E-Filing Tax Returns: Penalty Authority and Digitizing More Paper Return Data Could Increase Benefits
Published: 2011-10-05T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Internal Revenue Service's (IRS) goal is to receive 80 percent of all major types of tax returns electronically by 2012. Legislation passed in November 2009 supports the 80 percent goal for individual income tax returns by requiring tax return preparers who file more than 10 individual returns per year to file them electronically, or e-file. GAO was asked to review IRS's implementation of this e-file mandate. Specifically, GAO (1) described e-file rates and preparers' experiences implementing the mandate, (2) assessed IRS's plans to enforce the mandate, (3) assessed IRS's analysis of options for digitizing more data from paper returns, and (4) determined whether there are any tax forms IRS cannot accept electronically and assessed IRS's plans for adding them to the e-file system. To conduct these analyses, GAO reviewed IRS processing data and e-file planning documents, and interviewed IRS officials and 26 members of national preparer organizations.
section_title: What GAO Found
paragraphs: In 2011, 79 percent of all individual tax returns were e-filed, a noticeable increase over prior years. Both preparer and self-prepared e-file rates increased, which IRS officials attributed to different factors. They said the e-file mandate was one key factor in the growth of preparer e-filing. Preparers GAO interviewed who were new to e-filing said they experienced increased costs and administrative burdens due to the mandate. Several preparers who had been e-filing prior to the mandate said they experienced some of these same problems when they first e-filed, but they now find that e-filing helps their business--for example, by reducing the time needed to file returns. IRS's plans to identify preparers who are not complying with the mandate are not fully developed because IRS does not know the extent of noncompliance and it may be low. Nonetheless, officials stated some noncompliance likely exists and may increase in 2012 when the mandate applies to more preparers. Regardless of the extent, IRS does not have authority under the IRC to assess penalties on preparers who fail to comply. IRS may be able to impose sanctions under Department of Treasury regulations that govern practice before IRS. However, the process is costly and the penalties, which could include suspension of practice, may be harsher than needed. IRS is considering pursuing two options to digitize more data--bar coding and additional transcription. IRS does not transcribe all lines from paper returns. IRS's policy is to post the same information from electronic and paper returns to its databases, so that similar paper and electronic returns have equal chances of being audited. IRS has not analyzed the costs and benefits of these options, which could support informed funding decisions. Some forms cannot be e-filed, including two relatively high-volume forms for amended returns and nonresident aliens. IRS has not developed a complete list of forms that cannot currently be e-filed nor does it have a time line for adding them to the e-file system. Without adding forms such as these to the system, IRS will limit e-filing's growth potential. Congress should consider amending the Internal Revenue Code (IRC) to provide IRS with penalty authority for preparer noncompliance with the mandate. GAO also recommends, among other things, that IRS conduct analyses on the costs and benefits of implementing bar coding and additional transcription and create a time line and list of forms to be added to the e-file system. IRS agreed with the recommendations.

section_title: Letter
paragraphs: Electronically filed (e-filed) tax returns have many benefits for taxpayers  such as improved convenience, higher accuracy rates, and faster  refunds. According to the Internal Revenue Service (IRS), taxpayers who  e-file can expect to get a refund within 3 weeks, while taxpayers who  paper file should expect their refund within 6 to 8 weeks. E-filed returns  also cost less to process—about $3.50 less per return, according to IRS  officials. IRS officials said that increased e-filing could make it possible to  transcribe more data from paper returns, which could result in increased  enforcement revenue and improved service to taxpayers. Nevertheless,  tens of millions of individual tax returns are still filed on paper. If these  remaining paper returns were e-filed, IRS could have saved about 85  percent of its processing costs during 2010, or about $131 million.
To support increased e-filing, Congress passed the Worker,  Homeownership, and Business Assistance Act of 2009, which requires  tax return preparers who expect to file more than 10 federal income tax  returns for individuals, estates, and trusts during a calendar year to e-file,  starting on January 1, 2011 (i.e., for tax year 2010).
Given the potential benefits for IRS, taxpayers, and preparers, you  requested that we review IRS’s implementation of this e-file mandate and  IRS’s plans and capacity to maximize its use of digital data. In March  2011, we issued an interim report that assessed IRS’s initial  implementation of the mandate and made recommendations to simplify  the e-filing process for preparers and better inform the taxpayers of the  benefits of e-filing, to which IRS agreed. To complete your request, in  this report we (1) describe e-file rates, IRS processing capacity, reasons  why preparers did not e-file, and their experiences implementing the  mandate; (2) assess IRS’s plans to enforce the mandate and determine  lessons learned; (3) assess IRS’s analysis of options for digitizing more  data from paper returns; and (4) determine whether there are any tax  forms IRS cannot accept electronically and assess IRS’s plans for adding  them to the e-filing system.
To accomplish our objectives, we obtained and analyzed e-file data prior  to and during IRS’s 2011 filing season, examined preparer e-file and  waiver applications, and interviewed 9 tax preparation software  companies and 26 representatives from tax preparation firms to obtain  their views about the mandate’s implementation. Companies and  preparers were identified through referrals from industry groups. We  reviewed IRS compliance and enforcement plans and interviewed officials  from IRS’s Office of Professional Responsibility (OPR). We analyzed prior  proposals to add a bar coding system to process paper returns as well as  IRS’s priority transcription list and calculated line-by-line transcription  costs. Finally, we reviewed IRS’s list of forms that can currently be e-filed  and analyzed when remaining forms would be added to the e-file  systems. For all objectives, we interviewed relevant IRS officials to collect  information on IRS’s mandate implementation efforts and future plans to  increase e-filing.
We reviewed documents and interviewed IRS officials and determined  that the data presented in our report were sufficiently reliable for our  purposes. We conducted this performance audit from March to October  2011, 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. (See app. I for more  information on our scope and methodology.)
subsections: section_title: Background
paragraphs: The IRS Restructuring and Reform Act of 1998 established a goal of  having 80 percent of individual returns filed electronically by 2007. IRS  worked to promote e-filing, and although rates increased steadily between  1998 and 2007, IRS did not meet the 80 percent goal. The IRS Oversight  Board recommended extending the goal’s time period to 2012 and  expanding the scope of the goal to include all major individual, business,  and exempt organization returns. Table 1 shows e-filing rates by type of  return for fiscal year 2010. Except for individual returns, those rates were  far from the 80 percent goal.
IRS is implementing the e-file mandate in two phases. In 2011, paid  preparers who reasonably expect to file 100 or more individual, estate, or  trust income tax returns are required to e-file. In 2012, the e-file  requirement will apply to paid preparers who reasonably expect to file  more than 10 individual, estate, or trust tax returns. IRS decided to  implement the mandate in two phases to give preparers time to make any  necessary changes to their business practices and to help IRS prepare  for the anticipated volume in e-file applications. (See app. II for possible  business changes affecting preparers as a result of the mandate as well  as a comparison of the paper filing and e-filing processes.)
In recent years, taxpayers have relied heavily on third party software  companies and preparers to get tax information and prepare their tax  returns. Figure 1 illustrates how taxpayers avoid direct interaction with  IRS by working with third parties. In 2010, 91 percent of all tax returns  were prepared using tax software—some by preparers and some by  taxpayers. Approximately 70 percent of all 2010 returns were e-filed  while the remainder were printed and mailed in on paper (see more  details of preparation and filing methods in app. III). Also, as reported in  IRS’s Return Preparer Review, many taxpayers often rely on third parties  to assist them with their tax law questions.
IRS accepts e-filed tax returns through two systems, the legacy Electronic  Management System (EMS) and the new Modernized e-File (MeF)  system. During filing season 2011, only certain forms were accepted  through the MeF system, so not all tax returns could be processed with  the new system. IRS plans to add all of the forms currently accepted in  EMS to MeF and discontinue use of EMS in October 2012. IRS officials  said that MeF provides several benefits; for example, MeF accepts or  rejects individual tax returns faster than the EMS and provides better  explanations for rejections. MeF will also allow taxpayers to attach  Portable Document Format (PDF) files to their tax returns, which will be  useful in instances where taxpayers are required to submit additional  documentation, such as settlement statements when claiming the First  Time Homebuyer Credit. Another benefit is that MeF accepts prior year  returns starting with tax year 2009. As we previously reported, IRS tested  MeF during the 2010 filing season, but use was low. Industry  stakeholders, who are major users of the e-filing systems, said MeF was  unstable (i.e., the system often had down time, time-outs, slow servers,  and delayed acknowledgments). Use of MeF increased during the 2011  filing season and industry stakeholders reported improvements and  positive experiences with the system. IRS officials said that plans to  exclusively use MeF for the 2013 filing season are viable.
E-filed tax returns provide IRS with digital information. IRS transcribes  select data from paper returns to convert it to a digital format. IRS’s policy  is to post the same information from electronic and paper returns to its  databases. Only information posted to its databases is readily available  for use in IRS’s enforcement programs and audit selections, which means  that similar paper and electronic returns have equal chances of being  selected for audit. In addition to e-filing or transcribing, IRS can  potentially obtain digital tax data from two-dimensional (2-D) bar coding.  A 2-D bar code is a black and white grid that encodes tax return data. Tax  software would print bar codes on paper tax returns and high-speed  scanners would scan them and import the data into IRS’s systems. IRS  released a study in December 2010 that found that using 2-D bar codes  would provide significant flexibility and generate cost savings. Paper  returns that were prepared with pens or typewriters rather than software  would still have to be transcribed.
section_title: Individual E-filing Rate Approaches 80 Percent Goal After First Year of Mandate, but Some Taxpayers Still Choose to File on Paper
subsections: section_title: 2011 E-filed Returns Have Surpassed Projections and Were Processed Smoothly
paragraphs: As of August 12, 2011, IRS processed 108 million returns electronically  and 29 million returns on paper, for an e-filing rate of about 79 percent,  according to IRS’s weekly processing data. IRS officials had estimated  that the mandate would increase the individual e-filing rate to 75 percent  in 2011 and 77 percent in 2012.
The e-file rate for preparers increased this year, to about 89 percent,  which is an increase of about 11 percentage points over last year’s rate,  according to data as of July 2, 2011, from the Individual Return  Transaction File. Although the e-file mandate did not apply to individual  taxpayers who self-prepared their returns using commercial tax software,  their e-file rate also increased to about 71 percent or about 7 percentage  points over last year’s rate. (See fig. 2.) Based on IRS processing data  and interviews with select software companies, IRS did not have any  problems processing the 7.9 million additional returns e-filed in 2011.
While IRS has not conducted an analysis to determine what factors  influenced e-file growth, officials in the Return Preparer Office said that  the mandate was one of the main contributors. According to IRS  Forecasting Office officials, the increased e-file rate for self-prepared  returns may have been due, in part, to IRS no longer mailing the paper  forms and instructions to taxpayers, and to taxpayers becoming more  comfortable with technology.
section_title: Most Preparers Who Did Not E-file Cited Taxpayer’s Choice as the Explanation
paragraphs: By far the most common reason preparers cited for not e-filing was that  the taxpayer asked to file on paper, as shown in figure 3. Preparers  subject to the mandate who did not e-file a tax return were required to  complete Form 8948, “Preparer Explanation for Not Filing Electronically,”  and submit it with the return. IRS has not analyzed why taxpayers  chose to file on paper, but it plans to do so in the future. Other reports  about e-filing suggest some taxpayers have security concerns with e- filing.
The preparers we talked with who were new to e-filing said they  experienced increased costs and administrative burdens as a result of the  mandate. Other preparers, who previously e-filed returns, told us that the mandate had little effect on their practice. We interviewed 26 prepare who were members of national preparer groups. Their views are not  parers, but they provide  representative of the entire population of pre some examples of preparer experiences.
Five of the 26 preparers we interviewed had not previously e-filed, and  they provided a variety of examples of how the mandate affected them.  One preparer noted that her software provider charged an addit to e-file returns. Another preparer stated he hired an additional  administrative employee to help manage requirements that were new to  him when e-filing, such as Form 8879, “IRS e-file Signature  Authorization.” Several preparers told us that it took them several ho make changes to rejected returns—a step that may not occur until  months later, if at all, when filing a paper return. Another preparer who  had not previously e-filed reported that she experienced a learning curv for e-filing, but after e-filing the first 10 or so returns, the process went  more smoothly. Several preparers who had been e-filing prior to the  mandate said they experienced some of these same problems when they  first e-filed, but do not any longer.
Some preparers who previously e-filed said that e-filing helped their  businesses and found that the mandate did not change their operations  greatly from the previous years. These preparers liked the convenience of  e-filing and told us that it reduced the time needed to file returns, ensured  y,  the receipt of returns at IRS, and did not cost them any additional mone but in fact saved them money. One preparer noted that he had e-filed  some returns in previous years, but this year was the first time tha all of his clients e-filed due to his encouragement because of the  mandate. He said he saved money by placing PDF versions of his clien returns on a secure network space for them  to review before he e-filed  the return with IRS, reducing printing costs.
Some preparers we interviewed relied heavily on software companies One preparer noted that he attends tax law training conducted by his  software company to get annual updates. Three of the preparers we  interviewed noted that their software automatically generated the new  forms needed to comply with the mandate (e.g., Form 8948), and two  preparers said that they heard about the mandate through their software  companies. .
section_title: IRS Is Developing ith Plans to Deal w Noncompliant Preparers and Study Lessons Learne E-file Mandate Implementation
subsections: section_title: IRS Does Not Know Extent of Preparer Noncompliance with t Mandate or Have the Authority to Issue Monetary Penalties
paragraphs: IRS officials believe there are potentially three types of p may not comply with the e-file mandate: Preparers who   the mandate or do not fully understand the  requirements;  know about the mandate, sign the tax return, but intentionally choose  not to e-file; or  complete tax returns, but do not sign the returns or submit them  electronically. IRS refers to these preparers as “ghost preparers.”
IRS has preliminary plans to identify each of these types of noncompliant  preparers, but the plans are not yet fully developed. To identify preparerswho may be unaware of or deliberately noncompliant with the mandate,  IRS plans to review paper tax returns and identify ones that were  completed by a preparer and appear eligible for e-filing but have no Fo 8948, “Preparer Explanation for Not Filing Electronically.” r  identify preparers who are willfully noncompliant with the mandate,  officials plan to review preparers’ use of Form 8948, but have not yet  determined how they will use this information to identify noncompliant  preparers. Officials in IRS’s Return Preparer Office also stated they plan  to modify the existing e-file monitoring program—currently focused on e-file security—to include compliance with the e-file mandate.  However, officials have not yet developed the selection criteria to  determine which preparers they will send notices to and visit, nor have  they determined how compliance with the e-file mandate will fit into the  scope of their visits. IRS has some plans regarding ghost preparers that er  were developed to enforce new regulations for preparers. Among oth  urns  things, IRS plans to send letters to taxpayers who submitted ret  yet appear to have had assistance  without preparer signatures completing their returns.
IRS officials said that one reason they have not completed t compliance plans is that they do not yet know the extent of  noncompliance with the mandate. IRS officials said an extensive  compliance strategy may not be needed unless noncompliance rates are  -year  high. They said that because this is the first year of the mandate’s 2 implementation period, there is not sufficient data to know whether  noncompliance with the e-file mandate is high or will be high in the future.
In fact, they suspect that noncompliance may be low, because e-file rates exceeded projections in the first year of the mandate. Nonetheless, th acknowledged that some noncompliance likely exists, and that there  could be more next year when the mandate is fully effective and the  threshold for the e-file requirement drops to more than 10 returns (down  from 100 in 2011).
A return that appears eligible for e-filing could include a paper return with a preparer tax  identification number (PTIN) but not a Form 8948, “Preparer Explanation for Not Filing  Electronically.” Starting in 2011, tax return preparers must obtain a PTIN, and use it to  sign all returns they prepare, paper and electronic. 26 C.F.R. § 1.6109-2. who fail to comply with the e-file mandate, but does have some authority to discipline preparers under the Department of Treasury’s Circular No.  230.  Circular 230 governs the practice of practitioners, including tax  o  return preparers, before IRS, and provides IRS with a limited ability t sanction preparers for failing to e-file. IRS’s Office of Professional  Responsibility (OPR) administers and enforces Circular 230 standards.  OPR officials said that they do not plan to frequently impose sanctions  against preparers for noncompliance with the e-file mandate because the lso  administrative process is resource-intensive and the sanctions may a be harsher than necessary. Prior to imposing sanctions, OPR must  provide practitioners with notice and an opportunity for a hearing. Buildin a case against a preparer is time-consuming, often taking longer than a  e  filing season. Sanctions can include censure, suspension from practic before IRS, or disbarment. IRS can also impose monetary sanctions  under Circular 230, but officials said they likely would not because the  agency does not have the authority to collect any unpaid amounts—such cases must be referred to the Department of Justice, adding to the time  and costs of enforcement.
Because imposing monetary sanctions under Circular 230 is time- consuming and costly, IRS could benefit from separate penalty authority  under the IRC. IRS already has authority under the IRC to impose  penalties in other, similar circumstances. For example, IRS may impose  a $50 penalty per return if a preparer neglects to sign a tax return or  include a Preparer Tax Identification Number (PTIN) on a return.  According to IRS’s penalty handbook, penalties exist to encourage  voluntary compliance by supporting the standards of behavior required by  the IRC. Granting IRS the authority to penalize for failing to e-file would  build upon IRS’s existing penalty regime and provide a more  commensurate sanction than those which can be imposed under Circular  230. Without such penalty authority, IRS may be limited in its ability to  deter noncompliance and enforce the e-file mandate.
section_title: Analyzing and Documenting Lessons Learned Could Improve the Implementation of Any Future E-file Mandates
paragraphs: According to the Director of the Return Preparer Office, IRS intends to  conduct a “lessons learned” review of steps taken to implement the e-file  mandate, but does not have a plan or schedule for doing so. As  discussed in our previous reports, lessons learned can be useful tools for  an organization to identify areas of improvement or document things that  worked well. Areas of focus could include a review of staffing levels,  timeliness of management decision making, and communication with the  public. One lesson learned during the first year of the e-file mandate may  be that additional staff helped IRS process e-file applications in a timely  manner. (See app. IV for more information on the e-file application  process.)
Performing a lessons learned analysis on the e-file mandate for preparers  could have future benefits because the fiscal year 2012 budget request  for IRS included five legislative proposals for additional e-file mandates.  Without identifying and documenting lessons learned, the knowledge  could be lost for reasons such as staff turnover. The scope and depth of a  lessons learned study should, of course, balance the costs of the study  against the potential benefits.
section_title: The Benefits and Costs of Different Options for Digitizing Remaining Paper Returns Have Not Been Fully Analyzed
paragraphs: Paper returns limit the effectiveness of IRS’s enforcement and service  programs. To control costs, IRS does not transcribe all the information on  paper tax returns into its computer databases. In addition, as previously  noted, IRS has a policy of posting the same information from electronic  and paper returns to its databases, so that similar paper and electronic  returns have equal chances of being selected for audit. In part, IRS’s  intention with this policy is to avoid disincentives to e-filing. Consequently,  if a line is not digitized from paper returns, it is not posted from electronic  returns either, which limits the amount of information readily available for  enforcement and service purposes. For example, taxpayers’ telephone  numbers are not digitized. When IRS wants to obtain a phone number  from a paper tax return, the number must be retrieved from the originally  filed return, which takes extra time.
Digitizing data can benefit taxpayers. In addition to faster refunds and  improved convenience, IRS officials said that having more tax return  information available electronically would improve audit selection, thus  reducing burdensome audits for compliant taxpayers. Additionally,  digital information can help some taxpayers get larger refunds, or reduce  their taxes due. For example, using automated error checking, IRS  corrected 7.7 million returns from taxpayers claiming the Making Work  Pay credit, about 60 percent of which were in the taxpayer’s favor.  These automated corrections, which reduced taxes, may not have been  possible without digitizing relevant data from paper returns.
According to IRS officials, digitizing and posting more comprehensive  information from individual income tax returns could also facilitate  enforcement efforts, expedite contacts for faster resolution, reduce  handling costs, and increase compliance revenue. For example, in fiscal  year 2010, IRS increased the amount of data it transcribed from Form  5405, “First-Time Home Buyer Credit.” It used this additional information  to conduct prerefund compliance checks to ensure that taxpayers do not  claim the credit in multiple years. We calculated IRS’s increased  enforcement efforts prevented about $95 million in erroneous refunds in  fiscal year 2010.
Options for digitizing more paper tax return data include optical character  recognition (OCR), bar coding, and transcription. An OCR system would  read text directly from paper returns using optical scanners and  recognition software and convert the text to digital data. IRS is not  currently considering implementing OCR to obtain more digital data  because of the high expense of the additional equipment needed.  Instead, IRS is pursuing what it considers to be a less costly bar coding  system and transcribing more data from paper returns.
subsections: section_title: Bar Coding Could Be Operational In Several Years
paragraphs: Two-dimensional (2-D) bar coding technology would capture data on v- coded returns, which are those returns that are prepared using software  but are printed and mailed to IRS. All of the information on a return can  be coded in bar codes, and unlike transcription, bar codes transfer data  with 100 percent accuracy (although poorly printed bar codes may be  rejected by the scanners). On a limited basis, IRS already uses bar  coding technology to digitize the Schedule K-1, “Partner’s Share of  Income, Deductions, Credits, etc.” This system, implemented in the early  1990s, was used to digitize about 15 million Schedule K-1s in fiscal year  2010. IRS also recently started to use bar codes to mask Social Security  numbers on communication letters to preparers.
IRS’s Submission Processing officials told us that they have written a  proposal for a bar coding system, and IRS may request funding for it in  the near future. Officials believe bar coding will improve tax return  processing and reduce costs. As we previously reported, bar coding could  contribute to IRS’s agency modernization goals and produce some of the  same efficiencies as e-filing by replacing the labor-intensive transcription  process and eliminating transcription errors. However, returns that were  prepared without software—for example, with a typewriter or pen—would  still require manual transcription, and bar coded returns would require  some paper processing such as receiving and opening mail. A cost-  benefit analysis for bar coding could include costs for processing and  transcribing remaining paper returns.
In our prior report, we recommended that IRS determine actions needed  to require bar coding and related costs. IRS’s 2012 Revenue Proposals  included a legislative proposal that would require all taxpayers who  prepare their returns electronically but print and file them on paper to print  the returns with a 2-D bar code. As of September 1, 2011, there had  been no action on this legislative proposal.
Officials also told us that even if a potential request is funded, it will be  another 18 to 24 months before IRS could begin scanning individual  paper returns using the technology. IRS has not yet produced a cost- benefit analysis or a return on investment study related to the bar coding  initiative. Without a cost-benefit study, IRS management and Congress  will lack key information useful for deciding whether to fund bar coding.
IRS officials told us that if IRS is able to implement bar coding, they plan  to model the bar code system on systems that states have developed and  standardized, working in collaboration with software companies. As of  2007, 24 states and the District of Columbia were using bar code  scanning to process some or all of their tax returns. State tax agencies  reported that bar coding is quicker, more accurate, and less expensive  than manual transcription of paper tax return data. A 2007 survey by the  Federation of Tax Administrators asked the states that bar coded various  state tax returns that year about savings they realized by bar coding  instead of transcribing data manually. Eleven states provided answers  with quantitative cost information; each of them reported that bar coding  cost less than manual transcription.
section_title: Transcribing More Lines of Data from Paper Returns May Have Net Benefits
paragraphs: Manual transcription of data is the primary method currently available to  IRS to digitize data from paper returns. IRS has analyzed the cost of  transcribing all remaining lines on individual paper tax forms, and  estimates that it would require 1,714 full-time equivalent (FTE) staff,  costing about $71 million, for fiscal year 2012. However, IRS officials told  us that IRS does not have funding at this time to transcribe all the  remaining data lines from paper returns. According to IRS officials, IRS  may increase the digital data available to its programs by transcribing  selected lines, although the amount of transcription needed would be  reduced if bar coding were implemented.
If the additional transcription is phased in, a cost-benefit analysis that  prioritizes data on a line-by-line basis could be used to determine which  lines would have the lowest costs and greatest benefits. IRS has not  completed such an analysis. IRS has taken some steps, such as  developing priority lists of additional lines to transcribe, but has not  quantified the costs or benefits of transcribing each line. Also, these  listings were developed in different business operating divisions and are  not integrated across divisions, so there is no ranking of the agency’s  transcription priorities as a whole.
Ranking transcription priorities could have benefits because the cost of  transcription varies by line. We used IRS data to develop calculations to  illustrate the potential variability of transcription costs across different tax  return lines that IRS included in its priority listing. We estimated the  costs of transcribing different lines from all paper tax returns submitted  during a filing season, and found that costs varied from less than $1,000  to more than $500,000.
We illustrate the variability of transcription costs by presenting averages  for all lines on selected forms. For example, if IRS were to transcribe an  average line on Form 1040 Schedule C from all paper tax returns for a  filing season, it would cost $123,400. Costs for different lines on Schedule  C would vary substantially around this average. Table 2 illustrates some  of the average costs for lines on high-volume forms and schedules. (More  details on our calculations are in app. V.)
Because an increasing percentage of returns are e-filed, IRS could be at  the tipping point where the service and compliance benefits of digitizing  additional data from paper returns are greater than costs. Given today’s  tight budget environment, additional resources for transcription would  likely have to be moved from other areas within IRS. In deciding on  whether to transcribe more lines, IRS would have to balance the benefits  of additional transcription against the value of the work foregone.
section_title: IRS Does Not Have a Complete List of Forms That Cannot Be Accepted Electronically Nor Does It Have a Time Line for Adding Them to the E-file System
paragraphs: Preparers and taxpayers wanting to e-file may not be able to because  some forms have not been added to IRS’s e-file systems. We identified  two high-volume individual forms that currently cannot be e-filed and do  not have a time line to be added to MeF.    Form 1040-X, “Amended U.S. Individual Income Tax Return.” About  6.9 million taxpayers submitted a Form 1040-X in fiscal year 2010.  Several tax preparers we spoke with said it was a burden not to be  able to e-file this form. Electronic Tax Administration officials said  eventually they would like to enable e-filing of the 1040-X, but they  have not done so because the technology would need to be  developed to check the amended data against what was originally  filed.    Form 1040-NR, “U.S. Nonresident Alien Income Tax Return.” About  621,000 taxpayers submitted a Form 1040-NR in 2010. IRS officials  said that Form 1040-NR was not included in the decision process  when IRS decided on the sequence of adding forms to e-file, but it  might be in the future.
Having a time line to add these high-volume or other forms to the e-file  system could help IRS further achieve its e-filing goals, consistent with  IRS’s e-Strategy for Growth. Without a time line, these high-volume or  other forms may not be added to the e-file system.
One reason IRS does not have a complete time line is that it has not  developed a complete list of forms that cannot currently be e-filed. IRS’s  Strategic Plan calls for using data and research across the organization to  make informed decisions and allocate resources. Adding forms to the e- file system requires one-time expenditures, but ultimately may have  compliance benefits, save IRS money, and reduce the burden on  preparers and taxpayers. Without a list of forms that are not currently e- filed, IRS would not be able analyze the costs and benefits of adding  different forms in order to prioritize which forms to add. Further, as with  additional transcription, IRS would need to weigh the benefits of shifting  resources to enable forms to be e-filed against the value of the work  forgone.
section_title: Conclusions
paragraphs: E-filing provides important benefits to taxpayers, including faster refunds  and more accurate returns. It provides a low-cost option for IRS to  improve enforcement operations and services to taxpayers. This is  especially important in an era of tight budgets when federal agencies will  be expected to do more with less. The increased e-filing rates from the  first year of the mandate are helping IRS do this.
IRS would benefit from having increased penalty authority to enforce the  mandate and deter noncompliance. There are also several steps IRS  could take to reduce costs, obtain more digital data, and facilitate further  growth in e-filing. Documenting lessons learned from the current mandate  might help with the implementation of future e-file mandates. Analysis of  the costs and benefits of bar coding technology and additional  transcription could better inform decisions about whether to digitize more  data from paper returns. Similarly, developing a list and scheduling the  addition of more forms to the e-file system could inform resource  allocation decisions.
section_title: Matter for Congressional Consideration
paragraphs: Congress should consider amending the Internal Revenue Code to  authorize IRS to assess penalties on preparers for failure to comply with  section 6011(e)(3).
section_title: Recommendations for Executive Action
paragraphs: To help increase electronic filing and to better target IRS’s efforts, we  recommend that the Commissioner of Internal Revenue direct the  appropriate officials to take the following five actions:    develop a plan for and schedule to conduct a study that identifies and  documents lessons learned from the implementation of the e-file  mandate;    determine whether and to what extent the benefits of bar-coding  would outweigh the costs;    determine the relative costs and benefits of transcribing different  individual lines of tax return data;    develop and prioritize a list of forms that still need to be added to the  Modernized e-File system; and  create a timetable to add additional forms to the Modernized e-File  system, particularly for high-volume forms, such as the 1040-X and  1040-NR.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to the Commissioner of Internal  Revenue for his review and comment. The Deputy Commissioner for  Services and Enforcement provided written comments, which are  reprinted in appendix VI. IRS also provided us with technical comments,  which we incorporated into the report as appropriate.
In response to our draft report, the Deputy Commissioner expressed  appreciation to GAO for recognizing the noticeable increase in e-file  participation this year and agreed with all five of our recommendations.  However, the steps IRS outlined in its comments may not fully address  two of our recommendations. Regarding our recommendation on the  relative costs and benefits of transcribing different individual lines of tax  return data, IRS stated that it has determined the relative costs of  transcribing individual lines. To fully address this recommendation,  however, IRS should also quantify the benefits of transcribing individual  lines and compare them to the individual costs. This analysis could inform  budget decisions by allowing IRS to compare the option of additional  transcription against any work foregone. Regarding our recommendation  to develop and prioritize a list of forms that still need to be added to MeF,  IRS outlined the next three releases scheduled for MeF (through filing  season 2014). While IRS has a list of forms it plans to transfer from EMS  to MeF, there are still some forms that cannot be e-filed on either system.   To fully address this recommendation, IRS should also develop a list of  forms and schedules that cannot currently be e-filed. A complete list  would enable IRS to analyze the costs and benefits of adding different  forms to MeF as well as prioritizing which forms to add first.
We plan to send copies of this report to the Chairmen and Ranking  Members of other Senate and House committees and subcommittees that  have appropriation, authorization, and oversight responsibilities for IRS.  We are also sending copies to the Commissioner of Internal Revenue, the  Secretary of the Treasury, the Chairman of the IRS Oversight Board, and  the Director of the Office of Management and Budget. This report is also  available at no charge on the GAO Web site at http://www.gao.gov.
If you or your staffs have any questions or wish to discuss the material in  this report further, please contact me 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.  Individuals making key contributions to this report can be found in  appendix VII.
section_title: Appendix I: Scope and Methodology
paragraphs: To describe electronic filing (e-file) rates, the Internal Revenue Service’s  (IRS) processing capacity, reasons why preparers did not e-file, and their  experiences implementing the mandate, we obtained and analyzed data  from IRS’s weekly processing reports and the Individual Return  Transaction File from Submission Processing and the Return Preparer  Office, respectively. Data included numbers of returns that were  completed by taxpayers and preparers as well as the filing method—e- filed, “v-coded,” and paper filed. In addition, we obtained and analyzed  data about Form 8948, “Preparer Explanation for Not Filing  Electronically,” and Form 8944, “Preparer e-file Hardship Waiver  Request.” To determine the reliability of IRS’s data, we interviewed IRS  officials who created the reports, reviewed related documentation, and  reviewed the data for obvious errors. We found the data to be sufficiently  reliable for our purposes. We interviewed Submission Processing officials  and representatives from the National Association of Computerized Tax  Processors about how well IRS processed additional e-filed returns this  year. We also interviewed 9 tax software companies and 26  representatives from tax preparation firms to obtain their views about the  mandate’s implementation. We chose a nonrepresentative sample of  preparers affiliated with national preparer groups: American Institute of  Certified Public Accountants, National Association of Tax Professionals,  and National Association of Enrolled Agents. Each group gathered 6 to 9  preparers for group interviews, and two of the groups identified 4  preparers whom we spoke with individually. Additionally, we spoke with  one preparer who contacted us in response to our previous report on e- filing.
To assess IRS’s plans to enforce the mandate and determine lessons  learned, we reviewed the 2011 planning documents for the integrated  preparer compliance strategy and E-file Monitoring Program. We also  interviewed officials from the Return Preparer Office about their  compliance and enforcement plans for ensuring preparers were following  the mandate. We interviewed officials from the Chief Counsel’s Office and  the Office of Professional Responsibility to determine current options  available to sanction preparers noncompliant with the e-file mandate. We  also interviewed IRS officials from the Return Preparer Office about IRS  plans for conducting a lessons learned study on the mandate’s  implementation.
To assess IRS’s analysis of options for digitizing more data from paper  returns, we reviewed IRS’s 2008 proposal, Modernized Submission  Processing: Solution Concept Briefing, to add a bar coding system to  process paper returns and analyzed IRS’s priority transcription list  developed by IRS’s Deputy Commissioner’s Office for Service and  Enforcement (Service and Enforcement). Using IRS data, such as staff  cost per keystroke and volume of paper forms, we estimated costs to  transcribe additional lines of data (see app. V). To determine the reliability  of IRS’s data, we interviewed IRS officials who developed the  transcription priority listing, reviewed related documentation, and  reviewed the data for obvious errors. We found these data to be  sufficiently reliable for our purposes. We shared our calculations with IRS  officials in Service and Enforcement who agreed with our approach. Also,  we interviewed IRS officials from Submission Processing and Service and  Enforcement about their plans to implement bar coding technology and  transcribe additional lines of data and any analysis of the costs and  benefits of implementing such methods.
To determine whether there are any tax forms IRS cannot accept  electronically and assess IRS’s plans for adding them to the e-filing  system, we compared a list and time line of all tax forms that Submission  Processing planned to add to the e-file system to a list of all existing IRS  forms obtained from the Forms and Publications division. We also  interviewed officials from the Wage and Investment division and the  offices of Electronic Tax Administration and Submission Processing about  their plans to add more forms to the e-file system.
For each objective, we also interviewed officials at IRS’s office of  Electronic Tax Administration and Return Preparer Office. Our work was  done primarily at IRS Headquarters in Washington, D.C. and its division  offices in New Carrolton, Maryland, and Atlanta, Georgia where the IRS  officials who manage the e-file mandate implementation are located.
We conducted this performance audit from March 2011 to October 2011,  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: Possible Changes Affecting Preparers as a Result of the E-file Mandate
paragraphs: Tax return preparers who have never electronically filed (e-filed) a tax  return may need to make some changes in their business practices as a  result of the e-file mandate. Some preparers may need to purchase a tax  software package to enable them to e-file. Most preparers will also need  to apply to become an Authorized E-file Provider with the Internal  Revenue Service (IRS), which allows them to submit electronic tax  returns to IRS.
New steps in preparing returns for those who have never e-filed could  include obtaining a taxpayer’s signature on Form 8879, “IRS e-file  Signature Authorization,” to document that the taxpayer has reviewed the  return and that it is ready for transmission to IRS. Also, preparers who e- file receive an acknowledgement from IRS stating that the return was  accepted or rejected into IRS’s e-file system. When a return is rejected,  the preparer must correct the error, sometimes with more information  from the taxpayer, in order to resubmit it to IRS. In instances when a  preparer needs to file a return on paper, the preparer must submit Form  8948, “Preparer Explanation for Not Filing Electronically.”
Figure 4 compares the processes preparers go through to submit a return  electronically versus on paper.
section_title: Appendix III: Trends in Preparer and Self- Prepared Filing Methods
paragraphs: As of July 2, 2011, almost 60 percent (about 76 million) of all individual  income tax returns were completed by a preparer and the remainder (54  million) were self-prepared by taxpayers (see fig. 5). Filing methods  include electronic filing (e-filing) and paper filing. Returns that are  prepared using software, but are printed and mailed to the Internal  Revenue Service (IRS), are called “v-coded” returns.
section_title: Appendix IV: E-file Application Processing
paragraphs: In order to e-file, a preparer must be an Authorized E-file Provider. The  requirements to become an Authorized E-file Provider include submitting  an application and passing background and suitability requirements. The  Internal Revenue Service (IRS) issues an Electronic Filing Identification  Number (EFIN) to firms or sole practitioners who meet these  requirements.
As of June 30, 2011, IRS processed 36,714 applications for preparers to  become Authorized E-file Providers, 19 percent more than during the  same time period in 2010—an increase that IRS officials said was due  predominantly to the mandate. Applications that were submitted  electronically had an average processing time of 18 days, while those  submitted on paper had an average processing time of 26 days—both  within IRS’s normal 45-day processing time. Overall, 89 percent of e-file  applications were processed in fewer than 45 days. For 2012, when the  mandate threshold is lowered to more than 10 returns, IRS officials  project that e-file applications will increase by 38 percent over the  average annual applications based on prior years. Electronic Products  and Support Services officials anticipate the preparers who apply to  become Authorized E-file Providers in 2012 will require additional  assistance resulting in longer calls or multiple calls. As shown in table 3,  IRS officials told us they will need 11 additional full-time equivalents  (FTE) to manage this workload.
section_title: Appendix V: Calculation of Costs of Transcribing Data Lines from Paper Returns
paragraphs: We used the Internal Revenue Service (IRS) data to develop calculations  to illustrate the potential variability of transcription costs across different  tax return lines that IRS included in its priority listing. The formula we  used to calculate the cost of transcribing a line of data is the following:  All of these elements can vary:    Cost/keystroke is based on the hourly rate for transcription staff  multiplied by number of keystrokes per hour. Number of keystrokes  per hour varies slightly for different forms.    Average keystrokes per line varies for different data lines, from 1 to  several hundred, with most under 10, as shown in figure 7.    Paper volume of the form is the number of forms that are submitted to  IRS on paper. For example, if 10,000 taxpayers submit paper returns  that include a given form, the paper volume of that form is 10,000.  Paper volume is related to the total volume of the form and the e-file  rate of the form:  Paper volume = # taxpayers who submit the form × (1 – e-file rate of form)    E-file rates vary significantly for different forms, as shown in figure 6;  for example, 78 percent of Form 8863s were e-filed for tax year 2009,  compared to 55 percent of Schedule C’s.    Number of taxpayers who submit the form varies significantly for  different forms, from under 10,000 to over 50 million.    Occurrence rate of the line is the rate at which the line is filled in.
Some lines are left blank most of the time, while others are filled in  more often or always. Occurrence rates vary from 1 percent to 100  percent.
IRS has all of these data for over 500 lines identified by its Business  Operating Divisions as high priorities for transcription. As an example of  variations in these factors, different e-file rates for some high-volume  forms are shown in figure 6. All other variables being equal, a line on a  form such as Schedule C with a 55 percent e-file rate (45 percent paper  file rate) would be about twice as expensive to transcribe as a line on a  form such as Form 8863 with a 78 percent e-file rate (22 percent paper  file rate). This is because there would be about twice as many returns  from which to transcribe that line (45 ÷ 22).
As another example, figure 7 is a frequency chart showing that most lines  would require 1 to 15 keystrokes to transcribe, while some would require  46 or more. All other variables being equal, a line that required 46  keystrokes would be 46 times more expensive to transcribe than one  requiring 1 keystroke.
section_title: Appendix VI: Comments from the Internal Revenue Service
section_title: Appendix VII: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Libby Mixon, Assistant Director;  Amy Bowser; Michele Fejfar; Cynthia Saunders; Robyn Trotter; and  Meredith Trauner made key contributions to this report.