United States General Accounting Office

GAO Report to the Chairman, Subcommittee

on Treasury, Postal Service, and General

Government, Committee on

Appropriations, House of

Representatives

October 1996 TAX

ADMINISTRATION

Alternative Filing

Systems

G O A

years

1921 - 1996

GAO/GGD-97-6

GAO United States

General Accounting Office

Washington, D.C. 20548

General Government Division

B-260171 

October 16, 1996

The Honorable James R. Lightfoot

Chairman, Subcommittee on Treasury, Postal

 Service, and General Government

Committee on Appropriations

House of Representatives

Dear Mr. Chairman:

Questions have been raised about the viability of reducing the burden of

annually filing tax returns by millions of taxpayers even though most have

fully paid their taxes through the withholding system. The Internal

Revenue Service (IRS) currently offers taxpayers several choices for filing

tax returns that are less burdensome than preparing paper tax returns,

such as filing returns electronically, over the telephone, or through use of

personal computers. Millions of taxpayers in at least 36 other countries

that also have tax withholding systems do not have to prepare income tax

returns because these countries have alternative filing systems not

currently available in the United States.

Generally, there are two types of such alternative filing systems found in

other countries. One type of filing system, which provides that the taxing

authority prepares the return for the taxpayer, can be referred to as the

“tax agency reconciliation” system. The other type of filing system

provides that taxpayers’ income tax is withheld at the source and remitted

to the tax agency by employers and other payers who are responsible for

withholding taxes that equal but do not exceed each taxpayer’s tax

liability. It can be referred to as a “final withholding” filing system.1

To explore the issues involved in considering the use of such approaches

in the United States, we initiated a review to determine the possible

benefits, impediments, or costs to individual taxpayers, IRS, and others of

establishing a tax agency reconciliation filing system under existing

federal income tax laws that taxpayers could voluntarily participate in.

This report was prepared under our basic legislative responsibilities for

reviewing federal programs and activities.

Because of the Subcommittee’s continuing interest in the efficiency of IRS’

operations, you asked that we address this report to you.

1

The tax agency reconciliation and final withholding systems are commonly referred to as “return-free”

filing systems.

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This report focuses on a tax agency reconciliation type system because

this kind of system would not require any tax law changes while a final

withholding type system would require tax law changes. We do, however,

provide some information about how a final withholding type system

might operate in the United States, in appendix I.

To examine the alternative of a tax agency reconciliation filing system, our

objectives were to (1) estimate how many taxpayers would not have to

prepare returns under such a system, (2) identify the operational

characteristics such a system might have, (3) identify the potential pros

and cons to taxpayers and IRS under such a system, and (4) identify any

major impediments to or costs in establishing this type of filing system

under the current federal tax laws.

Results in Brief We estimated that as many as 51 million or about 45 percent of the

113.6 million taxpayers who filed tax year 1992 returns would not have to

prepare returns if IRS were able to establish a voluntary tax agency

reconciliation filing system. These taxpayers consisted of those who

claimed the standard deduction and had income from only wages, interest,

dividends, pensions, and unemployment compensation.

One general concept of such a system would be for IRS to produce tax

returns for individuals who volunteered to be covered by the system on

the basis of (1) income reported on information returns and

(2) information on filing status and dependents provided by taxpayers on a

new simpler tax form. IRS would then mail the returns and refunds or tax

bills to taxpayers, who would need to review their returns and notify IRS

whether they agreed with the return information.

While both individual taxpayers and IRS could benefit from such a tax

agency reconciliation system, significant obstacles would have to be

overcome and some affected parties—such as tax preparers, some

financial institutions, and employers—might be negatively affected. For

example, we estimated that taxpayers could reduce the amount of time

they spend preparing tax returns by as much as 155 million hours annually

and could save millions of dollars in fees paid to tax return preparers. A

tax agency reconciliation system would also be likely to further reduce the

volume of paper documents IRS would have to process, which is one goal

of IRS’ long-term business vision. Such a system could also reduce IRS’

returns processing and compliance costs by as much as $37 million

annually.

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However, taxpayers would have to continue to keep records to be able to

accurately review the IRS-proposed tax return and tax assessment. It is

unclear to what extent taxpayers would continue to rely on tax preparers

to assist them in reviewing their returns, but tax preparers would likely

lose some business under such a system.

A major operational impediment to establishing a tax agency

reconciliation system is that IRS does not currently process information

returns in sufficient time to send taxpayers their tax returns before the

April 15 tax return filing date. Payers are required to file information

returns by the last day of February. However, under IRS’ current

information returns processing operations, it is about 6 months later, or

the end of August, before information returns, including wage statements,

could be used to create tax returns. The 6-month interval occurs because

of the amount of time it takes to process paper information returns, payer

extensions for filing information returns, and payee corrections to

information returns.

As part of its business vision, IRS plans to be able to match information

return data against tax return data sooner; but the plans are not

specifically directed to having all information returns processed before the

April 15 filing date, as would be necessary for use in a tax agency

reconciliation system unless the filing date were changed. IRS has two

initiatives under way aimed at speeding up information returns processing.

One initiative deals with electronically scanning paper information

returns, and the other is working with the Social Security Administration

(SSA) to get employers to file wage documents electronically. IRS has

planned a third initiative to start in fiscal year 1997 to get payers to file

more nonwage information returns electronically.

In a 1987 study, IRS found that a tax agency reconciliation system was not

feasible then because of the amount of time it took to process and correct

information return data. The study indicated that with technological

advances such a system could be feasible in the future. Electronic filing of

tax data may be one such technological advance that could make a tax

agency reconciliation system a more viable filing option if IRS could get

more payers to file information returns electronically. Electronically filed

information returns can be processed faster and with fewer errors than

returns submitted on paper or magnetic media. While faster filing of

information returns or increased use of electronic filing would increase

the feasibility of an alternative filing system, additional costs or burdens

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may result for businesses or other entities responsible for filing

information returns.

Although federal tax law could be changed to delay the return filing date

past April 15 to permit sufficient processing of information returns to

make a tax agency reconciliation system more feasible, the April 15 return

filing date is important for some state income tax purposes. We estimate

that 15.8 million or 31 percent of the 51 million taxpayers whose returns

could be prepared by IRS under a tax agency reconciliation system may not

need their federal tax return to calculate state taxes. These taxpayers

resided in states that either have no state income tax or are not linked to

the federal tax system. Another 29.6 million taxpayers (58 percent) resided

in states where state taxes are based on federal adjusted gross income,

which could be calculated from information return data sent to taxpayers

as well as IRS. The remaining 5.6 million taxpayers eligible for tax agency

reconciliation resided in 11 states that used either the federal taxable

income or tax liability as the basis for calculating their state income tax

liability. These taxpayers might be less likely to volunteer for tax agency

reconciliation if IRS were unable to provide their returns before April 15.

Otherwise, these taxpayers would have to compute their federal taxable

income or tax liability or file their state tax returns late, which could

subject them to state penalties for filing late returns.

According to an IRS focus group conducted in 1993, taxpayers may be

reluctant to rely on IRS to prepare their tax returns under a tax agency

reconciliation system, regardless of when IRS could produce tax returns,

because they may not trust IRS to accurately calculate their taxes.

Representatives of the paid preparer community also told us that many of

their clients do not trust IRS to prepare accurate returns and would

continue to rely on paid preparers for return preparation services under a

tax agency reconciliation system. Also, some taxpayers may not want to

participate in such a system because they may not get their refunds as

early in the tax filing season as they currently do. However, if IRS could

demonstrate through a pilot test of a tax agency reconciliation option the

capability to produce timely and accurate tax returns, taxpayer

acceptance of such a voluntary system might be enhanced.

Background Of the 36 countries with alternative filing systems, only Denmark and

Sweden have tax agency reconciliation systems. The remaining 34

countries have final withholding filing systems. There are several potential

barriers to adopting a final withholding system in the United States.

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Specifically, before a final withholding system could be instituted in the

United States, the law would have to be changed to require employers to

calculate employees’ tax liability and adjust employees’ last paychecks so

that total yearly withholdings would equal employees’ tax liability. Also,

unlike many countries with final withholding systems, the United States

tax system does not exempt or limit taxes on interest and dividend

income, nor does it require married couples to file separately. (Appendix I

lists these 34 countries and describes how final withholding systems

generally operate in those countries.)

A tax agency reconciliation system would be easier to implement in the

United States because it would not require statutory changes. In general,

under a tax agency reconciliation type system, the tax agency is to

calculate the tax liability on the basis of information returns or income

reports received from payers, such as wage reports prepared by employers

and interest income reports prepared by financial institutions. The tax

agency then is to send the taxpayer a printed tax return or reconciliation

statement. Upon receipt of the tax return, the taxpayer is to review and

correct its contents, add information if any is missing, and return the

completed return to the tax agency. After the tax agency receives and

reviews the tax return, it is to send the taxpayer either a refund or tax bill.

In 1994, Denmark prepared tax returns for 85 percent of its 4.5 million

taxpayers, and Sweden prepared returns for 74 percent of its 7.3 million

taxpayers.

In 1987, in response to a provision in the Tax Reform Act of 1986, IRS

studied the feasibility of a tax agency reconciliation filing system.2 IRS

estimated that 55 million individual taxpayers would be eligible to use

such an alternative filing system. This estimate included all taxpayers who

were filing Form 1040EZ, most taxpayers who were filing Form 1040A, and

a few who were filing Form 1040.

Under the system IRS studied, employers and payers would be required to

submit wage statements (Form W-2) and information returns (Form

1099) by the end of January, instead of the end of February as is now

required. IRS would spend the next 4 to 6 weeks processing these

documents. Some taxpayers would receive their returns in early March,

but most taxpayers would start receiving theirs in early April.

2

Department of the Treasury, Internal Revenue Service, Current Feasibility of a Return-Free Filing

System, Oct. 1987.

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IRS concluded that the tax agency reconciliation filing system it studied

was not feasible primarily because it would be very difficult to receive,

verify, and post over 900 million wage and information documents in time

to generate tax returns. IRS determined that checking all of the documents

for accuracy and correcting them in time to generate returns was beyond

its capabilities.

Objectives, Scope,

and Methodology

Our objectives in describing the potential benefits and impediments of a

voluntary tax agency reconciliation type filing system were to (1) estimate

how many taxpayers would not have to prepare returns under this kind of

system, (2) identify the operational characteristics such a system might

have, (3) identify the pros and cons of such a system to taxpayers and IRS,

and (4) identify any major impediments to or costs in establishing such a

system under the current federal tax laws.

It is important to note that we focused our work on the impact that an

alternative filing system might have for individual taxpayers and IRS. We

recognize that establishing such a system would affect other stakeholders

such as (1) some employers and financial institutions that would probably

incur additional costs to modify existing systems or establish new systems

for information reporting and (2) tax preparers who might lose revenue

from reduced demand for their services or might have to change the

services they offer to meet any new type of demand from taxpayers.

However, we did not attempt to quantify the benefits and costs to them of

implementing such a system. Rather, we viewed the approach to

considering the feasibility and desirability of devising an alternative filing

system as encompassing two levels of efforts: first, an initial look using

readily available data to determine whether additional research by IRS

might be warranted and second, a more detailed effort that might involve

gathering and analyzing additional data, including specific impacts on

third party stakeholders. While we restricted our effort to the first of these

two levels of effort, we did make a presentation, on how a tax agency

reconciliation system would work, to IRS’ Information Reporting Program

Advisory Committee, which is composed of representatives from

third-party stakeholders, such as financial institutions, employers, and

other payers. We also discussed a tax agency reconciliation system with

officials of the American Institute of Certified Public Accountants and

H&R Block, Inc., which is a national tax return preparation company.

To estimate the number of taxpayers that would be eligible for a tax

agency reconciliation system, we used IRS’ tax year 1992 Statistics of

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Income (SOI) file to extract records that met the income and deduction

criteria we established for a hypothetical tax agency reconciliation system.

These criteria were that taxpayers would only have income that was

reported on information returns and that taxpayers would not itemize

deductions.

To identify the operational characteristics a tax agency reconciliation type

system might have, we reviewed IRS’ 1987 return-free filing study. We also

interviewed officials at the Department of the Treasury and IRS to

determine what administrative changes would have to be made to the

federal tax system to have a voluntary tax agency reconciliation type

system. We also reviewed the literature on how the tax agency

reconciliation systems worked in Denmark and Sweden. We compared

information on the operations of tax systems in these countries with the

operations of our federal income tax system to determine how they

differed. We also interviewed representatives from local consulates to

Denmark’s and Sweden’s foreign embassies about how their tax agency

reconciliation filing systems worked.

To determine potential pros and cons of a tax agency reconciliation type

system for taxpayers, we reviewed the return preparation tasks IRS

published in its 1994 individual income tax booklets. We compared these

tasks with the type of tasks taxpayers would have under a tax agency

reconciliation type system. We also reviewed literature on costs to

taxpayers to have paid preparers complete their tax returns.

To determine any potential benefits and costs to IRS under a tax agency

reconciliation system, we applied IRS’ methodology for estimating its cost

to process tax returns to the filing population eligible for tax agency

reconciliation to estimate the cost to process documents under such a

system. We also used IRS’ costing methodology to estimate the cost to

process tax returns under the current system for the population eligible

for tax agency reconciliation.

To identify the impediments to establishing a tax agency reconciliation

type system, we reviewed IRS’ procedures for processing information

returns and obtained IRS officials’ views on potential impediments. To

determine the effect of a tax agency reconciliation system on taxpayers’

ability to file state income tax returns, we discussed a hypothetical system

with representatives of the Federation of Tax Administrators and state tax

officials who attended the federation’s national conference held in

Cleveland, Ohio, in June 1995. We also reviewed an IRS document on

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taxpayers’ opinion of a tax agency reconciliation system and discussed the

conclusions with IRS officials.

Our work was done from November 1994 through April 1996 in

accordance with generally accepted government auditing standards. We

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

Internal Revenue, and on August 19, 1996, we received written comments

from the Deputy Commissioner. His comments are discussed on pages 21

to 22 and a copy of the comments appear in appendix III. We also

requested and received comments on a draft of this report from the

American Institute of Certified Public Accountants and IRS’ Information

Reporting Program Advisory Committee. These comments are discussed

on pages 22 to 24.

Millions of Taxpayers

Could Be Covered by

a Tax Agency

Reconciliation Type

Filing System

To determine how many taxpayers potentially could be covered by a tax

agency reconciliation system, we used income and deduction criteria that

would maximize the number of taxpayers that could be included in the

system, while minimizing administrative changes. Taxpayers who met

these criteria included those who

• had taxable income from wages, interest, dividends, pensions, and

unemployment compensation;

• did not itemize deductions and, instead, took the standard deduction; and

• did not take any tax credits except the earned income tax credit.

We estimated that about 51 million taxpayers who filed tax year 1992

returns, which was the latest year that data were available to make our

estimate, met these conditions. The 51 million taxpayers accounted for

about 45 percent of the 113.6 million taxpayers who filed tax year 1992

returns and had about 14 percent of the total individual income tax

liability reported that year. Also, the majority of these taxpayers, about

28.7 million or 56 percent, had taxable income from wages only.

We limited eligibility for the system to taxpayers with taxable income from

wages, interest, dividends, pensions, and unemployment compensation

because IRS receives information returns on these income types, which

could be used to calculate taxpayers’ tax liabilities. Taxpayers with other

types of income, such as rents, royalties, capital gains, and

self-employment (i.e., nonemployee compensation), were excluded from

eligibility because the information returns with these types of income

showed gross income amounts and needed to be reduced by taxpayers’

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costs to determine the net taxable amounts. IRS does not receive

information returns on taxpayers’ costs to produce income.

Similarly, taxpayers who itemized deductions were excluded from the

eligible population because some itemized deductions, such as medical

expenses and charitable contributions, are not reported on information

returns. Regarding tax credits, the earned income tax credit was the only

individual tax credit that could be calculated with the income and entity

information that would be available to IRS.

3

Characteristics of a

Tax Agency

Reconciliation Type

System

The following sections describe one way a tax agency reconciliation

system might work. This version of a tax agency reconciliation system

would consist of four operational characteristics.4

Taxpayer information needed by IRS: To calculate taxpayer tax liability and

the earned income tax credit, if applicable, some of the information IRS

would need on each taxpayer would include the following:

• name and address,

• Social Security Number (SSN),

• filing status,

• name and SSN of spouse,

• name and SSN of dependents and qualifying children,5

• relationship of dependents and qualifying children to taxpayer, and

• number of months dependents and qualifying children lived with taxpayer

during the year.

Taxpayers are currently required to report these data on their tax returns.

While IRS records would contain taxpayer entity information data from

prior year returns, IRS would need to develop a process or form to collect

3

Individuals can claim a credit for child and dependent care expenses and a credit for the elderly or the

disabled. Both of these credits require a separate tax form and contain taxpayer information that is not

provided to IRS by third parties. Individuals engaged in business or with certain types of investments

can also get tax credits. However, our hypothetical tax agency reconciliation system excludes these

types of taxpayers.

4

The characteristics of this hypothetical system are similar to those described in IRS’ 1987 return-free

filing system study.

5

For earned income tax credit purposes, a qualifying child is a child who (1) is either the taxpayer’s

son, daughter, adopted child, grandchild, stepchild, or foster child, and; (2) was, at the end of the tax

year, either under age 19, under age 24 and a full-time student, or any age and permanently and totally

disabled; and (3) lived with the taxpayer in the United States for more than half of the tax year (or all

of the tax year if a foster child).

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this information for the current year or to confirm or change its prior

year’s records.6

IRS could use the taxpayer identification information part of the tax return

package it sends to taxpayers at the beginning of the tax year to confirm

the necessary taxpayer information. Taxpayers who volunteered to be

covered by tax agency reconciliation filing could send the necessary

information to IRS at the start of the tax filing season, perhaps on a form

developed for that purpose. As an alternative to having all taxpayers mail a

form to IRS, the system could be developed so that only taxpayers whose

prior year’s information was in error or needed updating would make

corrections and send them to IRS. Other taxpayers who volunteered to be

covered by a tax agency reconciliation system could confirm the

information to IRS via telephone.7

IRS preparation of tax return: IRS would need to process the taxpayer

information and enter the data onto the taxpayer’s master file record. IRS

would associate all the information return data it received from employers

and other payers with the taxpayer information. Using these data, IRS’

computers would calculate the taxpayer’s tax liability and, if eligible, the

earned income tax credit. A computer-generated tax return and a list of

information returns used to create the tax return would be produced and

sent to the taxpayer for verification.

IRS could either send the refund to the taxpayer at the same time the return

is sent or it could wait until the taxpayer verified the return information.8

Factors for consideration in deciding when to send the refund include the

risk that the taxpayer would accept a refund without verifying that the

return information was accurate and the length of time it would take IRS to

send the refund after the taxpayer verified the return information. IRS

could develop a test to determine whether the risk involved in sending the

refund with the return would be acceptable.

6

Currently, under IRS’ TeleFile program, which allows taxpayers to file Form 1040EZ via touch-tone

telephones, IRS identifies taxpayers who are eligible to participate in the program on the basis of their

prior year return.

7

Because we had no basis for determining how many taxpayers would have changes from one year to

the next, we developed our hypothetical tax agency reconciliation system so that all taxpayers would

submit information to IRS on a form. Also, in its 1987 study of a tax agency reconciliation system, IRS

assumed that all taxpayers would mail their taxpayer information to IRS.

8

For the alternative filing system described in IRS’ 1987 return-free filing study, the refund was sent

along with the IRS-generated tax return.

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The tax return would serve as a tax bill if the taxpayer’s income tax

withholdings did not cover the taxpayer’s tax liability. About 43.3 million

or 85 percent of the 51 million taxpayers who met the criteria for eligibility

for a tax agency reconciliation system either received refunds or owed no

taxes in 1992. The remaining 7.7 million taxpayers owed an average of

$253 in additional taxes.

To facilitate taxpayer communication by telephone, IRS could also assign

personal identification numbers to each taxpayer that would serve as their

electronic signature, which is essentially what IRS currently does under its

TeleFile program.

Taxpayer review of tax return: When taxpayers received the

computer-generated tax return, they would need to compare the

information on the form to their records (e.g., information returns).

Taxpayers who agreed with the return information could notify IRS of their

acceptance, possibly by telephone using, their personal identification

number as their electronic signature. Taxpayers with changes could either

make corrections to the tax return, sign the return, and send it back to IRS

or make corrections via telephone, using their personal identification

number. Using IRS data, we estimated that about 275,000 of the possible

51 million computer-generated tax returns would be likely to be

questioned by taxpayers because of erroneous information return data.

(See app. II for information on how we developed this estimate.)

IRS corrections to tax returns: When IRS receives the results of a taxpayer’s

review of the tax return data (either via the return itself or by telephone),

it would process any corrections and, if necessary because of the

corrections, send the taxpayer either a revised refund or a revised tax bill.

Pros and Cons of a

Tax Agency

Reconciliation System

to Taxpayers, IRS, and

Others

Under a tax agency reconciliation system, taxpayers could save millions of

hours in tax return preparation time and millions of dollars in paid

preparer fees. A tax agency reconciliation system would also benefit IRS by

helping to achieve its business vision goals and reducing its returns

processing and compliance costs. However, while tax preparation burden

could be reduced for individual taxpayers, others now involved in the

process such as tax preparation firms, financial institutions, and other

payers could be negatively affected. We did not identify a readily available

basis for estimating the time or assistance required by taxpayers to submit

taxpayer information to IRS or review the IRS-generated returns.

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Taxpayers’ Return

Preparation Time and

Costs Would Be Reduced

On the basis of IRS data, we estimated that the 51 million taxpayers who

could be covered by a tax agency reconciliation system spend about

262 million hours collectively on tax return preparation tasks.9

 Breaking

the data into task groupings, we estimated that these taxpayers could

reduce time spent on certain return preparation tasks by as much as

155 million hours. For example, taxpayers would be relieved of the

requirement of preparing tax returns and the related burden of learning

how to do so. However, taxpayers would still have to complete the

taxpayer information form and send it to IRS. Similarly, taxpayers would

still need to keep records on their income to be able to verify that IRS

accurately computed their income tax liability. Also, taxpayers would have

to notify IRS of their agreement or disagreement with IRS’

computer-generated tax returns. Appendix II provides a detailed

explanation of how we arrived at our estimates.

Under a tax agency reconciliation system, taxpayers who use paid

preparers could be free of the task of finding and paying for their services.

We estimated that 16.6 million or almost one-third of the 51 million

taxpayers used paid preparers and could save millions of dollars in paid

preparer fees.10

An Alternative Filing

System Could Help IRS

Achieve Its Business Vision

Goals

The tax agency reconciliation system could help IRS achieve one of its

long-term business vision goals, which is to reduce the amount of paper

documents it has to process. Under this system, IRS would have to process

the taxpayer information documents it receives, but this would require

less paper than some tax returns.

Currently, IRS envisions reducing the amount of paper documents it

processes, by increasing electronic filing of tax returns. Some taxpayers

can file electronically by telephone through IRS’ TeleFile program, but

most electronic filing is done through a tax return preparer or an

electronic return transmitter. Taxpayers generally pay from $15 to $40 for

such services.

9

These tasks consist of recordkeeping; learning about the law or tax form; preparing the form; and

copying, assembling, and sending the form to IRS.

10One national return preparer service charges an average of $30 to prepare a form 1040A. (See George

Gutman, “Electronic Filing: Who Pays, Who Benefits,” Tax Notes, Mar. 20, 1995, pp. 1750-1759.)

However, while tax preparers would be affected by a tax agency reconciliation system, the extent of

that impact (or cost reduction for taxpayers) could be affected by whether additional services are

provided, such as services to assist taxpayers to review their IRS-generated returns.

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Electronic filing has several benefits for taxpayers, including ensuring that

(1) the returns are mathematically accurate and (2) information on the

returns has been accurately posted to the taxpayers’ accounts in IRS’

records. These same benefits would be available to taxpayers under a tax

agency reconciliation system. And, taxpayers would get the benefits of

electronic filing without incurring the costs, since under a tax agency

reconciliation system IRS would be electronically filing returns for

taxpayers.

Processing and

Compliance Costs of a Tax

Agency Reconciliation

System Should Be Less

Than Current System

Another benefit to IRS of a tax agency reconciliation system is that the

combined cost to process taxpayer information forms and

computer-generated tax returns should be less than the cost to process

taxpayer-submitted tax returns. Using IRS data, we estimated that it would

cost IRS about $182.3 million to process tax returns under the current

system for the 51 million taxpayers who could be covered by a tax agency

reconciliation system. In comparison, we estimated that the cost

associated with processing taxpayer information forms, generating tax

returns, processing tax payments, and handling taxpayer inquiries under

an alternative system could be about $160 million. This would result in an

approximate savings of $22 million for IRS. Appendix II gives details on

how we made our cost estimates.

IRS would also benefit from a tax agency reconciliation system because its

compliance costs could be reduced. Savings would result from not

subjecting the 51 million taxpayers to IRS’ underreporter program. This

computerized compliance program matches income shown on information

returns with income that taxpayers report on their tax returns to

determine whether taxpayers reported all their income. When

discrepancies are found, IRS contacts taxpayers to resolve the issue and

assess additional taxes, if required.

Under a tax agency reconciliation system, document-matching would not

be necessary because IRS would prepare returns and assess taxes on the

basis of the information returns and taxpayer-supplied entity data it has in

its computers. As a result, compliance resources that would have been

spent on working potential underreporter cases that may have resulted

from taxpayer-prepared returns would be saved. We estimate that about

858,000 of the 51 million tax agency reconciliation eligible taxpayers

would have been pursued by IRS under its underreporter program at a cost

of $17.61 per taxpayer. Therefore, under a tax agency reconciliation

system, the underreporter program cost savings would be about

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$15 million. Thus, the net processing and compliance cost for such a tax

agency reconciliation system would be about $145 million, as compared

with about $182 million under the current system for an approximate

savings of $37 million. Appendix II shows how we developed these

estimates.

Tax Preparers and Others

Might Be Negatively

Affected Under a Tax

Agency Reconciliation

System

As noted above, about one-third of the taxpayers who met the criteria we

identified for eligibility to file under a tax agency reconciliation system

used tax preparers to file their tax returns in 1992. A tax agency

reconciliation filing system could eliminate the need for such assistance,

with the consequence that tax preparers could lose a substantial part of

their business. On the other hand, since many of the filers who are eligible

for such a system file relatively simple returns, their need for assistance to

do so may suggest that under a tax agency reconciliation system, they

might also need assistance to send IRS the necessary taxpayer information

or review the IRS-generated tax return. We had no readily available basis to

estimate the extent to which this business substitution might occur.

Nonetheless, the impact of a tax agency reconciliation system on tax

preparers would need to be considered in deciding whether to adopt such

a system.

Although IRS’ business vision already contemplates improving the filing

and processing of information returns through increased use of electronic

filing, the introduction of a tax agency reconciliation system could put

additional burdens on employers, some financial institutions, or others

who would be obligated to file information returns more quickly or in

electronic form. We had no readily available basis to estimate the costs or

other difficulties with such an additional reporting burden. Nonetheless, as

with the tax preparer industry, the impact on these third-party participants

in the tax system would need to be considered during deliberations on the

feasibility of an alternative filing system.

Significant

Operational

Impediments Exist to

Implementation of a

Tax Agency

Reconciliation System

A major impediment to a tax agency reconciliation type system is that IRS’

present time frame for processing information returns is too long for tax

returns to be verified by taxpayers by April 15, which is the filing date for

federal returns. However, IRS has several initiatives that could eventually

allow it to process information returns sooner. Further, taxpayers in 11

states would need information from their federal returns before April 15 so

that they could file their state tax returns on time. However, even if IRS

could produce tax returns prior to April 15, some taxpayers may be

Page 14 GAO/GGD-97-6 Alternative Filing Systems
B-260171 

reluctant to participate in this voluntary program because they distrust IRS

to accurately prepare their returns or because they would not be able to

get access to refunds early in the tax filing system.

Information Returns Not

Processed in Time for a

Tax Agency Reconciliation

System

A major stumbling block to a tax agency reconciliation system is the

amount of time it presently takes IRS to process information returns.

Currently, many information returns, including form W-2s, are not

processed until August or 6 months after the due date for filing them.

Currently, IRS receives over 1 billion information returns each year. About

200 million are form W-2s that employers are required to submit to SSA by

the end of February. According to an SSA official, about 35 percent of the

form W-2s are submitted on paper and the rest are submitted on magnetic

media. After SSA processes the form W-2s, they are sent weekly beginning

in March to IRS on computer tapes. The remaining 800 million information

returns are primarily the Form 1099 series of information returns, such as

those reporting interest income, which are due to taxpayers at the end of

January and to IRS at the end of February. Most of the 800 million

information returns are sent directly to IRS’ Martinsburg Computing Center

on magnetic media. Payers send their paper Form 1099 information

returns to IRS service centers for processing. About 7 percent of the

information returns are paper.

Although information returns are due by the end of February, certain

factors tend to lengthen the time it takes to process them. These factors

include the time it takes to process paper information returns, payer

extensions for filing returns, and payee corrections to information returns.

However, according to IRS and SSA officials, the most significant factor for

processing delays is that about 10 percent of the information returns must

be sent back to payers because they cannot be processed by either IRS or

SSA. Various reasons contribute to this problem, such as incomplete data

and incorrect data format. When information returns are sent back to a

payer for replacement, IRS allows a minimum of 45 days to correct and

send back the data.

According to IRS data, over 80 percent of Form 1099 information returns

and about 65 percent of the forms W-2 are processed and validated by the

end of June. It is not until the end of July that IRS has usually processed

95 percent of the information returns and not until the end of August that

93 percent of the forms W-2 have usually been processed.

Page 15 GAO/GGD-97-6 Alternative Filing Systems
B-260171 

IRS Initiatives Could Speed

Up Information Returns

Processing

Given the current April 15 filing due date, the key to making a workable

tax agency reconciliation system would be receiving and processing

information returns sooner. As part of its long-term business vision, IRS

plans to have the capability to process information returns sooner so it

can match information return data to tax returns to identify unreported

income sooner. Its business vision does not include using information

returns for a tax agency reconciliation system, but it does include more

up-front matching of information returns to tax returns before refunds are

issued.

IRS currently has a couple of initiatives under way that should speed up

information returns processing. These initiatives are not specifically

directed to having all information returns processed before April 15.

One initiative is the Service Center Recognition/Image Processing System,

which is a multimillion dollar system designed to process Form 1040EZ

income tax returns and information returns by electronically scanning the

document. While only about 7 percent of the information returns are filed

on paper, these paper information returns are usually not processed until

sometime after April 15. This system, if proven successful, should allow IRS

to process paper information returns soon after the February 28 filing

date.

Also, IRS and SSA are involved in a multiagency project called the Simplified

Tax and Wage Reporting System (STAWRS), which deals, in part, with the

processing of forms W-2. STAWRS has projects under way dealing with the

electronic transmission of Form W-2 data and with employer validation of

employees’ SSNs via telephone and computer. The success of these

projects could help improve the accuracy of Form W-2 data and speed up

Form W-2 processing. However, STAWRS officials did not have estimates on

when these projects would become operational.

As part of its business vision, IRS has an electronic filing strategy that

focuses primarily on getting taxpayers to file their tax returns either

electronically or by touch-tone telephone. A smaller component of this

strategy is an initiative to target large volume information returns such as

forms 1099 on interest and dividends for electronic filing beginning in

fiscal year 1997. IRS already receives some information returns

electronically. For 1995, IRS estimated that it received about 42.8 million

electronically filed nonwage information returns and estimated that

48.9 million will be filed in 1998. The estimated volume of electronically

filed information returns is small, compared with the 800 million nonwage

Page 16 GAO/GGD-97-6 Alternative Filing Systems
B-260171 

information returns that are filed annually. IRS officials said these

estimates could change depending on the number of payers who are

willing to file electronically.

Electronic filing of information returns could be one way to get

information returns processed in time to be used for a tax agency

reconciliation system. In its 1987 study on return-free filing, IRS concluded

that such a system was not feasible when the study was made. IRS found

that the amount of time it took to process information returns was the

primary administrative obstacle to return-free filing because of the amount

of time it took to correct information returns data. However, the study

noted that long-term technological improvements in IRS’ tax processing

could result in such a system being feasible in the future. The study further

indicated that IRS would consider a tax agency reconciliation filing concept

in connection with its ongoing tax system redesign efforts.

Since its 1987 study, IRS has not reexamined the operational characteristics

of a tax agency reconciliation filing system as a potential alternative for

filing tax returns, even though technological improvements, such as

electronic filing, may make it possible to speed up information returns

processing. One of the benefits of electronic filing is that returns, whether

tax returns or information returns, can be processed faster and with fewer

errors because IRS computer programs are designed to detect errors before

its computers will accept electronically filed returns. However, it is

unknown how many payers would file information returns electronically

and whether electronically filed information returns would shorten the

time frame needed to make a tax agency reconciliation system workable.

Some Taxpayers Need

Federal Income Tax Data

to Prepare Their State

Income Tax Returns

Federal income tax return information is not used exclusively for federal

tax purposes. A majority of states require their taxpayers to use

information from their federal tax returns to calculate state taxes. Table 1

shows the tax base for the 50 states and the District of Columbia and the

estimated number of taxpayers potentially eligible for tax agency

reconciliation filing in each state.

Page 17 GAO/GGD-97-6 Alternative Filing Systems
B-260171 

Table 1: Tax Bases of States With Tax

Systems Linked to Federal Law

Tax base States

Estimated number of tax

agency reconciliation filers

Federal adjusted gross

income

Arizona, California,

Connecticut, Delaware,

Georgia, Illinois, Indiana,

Iowa, Kansas, Kentucky,

Louisiana, Maine, Maryland,

Massachusetts, Michigan,

Missouri, Montana,

Nebraska, New Mexico,

New York, Ohio, Oklahoma,

Virginia, West Virginia,

Wisconsin, and the District

of Columbia

29.6 million

Federal taxable income Colorado, Hawaii, Idaho,

Minnesota, North Carolina,

Oregon, South Carolina,

and Utah

5.2 million

Federal tax liability North Dakota, Rhode

Island, and Vermont

0.4 million

State income tax not linked to

federal system

Alabama, Arkansas,

Mississippi, New

Hampshire, New Jersey,

Pennsylvania, and

Tennessee

7.3 million

No state income tax Alaska, Florida, Nevada,

South Dakota, Texas,

Washington, and Wyoming

8.5 million

Source: Federation of Tax Administrators and IRS’ tax year 1992 SOI data.

As shown in table 1, 36 states and the District of Columbia have income

tax systems that are linked to a federal tax base. These states typically

require taxpayers to use information from their federal income tax return

as a starting point for state tax computation. Taxpayers in such states are

usually required to report either their federal adjusted gross income,

federal taxable income, or federal tax liability on their state tax returns.

Under a tax agency reconciliation system, 45.4 million or 89 percent of the

potential 51 million filers would not need their federal return to calculate

state income taxes. For example, the 29.6 million taxpayers that reside in

states that use federal adjusted gross income as the tax base could

calculate their state income tax from information returns they receive

from employers and other payers because the total income shown on the

information returns would equal federal adjusted gross income. Also,

7.3 million taxpayers reside in states that are not dependent on the federal

Page 18 GAO/GGD-97-6 Alternative Filing Systems
B-260171 

tax return for state income tax calculations, and 8.5 million taxpayers

reside in states that do not assess a state income tax.

The 5.6 million potential return-free filers who reside in the 11 states that

use either federal taxable income or federal tax liability as the state

income tax base might be less likely to volunteer to participate in the

system if they did not receive their federal tax returns in time to meet state

filing requirements, which is typically April 15. Unless IRS is able to get

returns to taxpayers before this date, these taxpayers would have to

compute their federal taxable income or tax liability or file their state tax

returns late. If they filed their state returns late, they could be subject to

state penalties for filing late returns.

Taxpayers May Not Want

to Participate in a Tax

Agency Reconciliation

System

A taxpayer focus group IRS held in 1993 did not support a tax agency

reconciliation system. According to IRS officials, the participants, who

expressed varying degrees of mistrust toward IRS, doubted that IRS had

complete and correct data with which to prepare their returns. Many

participants also felt that their tax liability would increase because IRS

would try to assess more taxes than they might otherwise owe. Also, the

participants expressed doubt that procedural remedies would be available

for obtaining adjustments if they disagreed with the return prepared by IRS.

Representatives of the paid preparer community also told us that many of

their clients do not trust IRS to prepare accurate returns and would

continue to rely on paid preparers for return preparation services under a

tax agency reconciliation system.

Taxpayers may also be reluctant to participate in a tax agency

reconciliation system if IRS could not issue refunds as early as it does when

taxpayers file their returns. Some taxpayer currently receive refunds by

late January. According to IRS data, about 57 million or 72 percent of the

93 million taxpayers who received refunds in 1995 were issued them by

the end of April. Under a tax agency reconciliation system, IRS may not be

able to issue refunds this early.

There may be no easy way to get taxpayers to change their attitude about

trusting IRS to accurately assess their taxes. However, taxpayers who

volunteer to participate in a tax agency reconciliation system would have

copies of their information returns to verify that IRS used the correct

income to calculate their taxes. Also, over 2 million taxpayers participated

in IRS’ tax year 1995 TeleFile program in which they relied on IRS to

Page 19 GAO/GGD-97-6 Alternative Filing Systems
B-260171 

accurately calculate their taxes. On the other hand, one of IRS’ selling

points for using TeleFile was that taxpayers would receive their refunds

sooner than if they filed paper returns. According to IRS, about 23 million

taxpayers who filed tax year 1995 forms 1040EZ were eligible to

participate in the TeleFile program in 1996, which was the first year the

program was available nationally.

As with other alternative filing options that IRS has introduced, such as

electronic filing and TeleFile, getting taxpayers to volunteer to participate

in a tax agency reconciliation system may depend upon how well the

system works. If IRS could produce timely and accurate tax returns,

taxpayer acceptance could be enhanced.

Conclusions As many as 51 million taxpayers, primarily wage earners, would not have

to prepare tax returns under a tax agency reconciliation type system.

Instead, IRS could prepare their returns for them on the basis of taxpayer

supplied information, such as filing status and dependents, which along

with information returns would be used to produce tax returns.

We estimated that under a tax agency reconciliation system, taxpayers

could save up to 155 million hours collectively on tax return preparation

tasks and millions of dollars in tax return preparer fees. Such a system

would also benefit IRS by reducing its returns processing and compliance

costs. An unknown, however, is the extent to which taxpayers would

voluntarily participate should such a system be adopted in the United

States. Key considerations in this regard would be taxpayers’ perceptions

of how efficiently, accurately, and fairly IRS could administer such a

system. In addition to addressing these perceptions, IRS would need to

design the system to minimize, to the extent possible, its own

administrative problems and any additional burden imposed on other

stakeholders, including employers and affected financial institutions in

proving information returns electronically and more timely.

A major impediment to establishing a tax agency reconciliation system is

the length of time it takes IRS to process information returns. IRS’ current

processing time frame would not allow it to provide taxpayers’ federal

returns before April 15, which is the due date for filing tax returns. IRS’

1987 study of return-free filing also noted this impediment as the major

reason why a return-free system could not be implemented at that time.

Technological advances, such as electronic filing, since that study may

Page 20 GAO/GGD-97-6 Alternative Filing Systems
B-260171 

make it possible to have a tax agency reconciliation system in the future if

more information returns were filed electronically.

Recommendation A tax agency reconciliation type filing system could make it easier and

cheaper for taxpayers to fulfill their tax return filing responsibilities.

Because of these factors and the technological advances made since IRS’

1987 return-free filing study, we recommend that the Commissioner of

Internal Revenue reexamine the feasibility and desirability of designing

and implementing a tax agency reconciliation system.

The reexamination should include a determination of methods to increase

trust among taxpayers in IRS’ ability to administer such a system fairly and

accurately. It should also assess the added burdens and costs that such a

system would have on employers, affected financial institutions, and other

stakeholders and develop ways of mitigating these burdens and costs.

Because of the uncertainty about stakeholder receptivity to such a system,

we also recommend that, if the reexamination results in IRS initially

determining that an agency reconciliation system may be feasible and

desirable, the Commissioner expand the reexamination to include a

limited pilot test. Such a test would provide IRS with useful data for

addressing stakeholder concerns and demonstrating its ability to

administer such a system fairly and accurately. If all of the improvements

necessary to fully implement a tax agency reconciliation system are not

feasible in the short term, it may still be possible to test the concept in one

or more states that have no income tax.

Comments and Our

Evaluation

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

of Internal Revenue, the American Institute of Certified Public

Accountants, and IRS’ Information Reporting Program Advisory

Committee.

IRS Comments In written comments on a draft of this report (see app. III), the IRS Deputy

Commissioner was supportive of exploring any proposal that would

reduce taxpayer burden and the volume of paper that needs to be

processed. He indicated that a reexamination of the feasibility and

desirability of designing and implementing a tax agency reconciliation

system could become part of the Tax Settlement Reengineering project,

which is an IRS initiative that uses a structured methodology to examine

Page 21 GAO/GGD-97-6 Alternative Filing Systems
B-260171 

IRS’ business processes and ways to reduce paper processing. However, he

noted that it would be a difficult task to do a complete cost-benefit

analysis of a tax agency reconciliation because much of the information

needed to do the analysis, such as private sector costs, may not be

available. We recognize the difficulty of obtaining complete information on

private sector costs, but we believe that IRS should be able to do an

adequate evaluation of the feasibility of a tax agency reconciliation system

because it has experience in evaluating other alternative filing systems

such as TeleFile.

The Deputy Commissioner noted that our report identified that the Service

Center Recognition and Image Processing System and the Simplified Tax

and Wage Reporting System as steps that IRS is taking to accelerate

information returns processing. However, he stated that the draft report

did not describe how close these activities are to accelerating information

returns processing and therefore did not accurately portray the impact of

this obstacle on a tax agency reconciliation system. During the course of

our work, we asked for, but IRS did not provide estimates of when these

initiatives are projected to be able to accelerate information returns

reporting. The Deputy Commissioner’s letter is also silent in this respect.

Finally, the Deputy Commissioner commented that the costs of a tax

agency reconciliation system would be more than the costs to process

electronically filed returns. We agree that the costs associated with the

type of tax agency reconciliation system described in the report would be

more than the costs to process the same number of returns electronically

filed. However, we estimated that only 8 million of the 51 million taxpayers

who could have been included in an alternative filing system in tax year

1992 filed electronically. If IRS could get most taxpayers to file

electronically there may be no need for other alternative filing systems.

American Institute of

Certified Public

Accountants Comments

In its written comments, the American Institute of Certified Public

Accountants stated that it did not believe that IRS has the ability to

implement a tax agency reconciliation system in the foreseeable future

because of (1) the current uncertainty of IRS budget and staffing levels,

(2) the inability of IRS to process and payers to file complete and accurate

information returns on a timely basis, (3) the unknown effect on voluntary

compliance that could occur if taxpayers fail to report income to IRS from

sources not covered by information returns, and (4) the potential for IRS to

make more errors processing taxpayers’ changes to IRS prepared returns

Page 22 GAO/GGD-97-6 Alternative Filing Systems
B-260171 

under an alternative system than it currently makes processing tax

returns.

We believe that the issues raised by the Institute are valid. Budget

constraints could hamper IRS’ ability to adopt a tax agency reconciliation

system, but this should not prevent it from reexamining the concept.

Similarly, if information returns processing cannot be accelerated in time

to issue tax returns well before April 15, IRS would not be able to

implement the type of tax agency reconciliation system described in the

report unless federal and state laws are changed. We expect that

information return filing and processing would be the key element in IRS’

examination of the system. In regards to whether taxpayers who volunteer

for the system may not let IRS know when they have income not covered

by information returns, we agree that the reporting of income not subject

to information returns is potentially problematic. However, that problem

exists today for paper returns and TeleFile, and we see no evidence it

would be worse under a tax agency reconciliation system. As part of its

examination of a tax agency reconciliation system, IRS may be able to get a

handle on this type of noncompliance by evaluating a sample of TeleFile

participants to determine whether they failed to report noninformation

return income. As to whether the IRS would be more error-prone in

processing tax changes under a tax agency reconciliation system than

processing tax returns, we assume that IRS would have controls and

procedures that would minimize errors under any system it develops.

The Institute noted that a tax agency reconciliation system is too

dependent on future IRS and SSA improvements and that it is too costly for

IRS to undertake such a system until after the successful implementation of

these future improvements. The Institute stated that paper processing may

be more efficiently reduced by expanding opportunities for electronic

filing and TeleFile and it concluded that IRS is correctly focusing its

attention on these initiatives. We agree that IRS should continue to reduce

taxpayer burden and paper processing through electronic filing and

TeleFile. Our recommendation is to have IRS reexamine a tax agency

reconciliation system to determine its feasibility as a supplement to these

voluntary alternative filing systems.

Information Reporting

Program Advisory

Committee Comments

In its written comments, the Information Reporting Program Advisory

Committee raised similar issues on IRS’ budget constraints, information

returns filing and processing constraints, and potential decreases in

voluntary taxpayer compliance levels that were raised by the American

Page 23 GAO/GGD-97-6 Alternative Filing Systems
B-260171 

Institute of Certified Public Accountants. The Committee also stated that

because many of the taxpayers who could be covered by a tax agency

reconciliation system already use electronic filing and TeleFile, our

estimates of cost savings are overstated. Our costs estimates were based

on the combined costs to process the Form 1040 series of returns, which

included both paper and electronically filed returns. The costs of TeleFile

returns were not considered because we used tax year 1992 return data,

and TeleFile was not implemented nationwide until 1996 for tax year 1995

returns. According to IRS, about 2.8 million taxpayers used TeleFile in

1996.

The Committee also pointed out that the report did not address the costs

to the paid preparer community of a tax agency reconciliation system.

These costs dealt with the loss of federal revenues due to a decrease in

taxable income reported by paid preparers and the costs of unemployment

insurance and public assistance payments if the paid preparer industry

experiences a significant loss of jobs. These types of costs are difficult to

quantify. However, our report acknowledges that paid preparers may see a

decrease in business if most taxpayers volunteer to be covered by a tax

agency reconciliation system. The report also states that the effect on paid

preparers and payers would need to be considered before such a system is

adopted. We would expect IRS to include an analysis of these costs in any

examination of a tax agency reconciliation system.

We will send copies of this report to the Ranking Minority Member of this

Subcommittee, the Commissioner of Internal Revenue, and other

interested parties. We also will make copies available to others upon

Page 24 GAO/GGD-97-6 Alternative Filing Systems
B-260171 

request. The major contributors to this report are listed in appendix IV. If

you have any questions, please call me at (202) 512-9044.

Sincerely yours,

Natwar M. Gandhi

Associate Director, Tax Policy and

 Administration Issues

Page 25 GAO/GGD-97-6 Alternative Filing Systems
Contents

Letter 1

Appendix I 

Characteristics and

Operations of Final

Withholding Type

Filing Systems

28

Final Withholding Systems in Other Countries 28

A United States Final Withholding System Would Require Tax

Law and Other Changes to Work Effectively

31

Appendix II 

Population and Cost

Estimates for a Tax

Agency Reconciliation

System

35

Population and Costs Estimates for Tax Agency Reconciliation

System

35

Hours Spent in Tax Return Preparation 42

Appendix III 

Comments From the

Internal Revenue

Service

46

Appendix IV 

Major Contributors to

This Report

48

General Government Division, Washington, D.C. 48

San Francisco/Seattle Field Office 48

Tables Table 1: Tax Bases of States With Tax Systems Linked to Federal

Law

18

Table I.1: Tax System Information for 34 Countries With Final

Withholding Systems

30

Table II.1: Number of Taxpayers by Type of Income for Tax

Agency Reconciliation System

35

Table II.2: Estimates of IRS’ Fiscal Year 1994 Processing Costs by

Form Type

36

Table II.3: Estimated Processing and Tax Return Costs Under Tax

Agency Reconciliation System

36

Table II.4: Estimated Cost to Process 1,000 Taxpayer Information

Forms

37

Page 26 GAO/GGD-97-6 Alternative Filing Systems
Contents

Table II.5: Methodology For Estimating Cost to Process

Adjustments to IRS Prepared Returns

40

Table II.6: Methodology For Estimating Underreporter Cost

Savings due to Tax Agency Reconciliation System

42

Table II.7: IRS’ Estimated Average Time Spent to Complete and

File Individual Tax Returns and Schedule EIC

43

Table II.8: Estimated Time Spent by Taxpayers Eligible for Tax

Agency Reconciliation System to Prepare Returns by Form Type

43

Abbreviations

EIC Earned Income Credit

IRS Internal Revenue Service

SOI Statistics of Income

SSA Social Security Administration

SSN Social Security Number

STAWRS Simplified Tax and Wage Reporting System

Page 27 GAO/GGD-97-6 Alternative Filing Systems
Appendix I 

Characteristics and Operations of Final

Withholding Type Filing Systems

This appendix describes some of the major characteristics of final

withholding type filing systems found in other countries. It also discusses

how final withholding works in other countries and how a United States

final withholding system might work.

Final Withholding

Systems in Other

Countries

Although none of the countries with final withholding type filing systems

are exactly alike, many share common characteristics such as

(1) withholding on wages, (2) exempting or limiting taxes on interest and

dividend income, and (3) requiring each spouse in a marriage who elects

final withholding to be taxed as an individual instead of jointly.

Under a final withholding system, as long as the proper amount of taxes

have been withheld from wages and other income sources, no tax return

has to be filed. However, there are differences among the countries using

this system in when and how employers calculate the final withholding.

For example, under the United Kingdom’s cumulative final withholding

system, the employer must calculate the employee’s tax for a given pay

period as well as the cumulative tax to date and then make any necessary

adjustments. To determine how much tax employers need to withhold, the

employee is to submit a form to the United Kingdom’s tax agency showing

basic factors affecting the taxpayer’s tax status, such as the number of

dependents and amount of allowances the taxpayer is entitled to claim.

From this information, the tax agency is to develop a code and give it to

the employer who then applies the code to tax tables to determine the

amount of taxes to withhold. Tax agency auditors are to later verify

whether employers withheld the correct amounts of taxes. More than

three-fourths of the 22.4 million taxpayers eligible for final withholding in

the United Kingdom did not have to file tax returns in 1994.

Germany’s final withholding system is similar to the United Kingdom’s

except that at the beginning of the calendar year the tax agency is to issue

a certified wage card to each employee, listing basic factors affecting the

employee’s tax status. The employee is to present the wage card to the

employer for use in determining the amount of taxes to withhold. At the

end of the year, the employer is to summarize the wage and withholding

information, and if necessary, adjust the employee’s last paycheck so that

the correct amount of taxes is withheld.

Under Japan’s final withholding system, employees are to submit to the

tax authorities, through their employer, statements providing exemption

information, which include the names of dependents and other necessary

Page 28 GAO/GGD-97-6 Alternative Filing Systems
Appendix I 

Characteristics and Operations of Final

Withholding Type Filing Systems

particulars. Employers are to use the exemption information to withhold

income tax on employment income according to tax tables based on

variables, including the size of the income, number of exemptions, and

periodic employment income. At the end of the year, the employer is to

compare the taxes collected with the yearly tax amounts due and adjust

the last paycheck so that the withholding equals the tax liability.

Many countries with final withholding filing systems reduce the number of

taxpayers required to file tax returns by either exempting, limiting, or

taxing interest and dividend income at the source. Fourteen countries

exempt all or a portion of interest, while another 14 countries tax interest

with a flat amount at the source (e.g., tax on interest is withheld by the

financial institution).

Countries with final withholding filing systems may not allow married

taxpayers to file joint returns. Twenty-two countries with a final

withholding filing system specifically require married taxpayers to file

separately. Other countries either require joint tax returns or give married

couples that option. According to International Monetary Fund officials,

administering a final withholding system with a “married filing joint” filing

status would be very difficult if both spouses work. In that circumstance,

each employer would need to take the income of the taxpayer’s spouse

into consideration when calculating the final withholding amount.

Under nearly all final withholding systems, including those of the United

Kingdom, Germany, and Japan, taxpayers are required to file returns under

some circumstances. For example, Chile requires employees to file tax

returns if they have a second employer. In Luxembourg, where the total

income of husband and wife is aggregated, a tax return must be prepared

when both spouses work.

Table I.1 describes the characteristics of the tax system for 34 countries

with a final withholding filing system.

Page 29 GAO/GGD-97-6 Alternative Filing Systems
Appendix I 

Characteristics and Operations of Final

Withholding Type Filing Systems

Table I.1: Tax System Information for 34 Countries With Final Withholding Systems

Country No return requirement

Interest income

requirement

Marital filing status

requirement

Argentina if earned income only savings/bank interest

exempt

married filing separate if

wife employed

Austria if earned income only flat tax at source married filing separate

Chile if earned income only from

one job

taxed through tax return married filing separate if

wife employed

Colombia if earned income less than

threshold

flat tax at source married filing separate

Costa Rica if earned income only flat tax at source, reconciled

through tax return

married filing separate

Czech Republic if income taxed at source or

if only earned income

flat tax at source married filing separate

Dominican Republic if earned income only interest exempt married filing separate

Ecuador if earned income and

employed by one company

flat tax at source,

reconciled through tax return

married filing separate

Egypt if earned income only savings/bank interest

exempt

married filing separate

Germany if earned income under a

certain threshold

interest above threshold

withheld at source

either joint or separate, but

taxed on joint

Hungary if sole income from one

employer or less than

threshold

flat tax at source married filing separate

Indonesia if income from one employer

only

flat tax at source married filing joint

Iran if income from one source

and less than threshold

taxed through tax return married filing separate

Ireland if earned income only flat tax at source either joint or separate, but

taxed on joint

Japan if one employer and earned

income and other income

less than threshold

flat tax at source married filing separate

Kenya if earned income from one

employer and no change in

personal circumstances

flat tax at source married filing joint

Republic of Korea if earned income only flat tax at source married filing separate

Luxembourg if earned income only, one

employer, and less than

threshold

amount above threshold

taxed through tax return

married filing joint

Malawi if earned income only amount above threshold

taxed through tax return

married filing joint

Mexico if employed by one

employer through 12/31

flat tax at source married filing separate

(continued)

Page 30 GAO/GGD-97-6 Alternative Filing Systems
Appendix I 

Characteristics and Operations of Final

Withholding Type Filing Systems

Country No return requirement

Interest income

requirement

Marital filing status

requirement

Morocco if earned income from one

employer only

taxed through tax return married filing separate

Netherlands if earned income only taxed through tax return married filing separate

Nigeria if earned income only and

less than threshold

flat tax at source, reconciled

through tax return

married filing separate

Panama if one source of income from

wages

flat tax at source either joint or separate

Papua New Guinea if earned income only savings/bank interest

exempt

married filing separate

Peru if earned income only taxed through tax return either joint or separate

Poland if earned income only savings/bank interest

exempt

either joint or separate

Romania if earned income only

(employer files return for

taxpayer)

savings/bank interest

exempt

married filing separate

Russian Federation if one company and less

than threshold

savings/bank interest

exempt

married filing separate

South Africa if earned income less than

threshold

amount above threshold

taxed through tax system

married filing joint

Tanzania if earned income only amount above threshold

taxed through tax return

either joint or separate,

unless in business with

spouse

Turkey if earned income less than

threshold

savings/bank interest

exempt

married filing joint

Uganda if earned income only taxed through tax return either joint or separate

United Kingdom if earned income only amount above threshold

taxed at source

married filing separate

Source: GAO analysis based on Price Waterhouse Individual Taxes: A Worldwide Summary, 1991

and 1994.

A United States Final

Withholding System

Would Require Tax

Law and Other

Changes to Work

Effectively

Before a final withholding system could be instituted in the United States,

the law would have to be changed to require employers to calculate

employees’ tax liability and adjust employees’ last paychecks so that total

yearly withholdings would equal employees’ tax liability. Also, unlike

many countries with final withholding systems, the United States tax

system does not exempt or limit taxes on interest and dividend income nor

does it require married couples to file separately. These features are

potential barriers to adopting a final withholding system in the United

States. Without changes to address these features, taxpayers that could be

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Appendix I 

Characteristics and Operations of Final

Withholding Type Filing Systems

covered by final withholding would be limited to those who only had wage

income, which is the only income source generally subject to withholding.

To determine how many taxpayers in the United States potentially could

be covered by final withholding, we identified criteria for eligibility for a

final withholding filing system. The final withholding criteria were

identified to minimize tax law and administrative changes, limit burden on

employers and other payers, and maximize the number of taxpayers that

could be included in the system. To meet these criteria,

• taxpayers would not be able to itemize deductions and, instead, would

take the standard deduction;

• taxpayers could have only wage income because other types of income are

generally not subject to withholding;

• only taxpayers with one employer could be covered by final withholding

because taxpayers with more than one employer would increase the

burden on employers, who would have to know the income received from

other employers to withhold the correct amount of taxes;

• married couples where both spouses had income were excluded because

employers would have to know the income of both spouses to withhold

the correct amount of taxes; and

• taxpayers could not claim any credits because employers would have to

calculate the credit, which would impose additional recordkeeping

burdens on them.

We estimated that about 18.5 million taxpayers in 1992 met these

conditions and could be covered under this type of final withholding

system.11 These 18.5 million taxpayers represented about 16 percent of the

taxpayers who filed returns, and they accounted for about 4 percent of the

total reported individual tax liability.

How a Final Withholding

System Might Operate

One way a final withholding system might work would be to have IRS

develop a new withholding form for taxpayers who volunteer for final

withholding. Employees would submit the withholding form to their

employers for withholding and tax calculation purposes. The new form

would have to contain such taxpayer entity data as

• name and address,

11To make this estimate, we used IRS’ tax year 1992 Statistics of Income (SOI) data and U.S. Bureau of

Census data. Census supplied data on the number of wage earners that had only one job and the

number of married couples where only one spouse worked. We adjusted the SOI data with the Census

data to make our estimate.

Page 32 GAO/GGD-97-6 Alternative Filing Systems
Appendix I 

Characteristics and Operations of Final

Withholding Type Filing Systems

• SSN,

• filing status, and

• name and SSN of spouse and dependents.

A new withholding form would have to be developed because the current

withholding form, Form W-4, Employee Withholding Allowance

Certificate, does not contain complete filing status information or

information on the employee’s spouse and dependents. Similar to current

procedures, employers would use the information from the new

withholding form to calculate the amount of income tax to be withheld

each pay period. However, unlike current procedures, employers would

enter Employer Identification Number on the new withholding form and

send it to IRS.

IRS would receive the new withholding form and enter the information on

its records. IRS could use this information for compliance purposes, such

as verifying the taxpayer’s and dependents’ SSNs. For the last pay period of

the year, the employer would have to calculate the employee’s tax liability

on the basis of the information provided on the employee withholding

certificate. The employer would need to compare the tax liability with the

amount withheld during the year and adjust the employee’s last pay check

so that the total yearly withholdings equaled the tax liability. If during the

year the withheld taxes exceeded the tax liability, the employee’s net pay

on the last paycheck would be higher than usual. However, if not enough

taxes were withheld during the year, the employee’s last paycheck would

be smaller than usual.

Potential Benefits and

Costs of Final Withholding

Final withholding would reduce the time taxpayers spend preparing

returns and possibly eliminate the cost of paying tax return preparers.

Thus, such a system would reduce taxpayer burden. However, it would

have a negative impact on paid preparers. On the other hand, IRS’ returns

processing costs would be reduced because it would not have to process

tax returns.

Final withholding would increase employers’ burden and costs in

complying with tax laws and regulations. For example, in addition to

knowing about current withholding requirements and forms, employers

would need to become familiar with separate withholding and reporting

requirements for employees who volunteer for final withholding and those

who do not. Unlike under the current employment tax requirements,

employers would need to ensure that they accurately track withheld taxes

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Appendix I 

Characteristics and Operations of Final

Withholding Type Filing Systems

so that they could make a year-end adjustment to make the withheld taxes

equal to the taxpayer’s tax liability. Otherwise, employers could be liable

for payment penalties for incorrectly withholding taxes on employees.

Employers and their representatives we talked to expressed concern over

some final withholding aspects. Some employers believed that final

withholding would require revising the entire payroll process to

accommodate year-end adjustments. We were told by some employers that

the current wage withholding system would need to be completely

overhauled because it was not designed to calculate the final amount of

taxes owed.

Taxpayers would not have a federal tax return to use to file their state

income tax returns. However, except for eligible taxpayers who reside in

the eight states that use federal taxable income as their tax base, eligible

taxpayers who are required to pay state taxes could calculate their state

taxes from the income and withholding information contained on their

withholding form. We estimated that about 2 million of the 18.5 million

taxpayers who could be eligible for final withholding reside in the eight

states where tax systems are linked to federal taxable income.12 For these

taxpayers to meet state tax requirements, they would have to determine

their federal taxable income. However, in the absence of federal tax

returns, officials from several of these states told us they would consider

developing supplemental instructions and worksheets in their tax booklets

that would allow taxpayers to calculate federal taxable income so that

taxpayers could calculate their state taxes.

12The eight states are Colorado, Hawaii, Idaho, Minnesota, North Carolina, Oregon, South Carolina, and

Utah.

Page 34 GAO/GGD-97-6 Alternative Filing Systems
Appendix II 

Population and Cost Estimates for a Tax

Agency Reconciliation System

This appendix describes how we derived the population and cost

estimates for the tax agency reconciliation type filing system. We used IRS’

1992 Statistics of Income (SOI) data to estimate the number of taxpayers

who would have met our eligibility criteria for the system and the amount

of time they could save in tax return preparation tasks. We used IRS’

Document 6746, Cost Estimate Reference for Service Center Returns

Processing for Fiscal Year 1994, to develop costs estimates.13

Population and Costs

Estimates for Tax

Agency Reconciliation

System

For a hypothetical tax agency reconciliation system, we made the

following estimates: (1) number of taxpayers in tax year 1992 who could

have been covered by the system, (2) fiscal year 1994 costs to process tax

returns for this population, (3) costs to process taxpayer information

forms, (4) costs to produce computer-generated tax returns, (5) costs to

process remittances for taxpayers who would owe taxes, (6) costs to

handle taxpayer inquiries about their computer-generated tax returns, and

(7) potential compliance savings from the underreporter program.

Number of Taxpayers

Eligible for a Tax Agency

Reconciliation System

Taxpayers who could have been covered by this system included those

who had income from wage, interest, dividend, pension, and

unemployment and claimed the standard deduction. We estimated that

51 million taxpayers would have met these eligibility criteria for a tax

agency reconciliation system.

Table II.1 shows the number of taxpayers included in a tax agency

reconciliation system by income type.

Table II.1: Number of Taxpayers by

Type of Income for Tax Agency

Reconciliation System

Numbers in millions

Income type Number of taxpayers

Wages only 28.7

Interest/Dividend only 1.0

Pension only 0.1

Unemployment compensation only 0.1

Other combinations 21.1

Total 51.0

Source: GAO analysis of 1992 SOI data.

13This document contained information on labor costs and staff hours for processing returns and

performing related functions in the service centers, which are computed using national totals and

rates.

Page 35 GAO/GGD-97-6 Alternative Filing Systems
Appendix II 

Population and Cost Estimates for a Tax

Agency Reconciliation System

Included in the 51 million taxpayers, but not shown in table II.1 because

they are already included based on their type of income, are 9.9 million or

19 percent of the taxpayers who claimed earned income tax credit (EIC).

Cost Estimates for

Processing Tax Returns

Table II.2 shows the number of tax returns by the type of form filed and

IRS’ combined paper and electronic filing cost to process each form.

Table II.2: Estimates of IRS’ Fiscal Year

1994 Processing Costs by Form Type Numbers and total costs in millions

Form type Number of returns Cost per form Total cost

1040EZ 19.0 $ 3.12 $ 59.3

1040A 23.0 3.69 84.9

1040 9.0 4.23 38.1

Total 51.0 N/A $182.3

Source: IRS’ 1992 SOI data and Document 6746, Cost Estimate Reference for Service Center

Returns Processing for Fiscal Year 1994.

Tax Agency Reconciliation

System Cost Estimates

Table II.3 shows the estimated costs associated with the tax agency

reconciliation system.

Table II.3: Estimated Processing and

Tax Return Costs Under Tax Agency

Reconciliation System

Numbers and costs in millions

Function Number Cost

Processing taxpayer information forms 51.0 $ 46.9

Computer-generated tax returns 51.0 49.5

Processing remittances 7.7 2.3

Handling taxpayer

adjustments to returns

.275 1.4

Telephone calls from taxpayers accepting IRS prepared

returns

50.725 59.9

Total processing and tax return costs $160.0

Less savings from underreporter program $ 15.1

Net processing and tax return costs $144.9

Source: IRS’ 1992 SOI data, IRS’ Document 6746, and GAO analysis.

The following sections describe how each of these estimates were done.

Page 36 GAO/GGD-97-6 Alternative Filing Systems
Appendix II 

Population and Cost Estimates for a Tax

Agency Reconciliation System

Estimated processing costs for taxpayer information form: For our

hypothetical tax agency reconciliation system, we assumed that IRS would

need to develop a form to collect taxpayer information that would be

needed to calculate a taxpayer’s tax liability. Some of the information IRS

would need on each taxpayer would include,

• name and address,

• SSN,

• filing status,

• name and SSN of spouse,

• name and SSN of dependents and qualifying children,

• relationship of dependents and qualifying children to taxpayer, and

• number of months dependents and qualifying children lived with taxpayer

during the year.

To determine IRS’ costs to process a form with these taxpayer information

items, we used the costing methodology in IRS’ Document 6746. Table II.4

shows the estimated cost to process 1,000 taxpayer information forms.

Table II.4: Estimated Cost to Process

1,000 Taxpayer Information Forms Type of cost Cost

Processing cost $391.66

Quality assurance ($12.34 X 2 hr.) 24.68

Subtotal 416.34

Overhead ($416.34 X 75 percent) 312.26

Subtotal 728.60

Employee benefits ($728.60 X 25.9 percent) 188.71

Total cost for 1,000 forms $917.31

Cost per form $0.92

Source: IRS’ Document 6746, Cost Estimate Reference for Service Center Returns Processing for

Fiscal Year 1994.

Fresno Service Center staff estimated that the processing cost for 1,000

forms would be $391.66 and would take 43.5 hours of labor to process. We

then used these processing costs and hours and Document 6746 quality

assurance methodology to determine quality assurance costs. Using

Document 6746 methodology, we multiplied the number of hours required

for processing taxpayer information forms (43.5 hours) by 4.5 percent to

determine the quality assurance time for 1,000 forms, which was about 2

hours (i.e., 43.5 hours x 0.045 = 1.958 or 2.0 hours). To compute the cost of

the quality assurance time, we multiplied the 2 hours by the $12.34 hourly

Page 37 GAO/GGD-97-6 Alternative Filing Systems
Appendix II 

Population and Cost Estimates for a Tax

Agency Reconciliation System

quality assurance rate used in Document 6746 and determined this cost to

be $24.68 ($12.34 x 2.0 hours).

To estimate overhead costs, we used the overhead percentage found in

Document 6746, which was 75 percent of direct costs (i.e., processing cost

of $391.66 plus quality assurance cost of $24.34 for a total of $416.34. We

estimated overhead cost to be $312.26, (416.34 x .75), which when added

to the combined processing and quality assurance costs was $728.60. To

determine employee benefits, we used the 25.9 percent benefit rate found

in Document 6746 and multiplied this rate by the direct and overhead

costs (i.e., $728.60 x 0.259). The employee benefits ($188.71) was added to

all other cost to give a total cost of $917.31 to process 1,000 forms. Thus,

the cost per form would be about 92 cents.

Computer-generated tax return: IRS essentially produces

computer-generated tax returns now in its document-matching program.

Under this program, IRS computer-matches income reported on

information returns with income reported on tax returns to determine

whether taxpayers reported all their income or failed to file required tax

returns. In this matching process, the computer internally creates the

equivalent of a tax return from the information return data. When the

computer identifies nonfilers, IRS service centers send a series of

computer-generated notices to potential nonfilers. Certain nonfiler cases

not resolved during the notice process are assigned to the Substitute for

Return Program.

14 Under this program IRS uses information returns to

prepare a tax return that “substitutes” for the return that the taxpayer

should have filed voluntarily. IRS estimated that it costs about 65 cents to

produce a substitute return and 32 cents to mail each one. On the basis of

these data, we estimated it would cost about $49.5 million to produce and

mail out 51 million computer-generated tax returns.

Processing remittances: On the basis of the SOI data, we estimated about

7.7 million or 15 percent of the 51 million taxpayers would owe taxes

when they received their computer-generated tax returns. The remaining

43.3 million either would receive a refund or owe no taxes. IRS Document

6746 data for fiscal year 1994 showed that it cost about 30 cents to process

a remittance. Therefore, we estimated the cost to process 7.7 million

remittances would be $2.3 million.

14This program is authorized under section 6020 of the Internal Revenue Code. It authorizes the

Secretary of the Treasury or his delegate to prepare tax returns for persons who file a false or

fraudulent return or fail to file a return.

Page 38 GAO/GGD-97-6 Alternative Filing Systems
Appendix II 

Population and Cost Estimates for a Tax

Agency Reconciliation System

Handling taxpayer adjustments to IRS prepared returns: On the basis of the

results of IRS’ underreporter program, it is likely that some of the

information returns that IRS receives will be in error and result in

erroneous tax returns. For the tax year 1991 underreporter program, IRS

created about 9.1 million potential underreporter cases for the

114.7 million returns filed that year. About 112 million of the returns had at

least 1 of the 5 types of income included in our tax agency reconciliation

model (i.e., wages, interest, dividends, pensions, and unemployment

compensation). IRS found that about 2.3 million or 2 percent of the

112 million taxpayers potentially underreported 1 or more of the 5 tax

agency reconciliation system income types.

To determine how many of the 51 million taxpayers eligible for tax agency

reconciliation filing would be potential underreporters, we assumed that

the underreporter caseload was spread out evenly among all 112 million

taxpayers who reported 1 of the 5 tax agency reconciliation system

income types. Therefore, we estimated that 46 percent (i.e., 51 million

divided by 112 million) or 1.1 million of the 2.3 million (2.3 million x

46 percent) potential underreporter cases could be eligible for tax agency

reconciliation filing.

IRS worked about 1.8 million of the 2.3 million potential underreporter

cases. IRS found when it investigated the 1.8 million cases that about

900,000 or 50 percent resulted in no change to the taxpayers’ tax liabilities

because taxpayers had reported either the income on their returns, which

was not detected in the computer-match, or the information returns were

in error. Using the 50 percent no-change rate, we estimated IRS would have

found that about 550,000 of the 1.1 million tax agency reconciliation

potential underreporters would not have underreported their income.

IRS does not maintain data on the number of erroneous underreporter

cases that are created because of erroneous information returns. However,

IRS Fresno Service Center officials estimated for us that between 5 and 10

percent of the no-change underreporter cases worked were due to

erroneous information returns. To be conservative, we assumed that 50

percent of the no-change underreporter cases would not be correct

because of erroneous information returns. We applied this 50 percent

erroneous information return rate to the 550,000 no-change underreporter

cases and estimated that IRS would create about 275,000 flawed tax returns

because of erroneous information returns. To be conservative, we

assumed that taxpayers who received these flawed returns would

correspond with IRS to resolve the erroneous conditions rather than

Page 39 GAO/GGD-97-6 Alternative Filing Systems
Appendix II 

Population and Cost Estimates for a Tax

Agency Reconciliation System

resolve them by telephone. IRS’ Document 6746 data showed that it costs

about $4.93 to handle a piece of correspondence from an individual

taxpayer. Therefore, on the basis of this data, we estimated it would cost

$1.4 million to handle the 275,000 taxpayer inquiries. Table II.5 shows the

calculations we made to estimate the cost of handling taxpayer inquires to

process adjustments to IRS prepared tax returns.

Table II.5: Methodology for Estimating

Cost to Process Adjustments to IRS

Prepared Returns

Data used to calculate underreporter cases Estimates

Number of taxpayers with wage, interest, dividend,

pension, and unemployment income in tax year 1992.

112 million

Number of taxpayers eligible for tax agency reconciliation

filing system.

51 million

Percent of taxpayers eligible for tax agency reconciliation

filing to total taxpayers. (51 million/112 million)

46 percent

Number of taxpers who IRS identified as potential

underreporters of wage, interest, dividend, pension, and

unemployment income in tax year 1991.

2.3 million

Number of taxpayers eligible for tax agency reconciliation

filing who were identified as potentially underreporting their

income in 1991. (.46 X 2.3 million)

1.1 million

No-change rate for tax year 1991 underreporter cases with

wage, interest, dividend, pension, and unemployment

compensation that were worked by IRS.

50 percent

Number of tax agency reconciliation underreporter cases

with no change. (1.1 million x 50 percent)

550,000

Percent of no-change cases that were due to erroneous

information returns.

50 percent

Number of tax agency reconciliation system no-change

cases that were due to erroneous information returns.

(550,000 x 50 percent)

275,000

Average cost to handle a piece of taxpayer

correspondence.

$4.93

Cost to process taxpayer inquiries for adjustments to IRS

prepared returns that were due to erroneous information

returns. ($4.93 x 275,000)

$1.4 million

Source: GAO’s analysis of IRS’ tax year 1991 underreporter data.

Handling telephone calls from taxpayers accepting IRS prepared returns:

We assumed that the estimated 50,725,000 taxpayers who would agreed

with their IRS prepared tax returns would telephone IRS with their

acceptance. IRS estimated that for fiscal year 1994, it cost about $1.18 for

each taxpayer service call. Using these data, we estimated that the cost to

IRS to handle 50,725,000 telephone calls would be about $59.9 million.

Page 40 GAO/GGD-97-6 Alternative Filing Systems
Appendix II 

Population and Cost Estimates for a Tax

Agency Reconciliation System

Savings from the Underreporter Program: Since the 51 million

computer-generated returns are created from information returns, the

51 million taxpayers covered by return-free filing would not be subject to

the underreporter program. Therefore, IRS would not incur underreporter

costs associated with investigating taxpayers who are part of the tax

agency reconciliation system. To determine the underreporter costs

savings that could result under a tax agency reconciliation system, we

used the results of IRS’ tax year 1991 underreporter program.

As discussed above, IRS worked about 1.8 million or 78 percent of the

2.3 million potential underreporter cases that have the 5 types of tax

agency reconciliation filing income (i.e., wages, interest, dividends,

pensions, and unemployment compensation). We also assumed that since

the 51 million taxpayers eligible for tax agency reconciliation filing

represented 46 percent of the taxpayers with the 5 income types that the

same percentage would apply to the potential underreporter population.

Therefore, the tax agency reconciliation underreporter population would

be 1.1 million taxpayers (2.3 million x 46 percent). Since underreporter

costs are only associated with cases that IRS worked, and it handled 78

percent of its cases in 1991, we estimated that IRS would have worked

858,000 of the 1.1 million tax agency reconciliation eligible cases. IRS

estimated that it cost about $17.61 to work and close a tax year 1991

underreporter case. Thus, the cost savings of not having to work these

underreporter cases would be about $15.1 million (858,000 x $17.61). Table

II.6 shows how we calculated this cost-savings estimate.

Page 41 GAO/GGD-97-6 Alternative Filing Systems
Appendix II 

Population and Cost Estimates for a Tax

Agency Reconciliation System

Table II.6: Methodology for Estimating

Underreporter Cost Savings Due to

Tax Agency Reconciliation System

Data used to calculate underreporter cases Estimates

Number of taxpayers with wage, interest, dividend,

pension, and unemployment income in tax year 1992.

112 million

Number of taxpayers eligible for tax agency reconciliation

filing system.

51 million

Ratio of taxpayers eligible for tax agency reconciliation

filing to total taxpayers (51 million/112 million)

46 percent

Number of taxpayers who IRS identified as potential

underreporters of wage, interest, dividend, pension, and

unemployment income in tax year 1991

2.3 million

Number of taxpayers eligible for tax agency reconciliation

filing who were identified as potentially underreporting their

income in 1991 (.46 X 2.3 million)

1.1 million

Number of tax year 1991 underreporter cases with wage,

interest, dividend, pension, and unemployment

compensation that were worked by IRS.

1.8 million

Percent of underreporter cases worked of total cases

created (1.8 million/2.3 million)

78 percent

Estimated number of underreporter cases worked by IRS

that also qualify for tax agency reconciliation filing

858,000

Average cost to work an underreporter case $17.61

Savings from not working tax agency reconciliation

underreporter cases ($17.61 X 858,000)

$15.1 million

Source: GAO’s analysis of IRS’ tax year 1991 underreporter data.

Hours Spent in Tax

Return Preparation

IRS has developed estimates of the average amount of time it takes

taxpayers to complete and file various types of tax returns and schedules.15

IRS breaks the return preparation time into four tasks: (1) recordkeeping;

(2) learning about the law or the form; (3) preparing the form; and

(4) copying, assembling, and sending the form to IRS. Table II.7 shows the

average amount of time to complete the four tasks by the three types of

individual income tax returns (forms 1040EZ, 1040A, and 1040) and for the

Schedule EIC, Earned Income Credit (Qualifying Child Information).

15IRS’ estimated average tax return preparation time are found in the instructions to the tax return

packages. We did not evaluate the reliability of these estimates. However, we use the estimates solely

for comparison purposes.

Page 42 GAO/GGD-97-6 Alternative Filing Systems
Appendix II 

Population and Cost Estimates for a Tax

Agency Reconciliation System

Table II.7: IRS’ Estimated Average Time Spent to Complete and File Individual Tax Returns and Schedule EIC

Form type

Record

keeping

Learning about the

law or the form

Preparing the

form

Copying,

assembling, and

sending the form

to IRS

Total hours

needed to

complete form

type

1040EZ 5 min. 49 min. 1 hr.

20 min.

40 min. 2.9 hr.

1040A 1 hr.

3 min.

2 hr.

14 min.

2 hr.

51 min.

35 min. 6.7 hr.

1040 3 hr.

8 min.

2 hr.

53 min.

4 hr.

41 min.

53 min. 11.6 hr.

EICa 0 min. 2 min. 4 min. 5 min. .2 hr.

aSchedule EIC is filed with forms 1040A and 1040 only.

Source: IRS’ 1994 individual tax return instructions.

Table II.8 shows that the 51 million taxpayers eligible for a tax agency

reconciliation filing system spent an estimated 316.3 million hours

completing and filing returns.

Table II.8: Estimated Time Spent by

Taxpayers Eligible for Tax Agency

Reconciliation System to Prepare

Returns by Form Type

Total time and numbers of taxpayers in million

Form type

Amount of time

spent to prepare

form (per taxpayer)

Number of

taxpayers Total time

1040EZ 2.9 hr. 19.0 55.1 hr.

1040A with EIC 6.9 hr. 8.7 60.0 hr.

1040A 6.7 hr. 14.4 96.5 hr.

1040 with EIC 11.8 hr. 1.2 14.2 hr.

1040 11.6 hr. 7.8 90.5 hr.

Total 51.0 316.3 hr.

Note: Totals may not add due to rounding.

Source: Table II.7 and GAO’s analysis of tax year 1992 SOI data.

On the basis of IRS’ 1992 SOI data, we estimated that about 16.6 million of

the 51 million taxpayers had their returns completed by paid preparers.

We estimated that these taxpayers would have spent an estimated

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Appendix II 

Population and Cost Estimates for a Tax

Agency Reconciliation System

54.1 million hours preparing their returns.16 Thus, we estimated that the

51 million taxpayers would have spent 262.2 million hours (316.3 million

minus 54.1 million) preparing tax returns.

To determine the number of hours taxpayers would spend on return

preparation tasks associated with a tax agency reconciliation system, we

analyzed the potential population of tax agency reconciliation filers by the

types of income they reported and their filing status. We estimated that

30 million of the 51 million taxpayers had income from wages, interest,

and unemployment compensation, their filing status was either single or

married filing joint returns, and they had no dependents. Taxpayers with

these characteristics would have return preparation tasks associated with

taxpayers who could file Form 1040EZ. The remaining 21 million

taxpayers reported income that included either dividends or pensions or

had dependents. Taxpayers with these income characteristics, regardless

of filing status, would have return preparation tasks associated with

taxpayers who could file Form 1040A. Using these data, we estimated the

time required for preparing tax returns under a tax agency reconciliation

system.

• Recordkeeping: We assumed the 30 million taxpayers who had Form

1040EZ characteristics and the 21 million taxpayers who had Form 1040A

characteristics would have the same recordkeeping time IRS estimated for

these forms, as shown in table II.7. We estimated that the 51 million

taxpayers would spend 24.6 million hours on recordkeeping tasks.

• Learning about the law or form: We made the same assumptions for this

task as we did for the recordkeeping task. We estimated that the 51 million

taxpayers would spend an estimated 71.4 million hours on this task.

• Preparing the form: To estimate the average time that would be spent on

preparing the taxpayer information form, we used IRS’ time estimates for

completing Schedule EIC. Schedule EIC contains information on the identity

of qualifying children for taxpayers claiming the earned income tax credit,

which is similar to the information that would be contained on the

taxpayer information form. IRS estimated that it takes taxpayers 4 minutes

to complete Schedule EIC. We assumed that taxpayers could take twice as

long to complete the taxpayer information form because taxpayers may

have to enter twice as much data on the taxpayer information form.

16To make this estimate, we took the amount of time spent to prepare returns from the “preparing the

form” column shown in table III.7 and multiplied that number by the appropriate number of return

types, which was 5.4 million forms 1040, 8.9 million forms 1040A, and 2.3 million forms 1040EZ. We

also multiplied the 4 minutes time spent to prepare the Schedule EIC shown in table III.7 by the

5 million taxpayers who, according to SOI data, claimed the credit and used paid preparers. We

summed these calculations to determine the amount of time taxpayers saved by using paid preparers.

Page 44 GAO/GGD-97-6 Alternative Filing Systems
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Population and Cost Estimates for a Tax

Agency Reconciliation System

Therefore, we estimated that the 51 million taxpayers would spend an

estimated 6.8 million hours preparing the form.

• Copying, assembling, and sending the form to IRS: For this task, we also

used IRS’ average time estimates for Schedule EIC, which was 5 minutes.

We assumed that since the taxpayer information form is a one-page form

like the Schedule EIC that the amount of time would be the same.

Therefore, we estimated that the 51 million taxpayers would spend about

4.3 million hours on this task.

In total, we estimated that taxpayers eligible for a tax agency

reconciliation system would spend about 107.1 million hours on preparing

tax returns, which is 155.1 million hours (262.2 million hours minus

107.1 million hours) less than estimated for preparing tax returns prepared

under the current return filing system.

Page 45 GAO/GGD-97-6 Alternative Filing Systems
Appendix III 

Comments From the Internal Revenue

Service

Page 46 GAO/GGD-97-6 Alternative Filing Systems
Appendix III 

Comments From the Internal Revenue

Service

Page 47 GAO/GGD-97-6 Alternative Filing Systems
Appendix IV 

Major Contributors to This Report

General Government

Division, Washington,

D.C.

Ralph Block, Assistant Director, Tax Policy and Administration

 Issues

Nancy Peters, Assignment Manager

San Francisco/Seattle

Field Office

Kathleen Seymour, Evaluator-in-Charge

Jack Erlan, Senior Evaluator

Sharon Caporale, Evaluator

David Elder, Evaluator

Tre Forlano, Evaluator

Eduardo Luna, Evaluator

(268664) Page 48 GAO/GGD-97-6 Alternative Filing Systems
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