Internal Revenue Service: Opportunities to Improve the Taxpayer Experience and Voluntary Compliance
Published: 2012-04-26T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The U.S. tax system depends on taxpayers calculating their tax liability, filing their tax return, and paying what they owe on timewhat is often referred to as voluntary compliance. Voluntary compliance depends on a number of factors, including the quality of IRSs assistance to taxpayers, knowledge that its enforcement programs are effective, and a belief that the tax system is fair and other people are paying their share of taxes. Voluntary compliance is also influenced by other parties, including paid tax return preparers, tax software companies, and information return filers (employers, financial institutions, and others who report income or expense information about taxpayers to IRS). For this testimony, GAO was asked to (1) evaluate the current state of IRSs performance and its effect on the taxpayer experience, and (2) identify opportunities to improve the taxpayer experience and voluntary compliance. This testimony is based on prior GAO reports and recommendations. Additionally, GAO analyzed IRS data in delivering selected taxpayer services in recent years.
section_title: What GAO Found
paragraphs: The Internal Revenue Service (IRS) has made improvements in processing tax returns, and electronic filing (e-filing), which provides benefits to taxpayers including faster refunds, continues to increase. However, IRSs performance in providing service over the phone and responding to paper correspondence has declined in recent years. For 2012, as with previous years, IRS officials attribute the lower performance to other funding priorities.
The following are among the opportunities to improve the taxpayer experience and increase voluntary compliance that GAO identifies in this testimony:
IRS can provide more self-service tools to give taxpayers better access to information. IRS can create an automated telephone line for amended returns (a source of high call volume) and complete an online services strategy that provides justification for adding new self-service tools online.
Better leveraging of third parties could provide taxpayers with other avenues to receive service. Paid preparers and tax software providers combine to prepare about 90 percent of tax returns. IRS is making progress implementing new regulation of paid preparers. As it develops better data, IRS should be able to test strategies for improving the quality of tax return preparation by paid preparers. Similarly, IRS may also be able to leverage tax software companies.
Expanded information reporting could reduce taxpayer burden and improve accuracy. Expanded information reporting, such as the recent requirements for banks and others to report businesses credit card receipts to IRS, can reduce taxpayers record keeping and give IRS another tool.
Implementing modernized systems should provide faster refunds and account updates. Modernized systems should allow IRS to conduct more accurate and faster compliance checks, which benefits taxpayers by detecting errors before interest and penalties accrue.
Expanding pre-refund compliance checks could result in more efficient error correction. Expanding such checks could reduce the burden of audits on taxpayers and their costs to IRS.
Reducing tax complexity could ease taxpayer burden and make it easier to comply. Simplifying the tax code could reduce unintentional errors and make intentional tax evasion easier to detect.
section_title: What GAO Recommends
paragraphs: GAO has made numerous prior recommendations that could help improve the taxpayer experience. Congress and IRS have acted on some recommendations, while others are reflected in the strategies presented in this testimony.

section_title: Letter
paragraphs: Thank you for the invitation to be here today to discuss how to improve  the taxpayer experience.
The U.S. tax system depends on taxpayers calculating their tax liability,  filing their tax return, and paying what they owe on time. The taxpayer  experience is at its best when taxpayers are able to fulfill these  responsibilities independently without intervention from the Internal  Revenue Service (IRS). This is often referred to as voluntary compliance.  Some of the obvious influences on taxpayers’ willingness and ability to  voluntarily comply include the quality of IRS’s service to taxpayers,  knowledge that IRS’s compliance checks and collection programs are  effective, and the belief that the tax system is fair and that others are  paying their share of taxes. Perhaps less obvious is the role of third  parties, including paid tax return preparers, tax software companies, and  information return filers (employers, financial institutions, and others who  report income or expense information about taxpayers to IRS) in  influencing voluntary compliance.
The taxpayer experience also depends on how IRS deals with taxpayers  who fail to voluntarily comply by helping taxpayers correct unintentional  errors, and identifying and pursuing taxpayers who intentionally try to  evade taxes.
Maximizing voluntary compliance is especially important today given the  nation’s large structural budget deficits and the size of the tax gap. Earlier  this year, IRS estimated the gross tax gap—the difference between taxes  owed and taxes paid on time—at $450 billion for tax year 2006. IRS  estimated that it would eventually collect $65 billion of this through  enforcement actions and late payments, leaving a net tax gap of $385  billion.
My statement today focuses on two areas: (1) evaluating the current state  of IRS’s performance and its effect on the taxpayer experience, and (2)  identifying opportunities to improve the taxpayer experience and voluntary  compliance. To address these objectives, we reviewed and summarized  prior GAO reports and recommendations. Additionally, we obtained and  analyzed IRS data in delivering selected taxpayer services in recent  years. We discussed newly reported information in this statement with  IRS officials. Additional information on the scope and methodology of  underlying work is available in published products, referenced throughout  this statement. We conducted our work in April 2012 in accordance with  generally accepted government auditing standards. Those standards  require that we plan and perform the audit to obtain sufficient, appropriate  evidence to provide a reasonable basis for our findings and conclusions  based on our audit objectives. We believe that the evidence obtained  provides a reasonable basis for our findings and conclusions based on  our audit objectives.
subsections: section_title: Taxpayers Have Benefitted from Improved Processing, but IRS’s Service to Taxpayers Has Declined
paragraphs: Taxpayers’ experience depends heavily on IRS’s performance during the  tax filing season, roughly mid-January through mid-April. During this  period, millions of taxpayers who are trying to fulfill their tax obligations  contact IRS over the phone, face-to-face, and via the Internet to obtain  answers to tax law questions and information about their tax accounts.  This period is also when IRS processes the bulk of the approximate 140  million returns it will receive, runs initial compliance screens, and issues  over 100 million refunds. In recent years, IRS has improved its returns  processing but has seen its taxpayer service performance deteriorate.
subsections: section_title: Increased Electronic Filing Contributes to Greater Return Accuracy and Faster Processing
paragraphs: For years we have reported that electronic filing (e-filing) has many  benefits for taxpayers, such as higher accuracy rates and faster refunds  compared to filing on paper. So far in 2012, the percentage of e-filed  returns has increased by 1.9 percentage points to 88.8 percent since  about the same time last year (a 2.2 percent increase), as table 1 shows.  Since the same time in 2007, the percentage of e-filed returns has  increased from 72.3 percent to 88.8 percent. This year, IRS may meet its  long-held goal of having 80 percent of individual tax returns e-filed.  However, the overall e-file percentage is likely to decline as the tax filing  season ends since IRS typically receives more returns filed on paper later  in the filing season. In addition, IRS is in the midst of a multi-phase  modernization project, known to as the Customer Account Data Engine  (CADE) 2, which will fundamentally change how it processes returns.  With CADE 2, IRS also expects to be able to issue refunds in 4 business  days for direct deposit and 6 business days for paper checks after IRS  processes the return and posts the return data to the taxpayer’s account.
Early in the 2012 filing season, IRS experienced two processing problems  that delayed refunds to millions of taxpayers, and reported the problems  had been resolved by mid-February. We summarized these problems in  an interim report on the 2012 filing season.
section_title: Taxpayer Service Has Declined
paragraphs: Providing good taxpayer service is important because, without it,  taxpayers may not be able to obtain necessary and accurate information  they need to comply with tax laws. In addition, more and more, taxpayers  are relying on IRS’s website to obtain information and execute  transactions, making it important that IRS have a modern website.  However, as we have reported, IRS has experienced declines in  performance in selected taxpayer service areas, most notably with  respect to providing live telephone assistance and timely responses to  taxpayers’ correspondence.from IRS to paper correspondence or have access to information online,  they call IRS, correspond again, or seek face-to-face assistance—all of  which are costly to IRS and burdensome to the taxpayer. Table 2 shows  the declines in telephone service and paper correspondence and the  goals for 2012 and 2013. Additional performance data is shown in  appendix I.
section_title: Opportunities Exist to Improve the Taxpayer Experience and Voluntary Compliance
paragraphs: To improve the taxpayer experience and voluntary compliance, IRS has a  range of options. Some of its options could provide taxpayers with better  information to accurately fulfill their tax obligations. Other options would  allow IRS to take enforcement actions sooner and with less burden on  taxpayers. Simplifying the tax code could reduce unintentional errors and  make intentional tax evasion harder.
subsections: section_title: IRS Can Provide More Self- Service Tools to Give Taxpayers Better Access to Information
paragraphs: GAO-12-176. develop an online locator tool listing volunteer tax preparation sites—  and IRS introduced an enhanced volunteer site locator tool in 2012;complete an Internet strategy that provides a justification for online  self-service tools as IRS expands its capacity to introduce such tools.
In addition to actions we recommended, IRS is also studying ways to  better communicate with taxpayers and determine which self-service tools  would be the most beneficial to taxpayers. According to IRS officials, the  study should be completed later this year. Identifying more efficient ways  to provide service also benefits IRS because it is able to make better use  of scarce resources.
section_title: Better Leveraging of Third Parties Could Provide Taxpayers With Other Avenues to Receive Service
subsections: section_title: Paid Preparer Regulations
paragraphs: GAO-12-176. most effective for improving the quality of tax returns prepared by different  types of paid preparers. Likewise, IRS has discussed how to measure the  effect of the requirements such as requiring continuing education and  testing on tax return accuracy. It will take years to implement the  approach as it will likely evolve over time and become more detailed.
Tax preparation software is another critical part of tax administration.  Almost 30 percent of taxpayers use such software to prepare their returns  and, in the process, understand their tax obligations, learn about tax law  changes, and get questions answered. Many also electronically file  through their software provider. Consequently, tax software companies  are another important intermediary between taxpayers and IRS. We have  reported that IRS has made considerable progress in working with tax  software companies to provide, for example, clearer information about  why an e-filed return was not accepted, require additional information on  returns to allow for IRS to better identify the software used, and enhance  security requirements for e-filing. To illustrate the potential for  leveraging tax software companies to improve taxpayer compliance, 4  years ago we recommended and IRS agreed to expand outreach efforts  to external stakeholders and include software companies as part of an  effort to reduce common types of misreporting related to rental real  estate. In another report, we discussed the value of research to better  understand how tax software influences compliance.
IRS has volunteer partners, often nonprofit organizations or universities,  that staff over 12,000 volunteer sites. Volunteers at these sites prepare  several million tax returns for traditionally underserved taxpayers,  including the elderly, low-income, disabled, and those with limited English  proficiency. In recent reports we have made recommendations about  estimating of the effectiveness of targeting underserved populations at  such sites and making it easier for taxpayers to find the locations of  nearby sites.to work with these volunteer partners to help improve assistance to  taxpayers with the goal of improving compliance.
section_title: Expanded Information Reporting Could Reduce Taxpayer Burden and Improve Accuracy
paragraphs: Information reporting is a proven tool that reduces tax evasion, reduces  taxpayer burden, and helps taxpayers voluntarily comply. This is, in part,  because taxpayers have more accurate information to complete their  returns and do not have to keep records themselves. In addition, IRS  research shows that when taxpayers know that IRS is receiving data from  third parties, they are more likely to correctly report the income or  expenses to IRS. As part of its recent update of its tax gap estimates, IRS  estimated that income subject to substantial information reporting, such  as pension, dividend, interest, unemployment, and Social Security  income, was misreported at an 8 percent rate compared to a 56 percent  misreporting rate for income with little or no information reporting, such as  sole proprietor, rent, and royalty income.
GAO, Tax Administration: Costs and Uses of Third-Party Information Returns,  GAO-08-266 (Washington, D.C.: Nov. 20, 2007). have not entered into an agreement with IRS to report details on U.S.  account holders to IRS.
As these three sets of information reporting requirements have only  recently taken effect, it is too soon to tell the impact they are having on  taxpayer compliance.
We have made recommendations or suggested possible legislative  changes in several other areas in which IRS could benefit from additional  information reporting. They include the following:
Service payments made by landlords. Taxpayers who rent out real  estate are required to report to IRS expense payments for certain  services, such as payments for property repairs, only if their rental  activity is considered a trade or business. However, the law does not  clearly spell out how to determine when rental real estate activity is  considered a trade or business.
Service payments to corporations. Currently, businesses must report  to IRS payments for services they make to unincorporated persons or  businesses, but payments to corporations generally do not have to be  reported.
Broader requirements for these two forms of information reporting,  covering goods in addition to services, were enacted into law in 2010, but  later repealed. We believe the more narrow extensions of information  reporting to include services, but not goods, remain important options for  improving compliance.
Additionally, we have identified existing information reporting  requirements that could be enhanced. Examples include the following:
Mortgage interest and rental real estate. We recommended requiring  information return providers to report the address of a property  securing a mortgage, mortgage balances, and an indicator of whether  the mortgage is for a current year refinancing when filing mortgage  interest statements (Form 1098) could help taxpayers comply with  and IRS enforce rules associated with the mortgage interest  deduction. We have reported that collecting the address of the  secured property on Form 1098 would help taxpayers better  understand and IRS better enforce requirements for reporting income  from rental real estate.
Higher education expenses. Eligible educational institutions are  currently required to report information on qualified tuition and related  expenses for higher education so that taxpayers can determine the  amount of educational tax benefits they can claim. However, the  reporting does not always separate eligible from ineligible expenses.  We recommended revising the information reporting form could  improve the usefulness of reported information.
Identifying additional third-party reporting opportunities is challenging.  Considerations include whether third parties exist that have accurate  information available in a timely manner, the burden of reporting, and  whether IRS can enforce the reporting requirement. We have noted, for  example, that the reason there is little third-party reporting on sole  proprietor expenses is because of the difficulty of identifying third parties  that could report on expense like the business use of cars.
section_title: Implementing Modernized Systems Should Provide for Faster Refunds and Account Updates
paragraphs: Modernized systems should better position IRS to conduct more accurate  and faster compliance checks, which benefits taxpayers by detecting  errors before interest and penalties accrue. In addition, modernized  systems should result in more up-to-date account information, faster  refunds, and other benefits, such as clearer notices so that taxpayers can  better understand why a return was not accepted by IRS. Two new,  modernized systems IRS is implementing include the following:
Customer Account Data Engine (CADE) 2. For the 2012 filing  season, IRS implemented the first of three phases to introduce  modernized tax return processing systems. Specifically, IRS  introduced a modernized taxpayer account database, called CADE 2,  and moved the processing of individual taxpayer accounts from a  weekly to a daily processing cycle. IRS expects that completing this  first phase will provide taxpayers with benefits such as faster refunds  and notices and updated account information. IRS initially expected to  implement phase two of CADE 2 implementation by 2014. However,  IRS reported that it did not receive funding in fiscal year 2011 that  would have allowed it to meet the 2014 time frame.
Modernized e-File (MeF). IRS is in the final stages of retiring its  legacy e-file system, which preparers and others use to transmit e- filed returns to IRS, and replacing it with MeF. Early in the 2012 filing  season, IRS experienced problems transferring data from MeF to  other IRS systems. IRS officials said that they solved the problem in  early February. IRS officials recently reiterated their intention to turn  off the legacy e-file in October 2012 as planned. However, more  recently, IRS processing officials told us they would reevaluate the  situation after the 2012 filing season. MeF’s benefits include  allowing taxpayers to provide additional documentation via portable  document files (PDF), as opposed to filing on paper. In addition, MeF  should generate clearer notices to taxpayers when a return is rejected  by IRS compared to the legacy e-file system.
section_title: Expanding Pre-Refund Compliance Checks Could Result in More Efficient Error Correction
paragraphs: The Commissioner of Internal Revenue has talked about a long-term  vision to increase pre-refund compliance checks before refunds are sent  to taxpayers. As previously noted, early error correction can benefit  taxpayers by preventing interest and penalties from accumulating. In one  example, IRS is exploring a process where third parties would send  information returns to IRS earlier so they could be matched against  taxpayers’ returns when the taxpayer files the return as opposed to the  current requirement that some information returns go to taxpayers before  being sent to IRS. The intent is to allow IRS to match those information  returns to tax returns during the filing season rather than after refunds  have been issued.
Another option for expanding pre-refund compliance checks is additional  math error authority (MEA) that Congress would need to grant IRS  through statute. MEA allows IRS to correct calculation errors and check  for obvious noncompliance, such as claims above income and credit  limits. Despite its name, MEA encompasses much more than simple  arithmetic errors. It also includes, for instance, identifying incorrect Social  Security numbers or missing forms. The errors being corrected can either  be in the taxpayers’ favor or result in additional tax being owed.
MEA is less intrusive and burdensome to taxpayers than audits and  reduces costs to IRS. It also generally allows taxpayers who make errors  on their returns to receive refunds faster than if they are audited. This is  due, in part, to the fact that IRS does not have to follow its standard  deficiency procedures when using MEA—it must only notify the taxpayer  that the assessment has been made and provide an explanation of the  error. Taxpayers have 60 days after the notice is sent to request an  abatement.
Although IRS has MEA to correct certain errors on a case-by-case basis,  it does not have broad authority to do so. In 2010, we suggested that  Congress consider broadening IRS’s MEA with appropriate safeguards  against the misuse of that authority. In the absence of broader MEA, we  have identified specific cases where IRS could benefit from additional  MEA that have yet to be enacted. These include authority to: use prior years’ tax return information to ensure that taxpayers do not  improperly claim credits or deductions in excess of applicable lifetime  limits, use prior years’ tax return information to automatically verify  taxpayers’ compliance with the number of years the Hope credit can  be claimed, and  identify and correct returns with ineligible (1) individual retirement  account (IRA) “catch-up” contributions and (2) contributions to  traditional IRAs from taxpayers over age 70½.
In 2009, Congress enacted our suggestion that IRS use MEA to ensure  that taxpayers do not improperly claim the First-Time Homebuyer Credit in  multiple years, which we estimate resulted in savings of about $95  million.
section_title: Reducing Tax Code Complexity Could Ease Taxpayer Burden and Make It Easier to Comply
paragraphs: Tax code complexity can make it difficult for taxpayers to voluntarily  comply. Efforts to simplify or reform the tax code may help reduce  burdensome record keeping requirements for taxpayers and make it  easier for individuals and businesses to understand and voluntarily  comply with their tax obligations. For example, eliminating or combining  tax expenditures, such as exemptions, deductions, and credits, could help  taxpayers reduce unintentional errors and limit opportunities for tax  evasion.
Frequent changes in the tax code also reduce its stability, making tax  planning more difficult and increasing uncertainty about future tax liabilities.  Limiting the frequency of changes to the tax code could also help reduce  calls to IRS with questions about the changes. We have reported that IRS  annually receives millions of calls about tax law changes.
Reducing complexity in the tax code could take a variety of forms, ranging  from comprehensive tax reform to a more incremental approach focusing  on specific tax provisions. Policymakers may find it useful to compare any  proposed changes to the tax code based on a set of widely accepted  criteria for assessing alternative tax proposals. These criteria include the  equity, or fairness, of the tax system; the economic efficiency, or  neutrality, of the system; and the simplicity, transparency, and  administrability of the system. These criteria can sometimes conflict, and  the weight one places on each criterion will vary among individuals. Our  publication Understanding the Tax Reform Debate: Background, Criteria,  & Questions may be useful in guiding policymakers as they consider tax  reform proposals.
In closing, improving the taxpayer experience and increasing voluntary  compliance will not be achieved through a single solution. Because  voluntary compliance is influenced by so many factors, multiple  approaches, such as those listed here, will be needed.
Chairman Baucus, Ranking Member Hatch, and Members of the  Committee, this completes my prepared statement. I would be happy to  respond to any questions you and Members of the Committee may have  at this time.
section_title: Contacts and Acknowledgments
paragraphs: For further information regarding this testimony, please contact James R.  White, Director, Strategic Issues, 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 statement. Individuals  making key contributions to this statement include Joanna Stamatiades,  Assistant Director; LaKeshia Allen; David Fox; Tom Gilbert; Kirsten  Lauber; Sabrina Streagle, and Weifei Zheng.
section_title: Appendix I: Selected Internal Revenue Service (IRS) Taxpayer Service Performance Data, Fiscal Years 2007 through 2013
paragraphs: As shown in table 3, in recent years, the level of access to telephone  assistors has declined and average wait time has increased. In addition,  the volume of overage correspondence has steadily increased. On a  positive note, tax law and account accuracy remains high.
section_title: Appendix II: Internal Revenue Service (IRS) Telephone Performance Data, January 1 through Early April, 2008 through 2012
paragraphs: As shown in table 4, access to IRS assistors has declined over the last  few years. IRS officials attribute the higher-than-planned level of service  so far this year to a slight decline in the demand for live assistance. At the  same time, the number of automated calls has significantly increased  which IRS officials attributed in part to taxpayers calling about refunds,  and requesting transcripts (i.e., a copy of their tax return information).