GAO 

United States Government Accountability Office

Report to the Committee on Finance, 

U.S. Senate 

TAX 

ADMINISTRATION 

IRS Should Evaluate 

Penalties and Develop 

a Plan to Focus Its 

Efforts 

June 2009 

GAO-09-567 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

June 2009

TAX ADMINISTRATION

IRS Should Evaluate Penalties and Develop a Plan to 

Focus Its Efforts

Highlights of GAO-09-567, a report to the 

Committee on Finance, U.S. Senate 

Civil tax penalties are an important 

tool for encouraging compliance 

with tax laws. It is important that 

the Internal Revenue Service (IRS) 

administers penalties properly and 

determines the effectiveness of 

penalties in encouraging 

compliance. 

In response to a congressional 

request, GAO determined 

(1) whether IRS is evaluating 

penalties in a manner that supports 

sound penalty administration and 

voluntary compliance and, if not, 

how IRS may be able to do so, and 

(2) whether IRS’s guidance for a 

new penalty for failure to disclose 

reportable transactions was issued 

in a timely manner and was useful 

to affected parties, and whether 

and how IRS has assessed the 

penalty. GAO reviewed IRS 

documents and guidance, and 

interviewed IRS officials and tax 

practitioners. 

What GAO Recommends

The Commissioner of Internal 

Revenue should direct the Office of 

Servicewide Penalties (OSP) to 

evaluate penalty administration 

and penalties’ effect on voluntary 

compliance and develop a plan to 

focus its efforts. The Commissioner 

also should use IRS’s standard 

outreach methods to again alert 

taxpayers of the need to disclose 

reportable loss transactions. 

In commenting on a draft of this 

report, IRS concurred with GAO’s 

recommendations, and summarized 

the actions it plans to take. 

OSP does not comprehensively evaluate the administration of civil tax 

penalties or their impact on voluntary compliance, but a plan could help it do 

so. OSP has responsibility for administering penalty programs and 

determining the action necessary to promote voluntary compliance. 

According to IRS policy, OSP should collect information to evaluate penalties 

and penalty administration and to determine the effectiveness of penalties in 

promoting voluntary compliance. This policy is consistent with positions 

expressed in 1989 by both an IRS Task Force report and by Congress when 

reforming penalties in 1989, and more recently by the National Taxpayer 

Advocate. OSP does not fulfill the responsibilities specified in IRS policy. 

Rather, OSP analysts focus on short-term issues, such as sudden spikes in 

assessments or abatements. OSP officials said that they have not done more 

to evaluate the administration of penalties and their effect on voluntary 

compliance because of resource constraints, methodological barriers, and 

limitations in available databases. 

A plan could help IRS focus its efforts and address the constraints to 

evaluating penalties. In developing a plan, IRS could identify the analyses it 

should do and the resources needed to do them. OSP could then determine 

what resources are available to assist it and what additional resources, if any, 

are needed. A plan also could lay out feasible research for evaluating the 

effect of penalties on voluntary compliance. For example, fairness is believed 

to undergird voluntary compliance. Thus, analyses that determine whether 

penalties are being consistently applied across IRS would provide pertinent 

information. Data limitations could be addressed in a plan, as well. The 

Enforcement Revenue Information System (ERIS) contains substantial data 

on IRS enforcement activities, but does not include all of the information 

recommended by the 1989 IRS Task Force report. For example, ERIS does not 

include readily usable information related to taxpayer income that could be 

used to determine equitable treatment of taxpayers. 

IRS issued guidance regarding its implementation of a penalty for failure to 

disclose reportable transactions— transactions IRS identified as tax 

avoidance transactions—within 3 months of the provision’s passage. IRS 

officials said that their criterion for issuing timely guidance is whether it was 

released in time to meet customers’ needs. Tax practitioners from two leading 

practitioner organizations said the guidance was issued timely and included 

information they needed. However, the practitioners said more targeted 

outreach about the penalty was needed, specifically regarding reportable loss 

transactions caused by the current economic climate in which many taxpayers 

may experience losses that could trigger the reportable transaction 

requirements. IRS officials recognize the need to further raise awareness of 

the penalty, but their planned efforts would reach only a small portion of tax 

return preparers and taxpayers. As of January 2009, IRS has assessed 98 

penalties for $13.7 million. In addition, 1,188 returns had been assigned to field 

groups. 

To view the full product, including the scope 

and methodology, click on GAO-09-567. 

For more information, contact Michael 

Brostek (202) 512-9110 or 

brostekm@gao.gov. 
Page i GAO-09-567 

Contents 

Letter 1

Background 3 

IRS Does Not Comprehensively Evaluate the Administration of Tax 

Penalties or Their Impact on Voluntary Compliance, but a Plan 

Could Help It Do So 5 

Reportable Transaction Guidance Was Timely Issued, but Could Be 

More Useful to Affected Parties 12 

Conclusions 15 

Recommendations for Executive Action 15 

Agency Comments and Our Evaluation 16 

Appendix I Comments from the Internal Revenue Service 18 

Appendix II GAO Contact and Staff Acknowledgments 21 

Abbreviations 

ABA American Bar Association 

AICPA American Institute of Certified Public Accountants 

ERIS Enforcement Revenue Information System 

FTA Federation of Tax Administrators 

FTD Failure to Deposit 

I.R.C. Internal Revenue Code 

IRS Internal Revenue Service 

NAEA National Association of Enrolled Agents 

OSP Office of Servicewide Penalties 

OTSA Office of Tax Shelter Analysis 

SB/SE Small Business/Self Employed division 

TAS Taxpayer Advocate Service 

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Tax Administration 
United States Government Accountability Office

Washington, DC 20548 

 

June 5, 2009 

The Honorable Max Baucus 

Chairman 

The Honorable Charles E. Grassley 

Ranking Member 

Committee on Finance 

United States Senate 

As a part of the Internal Revenue Service’s (IRS) enforcement programs 

and activities, civil tax penalties are an important tool for encouraging 

taxpayer compliance with tax laws. It is important that IRS administers 

penalties properly and determines the effectiveness of penalties in 

encouraging compliance. The Internal Revenue Code (I.R.C.) has more 

than 150 penalties. In fiscal year 2007, IRS assessed more than 37.6 million 

civil penalties, totaling more than $29.5 billion, while abating—that is, 

rescinding in whole or in part—more than 4.9 million civil penalties for 

more than $11.1 billion. Major reforms to civil tax penalties were last made 

in 1989. 

Your committee has expressed interest in the process IRS follows when 

administering penalties and the effectiveness of the penalty regime, and 

about the implementation of a penalty for failing to disclose reportable 

transactions—transactions IRS has identified as tax avoidance 

transactions or that are substantially similar thereto—and whether it was 

being appropriately assessed. Therefore, we agreed to determine 

(1) whether IRS is evaluating penalties in a manner that supports sound 

penalty administration and voluntary compliance and, if not, how IRS may 

be able to do so and (2) whether guidance for a new penalty for the failure 

to disclose reportable transactions was issued in a timely manner and was 

useful to affected parties, and whether and how IRS has assessed the new 

penalty. 

To determine whether IRS is evaluating penalties in a manner that 

supports sound penalty administration and voluntary compliance, we 

reviewed official documents and guidance, including the Internal Revenue 

Manual. We interviewed officials from the IRS Office of Servicewide 

Penalties (OSP) and the four IRS business divisions (Small Business/Self 

Employed (SB/SE), Large & Mid-Size Business, Tax Exempt and 

Government Entities, and Wage and Investment) to determine their roles 

in penalty administration. In addition, we interviewed state officials and 

reviewed academic studies regarding assessments of penalty effectiveness 

Page 1 GAO-09-567 Tax Administration
 

and contacted the Federation of Tax Administrators (FTA) for 

recommendations of states to contact.1

 In all, we spoke with 

representatives of 25 states.2

 To determine whether IRS issued guidance 

for a new penalty for failure to include reportable transactions information 

with returns3

 in a timely manner that was useful to affected parties and 

whether and how IRS has assessed the new penalty, we reviewed IRS 

documentation and guidance for implementing the penalty and 

implementation action plans. We also interviewed officials from IRS’s 

Office of Tax Shelter Analysis (OTSA), Office of Chief Counsel, and the 

four business units about their roles in implementing the penalty, as well 

as officials from the Department of the Treasury’s (Treasury) Office of Tax 

Policy. Finally, because they collectively represent a significant portion of 

tax preparers, we contacted the American Institute of Certified Public 

Accountants (AICPA), the American Bar Association (ABA), and the 

National Association of Enrolled Agents (NAEA) and asked to interview 

members who were knowledgeable about the reportable transaction 

penalty. We interviewed nine tax practitioners affiliated with the AICPA 

and the ABA about the timeliness and usefulness of IRS outreach efforts 

regarding the implementation of the reportable transaction penalty, as 

well as their observations on IRS’s use of the penalty. The NAEA said that 

its membership had little experience with the reportable transaction 

penalty, and did not provide names of any members for us to contact. 

Because we interviewed a nonprobability sample of practitioners, our 

discussion about the effectiveness of IRS’s implementation of the 

reportable transaction penalty cannot be used to generalize to any other 

practitioners or group. Additionally, those we spoke with presented their 

personal views, not those of the professional associations through which 

they were contacted. 

 

1

 FTA provides services to state tax authorities and administrators. These services include 

research and information exchange, training, and intergovernmental and interstate 

coordination. FTA staff members regularly monitor the activities of state tax agencies and 

the federal government in order to serve as a clearinghouse on topics important to tax 

administrators. 

2

 We spoke with officials from Alabama, Arizona, California, Delaware, Florida, Hawaii, 

Illinois, Iowa, Indiana, Louisiana, Maine, Massachusetts, Minnesota, Montana, Nebraska, 

New York, North Carolina, Oklahoma, Oregon, Tennessee, Texas, Utah, Vermont, 

Washington, and Wisconsin. To select the states, we reviewed information contained on 

state tax bureau Web sites, such as press releases related to penalties, and contacted FTA 

for recommendations. 

3

 26 U.S.C. § 6707A. 

Page 2 GAO-09-567 Tax Administration
 

We conducted our work from October 2007 through May 2009 in 

accordance with generally accepted government auditing standards. Those 

standards require that we plan and perform the audit to obtain sufficient, 

appropriate evidence to provide a reasonable basis for our findings and 

conclusions based on our audit objectives. We believe that the evidence 

obtained provides a reasonable basis for our findings and conclusions 

based on our audit objectives. 

The U.S. tax system depends on the principle of voluntary compliance, 

that is, when taxpayers comply with the law without compulsion or threat. 

Penalties are intended to encourage compliance by supporting the tax 

reporting and remittance standards contained in the I.R.C. According to 

IRS’s penalty handbook, in order to advance the fairness and effectiveness 

of the tax system, penalties should be severe enough to deter 

noncompliance, encourage noncompliant taxpayers to comply, be 

objectively proportioned to the offense, and be used to educate taxpayers 

and encourage their future compliance. 

Background 

Penalties are assessed either automatically by IRS’s systems or as a result 

of audits that reveal the compliance issues. For example, the penalty for 

filing a tax return late is usually assessed automatically when IRS’s 

computer system detects a return filed after the filing deadline. Penalties 

such as those assessed against taxpayers involved with abusive tax 

shelters are assessed as a result of audits. Supervisors must review and 

approve the results of an audit to assess a penalty. Most penalties can be 

abated for reasonable cause if IRS determines that the taxpayer exercised 

ordinary business care and prudence in determining tax obligations but 

nevertheless was unable to comply with those obligations. Examples of 

reasonable cause include, but are not limited to, serious illness or an 

inability to obtain records. 

Following the release of an IRS Task Force report on civil tax penalties in 

19894

 Congress made its last major effort to reform the tax penalty regime 

because of concerns that a piecemeal approach to legislating civil tax 

penalties over the course of many years resulted in a complex penalty 

system that was difficult for IRS to administer and the taxpayer to 

comprehend. The legislation, the Improved Penalty Administration and 

 

4

 See Executive Task Force for the Commissioner’s Penalty Study, Report on Civil Tax 

Penalties (Washington, D.C.: Feb. 22, 1989). 

Page 3 GAO-09-567 Tax Administration
 

Compliance Tax Act,5 was enacted in large part to simplify civil tax 

penalties. For example, the act consolidated into one part of the I.R.C. all 

of the generally applicable penalties relating to the accuracy of tax returns 

and reorganized accuracy penalties to eliminate situations where one 

infraction could receive more than one penalty. Overall, the act reformed 

information reporting penalties; accuracy-related penalties; preparer, 

promoter, and protester penalties; and penalties for failure to file, pay, 

withhold, and make timely tax deposits. 

OSP is assigned overall responsibility for IRS’s penalty programs. As such, 

OSP is charged with coordinating policy and procedures concerning the 

administration of penalty programs, reviewing and analyzing penalty 

information, researching taxpayer attitudes and opinions, and determining 

appropriate action to promote voluntary compliance. 

Current Treasury regulations6

 state that every taxpayer that has 

participated in a reportable transaction7

 and that is required to file a tax 

return must attach a disclosure statement to his or her return for the 

taxable year and send a copy to OTSA.8

 In 2004, the American Jobs 

Creation Act9

 created a new penalty for failing to disclose reportable 

 

5

 The Improved Penalty Administration and Compliance Tax Act was enacted as part of the 

Omnibus Budget Reconciliation Act of 1989. Pub. L. No. 101-239 (1989). 

6

 Treasury Regulation § 1.6011-4. 

7

 Currently, reportable transactions include: (1) listed transactions, which are the same as 

or substantially similar to one of the types of transactions that IRS has determined to be 

tax avoidance transactions; (2) confidential transactions, which are transactions that are 

offered to a taxpayer or a related party under conditions of confidentiality and for which a 

taxpayer or a related party paid an advisor a minimum fee; (3) transactions with 

contractual protection, which are transactions for which a taxpayer has, or a related party 

has, the right to a full refund or partial refund of fees if all or part of the intended tax 

consequences from the transaction are not sustained; (4) loss transactions, which are 

transactions that result in a taxpayer claiming a loss under IRC section 165 exceeding 

specified amounts; and (5) transactions of interest, which are the same as or substantially 

similar to one of the types of transactions that IRS has identified by notice, regulation or 

other form of published guidance as transactions of interest. The regulations state that the 

fact that a transaction is a reportable transaction does not affect the legal determination of 

whether the taxpayer’s treatment of the transaction is proper. 

8

 IRS Form 8886, Reportable Transaction Disclosure Statement. When IRS identifies a 

transaction as a listed transaction after a taxpayer has filed a return reflecting participation 

in the transaction, the taxpayer has 90 days to file a disclosure statement with OTSA. 

9

 Pub. L. No. 108-357 (2004). 

Page 4 GAO-09-567 Tax Administration
 

transactions with a tax return.10 The purpose of the reportable transaction 

penalty is to promote compliance with taxpayers’ duty to disclose their 

participation in transactions IRS has determined to have potential for tax 

avoidance or evasion. For example, a taxpayer claiming a loss on their tax 

return of at least $2 million in a single taxable year must separately 

disclose the transaction to IRS. For most types of reportable transactions, 

the penalty is $10,000 for an individual taxpayer’s return and $50,000 for 

other returns, such as business returns and returns for benefit plans. For 

one type of reportable transaction, a listed transaction, the amount of the 

penalty is increased to $100,000 for individuals and $200,000 for other 

returns. The Commissioner of Internal Revenue can abate the penalty for a 

reportable transaction, other than a listed transaction,11 if abating the 

penalty would promote compliance with the requirements of the I.R.C. and 

effective tax administration. The decision to abate must include a record 

describing the facts and reasons for the action and the amount abated, and 

any decision to not abate the penalty is not subject to judicial review. 

Although IRS policies state that IRS should collect information to evaluate 

the administration of penalties and their impact on voluntary compliance, 

and IRS is collecting some relevant information, OSP is not 

comprehensively evaluating penalty administration or penalties’ impact on 

voluntary compliance. According to IRS policies, OSP is to do the 

following: 

• Administer the penalty statutes in a manner that is fair and impartial to 

both the government and the taxpayer, is consistent across taxpayers, and 

ensures the accuracy of the penalty computation. 

• Collect statistical and demographic information to evaluate penalties and 

penalty administration and to determine the effectiveness of penalties in 

promoting voluntary compliance. 

• Design, administer, and evaluate penalty programs based on how those 

programs can most efficiently encourage voluntary compliance. 

IRS Does Not 

Comprehensively 

Evaluate the 

Administration of Tax 

Penalties or Their 

Impact on Voluntary 

Compliance, but a 

Plan Could Help It Do 

So 

• Continually evaluate the impact of the penalty program on compliance and 

recommend changes when the I.R.C. or penalty administration does not 

effectively promote voluntary compliance. 

 

10 26 U.S.C. § 6707A. 

11 As of May 2009, there is a bill in the Senate and a bill in the House of Representatives that 

would eliminate the abatement provisions and add an exception to the penalty for failure to 

disclose reportable transactions when there is reasonable cause for such failure. See S. 765, 

April 1, 2009, and H.R. 2143, April 28, 2009. 

Page 5 GAO-09-567 Tax Administration
 

These policies are consistent with positions expressed in the 1989 IRS 

Task Force report and by Congress when reforming penalties in 1989 and 

with more recent views expressed by the National Taxpayer Advocate. All 

stressed the need for IRS to evaluate the administration of penalties and 

their impact on voluntary compliance. For example, the task force’s report 

and Congress in the conference report for the act that included the penalty 

reform recommended that IRS analyze information concerning the 

administration and impact of penalties for the purpose of suggesting 

changes in compliance programs, educational programs, penalty design, 

and penalty administration. The task force also recommended that IRS 

analyze data to enable IRS, Treasury, and Congress to evaluate how well 

penalties operate and what impact they have on voluntary compliance. 

Similarly, in her 2008 annual report, the National Taxpayer Advocate 

wrote that before serious penalty reform can occur, better data about 

whether and how penalties promote voluntary compliance is needed.12

However, OSP generally does not fulfill the responsibilities specified in 

IRS policy or as envisioned by the 1989 IRS Task Force report, Congress, 

or the National Taxpayer Advocate. Rather, OSP analysts focus most of 

their efforts on addressing short-term issues, such as sudden spikes in 

assessments or abatements. These analyses are useful and should 

continue, as they could identify emerging problems with how penalties are 

being administered, but they do not constitute a comprehensive 

assessment of penalty administration. 

OSP officials said that they have not done more to evaluate the 

administration of penalties and their effect on voluntary compliance 

primarily because of resource constraints both within OSP and IRS’s 

various research units, methodological barriers that impede their ability to 

research the effect of penalties on voluntary compliance, and limitations in 

available databases. 

 

12 National Taxpayer Advocate, 2008 Annual Report to Congress, vol. 2 (Washington, D.C.: 

Dec. 31, 2008). 

Page 6 GAO-09-567 Tax Administration
 

OSP does not have a plan for fulfilling its responsibilities. The Government 

Performance and Results Act of 199313 may be a useful resource in 

developing such a plan as it provides several key management principles 

needed to effectively guide, monitor, and assess program implementation. 

These principles include (1) general and long-term goals and objectives, 

(2) a description of actions to support goals and objectives, 

(3) performance measures to evaluate specific actions, (4) schedules and 

milestones for meeting deadlines, (5) identification of resources needed, 

and (6) evaluation of the program with processes to allow for adjustments 

and changes. This approach is intended to ensure that agencies have 

thought through how the activities and initiatives they are undertaking are 

likely to add up to the meaningful result that their programs are intended 

to accomplish. 

A Plan Could Help Identify 

Needed Resources and 

Support Resource 

Requests 

A plan would help to identify resource requirements and support resource 

requests. In developing a plan, OSP would need to identify the key penalty 

issues on which to focus its efforts, the types of analyses that would best 

address those key issues, and the type and amount of resources—whether 

within OSP or elsewhere in IRS—needed to execute the plan. Thus, by 

focusing on what it is attempting to accomplish by developing a plan, OSP 

would be better positioned to determine what resources within IRS are 

available to assist it. Further, a well-developed plan can provide 

policymakers within the executive branch and Congress a better basis for 

determining the appropriate level of resources for a program. 

A Plan Could Lay Out 

Feasible Research for 

Evaluating the Effect of 

Penalties on Voluntary 

Compliance 

Although OSP officials’ concerns about methodological barriers to 

determining the effect of penalties on voluntary compliance are valid, 

relevant analyses likely could be performed. Developing a plan would help 

OSP officials determine which analyses could be useful for this purpose 

and possible strategies for furthering the state of knowledge on the effect 

of penalties on compliance. 

OSP officials pointed to several examples of the methodological barriers 

to determining the effect of penalties on voluntary compliance. For 

example, increases in penalty amounts might be accompanied by other 

changes in enforcement activities, such as a higher audit rate, and 

separating the effect of these factors on voluntary compliance is difficult. 

In addition, a number of issues other than IRS enforcement activities 

 

13 Pub. L. No. 103-62 (1993). 

Page 7 GAO-09-567 Tax Administration
 

affect a taxpayer’s behavior, including income, tax rates, demographics 

and social factors, and the influence of tax practitioners. Another 

complication is that a penalty set at a certain amount may effectively 

encourage voluntary compliance for one type of taxpayer, such as 

individuals, but not for another type of taxpayer, such as businesses. 

Our discussions with state officials and review of academic studies raised 

similar concerns about the methodological barriers. None of the 25 states 

we contacted evaluate the impact of penalties on voluntary compliance, 

and FTA was unaware of any states currently doing such evaluations. State 

officials added that limited resources, political disinterest, and 

technological barriers further constrain their penalty analysis capacities. 

Some state officials said that they rely on IRS information and research to 

establish state enforcement priorities and similarly would look to IRS for 

penalty research. The academic studies we reviewed concluded, 

consistent with OSP’s view, that measuring the impact of penalties on 

voluntary compliance is difficult because numerous variables go into 

determining a taxpayer’s decision to voluntarily comply with tax laws. 

These variables include how risk averse a person is and how likely he or 

she is to attempt to “get away” with not complying. 

Nevertheless, some analyses likely would be useful for better 

understanding the effect of IRS penalties on taxpayers’ voluntary 

compliance. For example, it is widely believed that taxpayers are more 

likely to comply voluntarily if they believe that the tax code is 

implemented fairly and consistently across taxpayers. The 1989 IRS Task 

Force noted that better knowledge of both penalty applications and the 

perceptions of taxpayers that have been penalized were important in 

ensuring that taxpayers feel they are being treated fairly. Thus, analyses 

that determine whether penalties are being consistently applied across IRS 

so that similarly situated taxpayers receive the same penalties could 

provide pertinent information. 

Penalties are also unlikely to have much effect on voluntary compliance if 

they are not used. Treasury noted the importance of better understanding 

the relationship between penalty administration and voluntary compliance 

in its strategic plan for reducing the tax gap.14 The plan states that 

Treasury wants penalties to be set at more appropriate levels because 

 

14 Department of the Treasury, Office of Tax Policy, A Comprehensive Strategy for 

Reducing the Tax Gap (Washington, D.C.: Sept. 26, 2006). 

Page 8 GAO-09-567 Tax Administration
 

some penalties may be too low to change behavior but others may be so

high that examiners are reluctant to assess them. 

 

The penalties for failure to provide appropriate information returns are an 

example of penalties that do not appear to be properly calibrated to 

influence compliance. The instructions for certain information returns15

require that taxpayers submit the form printed with special ink.16 Those 

that fail to do so are subject to a $50 penalty. IRS officials said that this 

penalty and other format-related penalties are not assessed because the 

cost of developing and asserting the penalty was not worth it. Instead, IRS 

officials correct the forms manually. IRS officials said that the penalty 

would have to be raised substantially to make it worthwhile to assess. The 

decision to not assess penalties for this error based only on the revenue 

received from those penalized may have actually undermined voluntary 

compliance. A version of a popular tax preparation software package 

informs taxpayers that IRS has accepted forms that are not printed with 

the special ink. 

In addition, IRS may be able to do certain longitudinal analyses of whether 

taxpayers assessed a penalty in one year become more compliant in future 

years. For example, IRS may be able to determine whether taxpayers that 

were assessed an underpayment penalty one year were assessed the same 

penalty in years that followed. Although multiple factors would influence 

the result, the data might help IRS better understand whether the penalty 

may have any effect on future compliance. 

Currently, SB/SE’s Research group is working on a project reviewing the 

First Time Abate policy that may provide some information related to 

certain penalties’ effect on compliance.17 IRS did not know some 

information about the results of the policy, including the number of 

penalties abated under the policy, the amount of money involved, and the 

number of taxpayers qualifying for the abatement but not receiving it. 

15 Examples include Form 1096, Annual Summary and Transmittal of U.S. Information 

Returns, and Form 1099, Miscellaneous Income. 

16 The special ink is a red drop-out ink. It is colored in such a way as to be invisible to 

optical scanning devices, increasing the efficiency of data processing by allowing the 

scanner to skip nonessential information. 

17 The First Time Abate policy is an exam program that grants relief to certain taxpayers 

who receive a failure to file, pay, or deposit penalty. Taxpayers with a clean history for the 

3 years prior to receiving the penalty may have it abated. No reason is required. The only 

caveat is that they must contact IRS regarding the penalty. 

Page 9 GAO-09-567 Tax Administration
 

Additionally, other questions have surfaced, including whether the policy 

is fair, whether taxpayers receiving the abatement “game” the system by 

complying for 3 years and then getting the abatement again, and, 

ultimately, whether the policy should be continued. Results of the project 

are expected in the summer of 2010. 

In addition to analyses related to voluntary compliance that could be done 

internally, by developing a plan, OSP may be able to identify other means 

of developing information useful to gauging penalties’ effect on voluntary 

compliance. Taxpayer surveys or focus groups, for instance, could provide 

information on taxpayers’ perceptions about the fairness of penalties. 

IRS could also explore other avenues for supporting research of penalty 

effectiveness, such as encouraging others to examine the relationship 

between penalties and voluntary compliance. For example, IRS hosts an 

annual research conference and 6 forums across the country used to 

discuss tax administration issues with experts and practitioners. These 

conferences and forums have been used to discuss compliance issues. At 

the 2008 IRS Research Conference, papers on measuring or improving tax 

compliance were presented. These types of studies, done independently, 

can potentially add valuable thoughts and information to the discussion on 

how best to encourage and increase taxpayer compliance with tax laws. 

Data Limitations Could Be 

Addressed in a Plan 

Finally, in developing a plan, OSP could assess options for overcoming the 

limitations in available data that officials say impede its ability to both 

assess the effect of penalties on voluntary compliance and perform more 

sophisticated reviews of IRS’s administration of penalties. The 1989 IRS 

Task Force report said IRS needed to develop an interactive database 

available for all management levels to perform ad hoc analysis of penalty 

administration and voluntary compliance. One of the task force’s 

recommendations was to develop a database that captured the maximum 

amount of data in order to avoid the expense and delay for special master 

file extracts. With this database, IRS would evaluate the equitable 

treatment of taxpayers with respect to all aspects of penalties (e.g., 

penalty waivers and taxpayer demographic information, such as income). 

The Enforcement Revenue Information System (ERIS) contains 

substantial data on all IRS enforcement activities, including penalties. 

However, ERIS does not meet several of the task force’s 

recommendations. For example, ERIS does not include readily usable 

information related to taxpayer income or practitioner representation that 

could be used to determine equitable treatment, develop employee 

Page 10 GAO-09-567 Tax Administration
 

training, or provide taxpayer education outreach. ERIS is not available at 

all management levels. While the system is used to develop many standard 

reports, officials say a lack of resources has prevented it from producing 

additional reports that could increase understanding of penalties. For 

example, the First Time Abate policy research project is using master file 

extracts instead of ERIS. 

In addition, IRS does not routinely use existing penalty data to evaluate 

the administration of penalties. For example, IRS does not identify 

• penalties with low or high assessment and abatement rates, 

• whether significant differences exist in the abatement rate for high-income 

taxpayers relative to lower-income taxpayers, 

• whether significant differences exist in penalty size between taxpayers 

that negotiate an installment agreement relative to those who pay cash, 

• whether returns prepared by a paid preparer are more or less likely to 

have penalties abated, 

• whether penalties are assessed or abated at different rates based on the 

geographic location where the case is worked, 

• whether individual taxpayers receive more or fewer abatements than 

businesses for the same penalties, and 

• whether the rate of erroneous penalty assessments is increasing or 

decreasing. 

Analyses of trends in penalty data could help IRS identify areas that need 

further investigation and when penalties may not be applied consistently 

and fairly. For example, a low assessment rate could indicate that a 

penalty is effectively deterring noncompliance and that the infrequency of 

its assessment is appropriate. However, a low assessment rate might also 

indicate that a penalty has become outdated or is deemed too burdensome 

to assess. Similarly, a high abatement rate could indicate that IRS officials 

are hesitant to sustain a penalty because they deem it too harsh for the 

infraction. 

IRS changed the process it follows to assess the penalty for an employer’s 

failure to deposit the correct amount of taxes for employees, known as the 

Failure to Deposit (FTD) penalty,18 based on a trend analysis done by 

others. The Taxpayer Advocate Service (TAS) noted in its 2003 report19

 

18 26 U.S.C. § 6656. 

19 Taxpayer Advocate Service, National Taxpayer Advocate 2003 Annual Report to 

Congress (Washington, D.C.: Dec. 31, 2003). 

Page 11 GAO-09-567 Tax Administration
 

that IRS abated a substantial number of FTD penalties and that the higher 

the penalty, the more likely the penalty was to be abated. According to 

IRS, 24 percent of FTD penalties had been abated in 2002 accounting for 

62 percent of the assessed dollars. Based in part on TAS’s data analysis, 

IRS changed the procedures it follows to assess the FTD penalty by 

sending a notice to taxpayers warning them of possible assessment if they 

did not deposit what they owed. According to a report by the Treasury 

Inspector General for Tax Administration,20 this procedural change helped 

lead to a decrease in penalty assessments and abatements. 

IRS issued guidance to implement a new penalty for taxpayers that fail to 

disclose a reportable transaction in a timely manner and began assessing 

penalties after audits had been conducted. The reportable transaction 

penalty was effective immediately after its passage in October 2004,21

making the development of guidance on how IRS would interpret and 

implement the law important. Within 3 months, in January 2005, IRS issued 

interim guidance to alert taxpayers and practitioners to the reportable 

transaction penalty and how IRS planned to implement it.22 For example, 

the interim guidance explains the conditions under which IRS would 

impose the penalty and how it would use the authority to abate the 

penalty. Officials in the Office of Chief Counsel told us that their criterion 

for issuing guidance successfully is whether it was released in time to 

meet their customers’ needs. The practitioners we spoke with from two 

leading practitioner organizations said that issuing the interim guidance in 

only 3 months was quick and the guidance included the information they 

needed to understand how IRS would implement the penalty. 

Reportable 

Transaction Guidance 

Was Timely Issued, 

but Could Be More 

Useful to Affected 

Parties 

Those same practitioners were concerned that other practitioners may 

lack an understanding of all of the requirements for disclosing reportable 

transactions and suggested that more targeted outreach regarding the 

reportable transaction penalty was needed, since the penalty is large and 

the process to get the penalty abated is difficult. As mentioned earlier, the 

Commissioner of Internal Revenue, or the Commissioner’s delegate, can 

abate the penalty for most types of reportable transactions, but if a 

 

20 Treasury Inspector General for Tax Administration, Federal Tax Deposit Penalties Have 

Been Significantly Reduced, but Additional Steps Could Further Reduce Avoidable 

Penalty Assessments, Reference Number 2005-30-136 (Washington, D.C.: September 2005). 

21 Pub. L. No. 108-357 (2004). 

22 Notice 2005-11. 

Page 12 GAO-09-567 Tax Administration
 

taxpayer is penalized for a listed transaction there is no abatement option. 

These practitioners said that it would be easy to inadvertently violate the 

provision because taxpayers and practitioners may not realize that 

transactions that seem reasonable to them and have resulted in no net gain 

are considered reportable. They noted that if some practitioners or 

taxpayers are associating this penalty only with abusive tax shelters, they 

may not realize all of the situations where the requirement to disclose a 

transaction applies. They added that in the current economic climate there 

are likely to be many transactions that result in a loss that do not get 

disclosed on the required form.23 The practitioners said that they were 

concerned because taxpayers and other practitioners may not have been 

in such situations before, and it is likely that IRS will see a significant 

increase in undisclosed transactions of this nature. 

In the 2008 Annual Report,24 TAS also expressed concerns that the 

reportable transaction penalty is being assessed against taxpayers for 

which it was not intended and that the penalty is unfairly harsh. According 

to TAS, the purpose of the penalty is to combat tax shelters by penalizing 

taxpayers that failed to disclose that they have entered into transactions 

deemed aggressive by IRS. Because the reportable transaction penalty 

applies without exception to the failure to include disclosure on a return 

when required, an improper tax benefit is not required as long as the tax 

return reflects tax consequences or a tax strategy described in public 

guidance. 

IRS officials said they conducted standard educational outreach to the 

practitioner community regarding the specifics of the reportable 

transaction penalty. This included sending updates to e-mail groups 

regarding notices and revenue procedures implementing the new penalty 

requirements, postings of the latest news to IRS’s Web site, and requesting 

comments on proposed regulations. In addition, officials in OTSA said that 

they had presented information on the penalty to practitioner groups as 

 

23 Specifically, these transactions are loss transactions resulting in a claim for a loss under 

I.R.C. § 165 of at least $10 million in any single taxable year or $20 million in any 

combination of taxable years for corporations or partnerships that have only corporations 

as partners; $2 million in any single taxable year or $4 million in any combination of taxable 

years for all other partnerships and individuals, S corporations, or trusts; and $50,000 in 

any single taxable year for individuals or trusts if the loss arises with respect to I.R.C. § 988 

relating to foreign currency transactions. 

24 Taxpayer Advocate Service, National Taxpayer Advocate 2008 Annual Report to 

Congress (Washington, D.C.: Dec. 31, 2008). 

Page 13 GAO-09-567 Tax Administration
 

part of larger presentations on civil penalties. However, some of the 

practitioners we spoke with said that in the current substantially altered 

economic climate, some taxpayers may be caught unaware of the need to 

disclose a reportable loss transaction and be penalized without a ready 

avenue for relief. Further, there is little basis to reliably predict which 

taxpayers might be caught in this situation. 

IRS officials recognize the need to further raise awareness with taxpayers. 

They plan to use the National Tax Forums25 during the summer of 2009 to 

hold focus groups regarding the reportable transaction penalty. The goal 

of the focus groups is to reach out to practitioners who may not 

understand the disclosure requirements and get the thoughts of those who 

have had experience with the reportable transaction penalty. However, at 

best, IRS would only reach a small portion of the tax return preparer 

community in this fashion even though many preparers may end up with 

clients susceptible to the penalty. Using its standard, low-cost outreach 

methods to again focus tax preparers and the public’s awareness on the 

disclosure requirements for the reportable loss transaction could reach a 

wider audience. 

IRS officials said that the majority of tax returns eligible for assessment of 

the penalty were not filed until fall 2005, well after the interim guidance 

had been released, and would not have been audited until 2006. IRS 

officials said that development of these cases takes time and that IRS 

could not assess the penalty until there was sufficient basis to believe that 

a taxpayer had participated in a reportable transaction during a specific 

taxable year, had a disclosure requirement, and failed to complete the 

required form. IRS receives the required forms at its Ogden facility but 

does not assess penalties until after referring cases to an examiner. A 

penalty is only assessed after an examiner reviews the case because 

examiners develop related issues that may not be apparent from the face 

of the form itself. If a taxpayer failed to report participation in a reportable 

transaction, IRS would not know of the taxpayer’s participation until it 

examined the tax return or investigated the promoter of the transaction. 

Therefore, the majority of cases for which a penalty may have been 

appropriate would not have been identified until late 2006 and 2007. 

According to IRS officials, as of January 2009, IRS had assessed 98 of the 

 

25 The National Tax Forums are held annually in multiple locations across the United 

States. Many groups, including the AICPA, the ABA, the NAEA, the National Association of 

Tax Professionals, the National Society of Accountants, and the National Society of Tax 

Professionals participate in the forums. 

Page 14 GAO-09-567 Tax Administration
 

penalties for $13.7 million and collected $2.7 million. In addition, 1,188 

returns had been assigned to field groups and 50 returns were being 

reviewed by IRS’s Appeals Division. 

Civil tax penalties play an important role in helping ensure that taxpayers 

make an honest effort to pay the taxes that they owe. Twenty years after 

Congress and an IRS Task Force said that IRS needs to conduct more 

continuous and comprehensive analyses of the penalties it administers and 

their effect on voluntary compliance, and after having designated an office 

with those responsibilities, IRS is not meeting this expectation. IRS does 

not have a plan that identifies how it will carry out these responsibilities 

and address the resource, methodological, and data limitations that 

officials say impede its progress. IRS should develop and execute such a 

plan to better focus its efforts and ensure that penalties are being 

administered efficiently, effectively, fairly, and consistent with 

encouraging taxpayers’ voluntary compliance. 

IRS issued guidance for the reportable transaction penalty in a timely 

manner following its passage in 2004. However, in the current economic 

climate certain transactions involving losses may subject many 

unsuspecting taxpayers to a harsh penalty. They may be unaware of 

reporting requirements because they have never been in such situations 

before. IRS’s planned additional outreach on this penalty is not sufficient. 

IRS should use its standard, low-cost outreach methods to alert as many 

tax return preparers and taxpayers as possible about the need to properly 

report loss transactions to avoid penalties. 

In order to ensure the most efficient, fair, and consistent administration of 

civil tax penalties, and that penalties are achieving their purpose of 

encouraging voluntary compliance, the Commissioner of Internal Revenue 

should direct OSP to evaluate penalty administration and penalties’ effect 

on voluntary compliance. The Commissioner also should direct OSP to 

develop and implement a plan to collect and analyze penalty-related data. 

The plan should address the constraints officials have identified as 

impeding progress in analyzing penalties. 

Conclusions 

Recommendations for 

Executive Action 

In addition, the Commissioner of Internal Revenue should use IRS’s 

standard, low-cost methods of outreach to again alert as many tax return 

preparers and taxpayers as possible about the need to properly report loss 

transactions to avoid penalties. 

Page 15 GAO-09-567 Tax Administration
 

The Deputy Commissioner for Services and Enforcement provided written 

comments in a May 26, 2009, letter, which is reprinted in appendix I. IRS 

staff also provided technical comments that we incorporated as 

appropriate. 

Agency Comments 

and Our Evaluation 

IRS agreed that OSP will develop a plan to comprehensively evaluate 

penalty administration and the impact of penalties on voluntary 

compliance. IRS said that such a plan was important in understanding the 

relationship between penalty administration and voluntary compliance 

and in identifying priorities and potential resource needs. Developing a 

comprehensive plan may take time. In the interim, we believe that the data 

IRS currently collects can be used to begin useful penalty analyses. For 

example, IRS could evaluate whether penalties are assessed or abated at 

different rates based on the geographic location of the office responsible 

for the case or whether significant differences exist in the abatement rate 

for high-income taxpayers relative to lower-income taxpayers. Such 

analyses could be done now and help IRS determine whether penalties are 

being applied consistently. 

IRS also agreed to undertake outreach to ensure that taxpayers are again 

alerted to the situations where disclosure of reportable transactions is 

needed. 

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

this report earlier, we plan no further distribution until 30 days from the 

report date. At that time, we will send copies to the Chairman and Ranking 

Member, House Committee on Ways and Means; the Secretary of the 

Treasury; the Commissioner of Internal Revenue; and other interested 

parties. This report also will be available at no charge on the GAO Web site 

at http://www.gao.gov. 

Page 16 GAO-09-567 Tax Administration
 

If you or your staff have any questions concerning this report, please 

contact me on (202) 512-9110 or brostekm@gao.gov. Contact points for 

our Offices of Congressional Relations and Public Affairs may be found on 

the last page of this report. Key contributors to this report are listed in 

Michael Bros

appendix II. 

tek 

Director, Tax Issues 

Strategic Issues Team 

Page 17 GAO-09-567 Tax Administration
Appendix I: Comments from the Internal Appendix I: Comments from the Internal Revenue Service 

Revenue Service 

Page 18 GAO-09-567 Tax Administration 
Appendix I: Comments from the Internal 

Revenue Service 

Page 19 GAO-09-567 Tax Administration
Appendix I: Comments from the Internal 

Revenue Service 

Page 20 GAO-09-567 Tax Administration
Appendix II: 

A

GAO Contact and Staff 

cknowledgments 

Page 21 GAO-09-567 

Appendix II: GAO Contact and Staff 

Acknowledgments 

Michael Brostek, (202) 512-9110 or brostekm@gao.gov 

In addition to the contact named above, Jonda R. Van Pelt, Assistant 

Director; Julia T. Coulter; Benjamin C. Crawford; Alison Hoenk; Ellen M. 

Rominger; Elwood D. White; and John M. Zombro made key contributions 

to this report. 

Tax Administration 

GAO Contact 

Acknowledgments 

(450624) 
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