Tax Refunds: IRS Is Exploring Verification Improvements, but Needs to Better Manage Risks
Published: 2013-06-04T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: For tax year 2011, IRS matched over 140 million individual income tax returns against the 1.6 billion information returns it received from third parties such as employers. Generally, this match does not occur until well after refunds are issued. In early 2011 the then IRS Commissioner outlined a vision for a "Real Time Tax" system--a strategy to improve verification by matching third party information to income tax returns before refunds are issued, and IRS began exploring options for Real Time Tax later that year. GAO was asked to review IRS's strategy for exploring Real Time Tax. This report (1) describes when IRS receives and matches individual tax and information returns and (2) assesses the extent to which IRS is following leading practices for managing an exploratory effort of this importance. GAO reviewed IRS documents and guidance, including the Internal Revenue Manual, information return forms, and drafts of Real Time Tax planning documents. GAO generated descriptive data on the timing and volume of 25 information returns using IRS's Compliance Data Warehouse database. GAO identified leading practices on planning new initiatives at IRS using past GAO reports, internal control standards, and IRS documents.
section_title: What GAO Found
paragraphs: The Internal Revenue Service (IRS) receives few information returns before issuing most tax refunds. In 2012, IRS issued 50 percent of tax year 2011 refunds to individuals by the end of February, but had only received 3 percent of information returns. Most information returns are not received by IRS until after mid-April, and IRS conducts the first match of tax and information returns in July, with subsequent matches in February and May of the following year. For tax year 2010, over a year passed on average before IRS notified taxpayers of matching discrepancies, and IRS recognizes that this long time lag burdens taxpayers.
IRS is generally following leading practices in its Real Time Tax exploratory effort by, for example, dedicating a team and defining program goals. IRS did not develop an overall timeline because management views Real Time Tax as a broad goal, and officials wanted to avoid causing concern that IRS had already decided on a path. Without a timeline for the overall exploratory effort, IRS cannot know if its efforts will be completed in even the broad time frames IRS is considering, and Congress may not be able to determine what legislative action might be required. IRS officials stated that managing risk is a high priority, but they have not developed an overall risk management framework, as they are still in the early stages of the exploratory effort. They said they plan to further develop the strategy if IRS pursues Real Time Tax. Without systematically identifying and evaluating the risks of Real Time Tax options, IRS officials may miss critical factors that could complicate the effort. A record of prior risk analyses could help prevent unnecessarily repeating the same analyses.
section_title: What GAO Recommends
paragraphs: GAO recommends IRS identify time frames for the exploratory effort's critical phases and activities and develop a risk management framework for Real Time Tax. IRS agreed with our recommendations.

section_title: Letter
paragraphs: The Internal Revenue Service’s (IRS) matching of tax returns to  information provided to it by third parties is a powerful tool for helping  ensure compliance with the tax laws. Doing so is a vast undertaking. For  tax year 2011, IRS matched over 140 million individual income tax returns  against the 1.6 billion third-party information returns, such as Form W-2,   This matching  Wage and Tax Statement, it received from employers.helped IRS verify that taxpayers accurately reported their income and  other information on their tax returns. While valuable, the matching  process also has limitations. For example, information returns are not due  to IRS until well after many taxpayers have filed their tax returns and  received any refunds. As a consequence, IRS is unable to match tax  returns to information returns before issuing most refunds. As a further  consequence, when a mismatch shows a taxpayer underreported his or  her tax liability, IRS cannot reduce the amount of any current refund.  Instead, IRS must contact the taxpayer and try to collect the tax debt.  This imposes additional burden on taxpayers and additional costs on IRS.  Also, if the refund has been spent, taxpayers may not be able to readily  pay the amount owed plus interest and any penalties.
In early 2011, the then IRS Commissioner outlined a vision for a “Real  Time Tax” system—a strategy to improve verification by matching third- party information to income tax returns during the pre-refund screening  process rather than after refunds are issued. In 2012, IRS launched a  three-phase exploratory effort to assess the tradeoffs inherent in pursuing  Real Time Tax. Moving the matching of third-party information during the  pre-refund screening process could have significant impacts on  taxpayers, third parties, and IRS processes and systems. It could also  require congressional action to authorize changes to the tax code,  including, perhaps, changes to some information return due dates.  Considerations associated with moving the due dates include whether  third parties have the information they need before the current due dates  and whether they would have sufficient time to detect and correct errors  before reporting. IRS officials noted that they do not yet consider Real  Time Tax a “project” and have not decided whether to pursue Real Time  Tax.
Given the potential benefits and costs, you asked us to review IRS’s  strategy for exploring Real Time Tax. The objectives of this report are to  (1) describe when IRS receives and matches individual tax and  information returns and (2) assess the extent to which IRS is following  leading practices for managing an exploratory effort of this importance at  IRS.
To describe when IRS receives and matches individual tax and  information returns, we reviewed IRS documents and guidance, including  the Internal Revenue Manual and IRS information return forms. We  limited the scope of our review to the Form 1040 series and the 25  information returns IRS officials said would likely be most relevant to  matching to individual income tax returns under a Real Time Tax system.These information returns are listed in appendix II. We generated  descriptive statistics by accessing selected data elements from IRS’s  Compliance Data Warehouse (CDW) database, which provides a variety  of tax return, enforcement, compliance, and other data. We assessed the  reliability of CDW data by (1) performing electronic or manual testing of  required data elements to identify obvious errors, (2) reviewing existing  information about the data and the system that produced them, and (3)  interviewing agency officials knowledgeable about the data. We  determined that the data were sufficiently reliable for the purposes of this  report.
We reviewed our previous reports, Standards for Internal Control in the  Federal Government, and IRS documents, including the 2009 to 2013  IRS Strategic Plan to identify leading practices that we consider relevant  for planning initiatives at IRS. The leading practices we identified do not  represent the universe of practices that IRS could employ when planning  a new initiative. We selected examples of leading practices that we  judged to be important for IRS to consider during its Real Time Tax  exploratory efforts. We discussed with IRS the practices on which we  based our descriptions and assessments during the course of our audit  work, and IRS agreed with our approach. To assess the extent to which  IRS is following leading practices in its exploratory efforts, we reviewed  IRS documents related to the Real Time Tax exploratory effort, all of  which were predecisional and subject to change. Documents we reviewed  included draft copies of the Real Time Tax Conceptual Future Operating  Model and the Real Time Tax Communications Strategy and Plan. We  then compared IRS efforts to the leading practices we identified. A  description of the leading practices is detailed in appendix III.
We conducted this performance audit from August 2012 to June 2013 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.
subsections: section_title: Background
paragraphs: Third-party information reporting dramatically increases the accuracy of  tax returns. Third parties—employers, banks, and others—report wages,  interest, and other information to both taxpayers and IRS. An IRS study  of individual tax compliance found that in tax year 2006, taxpayers  accurately reported over 90 percent of income with substantial  information reporting requirements, such as interest and dividend  income.only 44 percent of income subject to little or no information reporting,  such as nonfarm sole proprietor income.
In contrast, the same study found taxpayers accurately reported  There are more than 40 different types of information returns, 25 of which  are directly matched against income tax returns filed by individuals.  According to IRS’s analysis of tax year 2009 data,  most taxpayers  receive at least one of three information return types: Form W-2, Wage  and Tax Statement; Form 1099-G, Certain Government Payments; or  Form 1098, Mortgage Interest Statement.information returns IRS receives, a few types of returns accounted for the  majority of returns in tax year 2011, as shown in figure 1.
section_title: IRS Issued Most 2012 Refunds Months Before Receiving Information Returns and Matching Them to Tax Returns
paragraphs: Consistent with IRS’s practice of issuing refunds promptly after a return is  filed, IRS issued 50 percent of 2012 refunds for tax year 2011 to  individual taxpayers by the end of February, at which point only 3 percent  of all information returns had been received. By April 19, 2012, IRS had  issued 82 percent of refunds to individual filers but had received only 30  percent of all information returns. By August 2, 2012, when IRS  completed its first match of information return data to tax returns, IRS had  issued 92 percent of refunds to individual taxpayers, as shown in figure 3.
Figure 4 expands upon figure 3 to show that IRS did not receive any type  of information return in significant numbers until March 2012. Of the 25  types of information returns represented in figure 4, IRS had received  more than 30 percent of the submissions by March 1, 2012, for one form,  Form 1099-G. For all other types, IRS had received less than 15 percent  of submissions by March 1, 2012.
As shown in figure 4, IRS receives many information returns after their  original due dates. To begin matching earlier in the year, one option is to  move up information return due dates. However, without an  understanding of why information returns are filed after they are due,  simply moving the dates may not be effective. As discussed below, IRS  frequently grants extensions to information return providers.
subsections: section_title: Filing Extensions Influence When IRS Receives Information Returns
paragraphs: Data from IRS did not indicate what proportion of the information returns  arriving after due dates was attributable to filing extensions, but an official  told us that the agency approved 371,000 requests for filing extensions  from information return providers for tax year 2011. According to IRS,  information providers request extensions for reasons that include complex  IRS regulations, changes in tax laws, and changes in information return  forms. In focus groups held by IRS, some providers of more complex  return types noted they automatically request a filing extension to allow  time for taxpayers to review their copy of the information return and notify  the provider of any needed corrections. Some providers said that they are  hesitant to provide returns to IRS before hearing from taxpayers because  IRS can levy penalties on providers that file forms with incorrect  information.
section_title: Amendment Rates Influence When Accurate Data Are Available for Matching
paragraphs: Moving information return due dates could affect the volume of  information return amendments. Amendments are changed information  returns resubmitted to IRS and the amendment rate is the percent of total  information return volume attributed to amended, duplicate, or corrected  returns received by IRS. In focus groups held by IRS, some information  return providers noted that accelerating submission due dates for  complex information returns would create challenges, as they often need  to correct information in consultation with information return recipients  before submitting data to IRS. We did not assess the volume or timing of  corrections made by providers before sending information returns to IRS.
On average, information returns had an amendment rate of less than 0.4  percent. Only 3 of the 25 information returns we reviewed had  amendment rates greater than 2 percent. While amendment rates for  most information returns were low for tax year 2011, they still represented  millions of returns. For example, the amendment rate for Form W-2 was  only 0.94 percent, but this represented over 2 million of the 213 million W- 2s for tax year 2011 that IRS received. One reason for low amendment  rates may be providers’ fear of penalties, as discussed above. Appendix  IV provides additional information on amendment rates.
section_title: On Average, More Than a Year Passes Before IRS Notifies Taxpayers of Matching Discrepancies
paragraphs: For 2010 income tax returns which were filed starting in 2011, IRS took  over 1 year (388 days), on average, to notify taxpayers about AUR  discrepancies. This is the elapsed time between when the taxpayer filed  his or her income tax return and when IRS issued the first notice. The  longest elapsed time was 763 days, just over 2 years. As a consequence,  taxpayers may not be notified about a potential error until after filing the  following year’s return. IRS officials acknowledge that such a delay may  be a burden to taxpayers and said they are interested in pursuing Real  Time Tax in order to improve the taxpayer experience. The officials noted  that the longer the time between filing an income tax return and receiving  a notice, the harder it is for some people to locate the records or other  information needed to understand the discrepancy, as well as to respond  to IRS and resolve the issue. In addition, if taxpayers spent their refund  or tax savings they may not have funds set aside for an unexpected tax  debt. Finally, penalties and interest may have accumulated, which  increases the amount due. One of the goals of Real Time Tax would be to  reduce the number of taxpayers facing these burdens by detecting and  resolving discrepancies before refunds are issued.
IRS identified nearly 24 million 2010 income tax returns with  discrepancies. According to IRS data, IRS selected about 22 percent (or  5.3 million) of these discrepant returns for review. After the review, IRS  sent at least one notice to over 4 million of these taxpayers informing  them of the discrepancy.
Figure 5 shows timelines for 2011 return processing, matching, and  taxpayer notification based on the first match at the end of July. The left  side of the graphic illustrates when IRS and taxpayers receive most  information returns, and the right side illustrates when IRS begins  notifying taxpayers of discrepancies.
section_title: IRS Is Generally Following Leading Practices in Its Exploratory Efforts, but Has Not Developed a Timeline or Risk Management Framework
subsections: section_title: IRS Is Exploring Options Before Deciding Whether to Pursue Real Time Tax
paragraphs: IRS officials and the planning documents they have developed make it  clear that Real Time Tax is an exploratory effort. IRS officials emphasized  that they have made no final decisions regarding Real Time Tax and that  they do not perceive it as a “project” at this time. As part of the  exploratory effort, IRS is collecting data to understand the potential  disruptions to taxpayers and information return providers that could result  should IRS implement a Real Time Tax system. Officials are also seeking  to understand whether doing so would be an improvement over current  processes, particularly AUR and accelerated matching for wage and  withholding data. IRS is conducting tests to determine potential benefits,  including whether IRS could match information returns at the time  taxpayers file their tax returns in a Real Time Tax environment.
IRS officials are analyzing six key questions they see at the heart of the  Real Time Tax concept. For each question, IRS has begun developing a  list of options and is assessing them (see table 1). Officials stressed that  they have made no final decisions regarding which options, if any, they  may pursue.
Each option presents challenges to IRS as it considers how a Real Time  Tax system might operate. For example, as noted previously, moving  information return due dates to earlier in the filing season may affect  amendment rates for some types of information returns.
IRS is exploring options using a three-phased approach that began in  2011. IRS focused its Phase 1 efforts on envisioning the taxpayer  experience, incorporating input from internal and external stakeholders.  During this phase, IRS held focus group meetings with stakeholders and  developed a conceptual model for Real Time Tax. Phase 2 is exploring  options for how business processes might change, and includes a gap  analysis which considers how business operations work now versus how  they may work if Real Time Tax was implemented. IRS officials told us  they anticipate completing Phase 2 by the end of April 2013. If IRS  proceeds to Phase 3, it will focus on determining what operational and  information technology infrastructure changes will be needed. As  documented in the draft Conceptual Future Operating Model, Phase 3  would include developing a roadmap for the proof of concept and implementation;  comparing Real Time Tax work streams with IRS’s long-term  enterprise roadmap; and evaluating competing demands for resources and facilitating decision  making around key investments supporting Real Time Tax.
section_title: Exploratory Efforts Generally Follow Leading Practices, but Plans Lack a Documented Timeline and Risk Management Framework
paragraphs: Figure 6 shows that IRS is following four of the six leading practices we  used as criteria for assessing IRS’s exploratory efforts, and plans to  implement the other two practices. Appendix III explains the practices in  more detail and the sources we used to develop the leading practices.  These criteria are drawn from our previous reports, IRS policy guidance,  and other sources.
The Commissioner’s Office created a team to lead IRS’s Real Time Tax  exploratory efforts. The team is comprised of Real Time Tax executives  from the Wage and Investment Division and Information Technology  organization; a core team of senior staff who work under the direction of  the Real Time Tax executives to lead the exploratory effort; a support  network of subject matter experts throughout IRS; and contractors. While  some core team members and subject matter experts have transitioned  on and off the effort to meet other organizational needs, IRS officials and  core team members said that they have developed strategies to ensure  the effort’s leadership is consistent and that it has the necessary  knowledge and skills. Core team members and other IRS officials  confirmed that IRS provides overlapping assignments to allow for team  members transitioning off the core team to brief incoming members on  the history and progress of the effort. As discussed in more detail below,  the core team has also identified external and internal stakeholders (see  fig. 7).
Key IRS stakeholders identified a vision and program goals for Real Time  Tax that link to IRS’s mission and consider taxpayer burden. For  example, the draft Conceptual Future Operating Model documents IRS’s  vision to reduce taxpayer burden, improve compliance, and increase  efficiency. IRS documents specify the following guiding principles and  overall program goals for Real Time Tax:
Minimize taxpayer burden by including measures to simplify the tax  filing experience and not introducing changes that increase the  burden for the majority of taxpayers.
Build for the future by developing Real Time Tax with a long-term  focus and implementing it with a phased approach that provides  incremental benefits in the near-term.
Leverage tax industry partners to help drive a successful Real Time  Tax model.
Mitigate vulnerabilities to identity theft and fraud to reduce the risk of  IRS issuing credits and refunds to identity thieves and other  fraudsters.
IRS has particularly emphasized the importance of minimizing taxpayer  burden. In addition to identifying it as a guiding principle, officials said  that, if they proceed, they will use statistical modeling to better  understand the Real Time Tax system’s potential effects on taxpayers.
The guiding principles outlined in the draft Conceptual Future Operating  Model link closely with IRS’s mission to provide taxpayers top-quality  service while enforcing the law and meeting the agency’s performance  goals and objectives. Officials told us the core team has provided input for  IRS’s next strategic plan.
IRS officials have begun planning for performance measurement and  have taken steps such as conducting a baseline analysis, hypothesis  testing, and considering performance measures. For example, IRS  conducted a baseline analysis to understand the current volume, timing,  filing patterns, and concentrations of tax filing activity for tax year 2009.  During Phase 2, officials said that the core team is using statistical  modeling to test possible Real Time Tax models to better understand  their potential effects. These tests will help them understand whether they  can match information return data at the time individuals file their tax  returns and the extent to which IRS can notify taxpayers of a discrepancy  at the time of filing. Officials noted that they are still determining what data  will be needed to assess Real Time Tax, and whether such a system can  provide benefits greater than those IRS and taxpayers receive under the  current system. Officials consider it too early in the exploratory effort to  define performance outcomes, but anticipate doing this as Real Time Tax  exploration and planning progress.
IRS documented time frames for its communication strategy and for  evaluating matching capabilities, but has not developed a timeline for the  exploratory efforts’ critical phases and essential activities. The draft  Communications Strategy and Plan documents a high-level timeline for  implementing IRS’s stakeholder communications strategy. IRS also  documented time frames for live tests that began in March 2013 that will  help officials understand whether IRS can match information return data  to simple tax returns at the time of filing. However, while officials noted  that the core team has a general idea about how long each planning  phase should take, IRS has not developed a timeline or planned interim  milestones for its overall exploratory effort. Officials noted that IRS  management views Real Time Tax as a broad goal, and the core team  did not set milestone dates to avoid causing concern among the  stakeholder community that IRS has already decided on a path for Real  Time Tax. Also, officials said that they want to conduct additional tests  before planning next steps and then use the results of those tests to help  determine if IRS should proceed with Phase 3.
As we have stated in prior reports, the demand for transparency and  accountability is a fact that needs to be accepted in an exploratory effort   Establishing a timeline that includes critical phases  of this magnitude.and essential activities that need to be completed by particular dates to  achieve results is important for accountability and success in  implementing a new exploratory effort. A full range of stakeholders and  interested parties, including Congress, are concerned not only with what  results are to be achieved, but also which processes are to be used to  achieve those results. Also, an exploratory effort can build momentum  internally and externally by demonstrating progress towards these goals.
We recognize that IRS’s planned time frames and milestones may evolve  as it learns from its exploratory efforts. Also, it may not be feasible for IRS  to develop a detailed timeline for the Real Time Tax initiative, as planning  efforts are still ongoing and officials have not decided whether to pursue  Real Time Tax or how to structure it. At this early stage, it may make  sense for IRS to identify contingency-based time frames rather than firm  dates for the exploratory effort. However, having a documented timeline  that identifies critical phases and milestones for essential activities—such  as time frames for developing the “proof of concept” in Phase 3—could  help IRS and Congress assess the progress of the exploratory efforts.  Without a timeline for the overall exploratory effort, planning may go on  endlessly, and IRS cannot know if its efforts are on track or will be  completed in even the broad time frames IRS is considering. In addition,  Congress may not be able to determine what legislative action may be  needed.
IRS officials stated that managing risk is a high priority for IRS, but while  they have documented potential risks to Phase 2 testing, they have not  developed an overall risk management framework for Real Time Tax. A  risk management framework helps ensure that managers systematically  identify, analyze, and manage risks. A documented risk management  framework articulates what managers have done to analyze the  consequences of identified risks and the likelihood they will occur, as well   Leading practices suggest that  as to assess alternatives to mitigate risk.a risk management framework should be developed early so that relevant  risks are identified and managed, and that the framework should evolve  and be reviewed on an ongoing basis. Such a framework could help IRS  identify and mitigate the risks stemming from options it is considering for  Real Time Tax, including the risks of moving information return due dates  and communicating electronically with taxpayers.
Officials stated they have not yet developed a risk management  framework because they are still in the early stages of their exploratory  efforts. Nevertheless, an IRS official stated that officials discuss potential  risks for Real Time Tax regularly and that they are developing  descriptions of “pros and cons” of the different approaches. IRS officials  plan to further develop the risk strategy if IRS decides to pursue Real  Time Tax.
Without systematically identifying and evaluating the risks of Real Time  Tax options, IRS officials may miss critical factors that could complicate  the effort, including the potential costs to IRS, taxpayers, and other  stakeholders. Furthermore, without a documented record of risk  discussions, IRS may lose its knowledge of what risks and mitigations  have been analyzed. For an effort that cuts across as many IRS functions  as Real Time Tax and will likely take years to implement, a record of prior  risk analyses could help prevent unnecessarily repeating the same  analyses.
IRS developed a communication strategy that identifies internal and  external stakeholders, defines stakeholder communication needs,  identifies communication media, and describes how IRS plans to  communicate its Real Time Tax efforts to stakeholders. In its draft  Communications Strategy and Plan, IRS developed talking points to  describe its vision for Real Time Tax and to explain what a possible Real  Time Tax system does not include. For example, IRS officials have stated  that Real Time Tax will not involve a prefill option (where IRS  prepopulates tax returns) or replace all compliance activity that occurs  after the filing season, such as AUR. The draft Communications Strategy  and Plan also states that IRS will work collaboratively with external  stakeholders to outline the vision for Real Time Tax. To obtain the views  of external stakeholders on potential frameworks for Real Time Tax, IRS  held two public meetings and six focus groups involving individuals  representing consumer groups, tax return preparers, the software  industry, oversight agencies, payroll providers, and state revenue  departments. IRS plans to continue activities aimed at increasing the  public’s awareness and understanding of the Real Time Tax exploratory  effort. These activities may include responding to media inquiries, posting  information to the IRS website, and sending IRS officials to speaking  engagements.
section_title: Conclusions
paragraphs: Real Time Tax has the potential to provide substantial benefits, including  reducing taxpayer burden and improving compliance by moving some  information matching earlier in the tax season. However, it also may  require significant and possibly costly changes to tax administration and  impose new burdens on third parties. Careful consideration of risks and  alternatives for mitigating those risks is crucial in weighing the potential  benefits and costs of Real Time Tax options. While IRS has taken  important steps in exploring the feasibility of Real Time Tax, much  remains unknown because the exploratory effort is still underway. IRS  has not yet developed time frames for the exploratory effort’s critical  phases and essential activities, and we anticipate IRS may revise time  frames as it obtains new information from its exploratory efforts. In  addition, IRS has not created a risk management framework, which would  provide valuable information about potential costs and benefits to IRS  management. Given the potential scope of a Real Time Tax system, both  agreed-upon time frames and a record of risk management  considerations are likely to be important management tools that will help  inform IRS management’s decisions about the future of Real Time Tax  and help Congress oversee IRS’s efforts.
section_title: Recommendations for Executive Action
paragraphs: Recognizing IRS’s exploratory efforts are in their early stages and the  Real Time Tax concept will likely evolve over time, we recommend the  Acting Commissioner of Internal Revenue take the following actions to  help ensure managers are able to assess the progress of exploratory  efforts and have the information needed to weigh the potential risks,  costs, and benefits of options:  Identify time frames for the Real Time Tax exploratory effort’s critical  phases and essential activities.
Develop a risk management framework for Real Time Tax that  includes a record of risk analyses.
section_title: Agency Comments
paragraphs: We provided a draft of this report to the Acting Commissioner of Internal  Revenue for comment. In written comments, reproduced in appendix V,  IRS agreed with our recommendations. IRS said that as it continues to  engage stakeholders and explore the Real Time Tax concept, it will  identify time frames for critical phases and key activities and develop a  risk management framework.
We are sending copies of this report to the Acting Commissioner of  Internal Revenue. In addition, the report is available at no charge on the  GAO website at http://www.gao.gov.
If you or your staff have any questions about this report, please contact  me at James R. White at (202) 512-9110 or whitej@gao.gov. Contact  points for our Offices of Congressional Relations and Public Affairs may  be found on the last page of this report. GAO staff who made key  contributions to this report are listed in appendix VI.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: This appendix describes our methodology for addressing the following  objectives: (1) describe when the Internal Revenue Service (IRS)  receives and matches individual tax and information returns and (2)  assess the extent to which IRS is following leading practices for  managing an exploratory effort of this importance at IRS.
To describe when IRS receives and matches individual tax and  information returns, we reviewed IRS documents and guidance, including  the Internal Revenue Manual and IRS information return forms. We  limited the scope of our review to the Form 1040 series and the 25  information returns IRS officials said would likely be most relevant to  matching to individual income tax returns under a Real Time Tax system.We list these information returns in appendix II. Due to the manner in  which IRS’s Compliance Data Warehouse (CDW) consolidates data for  Forms SSA-1099 and RRB-1099, we analyzed the combined data for  these two returns. These two types of returns collectively accounted for  3.8 percent (59 million out of 1.6 billion returns) received by IRS for tax  year 2011.
We generated descriptive statistics by accessing selected data elements  from the CDW database, which provides a variety of tax return,  enforcement, compliance, and other data. To develop information related  to return volume, timing of return receipts and amendments, and refund  issuance, we analyzed data for tax year 2011 returns, as this is the most  recent year for which relatively complete data are available.when tax returns were received by IRS, we used the cycle posting date,  when IRS posts tax return data to the master file, as it represents when  the tax return data are available for matching. Officials noted that IRS  must cleanse the data prior to posting to IRS systems. This may include  identifying and correcting incomplete or inaccurate data before posting  the data to IRS systems. To develop information related to the elapsed  time between matching information returns to income tax returns and  when IRS issued the first notice of discrepancy to taxpayers, we analyzed  data for tax year 2010 as this is the most recent year for which IRS has  completed the three phases of its matching process. We assessed the  reliability of CDW data by (1) performing electronic or manual testing of  required data elements to identify obvious errors, (2) reviewing existing  information about the data and the system that produced them, and (3)  interviewing agency officials knowledgeable about the data. We  determined that the data were sufficiently reliable for the purposes of this  report.
GAO, Standards for Internal Control in the Federal Government, GAO/AIMD-00-21.3.1  (Washington, D.C.: Nov. 1, 1999). the course of our audit work, and IRS agreed with our approach. Officials  noted that they do not yet consider Real Time Tax a “project” and have  not decided whether to pursue Real Time Tax. A description of the  leading practices is detailed in appendix III.
We conducted this performance audit from August 2012 to June 2013 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.
section_title: Appendix II: Information Returns Used in Matching Against Individual Income Tax Returns
paragraphs: Description  Filed by lenders to report mortgage interest of $600 or more.  Certain points (prepaid interest on a mortgage loan) are also  reported if the points, plus other interest on the mortgage, are  $600 or more.
Filed by lenders to report student loan interest of $600 or more  received.
Filed by eligible educational institutions and insurers (who make  reimbursements or refunds) to report payments received or  amounts billed for qualified tuition and related expenses.
Issued by lenders who acquire an interest in property that was  security for a loan, or who know such property has been  abandoned, to report income or loss.
Filed to report proceeds from broker and barter exchange  transactions.
Filed by lenders to report cancelled debt of $600 or more.
Issued by banks and other financial institutions to report  dividends and other distributions.
Filed by federal, state, and local government units to report  payments of: unemployment compensation; state or local  income tax refunds, credits or offsets; taxable grants; and/or  agricultural payments.
Filed to report interest income or U.S. Savings Bond and  Treasury obligation interest of $10 or more, withholding for  foreign taxes paid on interest, and backup withholding.
Issued by payment settlement entities to report merchant card  payments and third-party network payments.
Filed by insurance companies, government units, and other  providers to report long-term care benefits.
Used to report miscellaneous income, such as: royalties or  broker payments in lieu of dividends or tax-exempt interest of  $10 or more; $600 or more in rents, services (including parts  and materials), prizes and awards, medical and health care  payments, crop insurance proceeds, cash payments for fish (or  other aquatic life); fishing boat proceeds; gross proceeds paid  to an attorney; direct sales of at least $5,000 of consumer  products for resale from other than a permanent retail  establishment; payments to independent contractors; directors’  fees; commissions paid to lottery ticket sales agents; and  backup withholding.
Description  Filed by financial institutions, brokers, and other entities to  report the original issue discount (the excess of an obligation’s  stated redemption price at maturity over its issue price)  includible in gross income of at least $10.
Filed by cooperatives to report payments of $10 or more in  patronage dividends and other distributions, as well as any  federal backup withholding.
Filed by states or eligible educational institutions to report  earnings or distributions from qualified tuition programs and  Coverdell Education Savings Accounts.
Used to report distributions of $10 or more from pensions,  annuities, individual retirement arrangements (IRAs), survivor  income benefit plans, charitable gift annuities, and profit-sharing  and retirement plans.
Used to report the sale or exchange of real estate.
Used to report distributions from a health savings account,  Archer Medical Savings Account, or Medicare Advantage  Medical Savings Account.
Filed by the Railroad Retirement Board (RRB) to report Tier 1  railroad retirement benefits (the benefits railroad employees or  beneficiaries would have been entitled to receive under the  Social Security system) and special guaranty benefit payments.
Filed by the Social Security Administration (SSA) to report  Social Security benefits.
Filed by the trustee or issuer of IRAs to report contributions,  including any catch-up contributions, and the fair market value  of the account.
Used to report contributions, including rollover contributions, to  any Coverdell Education Savings Account.
Filed by a trustee or custodian of health savings accounts,  Archer Medical Savings Accounts, and Medicare Advantage  Medical Savings Accounts to report contributions, rollovers, and  fair market value.
Filed to report certain gambling winnings and any federal  income tax withheld on those winnings.
Filed by employers to report wages paid to each employee from  whom income, Social Security, or Medicare tax was withheld or  from whom income tax would have been withheld if the  employee had claimed no more than one withholding allowance  or had not claimed exemption from withholding on Form W-4  (Employee’s Withholding Allowance Certificate).
The types of payments reportable on a 1099-MISC and their reporting thresholds vary widely. These  include payments to nonemployees for services of at least $600 (called nonemployee compensation),  royalty payments of $10 or more, and medical and health care payments made to physicians or other  suppliers (including payments by insurers) of $600 or more.  If reporting substitute payments in lieu of dividends or interest or gross proceeds paid to an attorney,  the due date was February 15, 2012.  Provider must have furnished fair market value information and required minimum distribution, if  applicable, to participants by January 31, 2012.  Paper returns were due to the Social Security Administration by February 29, 2012, and electronic  returns were due by April 2, 2012.
section_title: Appendix III: Leading Practices for Planning New Internal Revenue Service Initiatives
paragraphs: We have identified a number of leading practices for planning new  initiatives at the Internal Revenue Service. Table 2 lists these leading  practices and the sources used to develop them. As the table makes  clear, we have applied these leading practices for a decade or more. In  addition, our own review found these leading practices still relevant today.  We discussed with IRS officials the leading practices on which we based  our descriptions and assessments during the course of our audit work,  and they agreed they are relevant to the Real Time Tax exploratory effort.
section_title: Appendix IV: Amendment Rates for Information Returns Used in Matching Against Individual Income Tax Returns
paragraphs: The figure below provides additional information on the amendment rates  for the 25 information returns we reviewed.
section_title: Appendix V: Comments from the Internal Revenue Service
section_title: Appendix VI: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
paragraphs: James R. White, (202) 512-9110 or whitej@gao.gov.
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, David Lewis (Assistant Director),  Shannon Finnegan (Analyst-in-Charge), Ellen Rominger, Andrew Ching,  and Albert Sim made key contributions to this report. Also contributing to  this report were Joanna Berry, Jehan Chase, Michele Fejfar, Robert  Gebhart, Robert Robinson, Sabrina Streagle, and John Zombro.