the codes cannot be relied upon as being correct. This report further concluded 

 

12 The Employer Identification Number is a unique nine-digit number issued by the IRS to identify a taxpayer’s 

business account. 

13 TIGTA, Ref. No. 2011-40-115, Affordable Care Act: The Number of Taxpayers Filing Tanning Excise Tax 

Returns Is Lower Than Expected (Sept. 2011).

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The Affordable Care Act: An Improved Strategy 

Is Needed to Ensure Accurate Reporting and Payment 

of the Medical Device Excise Tax 

that the IRS faced difficulties in identifying the population of businesses subject to the tanning 

excise tax. With regard to nonfiling of the required Forms 720, the IRS recognized that some 

taxpayers that had not filed required returns may have simply been unaware of the new tax rather 

than willfully ignoring the law. In June 2011, the IRS issued notices to approximately 

14,000 taxpayers that were identified through various data sources as potentially owing the 

tanning excise tax but had not filed a Form 720 during the third or fourth quarters of Calendar 

Year (CY) 2010. 

The IRS indicated that the experience realized with the indoor tanning tax is not relevant to the 

medical device excise tax due to the dissimilarity of the industries and taxpayers involved. IRS 

management indicated that they are pursuing the use of the FDA registration database, 

Form 637, Application for Registration (For Certain Excise Tax Activities), registration 

information, and other information to identify and perfect information on potential medical 

device nonfilers. Once the population of nonfilers is identified, the IRS will evaluate 

alternatives, which may include the issuance of a notice. 

Tax returns filed and taxes reported are lower than original estimates 

Our review found that both the number of Forms 720 filed and the amount of the medical device 

excise tax revenue being reported are lower than estimated. Figure 2 shows that the IRS 

processed 5,107 Forms 720 with reported excise taxes of $913.4 million for the quarters ending 

March 31 and June 30, 2013. The IRS estimated between 9,000 and 15,600 quarterly Forms 720 

tax returns with excise tax revenue of $1.2 billion for this same period. 

Figure 2: Quarterly Return Filings 

and Medical Device Excise Tax Revenues 

Quarter (period ended) Returns Filed Taxes Reported 

March 31, 2013 2,729 $478.6 million

June 30, 2013 2,378 $434.8 million 

Total 5,107 $913.4 million 

Source: TIGTA’s analysis of the Business Return Transaction File (BRTF)14 as of 

September 5, 2013. 

Recommendation 

Recommendation 1: The Commissioner, Small Business/Self-Employed Division, should 

continue refining its compliance strategy to include actions that can be taken to identify 

noncompliant manufacturers. This should include an assessment of the benefit of issuing notices 

 

14 IRS database that contains tax return information originally filed by the taxpayer and transcribed from Forms 720.

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The Affordable Care Act: An Improved Strategy 

Is Needed to Ensure Accurate Reporting and Payment 

of the Medical Device Excise Tax 

to potential nonfilers of the medical device excise tax identified from the manufacturers 

registered with the FDA. 

Management’s Response: The IRS agreed with this recommendation. The IRS is 

considering alternative strategies for identifying noncompliant medical device 

manufacturers and may issue notices to potential nonfilers if there appears to be a benefit 

to future tax administration. 

Processing Controls Do Not Ensure the Accuracy of Medical Device 

Excise Tax Figures Reported on Paper-Filed Forms 720 

Our analysis of 5,107 Forms 720 processed for the quarters ending March 31 and June 30, 2013, 

identified discrepancies in the amount of the medical device excise tax and/or taxable sales 

amount captured from 276 paper-filed tax returns. We identified medical device excise tax 

discrepancies totaling almost $117.8 million when comparing the excise tax amount captured by 

the IRS from the Form 720 to the excise tax amount we calculated. Our calculated excise tax 

amount was computed by taking the taxable sales amount captured by the IRS from the 

Form 720 and multiplying this amount by the tax rate (i.e., 2.3 percent). 

The discrepancies we identified included instances in which our calculated excise tax amount 

was less than the amount of tax captured from the Form 720 (potential overstated tax amount) 

and more than the amount of tax captured from the Form 720 (potential understated tax amount). 

Figure 3 details the 276 paper-filed Forms 720 for which the tax amount was either overstated or 

understated by $100 or more based upon the amount reported or captured for taxable sales. 

Figure 3: Discrepancies on Forms 720 Reporting Medical Device Excise Tax 

Amounts for Quarters Ending March 31 and June 30, 2013 

Description Potential Overstated 

Tax Amount

Potential Understated 

Tax Amount Total

Number of Tax Returns 225 51 276 

Reported Tax Amount on 

Forms 720 $43.3 million $2.9 million $46.1 million15

TIGTA’s Calculated Tax 

Amount $1.7 million $79.1 million $80.8 million 

Total Discrepancy $41.6 million $76.2 million16 $117.8 million 

Source: TIGTA’s analysis of the BRTF as of September 5, 2013.

 

15 Total does not equal sum of overstated and understated tax amounts due to rounding. 

16 ***************************1*************************. 

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The Affordable Care Act: An Improved Strategy 

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of the Medical Device Excise Tax 

The IRS does not systemically verify tax calculations on paper-filed Forms 720 

IRS instructions for Form 720 require taxpayers to enter the total sales price of all taxable 

medical devices sold during the quarter and the total tax due. The IRS systemically rejects 

electronically filed (e-filed) Forms 720 when the medical device excise tax amount does not 

equal the sum of taxable sales multiplied by the 2.3 percent tax rate. However, a similar control 

is not in place for paper-filed Forms 720. Discrepancies can result from taxpayer errors or tax 

examiner errors when inputting data from the paper-filed Forms 720 into IRS computers. Our 

analysis of the 276 paper-filed Forms 720 with discrepancies found that: 

 106 (38 percent) Forms 720 contained a sales price amount with a decimal that was likely 

excluded, misplaced, or missed during the processing of these tax returns. The IRS 

indicated that during post-processing actions it identified a transcription problem with the 

taxable sales recorded during processing that involved a missing or excluded decimal 

point. For example, 

Taxpayer A enters taxable sales as $1234567 without a comma or decimal 

point. During tax return processing, an IRS tax examiner enters this 

amount as $12,345.67; however, the actual taxable sales was $1,234,567. 

The IRS indicated that this type of discrepancy occurred because the Tax Year 2013 

Form 720 did not contain a cents column for the taxable sales. The IRS revised 

Form 720 for Tax Year 2014 to include a cents column to encourage taxpayers to report 

the taxable sales amount in a dollar and cents format. 

 88 (32 percent) Forms 720 contained an excise tax amount that was the same as the 

taxable sales amount. 

 82 (30 percent) Forms 720 had no specific pattern in the discrepancy. 

IRS management explained that the discrepancies included inaccurate decimal point placement 

and transcription errors of the taxable sales amount and not errors resulting in actual lost 

revenue. ***************************2************************** 

***********************************2******************************************

***********************************2******************************************

***********************************2******************************************

**2**. Otherwise, implementing the changes would result in system downtime and processing 

delays. However, we noted that the IRS has programmed a systemic check for e-filed returns 

received through the Modernized e-File system17 to identify and reject tax returns with 

discrepancies in tax amounts reported on Form 720. 

 

17 The Modernized e-File system is the IRS’s electronic filing system that enables real-time processing of tax returns 

while improving error detection, standardizing business rules, and expediting acknowledgements to taxpayers.

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The Affordable Care Act: An Improved Strategy 

Is Needed to Ensure Accurate Reporting and Payment 

of the Medical Device Excise Tax 

The IRS calculates tax amount or taxable sales when missing on paper-filed 

returns 

In addition to the discrepancies in tax amounts, we also found that when a filer does not include 

the taxable sales or tax amount on a paper-filed Form 720 reporting the medical device excise 

tax, the IRS identifies these tax returns for correction during the processing of the tax return. 

Contrary to the processing of e-filed Forms 720, which are systemically rejected when the 

taxable sales or tax amount is missing, for paper-filed returns the IRS will calculate the missing 

amount using whichever amount is present (i.e., taxable sales or tax amount). For example, if 

the tax amount is missing, the IRS calculates it by multiplying the taxable sales amount by 

2.3 percent. As of September 4, 2013, the IRS’s systemic check for missing medical device sales 

price or tax amount identified 261 paper-filed returns requiring correction. 

The process the IRS follows in calculating missing amounts for the medical device excise tax is 

not consistent with the IRS’s processing procedures for another excise tax. For example, when 

taxpayers file a Form 720 to report excise tax on tires,18 the IRS will correspond with the 

taxpayer to obtain missing information such as the number of tires. When we brought this to IRS 

management’s attention, they explained that paper-filed tax returns are perfected according to 

taxpayer intent in the IRS’s Submission Processing Document Perfection Operation. IRS 

management also indicated that the IRS has the authority to correspond for missing information. 

However, if the taxpayer failed to reply, the IRS would ultimately have to calculate the tax based 

on the information provided on the return and follow the taxpayer’s intent. 

When the taxable sales or tax amount is missing or the tax return contains potential discrepancies 

in tax amount, the IRS cannot ensure the accuracy of the tax return information and may post an 

incorrect tax amount to the taxpayer’s account. This could lead to erroneously issued refunds or 

erroneous tax assessments. 

Recommendations 

Recommendation 2: The Commissioner, Small Business/Self-Employed Division, should 

conduct a review of the 276 paper-filed tax returns we identified with a discrepancy between the 

excise tax amount captured by the IRS from the Form 720 and the excise tax amount we 

calculated as being owed to determine the proper excise tax owed. 

Management’s Response: The IRS agreed with this recommendation. The IRS 

indicated that it completed a review of approximately two-thirds of the 276 paper-filed 

returns identified by TIGTA as having a discrepancy. The review included returns with 

both overstatements and understatements; however, these discrepancies had no tax 

consequence. The payments and deposits on those returns equaled the amount of 

 

18 A taxable tire is any tire of the type used on highway vehicles if wholly or partially made of rubber and if marked 

according to Federal regulations for highway use.

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reported tax. The IRS indicated that since two-thirds of the 276 identified returns were 

reviewed and no change to the reported tax was found, no further action will be taken 

with regard to those returns. 

The Commissioner, Wage and Investment Division, should:

Recommendation 3: Establish a process for paper-filed Forms 720 to math verify the 

accuracy of the medical device excise tax amount and correspond with taxpayers on the 

corrected taxable amount. 

Management’s Response: The IRS agreed with this recommendation. The IRS will 

identify the programming changes needed to improve math verification for paper-filed 

Forms 720 and will determine if those changes can be accomplished within budgetary 

and resource constraints. Dependent on the deployment of the programming changes, the 

IRS will identify those returns with errors and correspond with the taxpayers to correct 

them. In the event the requested programming changes are not funded, the IRS will 

consider this action closed upon completion of the cost analysis and funding decision. 

Recommendation 4: Initiate a process to correspond with taxpayers to obtain missing taxable 

sales or tax amounts during the processing of paper-filed Forms 720 reporting the medical device 

excise tax. 

Management’s Response: The IRS agreed with this recommendation. Dependent 

on the deployment of programming changes discussed above, the IRS will implement 

procedures for corresponding with taxpayers to obtain missing information needed to 

accurately process paper-filed Forms 720. In the event the requested programming 

changes are not funded, the IRS will consider this action closed upon completion of the 

cost analysis and funding decision. 

Taxpayers Were Erroneously Assessed Failure to Deposit Penalties 

During the Penalty Relief Period 

The IRS erroneously assessed 219 FTD penalties during the period July 8 to December 9, 2013, 

totaling $706,753 against businesses filing a Form 720 for the quarters ending March 31 and 

June 30, 2013, which was designated as part of the penalty relief period. The IRS and the 

U.S. Department of the Treasury recognized that many medical device manufacturers would still 

be preparing their systems to comply with the medical device excise tax when the tax went into 

effect on January 1, 2013, including the requirement to make semimonthly deposits. As a result, 

the IRS issued Notice 2012-77, Interim Guidance and Request for Comments; Medical Device 

Excise Tax; Manufacturers Excise Taxes; Constructive Sale Price; Deposit Penalties, on 

December 5, 2012, which provided temporary relief from the penalty for manufacturers who fail 

to make timely deposits during the first three quarters of CY 2013 so long as the taxpayer shows 

a good faith effort to comply. 

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As of January 8, 2014, the IRS reversed 133 of the 219 penalty assessments. The IRS advised us 

that these penalty reversals may have occurred due to taxpayer responses to assessment notices. 

When we alerted the IRS of the 86 unreversed penalty assessments, it agreed that the penalties 

were assessed in error because of employee error and the fact that the Internal Revenue Manual19

was not properly updated. As a result, IRS management reversed the penalties and issued 

apology letters to the 86 affected taxpayers we identified. In addition, IRS management 

reminded employees working the FTD penalty assessments of the temporary FTD penalty relief 

and updated the Internal Revenue Manual to reflect that penalties would not be assessed in the 

first three quarters of CY 2013 so long as the taxpayer shows a good faith effort to comply. 

Finally, the IRS obtained an extract from the Master File20 listing accounts that contained an 

FTD penalty associated with the medical device excise tax for the first three quarters of 

CY 2013, reversed erroneous penalty assessments, and issued apology letters to the affected 

taxpayers. 

Processes Were Timely Developed to Review Applications for Medical 

Device Excise Tax-Exempt Registrations 

As of December 5, 2013, the IRS had approved Forms 637 for 1,823 of the 2,295 manufacturers 

applying for tax-exempt status. The IRS timely ensured that the manufacturers applying for 

tax-exempt status were engaged in the manufacturing and/or distribution of medical devices and 

had a satisfactory tax filing history. Our review of a statistically valid sample of 

77 manufacturers21 with approved Forms 637 found that the IRS reviewed the exempt 

registrations within the required 60-day time frame.22 In addition, the IRS correctly ensured that 

the businesses were engaged in the manufacturing and/or distribution of medical devices and had 

a satisfactory tax filing history.23 

Under certain conditions, manufacturers may engage in a nontaxed sale of medical devices that 

would otherwise be taxed. Tax-free sales include medical devices sold to a buyer for the purpose 

of further manufacture or resale to a buyer for further manufacture as well as sales to a buyer 

with a place of business in the United States for export or for resale to a second purchaser for 

 

19 The IRS’s official policies and procedures. 

20 The IRS database that stores various types of taxpayer account information. This database includes individual, 

business, and employee plans and exempt organizations data. 

21 We used attribute sampling to calculate the minimum sample size of 77 approved Forms 637 based on a 

confidence level of 90 percent, an expected rate of occurrence of 5 percent, and a precision rate of ± 4 percent. 22 Only ***********************1********************************; therefore, based on a one-sided 

90 percent confidence level, we are 90 percent confident that at most 90 Forms 637 were not timely processed. 

23 We did not identify any exceptions from a sample of 77 approved Forms 637; therefore, based on a one-sided 

90 percent confidence level, we are 90 percent confident that at most 54 Forms 637 have invalid application 

approvals. 

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export. To qualify as a tax-free sale, both parties must be registered with the IRS using 

Form 637. 

In anticipation of an influx of manufacturers applying for tax-exempt registrations, the IRS 

developed a provisional registration approval process to expedite evaluation of the tax-exempt 

status applications. This process included revising Form 637 and updating the associated 

instructions to permit businesses to use Form 637 to request a registration for nontaxed sales of 

medical devices. For the provisional registration, the IRS review process did not include a field 

visit or inspection of taxpayer records. The IRS included an addendum to the registration letter 

to the manufacturer to advise that IRS approval was conditional and subject to further review. 

Furthermore, IRS guidance requires a revenue agent or tax examiner within the Small Business/ 

Self-Employed Division to complete evaluations of Form 637 applications within 60 days from 

the date of assignment. The two primary factors, whether provisional or not, considered during 

the application review process include the “Activity Test” and the “Satisfactory Tax History 

Test.” 

 Activity Test: The taxpayer’s business operations show that the applicant is regularly 

engaged in the activity for which the registration is requested. 

 Satisfactory Tax History Test: The taxpayer has a satisfactory tax filing history 

including deposit, payment, reporting, and claims for all Federal taxes. 

Accurately processing approvals for tax-exempt registration provides the IRS a reasonable basis 

for entrusting these manufacturers to engage in nontaxed sales of medical devices that would 

otherwise be taxed. 

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Appendix I 

Detailed Objective, Scope, and Methodology 

Our overall objective was to assess the effectiveness of IRS processing of tax returns reporting 

the medical device excise tax and efforts to identify taxpayer noncompliance. To accomplish 

this objective, we: 

I. Evaluated the effectiveness of IRS controls to verify the accuracy of the medical device 

excise tax amount reported by manufacturers on Form 720, Quarterly Federal Excise Tax 

Return. 

A. Reviewed the IRS’s Internal Revenue Manual1

 and Modernized e-File system2

business rules and met with IRS personnel to identify processing controls to ensure 

the accuracy of the medical device excise tax amount reported on Form 720. 

B. Compared the filing requirements between paper- and e-filed Forms 720 to identify 

inconsistencies between the two filing methods. 

C. Conducted a walkthrough at the IRS Submission Processing Site in Covington, 

Kentucky, to observe measures taken by the Error Resolution and Document 

Perfection Operation functions to ensure the accuracy of the medical device excise 

tax amounts reported on Forms 720 during processing. 

D. Reviewed management information reports to identify the volume of error conditions 

associated with Forms 720 reporting the medical device excise tax. 

E. Assessed the accuracy of the medical device excise tax amount reported on Form 720. 

1. Identified 5,107 Forms 720 processed for the quarters ending March 31 and 

June 30, 2013, reporting medical device excise taxes from the BRTF3

 as of 

September 5, 2013. 

2. Evaluated the accuracy of the tax amount recorded on the BRTF. 

a) Calculated the medical device excise tax based on the taxable sales recorded 

on the BRTF multiplied by the tax rate of 2.3 percent. 

 

1

 The IRS’s official policies and procedures. 

2

 The Modernized e-File system is the IRS’s electronic filing system that enables real-time processing of tax returns 

while improving error detection, standardizing business rules, and expediting acknowledgements to taxpayers. 3

 IRS database that contains tax return information originally filed by the taxpayer and transcribed from Forms 720. 

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b) Compared the excise tax amount calculated in Step I.E.2.a to the medical 

device excise tax recorded on the BRTF and posted to the Master File.4 

c) Identified 276 Forms 720 for which the medical device excise tax amount was 

either overstated or understated by $100 or more based upon the reported 

taxable sales amount, resulting in a potential difference of $117.8 million in 

excise taxes. 

II. Assessed the effectiveness of IRS efforts to promote taxpayer compliance and identify 

nonfilers. 

A. Identified IRS communication materials available to inform the business community 

about the medical device excise tax and return filing and reporting requirements. 

B. Discussed with IRS management the post-processing compliance measures as 

planned for the medical device excise tax. 

C. Discussed with IRS management their efforts to identify nonfilers. 

D. Assessed the use of NAICS5 codes to identify nonfilers. 

1. Identified 6,266 Tax Year6 2012 tax returns with gross receipts greater than $0 

reporting NAICS Code 339110 (Medical Equipment and Supplies 

Manufacturing). 

2. Of the 6,266 Tax Year 2012 tax returns identified in Step II.D.1, determined that 

5,575 Tax Year 2012 tax returns did not report the medical device excise tax on a 

Form 720 for the quarters ending March 31 and June 30, 2013, processed through 

September 5, 2013. 

3. Of the 5,575 Tax Year 2012 tax returns identified in Step II.D.2, determined that 

5,443 Tax Year 2012 tax returns were not associated with a business approved by 

the IRS for tax-free sales (i.e., the IRS had no record of Form 637, Application for 

Registration (For Certain Excise Tax Activities), for these taxpayers). 

 

4

 The IRS database that stores various types of taxpayer account information. This database includes individual, 

business, and employee plans and exempt organizations data. 

5

 The Office of Management and Budget’s NAICS is a system for classifying business establishments by type of 

economic activity. The NAICS is the standard used by Federal statistical agencies in classifying business 

establishments for the purpose of collecting, analyzing, and publishing statistical data related to the U.S. business 

economy. 

6

 A 12-month accounting period for keeping records on income and expenses used as the basis for calculating the 

annual taxes due. 

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III. Evaluated the effectiveness of IRS procedures to assess eligibility requirements for 

manufacturers requesting exemption to the excise tax and to ensure that the applications 

were timely processed. 

A. Reviewed the Internal Revenue Manual to identify the criteria for determining 

whether a business should be granted tax-exempt status during the Form 637 review 

and approval process. 

B. Discussed with IRS management the provisional Form 637 application approval 

measures to determine whether it lessened the review process required by the Internal 

Revenue Manual. 

C. Obtained from the IRS a listing of 2,295 businesses filing a Form 637 requesting a 

Letter of Registration for tax-free sales and selected a statistically valid random 

sample of 77 manufacturers7

 from the 1,823 businesses receiving an approved 

registration for tax-exempt medical device excise tax sales during the period 

January 1 through December 5, 2013. 

1. Reviewed IRS documentation of the Form 637 registration review and determined 

whether the manufacturer met the activity requirement8 for the registration and 

had a satisfactory tax filing, deposit, payment, and claim history for all Federal 

taxes of the applicant/registrant. 

2. Determined that all 77 application approvals for tax-free sales were supported by 

a review of the business activity and tax filing history. Based on a one-sided 

90 percent confidence level, we are 90 percent confident that at most 

54 Forms 637 in the population have invalid application approvals. 

3. Compared the completion date to the assignment date and determined that 

****************************1*************************************

**************1*****************. Based on a one-sided 90 percent 

confidence level, we are 90 percent confident that at most 90 Forms 637 in the 

population were not timely processed. 

 

7 We used attribute sampling to calculate the minimum sample size of 77 approved Forms 637 based on a 

confidence level of 90 percent, an expected rate of occurrence of 5 percent, and a precision rate of ± 4 percent. We 

selected a statistically valid random sample to help quantify the extent of the problem over the entire population. A 

contract statistician assisted with developing our sampling projections. 8 The taxpayer is regularly engaged, or will be regularly engaged, within a reasonable time, in the activity for which 

the registration is being requested (i.e., tax-free sales of medical devices).

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IV. Determined if the IRS had effective processes and procedures to prevent erroneous 

assessments of the FTD penalty. 

A. Identified from the Business Master File9 221 FTD penalties totaling $707,203 

assessed through December 28, 2013, on Forms 720 reporting the medical device 

excise tax for the quarters ending March 31 and June 30, 2013, processed through 

September 5, 2013. 

B. Of the 221 FTD penalties identified in Step IV.A, determined that 219 FTD penalties 

totaling $706,753 were erroneously assessed. 

Data validation methodology 

During this review, we relied on Tax Year 2013 Form 720 data extracted from the BRTF for 

Processing Year10 2013 as of September 5, 2013, and taxpayer account transaction data extracted 

from the Business Master File through the end of Processing Year 2013 that were provided by 

the TIGTA Office of Investigations’ Strategic Data Services. To assess the reliability of 

computer-processed data, programmers within Strategic Data Services validated the data extract 

files, while we ensured that each data extract contained the specific data elements we requested 

and that the data elements were accurate. For example, we reviewed judgmental samples11 of the 

data extracts and verified that the data in the extracts were the same as the data captured in the 

IRS’s Integrated Data Retrieval System.12 We also validated the IRS’s listing of Form 637 

applications for the medical device excise tax by comparing selected data fields for our 

statistically valid sample of records to the case file information obtained from the Issue 

Management System.13 As a result of our testing, we determined the data used in our review 

were reliable. 

Internal controls methodology 

Internal controls relate to management’s plans, methods, and procedures used to meet their 

mission, goals, and objectives. Internal controls include the processes and procedures for 

planning, organizing, directing, and controlling program operations. They include the systems 

for measuring, reporting, and monitoring program performance. We determined that the 

following internal controls were relevant to our audit objective: IRS communication and 

outreach efforts to ensure that tax returns were accurately and timely filed, policies and 

 

9

 The IRS database that consists of Federal tax-related transactions and accounts for businesses. These include 

employment taxes, income taxes on businesses, and excise taxes. 

10 The calendar year in which the tax return or document is processed by the IRS. 11 A judgmental sample is a nonstatistical sample, the results of which cannot be used to project to the population. 

12 IRS computer system capable of retrieving or updating stored information. It works in conjunction with a 

taxpayer’s account records.

13 The Issue Management System is designed to be used by revenue agents and specialists during the process of 

performing reviews of Form 637 applications. It supports issue identification, tracking, and management through a 

suite of automated tools. 

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procedures to ensure that taxpayers are filing required returns and paying the correct amount of 

tax, and actions taken to ensure that approved applications for exemption to the tax are properly 

processed. TIGTA’s contract statistician assisted with developing projections of potentially 

invalid and untimely Form 637 application approvals.

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Appendix II 

Major Contributors to This Report 

Russell P. Martin, Acting Assistant Inspector General for Audit (Returns Processing and Account 

Services) 

Diana M. Tengesdal, Acting Director 

Darryl Roth, Audit Manager 

Van Warmke, Lead Auditor 

Kyle Bambrough, Senior Auditor 

Jack Laney Jr., Auditor 

Kevin O’Gallagher, Information Technology Specialist 

Steven Vandigriff, Information Technology Specialist 

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Appendix III 

Report Distribution List 

Commissioner C 

Office of the Commissioner – Attn: Chief of Staff C 

Deputy Commissioner for Services and Enforcement SE 

Deputy Commissioner, Wage and Investment Division SE:W 

Deputy Commissioner, Small Business/Self-Employed Division SE:S 

Director, Affordable Care Act Office SE:ACA 

Director, Customer Account Services, Wage and Investment Division SE:W:CAS 

Director, Specialty Programs SE:S:SP 

Director, Submission Processing, Wage and Investment Division SE:W:CAS:SP 

Chief Counsel CC 

National Taxpayer Advocate TA 

Director, Office of Legislative Affairs CL:LA 

Director, Office of Program Evaluation and Risk Analysis RAS:O 

Office of Internal Control OS:CFO:CPIC:IC 

Audit Liaisons: 

Commissioner, Small Business/Self-Employed Division SE:S 

Chief, Program Evaluation and Improvement, Wage and Investment Division 

SE:W:S:PEI 

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Appendix IV 

Outcome Measures 

This appendix presents detailed information on the measurable impact that our recommended 

corrective actions will have on tax administration. These benefits will be incorporated into our 

Semiannual Report to Congress. 

Type and Value of Outcome Measure: 

 Reliability of Information – Potential; $117.8 million1

 in excise taxes on 276 taxpayer 

accounts that are incorrectly recorded on the IRS’s BRTF2 for Tax Year3 2013 (see page 7). 

Methodology Used to Measure the Reported Benefit: 

We conducted reliability testing of the 5,107 Forms 720, Quarterly Federal Excise Tax Return, 

reporting the medical device excise tax as part of our evaluation of IRS controls to verify the 

accuracy of the medical device excise tax amount on the IRS’s BRTF. We identified 

276 paper-filed Forms 720 for the quarters ending March 31 and June 30, 2013, processed 

through September 5, 2013, that contained discrepancies in the amount of the medical device 

excise tax or taxable sales amount. We identified total discrepancies, in terms of the medical 

device excise tax amount, of almost $117.8 million by comparing the excise tax amount captured 

by the IRS from the Form 720 to the excise tax amount we calculated. We based our calculated 

excise tax amount on the taxable sales amount captured by IRS from the Form 720 and 

multiplied this amount by the tax rate (i.e., 2.3 percent). 

For these 276 returns, the calculated tax amount was either overstated or understated by $100 or 

more. This includes 225 returns for which our calculated excise tax amount was less than the 

amount of tax captured from the Form 720 (potential overstated tax amount) with a total 

difference of $41.6 million and 51 returns for which our calculated excise tax amount was more 

than the amount of tax captured from the Form 720 (potential understated tax amount) with a 

total difference of $76.2 million. We added the $41.6 million to the $76.2 million to arrive at the 

$117.8 million. 

 

1

 **************************1*********************************.

2 IRS database that contains tax return information originally filed by the taxpayer and transcribed from Forms 720.

3

 A 12-month accounting period for keeping records on income and expenses used as the basis for calculating the 

annual taxes due. 

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Type and Value of Outcome Measure: 

 Taxpayer Rights and Entitlements – Actual; $378,835 in erroneous FTD penalty assessments 

on 86 taxpayer accounts in Tax Year 2013 (see page 11). 

Methodology Used to Measure the Reported Benefit: 

The IRS processed 5,107 Forms 720 reporting the medical device excise tax for quarters ending 

March 31 and June 30, 2013, through September 5, 2013. We identified 221 FTD penalties 

totaling $707,203 that were assessed on the Forms 720 through December 28, 2013. From this 

population, we determined that 219 FTD penalties totaling $706,753 were assessed erroneously 

since the taxpayers were provided temporary relief from the penalty if they failed to make timely 

deposits during the first three quarters of CY 2013. We found that 133 of the 219 penalty 

assessments had been reversed. However, 86 (39 percent) of the 219 erroneous FTD penalties 

totaling $378,835 remained on the taxpayer accounts as of January 8, 2014. 

 

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Appendix V 

Management’s Response to the Draft Report 

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