Internal Revenue Service: Assessment of the Interim Results of the 2006 Filing Season and Fiscal Year 2007 Budget Request
Published: 2006-04-27T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Internal Revenue Service's (IRS) filing season performance affects tens of millions of taxpayers who expect timely refunds and accurate answers to their tax questions. IRS's budget request is a planning tool showing how it intends to provide taxpayer service and enforce the tax laws in 2007. It is also the first in a series of annual steps that will determine whether IRS meets its new long-term goals of increasing tax compliance and reducing taxpayers' acceptance of cheating on their taxes. Tax law enforcement remains on GAO's list of high-risk federal programs, in part, because of the persistence of a large tax gap. IRS recently estimated the gross tax gap, the difference between what taxpayers owe and what they voluntarily pay, to be $345 billion for 2001. GAO assessed (1) IRS's interim 2006 filing season performance; (2) the budget request; and (3) how the budget helps IRS achieve its longterm goals. GAO compared performance and the requested budget to previous years.
section_title: What GAO Found
paragraphs: IRS has improved its filing season performance so far in 2006, continuing a trend. More refunds were directly deposited, which is faster and more convenient. Electronic filing continued to grow, but at a slower rate than in previous years. IRS's two most commonly used services--telephone and Web site assistance--continued to improve. IRS estimates that the accuracy rate for its telephone answers is now at 90 percent or more. Taxpayers continued the recent pattern of using IRS's walk-in sites less and community-based volunteer sites more. While millions of taxpayers use chain paid tax preparers, taxpayers may not be receiving accurate and complete assistance, putting them at risk of owing back taxes, interest, and penalties. The 2007 budget request of $11 billion (a small decrease after adjusting for inflation) sets performance goals for service and enforcement that are all equal to or higher than the 2006 goals. The budget reduces funding by 15 percent for Business Systems Modernization, the ongoing effort to replace IRS's aging information systems. The reduction could impede progress delivering improvements to taxpayers. The budget request identified over $121 million in savings; however, opportunities exist for further savings. For example, IRS officials told us IRS's 25 call centers have underutilized space. Those centers could be consolidated without affecting service to taxpayers. Achieving IRS's long-term compliance goals will be challenging because the tax gap has persisted for many years at about its current level. In addition, because the effect of taxpayer service and enforcement on compliance has never been quantified, IRS does not have a data-based plan demonstrating how it will achieve its goals. Nor does IRS have a plan for measuring compliance by 2009, the date for achieving the goals. Reducing the tax gap will likely require new and innovative solutions such as simplifying the tax code, increasing income subject to withholding, and increasing information reporting about income.

section_title: Letter
paragraphs: Since the passage of the Internal Revenue Service (IRS) Restructuring and  Reform Act of 1998 (RRA 98), IRS has made noticeable improvements to  taxpayer services such as telephone assistance and delivered some  modernized information systems that, among other benefits, speed up  refunds to taxpayers. Increased funding financed some of the  improvements, but a significant portion has been financed internally  through efficiencies from increased electronic filing of tax returns and  other operational improvements.
IRS has also increased revenue collected through its enforcement  programs; however, tax law enforcement continues to be included on our  list of high-risk federal programs. This is due, in part, to the persistence of  a large tax gap.  IRS estimated the gross tax gap to be $345 billion for tax  year 2001. After late payments by taxpayers and revenue brought in by  IRS’s enforcement efforts, the resulting net tax gap is estimated to be $290  billion. Even modest progress in reducing the tax gap would yield  significant revenue; each 1 percent reduction would likely yield nearly $3  billion annually.
If its 2007 budget request is a harbinger of longer term funding, IRS faces  an era of tight budgets. Consequently, continued performance  improvements will depend on the extent to which IRS can make more  efficient use of limited resources to provide internal funding for the  improvements. By indicating how resources are allocated to specific  programs and activities within the agency, the budget request is a key  planning tool showing where the agency intends to achieve additional  efficiencies.
The 2007 budget request is also an indication of how IRS intends to  achieve longer term goals. For the first time, IRS lists two agencywide  long-term goals: to increase the compliance rate and reduce the proportion  of taxpayers who think it is acceptable to cheat on their taxes. This  budget can be viewed as a first step in a series of annual steps that will  determine whether IRS achieves these long-term goals.
Our statement discusses IRS’s 2006 filing season performance to date and  fiscal year 2007 budget request. To address your request, we assessed (1)  the interim results of IRS’s 2006 filing season performance compared to  prior years; (2) IRS’s budget request compared to prior years; and (3) how  the budget helps IRS achieve its long-term goals aimed at reducing the tax  gap.
Our assessment of the interim results of IRS’s filing season is based on  comparing IRS’s performance this year to prior filing seasons, monitoring  various production meetings and production statistics, reviewing other  IRS documents and reports, interviewing IRS and Treasury Inspector  General for Tax Administration (TIGTA) officials and paid tax preparers  and other external stakeholders, reviewing TIGTA and other external  reports, and reviewing IRS’s Web site. Our assessment of the budget  request is based on a comparative analysis of IRS’s fiscal year 2002 (in  most cases) through 2007 budget requests, funding, expenditures, and  other documentation and interviews with IRS officials. We used historical  budget and performance data from reports and budget requests used by  the IRS, Department of the Treasury, and Office of Management and  Budget. In past work, we assessed IRS’s budget and performance data.  Since the data sources and procedures for producing this year’s budget  and performance data have not significantly changed from prior years, we  determined that the data were sufficiently reliable for the purposes of this  statement. We did not verify IRS’s estimates for enforcement revenue and  the tax gap. IRS presents tax gap information as supplemental information  in its financial statements; that information is not required to be audited.  However, we have been involved in tax gap methodology briefings, and the  TIGTA has an ongoing review of the accuracy of IRS’s tax gap estimates.
Additionally, our analysis of IRS’s Business Systems Modernization (BSM)  program was based primarily upon the results of our detailed review of  IRS’s fiscal year 2006 BSM expenditure plan that we recently reported to  you. We performed our work in Washington, D.C., and Atlanta, Georgia,  from January 2006 through April 2006, in accordance with generally  accepted government auditing standards.
Our statement makes these key points:  IRS has improved its 2006 filing season performance to date in  important areas compared to last year, continuing a recent trend. IRS’s  returns processing has gone smoothly and over 64 percent of refunds  are now directly deposited to taxpayers’ bank accounts, which is  faster, more convenient and less costly than issuing paper checks.  Electronic filing continues to grow, but at a slower rate.  So far this  filing season, electronic filing rate has increased 2.1 percentage points  compared to an average percentage point increase of 5.1 annually for  the previous two years. According to IRS officials, the slower rate of  growth is due, in part, to new income limits in the Free File program,  which reduced the number of taxpayers eligible to file electronically  for free via IRS’s Web site, and the termination of the TeleFile  program, which eliminated electronic filing by phone. Telephone  assistance has improved this year, in part, due to lower call volume.  The percentage of taxpayers attempting to reach an IRS telephone  assistor and who actually received service increased 1.6 percentage  points to 83.3 percent this filing season and the length of time  taxpayers waited to get their calls answered decreased from 256  seconds to 205 seconds. The accuracy of IRS’s responses to tax law  and account questions improved—both are now at 90 percent or more.  IRS’s Web site is being used more, is performing well based on third- party evaluations, and has been reconfigured with the goal of  improving taxpayer service. Taxpayers continued the recent pattern of  using IRS’s walk-in sites less, and using sites run by community-based  organizations and staffed by volunteers more. In addition to service  from IRS, millions of taxpayers—particularly those with complicated  returns—receive service from paid preparers. However, we recently  reported that chain paid tax preparers may not be providing accurate  and complete assistance, putting taxpayers at risk of owing back taxes,  interest, and penalties.
IRS’s fiscal year 2007 proposed budget is $11 billion, which is a small  decrease compared to the 2006 enacted level after adjusting for  expected inflation.  For service, the budget proposes to cut staffing by  4 percent. For enforcing tax laws, the budget proposes to cut staffing  by 2 percent. However, for service and enforcement, the budget sets  performance goals for 2007 that are higher than or equal to those for  2006. For maintaining and operating IRS’s existing information systems  (IS), the 2007 budget request shows an increase in resources when  compared to the 2006 enacted budget. However, when compared to the  level currently assumed for 2006, the 2007 budget request leaves Full- time Equivalents (FTE) for IS virtually constant. For the BSM  program, which is the ongoing effort to replace the agency’s aging  information systems, the budget proposes to reduce spending by about  15 percent. This reduction could delay delivery of improved services  for taxpayers. As it has in prior years, IRS’s budget request identifies  savings—the 2007 budget proposes to save over $121 million and 1,424  FTEs. However, additional opportunities exist for savings. One would  be to increase electronic filing by additional use of mandates. IRS  currently mandates electronic filing by large corporations and 12 states  currently mandate electronic filing of individual income tax returns by  certain tax preparers. Another opportunity would be to consolidate  IRS’s 25 telephone call sites. IRS officials told us that the call sites have  space that is not used for 850 staff. Call sites could be consolidated  without affecting service to taxpayers. Finally, IRS has long been  hampered by a lack of current and accurate cost information for  making resource allocation decisions. IRS recently implemented  components of a cost accounting system, but needs to continue  gathering the cost data needed to make it an effective planning tool.
IRS’s budget request sets two long-term goals: increasing the rate of  voluntary compliance from 83 percent to 85 percent by 2009 and  reducing the percentage of taxpayers who think it is acceptable to  cheat on their taxes from 10 percent to 9 percent in 2008. These goals  will be challenging to meet because the tax gap has persisted at a  relatively stable level of 81 to 84 percent for many years. However,  because the effect of taxpayer service and enforcement on compliance  has never been quantified, IRS does not have a data-based plan  demonstrating how it will use its programs to achieve its goals and  reduce the tax gap. Nor does IRS have a plan for measuring compliance  by 2009. Reducing the tax gap will likely require new and innovative  solutions such as simplifying the tax code, increasing income subject to  withholding, and increasing information reporting about income.  Despite these limitations, IRS’s budget request includes several  proposals for increasing compliance that would not require additional  resources for IRS. For example, the Department of the Treasury plans  to study, and we have long supported, clarifying the definition of  independent contractors and requiring additional information reporting  on their income, steps that could increase tax revenue by billions of  dollars.
subsections: section_title: IRS’s Filing Season Performance to Date Has Improved in Important Areas, Continuing a Recent Trend
paragraphs: IRS improved its 2006 filing season performance in important areas that  affect large numbers of taxpayers. This continues a trend of improvement  since at least 2002. Returns processing has gone smoothly and electronic  filing continues to grow, although at a slower rate than in previous years.  Taxpayer assistance has improved in the two most commonly used  services—toll-free telephones and the Internet Web site. Fewer taxpayers  visited IRS’s walk-in sites, and more sought assistance at volunteer-staffed  sites.
subsections: section_title: Return Processing Has Been Smooth and Electronic Filing Continues to Grow, Although At a Slower Rate Than Previous Years
paragraphs: From January 1 through April 14, 2006, IRS processed 91.8 million  individual income tax returns. Of those returns, 63.4 million returns were  filed electronically (up 2.3 percent) and 28.3 million returns were filed on  paper (down 7.1 percent).
According to IRS data and officials, returns processing has gone smoothly  so far this filing season. IRS issued 78 million refunds, 50 million, or 64  percent of which were directly deposited, up 5.4 percent over the same  period as last year. Direct deposit is faster, more convenient for taxpayers,  and less expensive for IRS than mailing paper checks.
Because of the volume of tax returns, it is normal for IRS to experience  some processing disruptions, although this year, disruptions have not been  significant. For example, 13 different tax forms were unavailable for  electronic filing until February 1 due to the late hurricane relief legislation,  which caused a minor processing delay for some returns.
Furthermore, IRS officials said that the new Customer Account Data  Engine (CADE), which is intended eventually to replace IRS’s antiquated  Master File system containing taxpayer records, processed over 6 million  returns and dispersed 5.3 million refunds as of April 14, 2006 without  disruptions. IRS is reporting that direct deposit refunds and paper check  refunds are being issued within 4 and 6 business days, respectively, after  tax returns are posted to CADE, which is faster than for returns processed  by the Master File system. CADE’s growth in future years will directly  benefit taxpayers. Not only can it speed up refunds, but it also updates  taxpayer account information quicker than the Master File system.
Representatives of the taxpayer industry corroborated IRS’s view that the  filing season is going smoothly. Groups and organizations that we talked  to included the National Association of Enrolled Agents, the American  Institute of Certified Public Accountants, and others. In addition, the  TIGTA recently testified that thus far it has seen no significant problems  during the filing season.
The growth of electronic filing is important, because it generates savings  by reducing staff years needed for labor intensive paper processing.  Between fiscal years 1999 and 2006, IRS reduced the number of staff years  devoted to paper and electronic processing by 1,586, or 34 percent as  shown in figure 1.
Electronic filing continues to grow but at a slower rate than previous  years. This year’s 2.1 percent rate of growth is less than the average annual  rate of growth of 5.1 percent for each of the preceding 2 years. According  to IRS officials, the slower growth in electronic filing this year is due, in  part, to changes in the Free File program, which reduced the number of  taxpayers eligible to file electronically for free this year and reduced  publicity and advertising by companies involved in that program, and the  termination of the TeleFile program, which eliminated the way for  taxpayers to file their returns electronically via telephone.
The Free File program enables taxpayers to file their returns electronically  via IRS’s Web site. Through IRS’s Web site, taxpayers can access the Web  sites of 20 companies comprising the Free File Alliance. The alliance is a  consortium of tax preparation companies that agreed to offer free return  preparation and electronic filing for taxpayers that meet certain criteria  (see app. 1 for further detail). In an amended agreement with IRS that took  effect this year, the Free File Alliance set a $50,000 income limitation on  taxpayer participation. This limit was absent last year and reduced the  number of taxpayers eligible to participate in the program. As of April 13,  2006, IRS processed about 3.5 million free file returns, which is a decrease  of 24 percent from the same period last year. This decline is inconsistent  with IRS’s projection that it would receive 6 million tax returns filed  through the Free File program, almost a million more compared to last  year.
For 2006, IRS terminated the TeleFile program. IRS expected that  eliminating TeleFile would reduce electronic filing, but justified the  decision because of declining usage and relatively high costs. The number  of taxpayers using the program had been decreasing—from approximately  5.7 million in 1999 to 3.8 million in 2004. IRS estimated the cost per tax  return submitted through TeleFile, typically Form 1040EZ, to have been  $2.63 versus $1.51 for a return filed on paper, largely due to contractor,  telecommunications, and other costs. Given the limitations of IRS’s cost  accounting system, the validity of these figures is unknown. IRS officials  stated that the reason for this year’s increase in the number of 1040EZ  returns filed on paper is due, in part, to the elimination of TeleFile.  Through April 14, 2006, the number of 1040EZ returns filed on paper has  increased 20 percent from last year.
Options for increasing electronic filing, in particular mandated electronic  filing, will be discussed in the budget section of this statement.
section_title: Telephone Access and Accuracy Improved, in Part Due to Lower Call Volume
paragraphs: Taxpayers’ ability to access IRS’s telephone assistors and the accuracy of  answers provided improved compared to previous years. From January 1  through April 15, 2006, IRS answered approximately 31 million phone  calls, which is about a 7 percent decline from the same period last year.  The call volume has been less than projected by IRS and less than was  assumed when IRS set staffing levels for telephone assistors for the filing  season. IRS officials offered several explanations for the unexpected  decline in call volume. One explanation is that more taxpayers are using  improved tax preparation software, which reduces their need to call IRS.  Another explanation is that more taxpayers are getting through to a  telephone assistor the first time they call, thus reducing the need for  taxpayers to call again.
As shown in table 1, the percentage of taxpayers who attempted to reach  an assistor and actually got through and received service—referred to as  the level of service—is 83.3 percent so far this filing season compared to  81.7 percent over the same period last year—and greater than its 2006  fiscal year goal of 82 percent. According to IRS officials, one possible  explanation for the improvement in access is the decline in overall call  volume. When call volume decreases, taxpayers are likely to wait less time  to speak with an IRS telephone assistor. As a result, fewer taxpayers  would likely hang up, increasing the percentage of taxpayers who get  through to an assistor.
IRS also reported that, so far this filing season, the average speed of  answer (length of time taxpayers wait to get their calls answered) is down  51 seconds from the same time last year to 205 seconds, a decrease of  about 20 percent, and significantly better than IRS’s 2006 fiscal year goal  of 300 seconds. IRS also reported that the rate at which taxpayers  abandoned their calls to IRS decreased from 12 percent to 9.7 percent  compared to the same period last year.
Using a statistical sampling process, IRS estimates that the accuracy of  telephone assistors’ responses to taxpayers’ tax law and account questions  improved compared to last year. IRS estimates its tax law accuracy rate to  be 90 percent, an increase of 1.9 percentage points over the same time  period last year, continuing an improvement since 2004. Additionally, IRS  estimates that the accuracy rate to taxpayers’ inquiries about their  accounts, to be 92.9 percent this year compared to 91.6 percent over the  same period last year, continuing an improvement since 2003. IRS officials  attribute these improvements in performance to several factors, including  better and more timely performance feedback for telephone assistors,  increased assistor experience, better training, and increased use of the  Probe and Response Guide, a script used by telephone assistors to  understand and respond to tax law questions.
section_title: IRS’s Web Site Is Being Used More, Is Performing Well, and Has Been Reconfigured with the Goal of Improving Taxpayer Service
paragraphs: Use of IRS’s Web site has increased so far this filing season compared to  prior years based on the number of visits and downloads. From January 1  through March 31, IRS’s Web site was visited 95 million times by visitors  who downloaded 90 million forms and publications. The number of visits  reflects a 7.5 percent increase over the same period last year while the  number of forms and publications downloaded has increased by 34  percent.
Further, IRS’s Web site is performing well. For example,    we found IRS’s Web site to be readily accessible, easy to navigate, and    an independent weekly study by Keynote, a company that evaluates  Web sites, reported that IRS’s Web site has repeatedly ranked second  out of 40 government agencies evaluated in terms of average download  time. The same study also reported that IRS has repeatedly ranked first  out of the most commonly accessed government related Web sites for  response time and success rate, and  the American Consumer Satisfaction Index overall customer  satisfaction with IRS’s Web site increased from 68 to 72 percent after  IRS reconfigured the site.
IRS reconfigured its Web site for the 2006 filing season. According to IRS  officials, the goal for reconfiguring the Web site was to improve overall  customer service through easier navigation and a more effective search  function. As a result, the number of Web site searches has decreased by 51  percent, from 108 million during the same period last year to 52.5 million  this year. Typically, search functions are used when users fail to find  information through links. According to IRS officials, the decrease in the  number of searches indicates that users are finding the information that  they need faster.
IRS also added the following new features to its Web site this year:    Electronic IRS: The Electronic IRS brand reconfigured the IRS’s Web  site and made it easier to locate items, as evidenced by the decline in  searches;    Alternative Minimum Tax (AMT) Assistant: Helps taxpayers determine  if they do not owe AMT; and    Help for Hurricane Victims: A special link that provides victims of the  recent hurricanes information on special tax relief, assistance and how  to get help with tax matters.
IRS’s Web site continues to include several important features in addition  to the Free File program:    Where’s My Refund, which allows taxpayers to check on the status of  their refunds. As of April 15, 2006, 24 million taxpayers accessed the  Where’s My Refund feature to check on the status of their tax refunds.  This was a 17 percent increase from the same period last year; and    Electronic Tax Law Assistance, where taxpayers can ask IRS general  tax law questions via its Web site. From January 1 through April 14,  2006, IRS received 10,160 emails requesting tax law assistance (down  over 43 percent compared to last year). As of March 31, 2006, IRS  estimated the accuracy rate of IRS’s responses to tax law questions  submitted via the Web site, to be 85 percent, similar to 2005. However,  the average number of days that it took IRS to respond to tax law  questions submitted via the Web site was 2.2 days, compared to 1.2  days in 2005.
section_title: Taxpayers Continue Their Recent Pattern of Using IRS’s Walk-In Sites Less and Using Volunteer Sites More, And Information About the Quality of Service Remains Limited
paragraphs: Fewer taxpayers have used IRS’s 400 walk-in sites so far in the 2006 filing  season compared to the same period in prior years. Staff at walk-in sites  provide taxpayers with information about their tax accounts and answer  taxpayers’ questions within a limited scope of designated tax law topics,  such as those related to income, filing status, exemptions, deductions, and  related credits. Walk-in site staffs also provide need-based tax return  preparation assistance, limited to taxpayers meeting certain  requirements. As of April 1, 2006, the total number of contacts at IRS’s  walk-in sites declined by approximately 12 percent compared to last year.  The decline thus far this year is consistent with the annual trends in walk- in use shown in figure 2, including IRS’s projection for 2006. The declines  in the number of taxpayers using IRS’s walk-in sites, including for tax  return preparation, are also consistent with IRS’s strategy to reduce its  costly face-to-face assistance by providing taxpayers with additional  options, such as IRS’s toll-free telephone service, Web site, and numerous  volunteer sites. It is unclear, however, whether the declining volume is an  indicator of how well IRS is meeting taxpayers’ demand for face-to-face  assistance. For example, IRS does keep track of the number of taxpayers  entering a walk-in site, taking a number to queue for service, but then  leaving the site without receiving service. If a taxpayer did not take a  number, IRS would have no way of counting those taxpayers.
IRS officials said the types of services offered at walk-in sites remained  constant for most sites from 2005 to 2006. For sites in areas with a high  number of natural disaster victims, IRS expanded the types of assistance  provided. For example, IRS adjusted the type of tax law questions that it  would answer at walk-in sites to include casualty loss and removed  income limitations for disaster victims seeking return preparation  assistance at walk-in sites.
In contrast to IRS walk-in sites, the number of taxpayers seeking return  preparation assistance at approximately 14,000 volunteer sites has  increased this year by 8.7 percent, continuing the trend since 2001 (see fig.  2). These sites, often run by community-based organizations and staffed by  volunteers who are trained and certified by IRS, do not offer the range of  services IRS provides at walk-in sites, but instead focus on preparing tax  returns primarily for low-income and elderly taxpayers and operate chiefly  during the filing season. As we have previously reported, the shift of  taxpayers from walk-in to volunteer sites is important because it has  allowed IRS to transfer time-consuming services, such as return  preparation, from IRS to other less costly alternatives that can be more  convenient for taxpayers.
IRS has used both walk-in and volunteer sites to provide relief efforts for  federally-designated disaster zones such as in hurricane-affected areas.  IRS developed a Disaster Referral Services Guide and new training  materials for employees to better equip them to address disaster-related  issues. In addition to the expanded services for disaster victims at IRS  walk-in sites noted above, volunteer sites performed outreach within their  network of partners by creating training material for tax preparers, and  agreeing with two organizations to accept referrals from IRS of disaster  victims needing tax return preparation assistance.
IRS continues to lack reliable data on the quality of the services provided  at walk-in and volunteer sites. As in previous years, TIGTA is conducting  an audit on the accuracy of some services provided at walk-in sites,  although the results will not be available until after the filing season.  However, TIGTA has noted problems with the quality of services provided  at IRS walk-in sites in prior reports. We have made recommendations for  IRS to improve its quality measurement at walk-in sites. At volunteer  sites, IRS is conducting different types of reviews to monitor tax return  preparation assistance. According to IRS officials, the results to date  show that the quality of service has improved at volunteer sites compared  to previous years, but they acknowledge that challenges remain in terms of  volunteers’ adherence to IRS’s procedures and use of IRS materials. As in  previous years, TIGTA will conduct limited quality reviews at volunteer  sites. While the results of those reviews are based on a judgmental sample,  TIGTA has concluded in the past that, while significant improvements  have been made in the oversight of volunteer sites, continued effort is  needed to ensure the accuracy of tax return assistance provided.
section_title: Taxpayers Using Chain Paid Tax Preparers May Receive Incorrectly Completed Tax Returns
paragraphs: In addition to service from IRS, millions of taxpayers receive service, such  as tax return preparation, from paid preparers.  About 56 percent of about  130 million individual tax returns filed for tax year 2002 used a paid tax  preparer, with higher paid preparer usage among taxpayers with more  complicated returns.
We recently reported, however, that some preparers make serious errors  when completing returns. Based on our very limited sample of 19 paid tax  preparers, taxpayers who rely on tax preparers to provide them with  accurate, complete, and fully compliant tax returns may not get what they  pay for. For example, during visits to paid preparers, tax returns prepared  for GAO often varied widely from what we determined the returns should  and should not include, sometimes with significant consequences.  Their  work resulted in unwarranted extra refunds of up to almost $2,000 in 5  instances, while in 2 cases they cost the taxpayer over $1,500.
Some of the most serious problems involved paid preparers: not reporting business income in 10 of 19 cases; not asking about where a child lived or ignoring GAO’s answer to  the question therefore allowing an ineligible child to be claimed for  the Earned Income Tax Credit in 5 out of the 10 applicable cases;   failing to take the most advantageous postsecondary education tax  benefit in 3 out of the 9 applicable cases; and   failing to itemize deductions at all or failing to claim all available  deductions in 7 out of the 9 applicable cases.
Many of the problems we identified put paid preparers, taxpayers, or both  at risk of IRS enforcement actions. According to IRS officials, paid  preparers and taxpayers risk enforcement action by filing a tax return that  includes the types of misstatements or omissions we reported.  According  to the officials, if IRS were to uncover problems with the preparation of  real tax returns similar to several that we found, the preparers would be  subject to civil sanctions.  If an erroneous return was prepared, in addition  to paying the correct tax due and any related late payment interest, the  taxpayer may also be assessed a penalty, depending on the facts and  circumstances of each situation, according to IRS officials. For example, if  taxpayers substantially understate income, overstate deductions, or  provide other incorrect information resulting in decreased tax or  improperly high refunds, they may be assessed an accuracy-related  penalty. The penalty could be assessed for any failure to comply with the  tax laws, including the failure to report self-employment income (further  discussion on the consequences of the errors of paid tax preparers is  provided in the discussion on the tax gap).
section_title: IRS’s Budget Proposes Decreases in Staffing and Identifies Savings, but Opportunities for Additional Savings Exist
paragraphs: IRS’s fiscal year 2007 budget request is a small decrease compared to 2006  enacted levels after adjusting for expected inflation. It proposes to reduce  overall staffing levels, as well as staffing levels for taxpayer service and  enforcement activities, while maintaining or improving taxpayer service  and enforcement. As it has in prior years, IRS has identified some savings,  but additional opportunities exist for enhancing savings.
subsections: section_title: IRS’s Budget Proposes Decreases in Funding After Adjusting for Expected Inflation and in Staffing
paragraphs: IRS’s proposed fiscal year 2007 budget is $11 billion (a 1.6 percent  increase), but after adjusting for expected inflation, it reflects a slight  decrease over last year’s enacted budget. The $11 billion includes $417  million from new and existing user fees and reimbursable agreements with  other federal agencies. The 2007 budget request for IRS’s appropriation  accounts is shown in table 2 (see app. II for more details).
The real decrease in the proposed budget can be seen in staffing. IRS  proposes to fund 95,476 FTEs in fiscal year 2007, down over 2 percent  from 97,754 FTEs in enacted fiscal year 2006 (see table 5 in app. II for  comparisons in enacted FTE levels for fiscal years 2002 through 2007).
Actual FTEs tend to be lower than enacted FTEs, in part, because of how  IRS absorbs unbudgeted costs (see table 6 in app. II for actual FTEs).
The decrease in FTEs may be greater than shown in IRS’s fiscal year 2007  budget request. Every year agencies, including IRS, are expected to absorb  some costs that are not included in their budget requests. For fiscal year  2007, IRS officials currently anticipate having to absorb over $117 million  in costs, including about $41 million for homeland security-related  controls over physical access to government facilities. Absorbing such  costs reduces the actual number of FTEs that IRS can support. For  example, for fiscal year 2005, the enacted level of FTEs was 96,435 but the  actual level was 94,282.
subsections: section_title: IRS’s Budget Request Proposes to Maintain or Improve Taxpayer Services with Fewer Resources
paragraphs: IRS is requesting $4.2 billion for PAM, including some user fees, which is  funding primarily spent on providing service to taxpayers. The amount  requested is about a 1.6 percent increase over fiscal year 2006 enacted  levels, but is a slight decrease after adjusting for expected inflation. This  funding level translates into reduced staffing, down over 4 percent from an  enacted level of 38,796 FTEs in fiscal year 2006 to 37,126 proposed FTEs in  fiscal year 2007. Since fiscal year 2002, FTEs devoted to PAM have  declined over 15 percent from an enacted level of 43,866 FTEs.
Despite the proposed inflation-adjusted decrease in funding in 2007, IRS is  planning to maintain or improve taxpayer services. For every one of the  major taxpayer services listed in the budget, 2007 planned performance  goals are higher or equal to 2006 performance goals. These services  include telephone assistance and refund issuance.
section_title: IRS’s Budget Request Reduces Enforcement Staffing Slightly, While Increasing Major Enforcement Activities
paragraphs: IRS is requesting $4.8 billion for TLE.  The 2007 budget request proposes  an overall decrease in enforcement FTEs, down over 2 percent to a  proposed 49,479 FTEs from last year’s enacted level of 50,559 FTEs. For  its three main categories of skilled enforcement staff, IRS is proposing a  marginal increase in staffing of 0.2 percent (see fig. 3). For special agents  (those who perform criminal investigations), the increase is 1.7 percent.  For the other two categories—revenue agents (those who examine  complex returns), revenue officers (those who perform field collection  work)—IRS is proposing to keep the number of staff the same as in 2006.
Despite keeping skilled enforcement staff virtually unchanged, IRS is  proposing to maintain or increase its major enforcement activities. For all  the major enforcement activities listed in the budget, IRS is establishing  goals in 2007 that are higher or equal to 2006 planned performance goals.  Major enforcement activities include individual taxpayer examinations,  collection coverage, and criminal investigations completed. IRS officials  anticipate increased revenue collected and other performance  improvements as a result of using data from IRS’s most current  compliance research effort, known as the National Research Program  (NRP).
section_title: Budget Request for IS Funding is Up Slightly, and IRS Has Taken Additional Steps to Improve Budgeting for IS Operations and Maintenance
paragraphs: IRS is requesting about $1.6 billion for IS in fiscal year 2007, which is  intended to fund information technology (IT) staff and related costs for  activities such as information security and maintenance and operations of  its current tax administration systems. Although the number of FTEs  proposed in 2007 is up when enacted FTEs are considered, it is virtually  the same as the operating level currently assumed in 2006 (see app. II for  more details).
In 2002, we reported that the agency did not develop its fiscal year 2003 IS  operations and maintenance budget request in accordance with the  investment management approach used by leading organizations. We  recommended that IRS prepare its future budget requests in accordance  with these best practices. To address our recommendation, IRS agreed to  take a variety of actions, which it has made progress in implementing. For  example, IRS planned to develop a capital planning guide to implement  processes for capital planning and investment control, budget formulation  and execution, business case development, and project prioritization. In  August 2005, IRS issued the initial version of its IT Capital Planning and  Investment Control (CPIC) Process Guide, which (1) provides executives  with the framework within which to select, control, evaluate, and maintain  the portfolio of IT investments to best meet IRS business goals and (2)  defines the governance process that integrates the agency’s IT investments  with the strategic planning, budgeting, and procurement processes.  According to IRS officials and documentation, the agency formulated its  prioritized fiscal year 2007 IT portfolio and associated budget request,  including operations and maintenance requirements, in accordance with  this CPIC Process Guide. We will continue to monitor the implementation  of IRS’s CPIC process as its IT investment management process matures.
In addition, IRS stated that it planned to develop an activity-based cost  module to plan, project, and report costs for business tasks/activities  funded by the IS budget. During fiscal year 2005, as part of the first release  of the Integrated Financial System (IFS), IRS implemented a cost module  that is potentially capable of allocating costs by activity. However, agency  officials stated that they needed to accumulate 3 years of actual costs to  have the historical cost data necessary to provide a basis for meaningful  future budget estimates. Since then, according to the Office of the Chief  Financial Officer, IRS has (1) populated the cost module with all actual  fiscal year 2005 expenses; (2) identified the data needed from IFS to  support its budget requests; and (3) developed a system to capture, test,  and analyze the cost data to devise a standard methodology to provide the  necessary data from the cost module. IRS still expects to have the  requisite 3 years of historical cost data available in time to support  development of the fiscal year 2010 budget request. Although IRS has  made progress in implementing best practices in developing its IS  operations and maintenance budget, until IRS completes the actions  necessary to fully implement the activity–based cost module, the agency  will not be able to ensure that its request is adequately supported.
section_title: IRS’s Proposed BSM Budget Reduction Could Impede Future Progress
paragraphs: BSM is a high-risk, highly complex effort that involves developing and  delivering a new set of information systems that are intended to replace  the agency’s aging tax processing and business systems. The program is  critical to supporting IRS’s taxpayer service and enforcement goals. For  example, BSM includes projects to allow taxpayers to file and retrieve  information electronically and to provide technology solutions to help  reduce the backlog of collections cases. It also helps IRS considerably in  providing the reliable and timely financial management information  needed to account for the nation’s largest revenue stream and better  enable the agency to both determine and justify its resource allocation  decisions and budget requests.
IRS’s fiscal year 2007 budget request of $167.3 million for the BSM  program reflects a reduction of about 15 percent (and even greater when  adjusted for expected inflation), or about $30 million, from the enacted  fiscal year 2006 budget of $197 million.
Over the past year, IRS has made further progress in implementing BSM,  although some key projects did not meet short-term cost and schedule  commitments. During 2005 and the beginning of 2006, IRS deployed  additional releases of several modernized systems that have delivered  benefits to taxpayers and the agency, including CADE, e-Services (a new  Web portal and electronic services for paid tax preparers), and  Modernized e-File (a new electronic filing system). While three BSM  project releases were delivered within the cost and/or schedule  commitments presented in the fiscal year 2005 expenditure plan, others  experienced cost increases or schedule delays. For example, two IFS and  Modernized e-File project release segments experienced cost increases of  93 percent and 29 percent, respectively. As we have previously reported,  the BSM program has had a history of cost increases and schedule delays  that have been due, at least in part, to deficiencies in various management  controls and capabilities that have not yet been fully corrected. IRS is in  the process of implementing our prior recommendations to correct these  deficiencies.
IRS has identified significant risks and issues that confront future planned  system deliveries. For example, according to IRS, schedule delays and  contention for key resources between multiple releases of CADE  necessitated the deferral of some functionality. This deferral, in  conjunction with additional recently reported risks and issues, may  negatively impact the cost, schedule, and functionality for future CADE  releases. The agency recognizes the potential impact of these project risks  and has developed mitigation strategies to address them. We will,  however, continue to monitor the various risks IRS identifies and the  agency’s strategies to address them and will report any concerns.
IRS also has made additional progress in addressing high-priority BSM  program improvement initiatives during the past year, including initiatives  related to shifting the role of systems integrator from the prime contractor  to IRS and establishing requirements management standards—an initiative  on which we recently issued a report to you, Mr. Chairman, and made a  number of recommendations for improvement. IRS’s program  improvement process appears to be an effective means of assessing,  prioritizing, and addressing BSM issues and challenges. However, much  more work remains for the agency to fully address these issues and  challenges.
In addition, in response to our prior recommendation, IRS is developing a  new Modernization Vision and Strategy to address BSM program changes  and provide a modernization roadmap. According to the Associate Chief  Information Officer for BSM, the agency’s new strategy focuses on  promoting investments that provide value in smaller, incremental releases  that are delivered more frequently, with the goal of increasing business  value. IRS is currently finalizing a high-level vision and strategy as well as  a more detailed 5-year plan for the BSM program. We believe these actions  represent sound steps toward addressing our prior recommendation to  fully revisit the vision and strategy and develop a new set of long-term  goals, strategies, and plans consistent with the budgetary outlook and with  IRS’s management capabilities. Further, this strategy is important because  it will describe how and when IRS will receive the full benefits from its  modernization efforts, such as when CADE will be able to replace the  Individual Master File.
While the requested fiscal year 2007 BSM budget will allow IRS to  continue the development and deployment of the CADE, Modernized e- File, and Filing and Payment Compliance (F&PC) projects, the proposed  reduced funding level would likely affect the agency’s ability to deliver the  functionality planned for the fiscal year and could result in project delays  and/or scope reductions. This could, in turn, impact the long-term pace  and cost of modernizing tax systems and of ultimately improving taxpayer  service and strengthening enforcement. For example, according to IRS  documents, the agency had planned to spend $85 million in fiscal year  2007 to develop and deploy additional CADE releases that would enable  the system to process up to 50 million individual tax returns by the 2008  filing season and issue associated refunds faster. However, with a  proposed budget of $58.5 million—over 30 percent less than anticipated— IRS would likely have to scale back its planned near-term work on this  project. In addition, the reductions to the planned budgets for the  Modernized e-File and F&PC projects may also result in IRS having to  redefine the scope and/or reassess schedule commitments for future  project releases.
The proposed BSM budget reduction would also significantly reduce the  amount allotted to program management reserve by about 82 percent  (from $13 million in fiscal year 2006 to $2.3 million in fiscal year 2007). If  BSM projects have future cost overruns that cannot be covered by the  depleted reserve, this reduction could result in increased budget requests  in future years or delays in planned future activities.
While the BSM program still faces challenges, IRS has recently made  progress in delivering benefits and addressing project and program-level  risks and issues. Reducing BSM funds at a time when benefits to taxpayers  and the agency are being delivered could adversely impact the momentum  gained from recent progress and result in delays in the delivery of future  benefits. However, until IRS addresses our prior recommendation by  clearly defining its future goals for the BSM program as well as the impact  of various funding scenarios on meeting these goals in its new  Modernization Vision and Strategy, the long-term impact of the proposed  budget reduction is unclear.
section_title: IRS’s Budget Request Identified Some Savings, but Opportunities Exist for Enhancing Savings
paragraphs: In its 2007 budget request, IRS identified savings as it has done in prior  years and plans to redirect some of those savings to front-line taxpayer  service and enforcement activities. IRS is proposing to save over $121  million and 1,424 FTEs by, for example, automating the process of  providing an individual taxpayer identification number to those taxpayers  ineligible for a Social Security number and improving data collection  techniques and work processes for enforcement activities through  increased financial reporting requirements and scanning and imaging  techniques.
IRS’s history of realizing savings proposed in past budget requests  provides some confidence that the agency will be able to achieve savings  in fiscal year 2007. For example, IRS reported it realized 88 percent of the  anticipated dollar savings and 86 percent of the anticipated staff savings  identified in the fiscal year 2004 budget request. IRS also reported  exceeding the savings targets in the fiscal year 2005 budget request (see  app. III).
In addition to the areas identified by IRS in its budget request, there may  be additional opportunities for efficiency gains.
Increasing electronic filing: In an era of tight budgets, continued  growth in electronic filing may be necessary to help fund future  performance improvements. One proposal for continuing to increase  electronic filing is additional use of electronic filing mandates.  Currently, IRS mandates electronic filing for large corporations. The  2007 budget request proposes a legislative change that would expand  its authority to require electronic filing for businesses. Moreover, 12  states now mandate electronic filing for certain classes of tax preparers  (see app. IV for more information on state mandates). As we have  reported, although there are costs and burdens likely to be associated  with electronic filing mandates for paid tax preparers and taxpayers,  state mandates have generated significant increases in electronic filing.  IRS has an electronic filing strategy, which the agency is updating.
Changing the menu of taxpayer services: IRS currently lacks a  comprehensive strategy explaining how its various taxpayer services  (including its telephone, walk-in, volunteer, and Web site assistance)  will collectively meet taxpayer needs. In response to a Congressional  directive, IRS is developing such a strategy. The strategy is important  because some taxpayers may not be well served by the current service  offerings. IRS’s attempts to reduce some taxpayer services, namely  reducing the hours of telephone operations and closing some walk-in  sites, have met with resistance from the Congress. Although  congressional directives to study the impact of IRS’s actions exist, we  still believe there may be opportunities to adjust IRS’s menu of services  to reduce costs, without affecting IRS’s ability to meet taxpayers’  needs.
Consolidating telephone call sites: IRS operates 25 call sites throughout  the country. Consistent with earlier plans, IRS closed two of its  smallest call sites—Chicago and Houston—in March 2006, to realize  savings in its toll-free telephone operations. Also, IRS has gained  efficiencies from using a centralized call router located in Atlanta. As a  result, there are currently more than 850 workstations that are not  being used; consequently, IRS may have the potential to close several  additional call sites. Consolidations would not affect telephone service  and would be invisible from the taxpayer’s perspective.
subsections: section_title: Accurate Cost Information Would Help IRS Make Resource Allocation Decisions, and Help Provide Some Information about the Return on Investment for its Programs
paragraphs: Managing a federal agency as large and complex as IRS requires managers  to constantly weigh the relative costs and benefits of different approaches  to achieving the goals mandated by the Congress. Management is  constantly called upon to make important long-term strategic as well as  daily operational decisions about how to make the most effective use of  the limited resources at its disposal. As constraints on available resources  increase, these decisions become correspondingly more challenging and  important. In order to rise to this challenge, management needs to have  current and accurate information upon which to base its decisions, and to  enable it to monitor the effectiveness of actions taken over time so that  appropriate adjustments can be made as conditions change.
In its ongoing effort to make such increasingly difficult resource allocation  decisions and defend those decisions before the Congress, IRS has long  been hampered by a lack of current and accurate information concerning  the costs of the various options being considered. Instead, management  often has relied on a combination of the limited existing cost information;  the results of special analysis initiated to establish the full cost of a  specific, narrowly defined task or item; and estimates based on the best  judgment of experienced staff. This has impaired IRS’s ability to properly  decide which, if any, of the options at hand are worth the cost relative to  the expected benefits. For example, accurate and timely cost information  may help IRS consider changes in the menu of taxpayer services that it  provides by identifying and assessing the relative costs, benefits, and risks  of specific projects. Without reliable cost information, IRS’s ability to  make such difficult choices in an informed manner is seriously impaired  and IRS cannot prepare cost-based performance measures to assist in  measuring the effectiveness of its programs over time.
Further, IRS does not have the capability to develop reliable information  on the return on investment for each category of taxpayer service and  enforcement. IRS lacks reliable information on both the return from  services (the additional revenue collected by helping taxpayers  understand their tax obligations) and the investment or cost of the  services. While developing return on investment information is difficult,  the cost component of that equation may be the least complex to develop.  Having such cost information is a building block for developing return on  investment estimates. For its enforcement programs, IRS has developed a  rough measure of return on investment in terms of tax revenue that is  directly assessed from uncovering noncompliance. Continuing to develop  return on investment measures could help officials make more informed  decisions about allocating resources. Even without return on investment  information, cost information can help IRS determine if, for example, IRS  should change the menu of services provided.
As discussed in the BSM section, in fiscal year 2005, IRS implemented a  cost accounting module as part of IFS. However, while this module has  much potential and has begun accumulating cost information, IRS has not  yet determined what the full range of its cost information needs are or  how best to tailor the capabilities of this module to serve those needs.  Also, IRS does not have an integrated workload management system  which would provide the cost module with detailed allocation of  personnel cost information. In addition, as noted in developing its IS  budget, because it generally takes several years of historical cost  information to support meaningful estimates and projections, IRS cannot  yet rely on IFS as a significant planning tool. It will likely require several  years, implementation of additional components of IFS, and integration of  IFS with IRS’s tax administration activities before the full potential of  IFS’s cost accounting module will be realized. Furthermore, IRS’s fiscal  year 2007 BSM budget request does not include funding for additional  releases of IFS. In the interim, IRS decision making will continue to be  hampered by inadequate underlying cost information.
section_title: IRS Sets Long-Term Goals, but Lacks a Data-Based Plan for Achieving the Goals, and Addressing the Tax Gap Requires Solutions Beyond Funding and Staffing for IRS
paragraphs: For the first time, IRS’s budget request sets long-term goals aimed at  reducing the tax gap, although IRS does not have a data-based plan for  achieving the goals. However, because of its persistence, reducing the tax  gap requires solutions which go beyond funding and staffing for IRS.
subsections: section_title: IRS’s Budget Proposes Long-Term Goals, but Lacks a Data-Based Plan for Achieving Them
paragraphs: IRS established two agencywide, long-term performance goals, as shown  in table 3. IRS plans to improve voluntary compliance from 83 percent in  2005 to 85 percent by 2009, and reduce the number of taxpayers who think  it is acceptable to cheat on their taxes from 10 percent in 2005 to less than  9 percent in 2010. According to IRS, these are the first in a series of  quantitative goals that will link to its three strategic goals—improve  taxpayer service, enhance tax law enforcement, and modernize IRS  through technology and processes.
These goals will be challenging to meet, because for three decades, IRS  has consistently reported a persistent, relatively stable tax gap. Although  IRS has made a number of changes in its methodologies for measuring the  tax gap, which makes comparisons difficult, regardless of methodology  used, the voluntary compliance rate that underpins the gap has tended to  range from around 81 percent to around 84 percent.
Because of a lack of quantitative estimates of how changes to its service  and enforcement programs affect compliance, IRS is unable to show in a  data-based plan how it will use those programs to reach the two long-term  goals shown in table 3. If IRS could quantify the impact of its service and  enforcement programs on the compliance rate or attitudes towards  cheating, it could use the information to show the kinds of changes to the  programs needed to achieve the long-term goals and how best to direct  resources towards achieving those goals. Unfortunately, quantifying the  impact of IRS’s service and enforcement programs on compliance or  cheating is very challenging. The type of data needed to make such a link  does not currently exist, and may not be easy to collect.
Lacking such quantitative estimates, IRS must take a more qualitative  approach in its plans for increasing compliance, which would likely also  involve changing attitudes towards cheating. IRS’s overall approach to  reducing the tax gap consists of improving service to taxpayers and  enhancing enforcement of the tax laws. We recently reported that IRS has  taken a number of steps that may improve its ability to reduce the tax  gap. Favorable trends in staffing of IRS enforcement personnel;  examinations performed through correspondence, as opposed to more  complex face-to-face examinations; and the use of some enforcement  sanctions such as liens and levies are encouraging. Also, IRS has made  progress with respect to abusive tax shelters through a number of  initiatives and recent settlement offers that have resulted in billions of  dollars in collected taxes, interest, and penalties. Finally, IRS has  continually improved taxpayer service by increasing, for example, the  accuracy of responses to tax law questions.
The effect of this overall approach and the 2007 budget proposal will have  on voluntary compliance has not been quantified by IRS. Therefore, the  Congress will have to rely on the IRS Commissioner for qualitative  explanations, of why, in his judgment, IRS’s mix of taxpayer service and  enforcement and overall approach for reducing the tax gap, including the  2007 budget proposal, will be sufficient to start IRS on a path towards  achieving its long-term goals. More specifically, such explanations could  include a clear statement of which service and enforcement programs  have priorities for expansion because they are expected to contribute the  most to increasing the compliance rate and the evidence that supports that  judgment.
In addition, IRS lacks a plan for measuring progress towards one goal— improving voluntary compliance. IRS plans to measure progress towards  the second goal—reducing the percentage of taxpayers who think it is  acceptable to cheat—via the IRS Oversight Board’s annual Taxpayer  Attitude Survey.
Nevertheless, IRS recently estimated voluntary compliance as part of the  NRP study, which reviewed the compliance of a random sample of  individual taxpayers and used those results to estimate compliance for the  population of all taxpayers. The study took several years to plan and  execute. In addition to providing an estimate of the compliance rate, the  study’s results will be used to better target IRS’s audits of potentially non- compliant taxpayers. Better targeting reduces the burden on taxpayers  because IRS is better able to avoid auditing compliant taxpayers.
At this time, however, IRS has not made plans to repeat the study in time  to measure compliance by 2009. Furthermore, doing compliance studies  once every few years does not give IRS or others information about what  is happening in the intervening years. Annual estimating of the compliance  rate could provide information that would enable IRS management to  adjust plans as necessary to help achieve the goal in 2009. One option that  would not increase the cost of estimating compliance would be to use a  rolling sample. IRS Oversight Board officials and we agree that instead of  sampling, for example, once every 5 years, one-fifth of the sample could be  collected every year. The total sample could include 5 years worth of  data—with each passing year the oldest year would be dropped from the  sample and the latest year added. The availability of current research data  would allow IRS to more effectively focus its service and compliance  efforts.
section_title: Addressing the Tax Gap Requires Solutions Beyond Funding and Staffing for IRS
paragraphs: For years, we have reported that tax law enforcement is a high-risk area,  in part because of the size of the gross estimated tax gap, which IRS most  recently estimated to be $345 billion for tax year 2001. IRS estimated it  would recover around $55 billion through late payments and enforcement  revenue, resulting in a net tax gap of around $290 billion. Reducing the  tax gap would yield significant revenue and even modest progress, such as  a 1 percent reduction, would likely yield nearly $3 billion annually. In  recent years, IRS reported increases in enforcement revenue—revenue  brought in as a result of IRS taking enforcement action. Between fiscal  years 2003 and 2005, IRS reported that enforcement revenue grew from  $37.6 billion to $47.3 billion, with a level of $48.1 billion estimated for 2006.  However, the voluntary compliance rate has persisted at a relatively stable  level.
Further, GAO recently reported that tax returns prepared by paid tax  preparers often contained errors such as unwarranted extra refunds and  underreported income. These findings are consistent with NRP data which  indicate that tax returns prepared by paid preparers contained a  significant level of errors.  These errors, whether they are the fault of the  preparer or the result of taxpayers providing incomplete or inaccurate  information, contribute to the tax gap.
We have reported that significant reductions in the tax gap will likely  require exploring new and innovative solutions. Such solutions that may  not require significant additional IRS resources, but are nonetheless  difficult to achieve, include    simplifying the tax code to make it easier for individuals and  businesses to understand and comply with their tax obligations; increasing tax withholding for income currently not subject to  withholding; improving information reporting; and leveraging technology to improve IRS’s capacity to receive and process  tax returns.
IRS’s 2007 budget request includes five new legislative proposals to  address some of these solutions to reduce the tax gap, along with a  proposal to study independent contractor compliance that would not  require additional resources. In recent testimony, the IRS Commissioner  stated that the amount of enforcement revenue IRS expects from the  legislative proposals will be $3.6 billion over the next 10 years (about 0.1  percent of the tax gap). However, the proposals should also increase  revenue voluntarily paid without any IRS enforcement actions. The  amount of that revenue is uncertain. The IRS Commissioner recognizes the  implications of the tax gap and states in the budget that addressing it is a  top priority. Although IRS’s 2007 budget request does not propose  allocating IRS resources to new initiatives to reduce the tax gap, according  to IRS officials, they plan to continue initiatives identified in prior budgets.  For example, IRS has two ongoing BSM projects—F&PC and Modernized  e-File—which, according to IRS’s Associate Chief Information Officer for  BSM, could help reduce the tax gap. F&PC is expected to increase IRS’s  capacity to resolve the growing backlog of delinquent taxpayer cases and  increase collections, while Modernized e-File is expected to help make it  easier for IRS to process tax returns, look for irregularities, and track  down unpaid taxes.
The budget request states that the administration will study the standards  used to distinguish between employees and independent contractors for  purposes of paying and withholding income taxes. We have long supported  efforts aimed at improving independent contractor compliance. Past IRS  data have shown that independent contractors report 97 percent of the  income that is reported on information returns to IRS, while contractors  that do not receive these information returns report only 83 percent of  income. We have also identified other options for improving information  reporting by independent contractors, including increasing penalties for  failing to file required information returns, lowering the $600 threshold for  requiring such returns, and requiring businesses to separately report on  their tax returns the total amount of payments to independent  contractors. We previously reported that clarifying the definition of  independent contractors and extending reporting requirements for those  contractors could possibly increase tax revenue by billions of dollars.
Two of the legislative proposals call for more information reporting on  payment card transactions from certain businesses and on payments by  federal, state, and local governments to businesses. Information reporting  has been shown to significantly reduce noncompliance. Although  information reporting is highly effective in encouraging compliance, such  reporting imposes costs and burdens on the businesses that implement it.  However, information reporting is a way to significantly increase  voluntary compliance without increasing IRS’s budget.
Mr. Chairman, this completes my prepared statement. I would be happy to  respond to any questions you or other members of the subcommittee my  have at this time.
section_title: Contacts and Acknowledgments
paragraphs: For further information regarding this testimony, please contact James R.  White, Director, Strategic Issues, on 202-512-9110 or whitej@gao.gov.or  David A. Powner, Director, Information Technology Management Issues,  on 202-512-9296 or pownerd@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this statement. Individuals making key contributions to this testimony  include Joanna Stamatiades, Assistant Director; Amanda Arhontas; Paula  Braun; Terry Draver; Paul Foderaro; Chuck Fox; Tim Hopkins; Kathryn  Horan; Hillary Loeffler; Sabine Paul; Cheryl Peterson; Neil Pinney; Steve  Sebastian; Tina Younger.
section_title: Appendix I: Differences Between the 2002 and 2005 Free File Agreements
paragraphs: In 2002, Internal Revenue Service (IRS) entered into a 3-year agreement  with the Free File Alliance, a consortium of 20 tax preparation companies  to provide free electronic filing to taxpayers who access any of the  companies via a link on IRS’s Web site. The 2002 Free File Agreement  stated that as part of the agreement, IRS would not compete with the  Consortium in providing free, online tax return preparation and filing  services to taxpayers.
IRS and the Consortium amended the agreement in 2005. Key differences  between the two agreements are: the new income limitation of $50,000 and  new language in the amendment that states the Alliance members must  disclose early on if state tax return services are available, and if so,  whether a fee will be charged for such services; and provide the necessary  support to accomplish a customer satisfaction survey. It also added  language pertaining to the marketing and offering of Refund Anticipation  Loans (RALs) whereby:    No offer of free return preparation and filing of an electronic return in  the free file program shall be conditioned on the purchase of a RAL;  and    RALs will be offered with clear language indicating, for example, that  RALs are loans, not a faster way of receiving an IRS refund; must be  repaid even if the IRS does not issue a full refund; are short-term loans  interest rates may be higher and customers may wish to consider using  other forms of credit; and may be offered but not promoted.
IRS tests each Consortium member’s software to ensure it is in  accordance with the Free File provisions, including those cited previously,  before allowing a link to IRS’s Web site. In addition, IRS officials monitor  complaints about the Free File program received via IRS.gov, including  allegations regarding false, deceptive, or misleading information or  advertising. While IRS does not track the number of complaints it receives,  according to IRS officials, most of the complaints received thus far were a  result of the taxpayer either not carefully reading or following  instructions, or incorrectly entering information. GAO conducted limited  testing of the Free File program and found that the Consortium members  were complying with the terms outlined in the amended Free File  agreement pertaining to RALs.
The amended Free File agreement contains provisions that enable IRS to  monitor taxpayer participation beginning in the 2006 filing season, unlike  prior years where Free File Alliance members self-reported filing figures.  IRS also tracks the number of free file users who are accepting any  financial products, such as RALs. As of April 17, IRS reported that 207,814  free file returns accepted financial products. This represents about 5  percent of all returns filed through the Free File program.
The number of taxpayers using free file to electronically file their  individual income tax returns has increased steadily from 2.8 million in  2003, to 3.5 million in 2004, to 5.1 million in 2005. The substantial growth  between 2004 and 2005 was due to, in part, several Consortium members  offering free filing to all taxpayers through the free file program regardless  of their income in 2005. However, according to IRS officials, the lack of  income limitation created conflict among Consortium members as it put  pressure on all Alliance members to offer free service, which may not have  been economically feasible for some, threatening competition if members  were to drop out of the Alliance.
IRS projected that 6.1 million taxpayers would use free file in 2006.  However, this projection may be optimistic, because between January 1  and April 13, IRS has reported receiving only 3.5 million free file returns  compared to 4.6 million during the same period last year, a decline of 24  percent. According to IRS officials, contributing factors to this decline are,  in part, due to decreased press attention and advertising by the  participating companies and the income limitation. The income limitation  provides coverage to 70 percent of the nation’s taxpayers, or more than 92  million people. This coverage includes taxpayers with an adjusted gross  income of $50,000 or less.
section_title: Appendix II: Comparison of IRS’s Actual and Enacted Funding and Full-Time Equivalents, Fiscal Years 2002 through 2007
paragraphs: For fiscal year 2007, the Internal Revenue Service (IRS) has requested  $10.7 billion in its appropriation accounts. This request consists of $10.6  billion in direct appropriations and $135 million in revenue from new user  fees, which IRS will commit to taxpayer service activities in its Processing,  Assistance, and Management (PAM), Tax Law Enforcement (TLE), and  Information System (IS) accounts. In addition, IRS is projecting to collect  and use $282 million from existing user fees and reimbursable agreements  with states and other federal agencies. This brings IRS’s proposed fiscal  year 2007 budget to approximately $11 billion (a 1.6 percent increase over  fiscal year 2006). After adjusting for expected inflation, IRS’s $11 billion  budget request reflects a slight decrease from last year’s enacted budget.
IRS’s enacted budgets for its appropriation accounts from fiscal years 2002  through 2007 are shown in table 4. IRS’s enacted budget has increased  almost 8 percent since fiscal year 2002. By far, the biggest percentage  increase has been in TLE—almost 21 percent—and is reflective of the shift  in resources devoted to TLE from PAM during this period. The biggest  percentage decrease was in the Business Systems Modernization (BSM)  program, down almost 58 percent.
Tables 5 and 6 show IRS’s enacted and actual Full-time Equivalents (FTEs)  for fiscal years 2002 through 2007. Overall, actual FTEs tend to be lower  than enacted FTEs due in part to the way IRS funds its unbudgeted costs.  When both enacted and actual FTEs are considered, FTEs for PAM have  steadily decreased and, for the most part, FTEs for TLE have increased  since fiscal year 2002. However, steady trends are not apparent when  comparing enacted and actual FTEs in IRS’s IS account. For example,  when enacted FTEs are considered, IS staffing appears to fluctuate up and  down between fiscal years 2002 through 2007; yet, when actual FTEs are  considered, IS staffing decreased from fiscal year 2002 through 2005 and  increased from fiscal years 2005 to 2006. IRS officials attribute these  fluctuations in FTEs to reorganizations and other factors.
Tables 5 and 6 also show significant differences in percentage changes  between enacted and actual FTEs in some of IRS’s appropriations  accounts from fiscal years 2006 to 2007. The enacted level of FTEs is the  number IRS projected it could support given the level of funding the  Congress enacted. According to IRS officials, enacted levels tend to be  overstated compared to actual FTEs for several reasons. First, IRS, like  most federal agencies, does not receive its budgets when expected and  cannot fill all positions. Also, as the costs of maintaining current FTE  levels increase annually, IRS is not able to realize all of the FTEs it  projects to fund with the appropriations the Congress enacts.
In its fiscal year 2006 budget request, IRS showed its budget distributed by  taxpayer services and enforcement, including IS funding for those areas,  because the agency’s current appropriation accounts are not divided  clearly between taxpayer service and enforcement. As table 7 shows,  funding for enforcement increased 15 percent between fiscal years 2004  and 2007 to $6.96 billion, while funding for taxpayer service declined over  3 percent to almost $3.6 billion.
section_title: Appendix III: IRS’s Estimated and Actual Savings and Reinvestments
paragraphs: In its 2007 budget request, the Internal Revenue Service (IRS) is proposing  to save over $121 million and 1,424 Full-time Equivalents (FTEs) and  reinvest over $12 million and 11 FTEs. Based on IRS’s ability to achieve  prior year savings and reinvestments as shown in table 8, we have a basis  to believe that IRS will achieve most, if not all, of these savings. For  example, IRS reported it realized 88 percent of its anticipated budget  savings and 86 percent of its anticipated staff savings for savings identified  in its fiscal year 2004 budget request, and IRS reported exceeding savings  targets in fiscal year 2005.
section_title: Appendix IV: State Mandates
paragraphs: Of the 50 states, 12 have electronic filing mandates for tax preparers in  effect for the 2006 filing season (see fig. 4). The mandates differ in their  implementation dates and schedules, thresholds for filing, and penalties.  The differences between mandates may affect the magnitude of electronic  filing increases in each state.
We recently reported that state mandates encourage electronic filing of  federal tax returns and recommended that IRS develop better information  about the costs to paid tax preparers and taxpayers of mandatory  electronic filing of tax returns for certain categories of tax preparers.
These mandates require tax practitioners who meet certain criteria, such  as filing 100 individual state tax returns or more, to file individual state  returns electronically.
Between tax years 2001 and 2004, electronic filing had grown in the 9  states with mandates from an average of 36.7 percent to 56.8 percent, or an  increase of over 20 percentage points, compared to an increase of 14  percentage points for the 41 non mandated states over the same time  period. We expect this trend to continue as 3 additional states—New York,  Utah and Connecticut—implemented mandates in time for the 2006 filing  season. Of these 3 states, New York may have the most to gain because it  currently has the lowest rate of electronic filing rate, with fewer than 38  percent of its nearly 9 million federal individual income tax returns  electronically filed last year.
section_title: Appendix V: Bibliography of GAO Resources
subsections: section_title: Filing Season Performance:
paragraphs: Tax Administration: IRS Improved Some Filing Season Services, but  Long-Term Goals Would Help Manage Strategic Trade-offs, GAO-06-51  Washington, D.C.: November 14, 2005.
Tax Administration: IRS Improved Performance in the 2004 Filing  Season, but Better Data on the Quality of Some Services Are Needed,  GAO-05-67 Washington, D.C.: November 10, 2004.
Tax Administration: IRS’s 2003 Filing Season Performance Showed  Improvements, GAO-04-84 Washington, D.C.: October 31, 2003.
IRS’s 2002 Tax Filing Season: Returns and Refunds Processed Smoothly;  Quality of Assistance Improved, GAO-03-314 Washington, D.C.: December  20, 2002.
section_title: IRS’s Budget Requests:
paragraphs: Internal Revenue Service: Assessment of Fiscal Year 2006 Budget  Request, GAO-05-566 Washington, D.C.: April 27, 2005.
Internal Revenue Service: Assessment of Fiscal Year 2006 Budget  Request and Interim Results of the 2005 Filing Season, GAO-05-416T  Washington, D.C.: April 14, 2005.
Internal Revenue Service: Assessment of Fiscal Year 2005 Budget  Request and 2004 Filing Season Performance, GAO-04-560T Washington,  D.C.: March 30, 2004.
section_title: Tax Gap and Compliance:
paragraphs: Tax Gap: Making Significant Progress in Improving Tax Compliance  Rests on Enhancing Current IRS Techniques and Adopting New  Legislative Actions, GAO-06-453T Washington, D.C.: February 15, 2006.
Tax Gap: Multiple Strategies, Better Compliance Data, and Long-Term  Goals Are Needed to Improve Taxpayer Compliance, GAO-06-208T  Washington, D.C.: October 26, 2005.
Tax Compliance: Reducing the Tax Gap Can Contribute to Fiscal  Sustainability but Will Require a Variety of Strategies, GAO-05-527T  Washington, D.C.: April 14, 2005.
Taxpayer Information: Data Sharing and Analysis May Enhance Tax  Compliance and Improve Immigration Eligibility Decisions, GAO-04- 972T Washington, D.C.: July 21, 2004.
Compliance and Collection: Challenges for IRS in Reversing Trends and  Implementing New Initiatives, GAO-03-732T Washington, D.C.: May 7,  2003.
section_title: Financial Statement Audits:
paragraphs: Financial Audit: IRS’s Fiscal Years 2005 and 2004 Financial  Statements, GAO-06-137 Washington, D.C.: November 10, 2005.
Internal Revenue Service: Status of Recommendations from Financial  Audits and Related Financial Management Reports, GAO-05-393  Washington, D.C.: April 29, 2005.
Financial Audit: IRS’s Fiscal Years 2004 and 2003 Financial  Statements, GAO-05-103 Washington, D.C.: November 10, 2004.
Internal Revenue Service: Status of Recommendations from Financial  Audits and Related Financial Management Reports, GAO-04-523  Washington, D.C.: April 28, 2004.
Financial Audit: IRS’s Fiscal Years 2003 and 2002 Financial  Statements, GAO-04-126 Washington, D.C.: November 13, 2003.
section_title: Business Systems Modernization:
paragraphs: Business Systems Modernization: IRS Needs to Complete Recent Efforts  to Develop Policies and Procedures to Guide Requirements Development  and Management, GAO-06-310 Washington, D.C.: March 20, 2006.
Business Systems Modernization: Internal Revenue Service’s Fiscal Year  2006 Expenditure Plan, GAO-06-360 Washington, D.C.: February 21, 2006.
Business Systems Modernization: Internal Revenue Service’s Fiscal Year  2005 Expenditure Plan, GAO-05-774 Washington, D.C.: July 22, 2005.
IRS Modernization: Continued Progress Requires Addressing Resource  Management Challenges, GAO-05-707T Washington, D.C.: May 19, 2005.
Business Systems Modernization: IRS’s Fiscal Year 2004 Expenditure  Plan, GAO-05-46 Washington, D.C.: November 17, 2004.
Business Systems Modernization: Internal Revenue Service Needs to  Further Strengthen Program Management, GAO-04-438T Washington,  D.C.: February 12, 2004.
IRS Modernization: Continued Progress Necessary for Improving  Service to Taxpayers and Ensuring Compliance, GAO-03-796T  Washington, D.C.: May 20, 2003.
section_title: Other:
paragraphs: Paid Tax Return Preparers: In a Limited Study, Chain Preparers Made  Serious Errors, GAO-06-563T Washington, D.C.: April 4, 2006.
Tax Administration: IRS Can Improve Its Productivity Measures by  Using Alternative Methods, GAO-05-671 Washington, D.C.: July 7, 2005.  21st Century Challenges: Reexamining the Base of the Federal  Government, GAO-05-325SP Washington, D.C.: February 2005.
High Risk Series: An Update, GAO-05-207 Washington, D.C.: January 21,  2005.
Internal Revenue Service: Challenges Remain in Combating Abusive Tax  Schemes, GAO-04-50 Washington, D.C.: November 19, 2003.
Tax Administration: IRS Is Implementing the National Research  Program as Planned, GAO-03-614 Washington, D.C.: June 16, 2003.
Tax Administration: IRS Needs to Further Refine Its Tax Filing Season  Performance Measures, GAO-03-143 Washington, D.C.: November 22,  2002.
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