Information Reporting: IRS Could Improve Cost Basis and Transaction Settlement Reporting Implementation
Published: 2011-05-19T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Effective implementation of two 2008 laws by the Internal Revenue Service (IRS) could increase taxpayers' voluntary compliance. Those laws require reporting to IRS and taxpayers of cost basis for sales of certain securities and of transaction settlement information (i.e., merchants' income from payment cards or third party networks). In response to a congressional request, GAO (1) assessed IRS's implementation plans for the laws; (2) determined the extent to which IRS issued timely regulations and guidance and did outreach; (3) examined how IRS will use the new data to improve compliance; and (4) analyzed IRS's plans to assess implementation and measure performance and outcomes. GAO compared IRS's implementation plans to criteria in past GAO work and other sources; interviewed industry groups and agency officials, and reviewed rulemaking documents; examined IRS's plans to use the new data; and compared IRS's measures and evaluation plans to GAO criteria.
section_title: What GAO Found
paragraphs: IRS is implementing cost basis and transaction settlement reporting through the new Information Reporting and Document Matching (IRDM) program in the Small Business/Self Employed (SB/SE) and Modernization and Information Technology Services (MITS) divisions. IRDM plans show several elements of effective program management, but do not document coordination with some related IRS projects such as Workforce of Tomorrow. IRS estimated IRDM costs, but MITS's estimate does not reflect some best practices, such as adjusting for inflation. Also, IRDM did not use substantiated tax form volume projections in some budget and risk decisions. To date, IRS spent about $28 million on IRDM and requested another approximately $82 million. IRS outreach with industry stakeholders was thorough early in the rulemaking process, but IRS missed its target dates for issuing regulations by about 1 year due, according to IRS officials, to time needed to learn the complex industries. After IRS released final regulations, industry stakeholders sought clarification of certain issues. IRS did not release additional written guidance until after the regulations' effective dates, which industry stakeholders said may affect their implementation of the new reporting requirements. Although IRS released drafts of the newly required or revised forms, they did not release draft instructions prior to the regulations' effective dates. To use the new data, IRS is developing systems that are expected to improve IRS's existing matching of information returns to individual tax returns and expand matching to business taxpayers. The initial enhancements are to be operational in 2012. IRDM appropriately plans to conduct research and test data quality. IRDM regularly documents lessons learned; however, IRDM has not assigned responsibility or established procedures to use them. IRDM also developed preliminary performance measures to assess the implementation and outcomes, including effects on revenue and compliance. However, IRDM has not documented a plan to finalize the performance measures, such as methodology.
section_title: What GAO Recommends
paragraphs: GAO recommends, among other things, that IRS improve cost estimation, form volume projections, stakeholder communication, and performance management. IRS generally agreed with the recommendations, but did not describe plans to release draft form instructions or communicate target guidance release dates, both of which would aid industry implementation.

section_title: Letter
paragraphs: The nation’s mounting $14 trillion plus debt, as of May 2011, coupled with  the $345 billion gross tax gap—or the difference between what taxpayers  should have paid and actually did—underscores the importance of the  Internal Revenue Service’s (IRS) efforts to ensure everyone meets their  obligation to pay taxes. Despite voluntary compliance on the part of most  taxpayers and vigorous enforcement, about 16 percent of taxes are  uncollected annually, according to IRS.
IRS seeks to increase voluntary compliance with tax laws, in part, by  comparing—i.e., matching—income or expenses reported by third parties  on information returns to those taxpayers report on their tax returns. To  increase the information available to IRS for compliance purposes—and  therefore increase the potential for raising revenue—Congress passed  several acts in recent years requiring new third-party information  reporting.  Establishing an effective matching program is important not  only for revenue collection, but also because the biggest benefit of  information reporting is the increase in voluntary compliance that is  expected to occur because taxpayers have the information they need to  accurately report income and they realize that IRS has access to those  data.  One provision of one of the new laws requires brokers to report the  adjusted cost basis for certain securities and identify whether a gain or  loss is short- or long-term (referred to in this report as “cost basis  reporting”). In 2008, the Joint Committee on Taxation (JCT) projected this  provision to generate $6.67 billion in revenue over 10 years. Another  provision in the other law requires the reporting of merchants’ gross  amount of income from payment card or third-party payment network  transactions (referred to in this report as “transaction settlement  reporting”). In 2008, the JCT projected this provision to generate $9.8  billion in revenue over 10 years. In prior reports, we recommended that  Congress consider cost basis reporting legislation and provided  information to Congress on payment card reporting.
Because IRS’s effective implementation of these laws could decrease the  tax gap, you requested that we: (1) assess IRS’s implementation plans for  the new reporting requirements, including its cost estimates; (2) determine  the extent to which IRS communicated with industry stakeholders, issued  timely regulations and guidance, and undertook outreach efforts to  facilitate stakeholders’ ability to comply with the new reporting  requirements; (3) examine how IRS will use the new returns to improve  compliance and determine how implementation may affect its other  functions and its ability to process and match other kinds of information  returns; and (4) analyze IRS’s plans to assess the implementation process,  develop performance measures to monitor operations, and determine any  outcomes, such as the effects of the new returns on voluntary compliance.
To do our work, we analyzed IRS’s planning, implementation, and cost  estimate documents to determine whether they met best practices  established by IRS guidance, such as its Internal Revenue Manual, and in  several prior GAO reports cited throughout this report. We also examined  budgets, the new legislation, IRS’s proposed regulations, and public  comments received, as well as information technology plans, preliminary  performance measures, and associated plans for the new requirements. We  interviewed IRS officials, including those who are a part of the  Information Reporting and Document Matching (IRDM) program, the  group responsible for the laws’ implementation. We also interviewed  industry stakeholders, which represent groups required to file information  returns under the new cost basis and transaction settlement provisions, as  well as members of IRS’s Information Return Program Advisory  Committee.
We conducted this performance audit from June 2010 through May 2011 in  accordance with generally accepted government auditing standards. Those  standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and  conclusions based on our audit objectives. We believe that the evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives. See appendix I for more information on our  scope and methodology.
subsections: section_title: Background
subsections: section_title: Cost Basis Reporting
paragraphs: IRS estimated, for tax year 2001, that $11 billion of the tax gap could be  attributed to individual taxpayers who misreport income from capital  assets, such as securities and other assets owned for investment or  personal purposes. Specific to securities transactions, we estimated  based on IRS data and examination of case files, that for the same year, 38  percent of individual taxpayers misreported their capital gains or losses.  To help prevent some taxpayer misreporting, brokers must, under the new  requirements, report the adjusted cost basis for certain securities on a  revised Form 1099-B, “Proceeds From Broker and Barter Exchange  Transactions.” For certain securities, brokers must begin collecting these  data on January 1, 2011, and report them to IRS in 2012.  Brokers must  begin collecting information on additional securities, beginning on January  1, 2012.
Generally, a taxpayer’s gain or loss from a securities sale is the difference  between the gross proceeds from the sale and the original purchase price,  or cost basis, net of any fees or commissions. However, to determine any  gains or losses from securities sales, the taxpayer must determine if and  how the original cost basis of the securities must be adjusted to reflect  certain events, such as stock splits. For years, brokers have been required  to report information on Form 1099-B such as descriptions of securities  sold, sales date, and gross proceeds. However, the law changed what  information is reported and who reports it. Prior to the law’s effective  date, the taxpayer was responsible for calculating cost basis and reporting  it to IRS on their tax return. Now, brokers will be responsible for reporting  cost basis information to taxpayers and IRS on the Form 1099-B. The Form  1099-B is due to taxpayers on February 15, and to IRS on February 28 for  paper returns and March 31 for electronic returns, for the prior calendar  year’s security sales. Additional changes resulting from the law are  described in table 4, appendix II.
section_title: Transaction Settlement Reporting
paragraphs: Transaction settlement reporting is expected to help IRS identify and  prevent the underreporting of businesses income. Under the new  requirements, all merchant transactions completed beginning on January  1, 2011, in which either a payment card or a third-party payment network  is used as the form of payment, must be reported by payment settlement  entities (PSE) on the new Form 1099-K, “Merchant Card and Third Party  Network Payments.” Information reporting on merchants—businesses  that accept payment cards or payment from a third-party settlement  organization for goods and services—is new for the transaction settlement  industry.
A payment card is a card-based payment, such as a credit card, debit card,  or prepaid telephone card, which is accepted by a group of unrelated  merchants. For example, a gift card for a shopping mall is a payment  card because it is accepted as payment at a network of unrelated stores;  however, a gift card for a specific store is not a payment card because it is  only accepted by the store that issued it. A third-party payment network  accepts various forms of payment from a customer to settle transactions  with merchants who are unrelated to the network. Examples of third-party  payment networks include PayPal, certain toll road automated payment  systems, and certain shared service organizations (such as certain  accounts payable services).
A PSE—a bank or other organization that processes transactions and  makes payments to the merchant accepting the payment card or the third- party settlement organization that makes payment to the merchant—is  responsible for reporting payment card and third-party network  transactions annually to IRS and to the merchant, on the Form 1099-K.   The new requirements direct PSEs to report the gross amount of  reportable payment transactions, which is the total dollar amount of  aggregate transactions for each merchant, for each calendar year, without  regard to adjustments for credits, cash equivalents, discounts, fees,  refunds, or other deductions. In some cases, more than one PSE may be  involved in a single transaction, in which case the PSE that actually makes  payment to the merchant is responsible for filing the Form 1099-K.
When a customer (cardholder) purchases goods or services from a  merchant using a payment card, the merchant submits the transaction to  the PSE for approval. The PSE submits a request through the card  network, such as Visa or Mastercard, to the bank or other entity that  issued the card (issuer). The issuer checks the customer’s account to  determine if the customer is able to cover the cost of the transaction. If so,  the issuer bills or debits the customer’s account for the amount of the  transaction. Figure 1 shows this process for a typical credit or debit card  transaction, two commonly used types of payment cards.
Third-party payment network transactions are similar to credit and debit  card transactions in that the third-party network facilitates transactions  between unrelated merchants and customers. Third-party payment  networks have widely varying business models, and can encompass many  different types of payment situations that are not easily generalized,  according to IRS officials and industry representatives. Typically, a  customer pays the third-party settlement organization for a transaction  with an agreed upon form of payment, which may include a payment card,  and the third-party settlement organization settles the transaction with the  merchant. One example of a third-party network is certain toll collection  networks. Some states that operate toll roads contract with a third-party  settlement organization to bill customers for road usage. The third-party  settlement organization provides a system that allows the toll facility to  record the passage of a vehicle with a transmitter inside.  The third-party  settlement organization periodically bills customers’ accounts and makes  payments to the state to settle the toll transactions.
section_title: IRS’s New Compliance Program for Using Information Returns
paragraphs: IRS initiated the IRDM program in 2009 in part to implement the two new  information reporting requirements, but more generally to increase  voluntary compliance by expanding and maximizing its ability to use  existing and future information returns and establishing a new business  information matching program. Formerly, IRS had only matched  information returns to individuals’ and sole proprietors’ tax returns.  Under IRDM, IRS plans to build several new information technology (IT)  systems and enhance some existing systems as well as implement  numerous organizational and process changes. Specifically, IRS plans for  IRDM to house a new process to use information returns to identify  individual and business tax returns that are likely sources of revenue and  that are overlooked by the current individual tax return matching system.
IRDM implementation involves many IRS groups and offices, and is led by  the Small Business/Self Employed (SB/SE) division and Modernization and  Information Technology Services (MITS). The Research Analysis and  Statistics (RAS) division, the Office of Chief Counsel, and the Tax Forms  and Publications group also have important roles in IRDM  implementation. For example, RAS is working with IRDM on a research  plan to assess the effectiveness of the program. IRDM capabilities will be  implemented in stages, beginning in 2012.
section_title: IRDM Implementation Plans Have Many Positive Aspects, but Could Better Demonstrate Coordination with Other IRS Projects, Adhere to Best Practices for Cost Estimation, and Use Reliable Data for Decision Making
subsections: section_title: IRDM Implementation Plans Address Several Key Areas for Effective Program Management
paragraphs: IRS developed a series of plans to implement the IRDM program, which  will be used to implement the new cost basis and transaction settlement  reporting requirements. IRDM plans cover program scope, management  structures, information technology system development, communications  with stakeholders, and other aspects of IRDM implementation.
We found that IRDM implementation plans generally are consistent with  criteria for effective program planning and implementation listed in our  prior reports and IRS guidance. For example, these criteria call for a  leadership structure, an internal communication strategy, staffing and  training provisions, a review process, risk management, and alignment  with the agency strategic plan. IRDM has a leadership structure, headed by  an executive steering committee at the highest level, with authority over  the IRDM Governance Board whose functions include program  management and coordination. It has a stakeholder management and  outreach plan that specifies communication strategies, as well as a  detailed staffing and organizational development plan to implement  document matching for business taxpayers. IRS’s plans include provisions  to review and assess the program for continuous improvement, such as a  requirement to document lessons learned at the end of each significant  project phase. Furthermore, IRDM has a plan that assesses and provides  for the management of program risks and a plan that provides for analysis  of related technology system interdependencies. IRS has begun  implementing several of these plans, to various degrees. It is too early in  the implementation process to comprehensively assess whether IRDM has  followed all of its plans or achieved outcomes and whether these efforts  will be effective.
Regarding the schedule of IRDM implementation, we found that IRS has  met most time lines established in the program implementation plans, with  two notable exceptions: the release of final regulations for cost basis and  transaction settlement reporting, to be discussed later in this report, and  certain software development milestones. Specifically, MITS did not  meet milestone dates for the development and testing of the software  expected to enhance IRS’s ability to select potential individual taxpayer  cases due to a procurement delay for the associated hardware, which  delayed testing by 1 month. This software is also expected to aid in the  development of a new IT system to select business taxpayer cases for  review.  In response to the delays, IRS officials said they have re- prioritized work and, as of May 2011, officials said they do not expect the  delays to affect the program’s progress.
section_title: IRDM Did Not Document Coordination with Related IRS Projects
paragraphs: The IRDM Strategic Roadmap is the foundational plan for IRDM that  describes the program’s scope, desired outcome, implementation phases,  and time line. IRS guidance and our prior work state that comprehensive  plans for implementing a new program should link with the agency’s  strategic plan and align with its core processes and agencywide  objectives. The Strategic Roadmap is aligned with IRS’s Strategic Plan,  which guides and sets goals for IRS’s work at a high level. For example,  the Strategic Plan establishes a goal of enforcing the law to ensure that  everyone meets their obligation to pay taxes which, according to the  Strategic Roadmap, IRDM intends to support by using third-party  information reporting to increase voluntary compliance and treat  noncompliance.
However, the Strategic Roadmap and other IRDM plans do not document  coordination with some significant recent and ongoing servicewide  initiatives, such as Workforce of Tomorrow and the Nonfiler Strategy. IRS  officials said they met with the initiatives’ team members to coordinate,  but did not document that coordination occurred and whether or how this  coordination ensured that IRDM and other servicewide initiatives were  consistent and would work well together. We did not find any aspects of  IRDM plans that conflict with Workforce of Tomorrow or the Nonfiler  Strategy, but documenting that IRDM plans are coordinated with  servicewide initiatives would be consistent with internal control standards  and could facilitate oversight, help prevent duplicative efforts, and foster a  common understanding of program plans and activities. For example,  IRDM has a workforce plan for staffing a new organization to work  business taxpayer cases identified by the new document matching  process. The plan addresses hiring, training, and leadership, but does not  show coordination with the servicewide Workforce of Tomorrow Task  Force and its specific recommendations to improve IRS’s overall  recruiting methods, hiring strategies, and leadership development. The  Workforce of Tomorrow report notes that better coordination of  leadership development efforts across IRS could lead to more consistent  application of talent management tools and more effective use of  processes and data for servicewide decision making.
IRDM is also planning new processes for identifying businesses that do not  file tax returns, including an incipient business Automated Substitute for  Return program. An IRDM plan recommends combining the planned  business Automated Substitute for Return program with a related  enforcement program for business nonfilers. This plan does not show  coordination with IRS’s servicewide Nonfiler Strategy or discuss the  Nonfiler Strategy’s potential effect on IRDM functions.  IRS’s Nonfiler  Strategy noted that a lack of coordination in nonfiler work results in  ineffective resource allocation. IRS provided us with a document that  officials stated was used to inform the Strategic Roadmap; it cites how  IRDM will make some accommodations for nonfiler programs, but it does  not mention or discuss coordination with the Nonfiler Strategy.
IRDM plans could demonstrate coordination with Workforce of Tomorrow  and the Nonfiler Strategy by describing IRDM’s relationship with and its  effect on these initiatives. After we discussed the issue with IRDM  management in January 2011, officials said they are working to document  this coordination in an updated version of the Strategic Roadmap, but  they had not done so as of May 2011.
section_title: IRS Estimated SB/SE and MITS IRDM Costs, but MITS’s Estimate Does Not Reflect Some Best Practices
paragraphs: SB/SE and MITS, the primary IRS divisions involved in IRDM  implementation, each estimated their share of IRDM program costs for  IRS’s budget. SB/SE’s first budget request for IRDM, about $36 million, was  made for fiscal year 2012. Officials expect that annual funding will  increase as the program becomes fully operational and then remain steady  for as long as IRDM continues to operate.
SB/SE worked with the IRS Chief Financial Officer’s (CFO) office to  develop its budget request. SB/SE calculated staffing needs based on the  number and types of cases it anticipated, then used a calculator developed  by the CFO’s office to determine the cost of the staff, including salaries,  benefits, training, facilities, and other direct and indirect costs.
MITS’s work on IRDM was funded at $23 million during fiscal year 2010,  and IRS plans for funding to continue at this level through fiscal year 2016,  yielding a total cost of about $166 million for fiscal years 2009-2016. MITS  developed an initial cost estimate in 2008 to formulate its budget request.  Total costs for IRDM since the program’s inception are shown in table 1.
According to best practices established by the GAO Cost Estimating and  Assessment Guide, a cost estimate should be comprehensive, well  documented, accurate, and credible. However, MITS’s IRDM cost  estimate does not fully meet these four best practices (for a description of  the best practices and the extent to which MITS met each characteristic,  see app. III).  For example,    The estimate substantially meets the best practices for a  comprehensive cost estimate. The estimate covers most life-cycle  costs, is supported by a document that defines the work needed to  accomplish the program’s objectives and relates cost and schedule to  deliverables, and provides technical descriptions for each project  phase. However, although it defines assumptions and estimating  standards, also referred to as ground rules, the cost estimate does not  cite a rationale for the assumptions and only considers the impact of  risks on a portion of the estimate.
The estimate partially meets best practices for a well documented cost  estimate. It provides technical descriptions for each project phase and  documents a management briefing, but it does not contain many details  about the underlying data used to develop the estimate. MITS used a  computer model to calculate the cost estimate, but the formulas built  into this model and the resulting calculations are not shown.  Thus, it  would not be possible for another cost analyst outside IRS to use  available documentation to recreate the estimate without access to this  computer model. Moreover, although IRS provided documentation of  its general cost estimation methodology, the methodology used to  develop this cost estimate was not provided at a meaningful level of  detail.
The estimate partially meets best practices for an accurate cost  estimate. The model used to calculate the estimate was developed  using data from other comparable projects, which provides insight into  actual costs on similar programs. However, inflation was not  included. According to IRS officials, inflation is not applied to cost  estimates because it is factored in automatically during the budget  process. If inflation were included in the cost estimate, it would  be  double-counted in the budget. Applying inflation is an important s creating a cost estimate and it is a best practice for inflation to be  included and documented when creating cost estimates. Cost data  must be expressed in like terms, which requires the transformation of  historical or actual cost data into constant dollars. Additionally, the  cost estimate does not explain variances between planned and actual  costs because the estimate was developed before the program started;  there were no actual IRDM cost data available. A comparison between  the original estimate and actual costs would allow estimators to see  how well they are estimating and how the program is changing over  time.  In 2008, the Treasury Inspector General for Tax Administration  (TIGTA) recommended that IRS provide similar information.
The estimate minimally meets best practices for a credible cost  estimate. It contains a risk analysis, but it only addresses risks on a  small portion of the overall costs and how the risk analysis was done is  not clearly documented. IRS performed a cross-check on the estimate  by using an alternative estimation method to see if it produced similar  results.  Specifically, IRS did one cross-check by comparing the  estimate to an expected ratio of operations costs and nonrecurring  costs. However, there was no evidence that other cross-checks were  performed. Further cross-checks using different calculation methods  could enhance the estimate’s reliability if they showed that different  methods produce similar results. In addition, the cost estimate does not  contain a sensitivity analysis, which would examine the effects of  changing assumptions and estimating procedures and therefore  highlight elements that are cost sensitive. IRS officials said they  typically do not perform a sensitivity analysis unless the program has  reached its preliminary design phase, which was not the case when  they estimated IRDM costs.  Furthermore, although the IRS group that  did the cost estimate was independent from the IRDM program office,  IRS did not obtain an independent cost estimate conducted by an  outside group to validate it. According to officials, due to limited  resources, IRS generally only does an additional independent cost  estimate for its largest programs and does not do an additional  estimate for a cost estimate done at the start of a program. Therefore,  because IRDM is not a large program, according to officials, and  because its cost estimate was done before the program started, an  additional independent cost estimate was not done. Although we  recognize that it would be challenging for IRS to do an independent  cost estimate for each project because IRS lacks the resource to do so,  it is a best practice to do an independent cost estimate because it  would provide an unbiased test of whether the original cost estimate is  reasonable.
IRS officials said that, because their cost estimation procedures became  more robust after this cost estimate was prepared in 2008, a revised cost  estimate would follow best practices to a greater extent. Officials also said  that they could more accurately estimate costs now that they know more  about the IRDM program, and that they are considering revising the  estimate but may not do so due to limited resources. If IRS revises the  IRDM cost estimate, following best practices from our cost estimating  guide could enhance its reliability.
section_title: IRS Did Not Use Substantiated Projections of Form 1099-K Volume for IRDM Resource Planning Decisions
paragraphs: IRDM did not use substantiated volume projections for the new Form  1099-K in some of its budget and risk management decisions because  official projections were not available when those decisions were made.  Making decisions without substantiated projections puts IRS at risk for  misallocating resources. To support sound decisions, the source or  method for obtaining data supporting decisions should be documented.  IRS research standards say that data must be validated, any limitations  must be disclosed, and documentation must be made available. More  specifically, IRS and industry guidance establish that estimates used in  project planning should have a sound basis and documentation to instill  confidence that any plans based on estimates are capable of supporting  project objectives.
IRS produced three different projections of the number of Forms 1099-K,  expected to be filed annually. One of these—the projection a contractor  developed in 2010 to assess the capacity of MITS’s Filing Information  Returns Electronically (FIRE) system—was developed without  consulting RAS, which produces form volume projections that IRS  considers reliable. This projection, and the 125 million projection SB/SE  developed in 2006, also lack documentation of the assumptions and  methods used to develop them. Table 2 describes the three Form 1099-K  volume projections and the decisions that were based on them.
The 125 million projection was used in part to calculate SB/SE’s fiscal year  2012 request for about $36 million and 415 full-time equivalent staff: it  factored into staffing calculations such as the number of employees  needed to screen potential cases and respond to discrepancies between  Forms 1099-K and related business tax returns. Other data also factored  into these budget and staffing calculations. In addition, the 60 million  projection was used to make decisions about MITS information  technology needs. The supported preliminary Form 1099-K projection  produced by RAS is less than half of the projection used to inform SB/SE’s  staffing calculations. IRDM officials were unable to provide  documentation of the methodology used to develop SB/SE’s 125 million  projection, but did provide us some of the assumptions. The FIRE  Capacity Study does not provide sufficient methodology or documentation  to support its findings, including its Form 1099-K projection. For example,  the study says that the assessment team obtained future volume  projections by holding meetings and exchanging e-mails, but does not  explain how those projections were calculated or the basis of the  information. IRDM identified the potential for new information returns to  strain FIRE’s capacity as a program risk. The contractor’s capacity study,  which IRS intended to address this risk, cannot reliably do so without  substantiated data inputs.
RAS is responsible for producing reliable form volume projections for IRS  decision making, but RAS had not yet produced an official Form 1099-K  projection at the time of the formation of the fiscal year 2012 IRDM budget  request and the FIRE study’s release.  RAS officials were not involved in  developing the projection used in the FIRE Capacity Study. Consulting  RAS when using Form 1099-K projections in decision making could  enhance the reliability of those projections. Since we identified the issue,  officials said they plan to reassess whether the FIRE system can handle  incoming information returns using RAS’s preliminary projection, but they  had not done so as of May 2011.
section_title: Additional IRS Communication and Guidance, and Release of Future Draft Form Instructions, Could Benefit Industry Implementation
subsections: section_title: IRS Communication with Industry Stakeholders Early in the Rulemaking Process Was Thorough
paragraphs: Prior to preparing the proposed regulations for cost basis and transaction  settlement reporting, IRS counsel met in person and via phone with  industry stakeholders to gain an understanding of issues facing the  industries. Treasury officials, who worked with IRS and ultimately  approve the regulations, also met with industry stakeholders. Additionally,  prior to publishing proposed regulations, IRS posted notices in the Internal  Revenue Bulletin to solicit responses to questions and comments on,  among other things, the definitions of key terms. Representatives from  the four cost basis and transaction settlement industry groups we  interviewed said IRS was responsive to their concerns and that its initial  outreach and information gathering efforts were good. In addition to direct  communication with industry groups, IRS also relied on the Information  Reporting Program Advisory Committee (IRPAC), whose members include  tax professionals and industry representatives, for input. Once each of  the two proposed regulations were published, IRS conducted a public  hearing and officials communicated with industry through the public  comment letter process. As evidenced in lessons learned from a prior IRS  implementation effort, this early engagement of external stakeholders is  important in the development of the compliance and operational functions  for new tax legislation.
section_title: Despite Noteworthy Efforts, IRS Did Not Meet Its Target Dates for Issuing Regulations
paragraphs: Due, according to IRS officials, to unanticipated complexities of the cost  basis and transaction settlement industries, IRS counsel did not meet its  target dates for issuing final regulations for either reporting requirement,  as shown in figure 2.
Final regulations on cost basis reporting were issued in October 2010, and  for transaction settlement reporting in August 2010. Both laws establish  January 1, 2011, as the effective date for data collection to begin—over 2  years after the laws’ enactment in 2008. Reporting data are due to IRS in  2012 for both laws.
Although IRS missed its target dates by about a year, the turnaround for  finalizing regulations was relatively fast, according to IRS counsel,  especially when compared with other information reporting rulemaking.  One cost basis group acknowledged the short time between the enactment  and the effective date of the laws.  IRS officials said that the rulemakings  did not meet deadlines because the cost basis and transaction settlement  industries were more complex than they anticipated and learning them  required more time than expected. Furthermore, according to IRS counsel,  IRS does not have complete control over the timing of the issuance of  regulations because they must be approved by the Department of the  Treasury, which sets priorities for when regulations are issued.  The cost  basis and transaction settlement reporting regulations were given priority,  having been listed in Treasury’s 2009-2010 Priority Guidance Plan.   However, Treasury counsel said the rulemakings posed unique challenges,  such as learning new systems and becoming familiar with the industries  affected by the regulations.  Another Treasury official said that their  review process for these regulations was relatively fast given the  complexities.  After the final regulations were issued, the cost basis and  transaction settlement industries had, respectively, 2 ½ months and 4 ½  months before data collection was to begin.
According to IRPAC and representatives from both industries, the timing  of final regulations left the industries with a short implementation time.  Three cost basis groups said that while the legislation was under  development, they requested from congressional staff 18 months to  implement any information systems or other changes needed to comply  with final regulations; third-party payment networks said they requested a  year.  A senior IRDM official said companies could have started systems  development before regulations were final.  Although some cost basis and  transaction settlement industry members used proposed regulations to  guide their initial implementation, IRPAC representatives said companies  had to make some assumptions about what would be in the final  regulations, which increases costs.
The short implementation time may affect the quality of data sent to IRS.   One cost basis industry group told us that small firms may not be ready to  comply with the regulations and, as a result, taxpayers and IRS may  receive inaccurate data on the Form 1099-B from those firms.  Although  cost basis industry representatives believe it is too soon to tell which data  quality issues will be most pressing, they pointed out that there may be  significant inconsistencies in gifted and inherited securities because  calculation methods are unclear and systems were not fully prepared for  implementation.  If these securities are transferred to other brokers, data  quality issues may follow, resulting in long-term consequences for  securities gifted or inherited in 2011, but sold in later years. A transaction  settlement industry group identified several issues as potential data quality  challenges, including that the industry does not identify merchants based  on Taxpayer Identification Numbers (TIN).  According to third-party  payment network representatives, it is too soon to tell how data may be  affected by the short implementation time.
section_title: Additional IRS Communication on Rulemaking, Guidance, and Outreach May Improve Industry Implementation
paragraphs: After IRS’s issuance of final regulations, industry stakeholders sought  clarification of certain issues. IRS did not provide additional written  guidance or participate in outreach events until after the effective dates of  the regulations. IRS officials told us that timing of the additional guidance  resulted from a lengthy review process, which included IRPAC’s review of  FAQs for transaction settlement regulations.  Regarding outreach, IRDM  officials told us that IRDM planned to begin outreach once final  regulations were issued so that messages would be based on stable  information.  Continuous engagement of external stakeholders is  important to ensure compliance with new tax legislation.
Because IRS did not release clarifying guidance or continue outreach until  after the effective dates of the laws, industry groups experienced a gap in  communication from IRS which, according to industry representatives,  could affect implementation.  Four industry groups told us after the final  regulations were issued that they were awaiting additional information,  including clarification on certain reporting responsibilities, which could  affect their implementation of the laws. For example, one cost basis group  pointed out that taxpayer confusion associated with reporting wash sales  may cause a large volume of corrected Forms 1099-B during the year  following implementation.
IRS released a Frequently Asked Questions (FAQ) document for cost basis  reporting on its Web site in March 2011.  For transaction settlement  reporting, as of May 4, 2011, IRS had not released additional written  guidance since issuing the final regulations. IRS counsel said some  transaction settlement companies and cost basis entities have contacted  them about technical details of implementation, such as filling out forms,  and that IRS has spoken with them. Additionally, outreach events that will  cover both laws, such as speaking at events for tax professionals, began in  February 2011 and, as of April 2011, are scheduled through November  2011. IRPAC and two industry groups we spoke with said they are not  always aware of IRS's plans for issuing guidance or beginning additional  outreach.
The transaction settlement industry’s implementation also could be  affected by the gap in guidance and outreach after the regulations were  issued. For example, the definition in the regulations for “third-party  payment network” is broad, according to representatives of several third- party payment network companies. The definition could lead some  companies to question whether they will need to file a Form 1099-K,  according to the companies. IRS counsel acknowledged that the  applicability of the definition depends on a company’s specific business  model and said the regulations could not address all possible examples of  third-party payment networks. IRS counsel said they plan to post FAQs on  their Web page and to do letter rulings on request. Third-party payment  network representatives we contacted told us they were unaware of IRS's  plans.
In addition to IRS counsel’s communication with reporting entities, IRDM  established a team and a plan for stakeholder outreach. IRDM hired an  employee shortly after the laws’ effective dates to lead the communication  team, and IRDM participated in its first external outreach event at the end  of February 2011. Earlier action by the IRDM outreach team might have  helped to bridge the communication gaps between IRS and the cost basis  and transaction settlement industries. Earlier outreach might have also  helped IRS raise awareness among companies, such as certain third-party  payment networks, who may not be aware that they will be required to  report. The IRDM Stakeholder Management and Communication Plan  provides a potentially useful framework to analyze stakeholders’ concerns  and to prescribe appropriate IRDM responses. For example, the plan  describes a methodology for analyzing the potential effect of IRDM  regulations on stakeholder groups, and the degree of influence of each  stakeholder.  The IRDM team is to analyze stakeholder concerns and  ideas, summarize trends, and develop strategies for specific groups.  The  plans also emphasize the need to gauge the effectiveness of IRDM  communications.  This framework, if followed, could be a useful tool to  help identify and assess stakeholder needs.
IRS already has a Web page on cost basis, transaction settlement, and  other new information reporting requirements. The page contains copies  of the information returns and regulations for both laws, cost basis FAQs,  and, for transaction settlement stakeholders, instructions for using IRS’s  TIN Matching Program. The page does not contain prospective  information about upcoming guidance or outreach or, for other  information reporting laws, upcoming rulemaking actions.  The  Department of Transportation has a Web page that contains information  about the status of significant rulemakings, including scheduled  milestones, actual dates that milestones were met, and explanations for  any delays.  The page is a public version of more detailed internal tracking  of rulemaking milestones and assessing schedules, which helps  department officials determine if a rule is on or behind schedule, based on  target dates.  A representative from a cost basis industry group referred  us to a similar Web page run by the Financial Industry Regulatory  Authority, which also contains outreach information on securities  regulations.
Additional Web-based information from IRS, such as information about  upcoming events or IRS’s approach to letter rulings, could benefit industry  stakeholders. IRS could use the Transportation or Financial Industry  Regulatory Authority pages as a guide for enhancing its Web-based  information on regulations and guidance, and could also include outreach  information. Such information could be especially helpful for the cost  basis industry as IRS begins a new rulemaking for additional securities  that will be required to collect cost basis information beginning in 2013.  Representatives from the cost basis and transaction settlement industries  said such a Web page, if kept up to date, would aid in their implementation  of the laws.
Officials at IRS told us their ability to provide projected issuance dates for  regulations is limited by the uncertainties in Treasury’s review process.   An official in Treasury’s Office of Tax Policy agreed that their review  process, which could result in significant revisions, makes it challenging to  post projected release dates that are useful and accurate.  According to the  official Treasury does not have an internal system for tracking rulemaking.   However, Treasury and IRS officials could work together to provide  projected release dates to the public.  Posting other information, such as  upcoming outreach events and the release of informal guidance, such as  FAQs, would also be beneficial.
section_title: IRS Did Not Release Draft Instructions for the Forms 1099-K and 1099-B for Public Comment
paragraphs: IRS released draft versions of the new Form 1099-K and the revised Form  1099-B for tax year 2011 when it released the proposed regulations in late  2009 for each law; however, IRS did not release draft instructions for  either form because, according to officials, they were not complete at that  time. IRS solicited comments on the forms during the rulemakings process  and continued communication afterwards with industry groups as new  drafts were created.  IRS has since posted final instructions for both  forms, and officials told us they are taking comments on the instructions  through August 2011.
IRPAC representatives said they were unable to adequately comment on  the draft forms without seeing definitions and other explanations typically  included in instructions, and cost basis and transaction settlement  industry stakeholders also emphasized the need for instructions to help in  their implementation of the laws. Not having instructions available when  draft forms were issued left industry stakeholders with some key  unanswered questions, whose outcomes may affect their system  development efforts and ultimately data reported to taxpayers and IRS.  For example, some transaction settlement representatives asked IRS why  the Form 1099-K requests the gross amount of “payments” rather than the  gross amount of “reportable payment transactions” as required in the  regulations. For the transaction settlement industry, there is a difference  between a payment and a transaction that could affect the dollar amount  reported. Specifically, the transaction amount of a purchase will almost  always be greater than the payment actually received by a merchant, due  to fees charged by the PSE, card issuers, or other entities facilitating the  transaction. The draft instructions explained what was meant by the term  “payments.” If transaction settlement groups had viewed the draft  instructions with the draft forms, their concerns may have been addressed  earlier and they could have proceeded with greater confidence in  designing their data collection processes.
IRS officials acknowledged that some comments made on the forms could  have been avoided if the instructions were available. According to IRS  officials, releasing draft instructions with draft forms is usually not done  because instructions are typically not complete by the time forms go out  for comment. However, IRS officials said they have released draft  instructions with forms on occasion and recognize the value in doing so.
section_title: IRDM Plans for IT Systems, New Workflows and Organization, and Research Are Expected to Improve the Compliance Programs for Individual and Business Taxpayers
subsections: section_title: Planned Enhancements Should Allow for New Information Return Data to be Used in New and Existing Compliance Efforts
paragraphs: IRDM’s plans to use the new cost basis and transaction settlement  reporting data rely upon new IT systems that are expected to  automatically match information returns to tax returns. The plans also  provide for a new organization and new workflows for business taxpayer  compliance staff.  The specific plans for electronically processing the new  information return data were nearly complete, as of May 2011, according  to a senior IRDM official.  The initial round of IT enhancements is to be  operational in 2012, utilizing tax year 2011 data, and over 400 full-time  equivalent staff have been requested in IRS’s fiscal year 2012 budget to,  among other things, transcribe new business tax return information and  reconcile returns.  Additional IT enhancements are planned for subsequent  years.  Eventually, all current and future information return data will go  through the IT systems created for IRDM.  (For additional details on  planned implementation time frames, see app. IV, table 6.)
The two existing programs that will be affected by IRDM are IRS’s  Automated Underreporter program (AUR) and nonfiler programs. The  existing AUR matches data on information returns and income reported by  individual taxpayers only. A notable planned AUR improvement is the  development of technology to match data from the Form 1099-K to  business tax returns.  The existing IRS nonfiler programs work individual  taxpayer and business nonfiler cases. IRS recently implemented a project  to modernize its business nonfiler compliance program and IRDM is  developing plans to use and work with that project, according to a senior  IRDM official.  In particular, IRDM is assessing the feasibility of  establishing a business version of the program IRS uses to estimate taxes  owed, known as the Automated Substitute for Return program, and submit  a return on behalf of individual nonfilers.  A summary of the planned  IRDM improvements is shown in table 3.
The IRDM IT systems are also intended to overcome several limitations in  IRS’s existing matching program, which will allow for better use of data,  including Form 1099-B data. For example, IRDM is planning to update  rules—criteria for selecting cases—based on prior case results and other  data. These rules are important for IRS to target the cases with potential  tax assessments.  With the existing system, rules are difficult to update.  Because this will be the first time IRS includes businesses in the document  matching program, IRS must establish rules for businesses.  IRDM is  conducting research to establish an initial rule set for tax year 2011,  according to a senior IRDM official.  As IRS gains information on business  cases, the rules are to be refined.  Eventually, according to the senior  official, they would like to use industry data on the usage of payment  cards to profile and segment business tax returns for appropriate  treatment.
IRS also plans to develop new technology to help manage individual and  business cases and, eventually, to contact business taxpayers  automatically through notices.  Additionally, IRDM is intended to enable  monthly updates and storage of 10 years worth of information return data,  thereby modernizing the existing reliance on files that cannot be updated  frequently. IRS expects to accomplish this by using the Integrated  Production Model (IPM) database to house the data that feed the matching  processes. IPM is designed to serve as a central repository for  compliance data.  It includes taxpayer data from databases known as  Master Files, which contain taxpayer and business account information.   In addition to the new matching technology, IRDM’s planned changes will  facilitate the use of data among compliance staff.  Appendix IV, figure 3  shows an overview of the planned state for information return processing  once IRDM is fully implemented.
As of May 2011, IRS was developing some details of the plans to use the  new data.  For example, IRDM officials were determining how certain  business taxpayer cases will be sent to, and worked, in IRS’s Large  Business and International division.
IRS intends for the individual AUR program to benefit from IRDM, but  potential resource limitations could affect the individual AUR program.  IRDM was developed under the assumption that the program cannot harm  the operations and production of the current individual AUR program, but  officials acknowledge some risks exist.  For example, IRDM plans  acknowledge a risk of personnel gaps in the individual AUR program if a  large number of those staff are hired into the business matching program.   IRDM plans also suggest that if funding is not received for fiscal year 2011,  staff from the individual program may be diverted from their current work  to help work in the business matching organization.  IRDM considers the  risk of not receiving 2011 funding to have a low probability of occurring  and, if it does occur, IRDM predicts a moderate impact on schedule.  As of  May 2011, according to a senior IRDM official, IRS does not plan to realign  individual AUR staff during fiscal year 2011, but a lack of funding will  impact the number of test cases IRS can complete.
section_title: Research and Testing Are Key Determinants of How Effectively IRS Will Use the New Information Return Data
paragraphs: IRS’s effective use of the new information return data to promote  compliance, particularly in initial years and for business filers, will rely  heavily on research to design the matching program, set initial case  selection criteria, and to ensure that data feeding the IT systems are  accurate.  To design the data matching program, IRS is evaluating filing  patterns of taxpayers and information return filers to determine when, and  how often, matching can be performed, according to a senior IRDM  official.
To develop initial rules for selecting businesses to contact when the  document matching program identifies discrepancies between Forms  1099-K and business tax returns, IRDM has conducted, and continues to  conduct, research on how to best identify revenue-producing business  taxpayer cases.  Specifically, IRS completed a manual review of  documents already filed by small corporations to estimate the volume,  amount, and potential tax revenue that may be collected by contacting  taxpayers about unreported income.  After contacting taxpayers about  income discrepancies, 21 percent of the cases resulted in a tax  assessment.  IRS is doing a follow-up study that will provide, among other  things, additional information on business case tax revenue, taxpayer  response rates to notices, and hours spent per case.  This research will  help establish a skeletal set of case selection criteria for 2011 data,  according to a senior IRDM official.  The results of this, and other  research, will support additional details in IRDM’s planned use of the new  data.
When the new data arrive in 2012, IRDM plans call for data quality testing,  prior to matching, on 2011 Form 1099-K data. Data quality testing could  identify potential reporting errors which industry groups are concerned  about.  The testing, and mitigating adjustments based on any errors found,  will be key to ensuring the long-term ability of IRDM’s IT systems to  identify productive cases.
section_title: IRS Has Plans to Assess Implementation and Outcomes, but Needs to Identify and Document IRDM Performance Measures Early on to Ensure Necessary Data Collection
subsections: section_title: IRDM Is Documenting Lessons Learned, but Lacks Accountability for Implementing Improvements
paragraphs: At the end of each IRDM IT project milestone IRDM produces a lessons  learned document, in accordance with IRS’s Enterprise Lifecycle  Guidance, which requires a lessons learned report at the end of each life- cycle phase.  Lessons learned can be useful tools for an organization to  identify areas of improvement as well as ways to make those  improvements.  The IRDM lessons identified at the end of Milestone 2  detail eight problem areas and ways to prevent them in the future.
IRDM does not include a plan for accountability, such as assignment of  implementation responsibility and a periodic review of the lessons learned  to ensure the improvements are implemented. For four of the Milestone 2  lessons, IRDM documented some actions to take to address each issue.   IRDM did not document those individuals or offices responsible for  implementing corrective measures or otherwise following up on the lesson  for any of the documented lessons learned. For example, in response to  challenges associated with assigning subject matter experts, the IRDM  lessons learned document states that the program should keep resource  reassignment to a minimum; however, there is no designation of who is  accountable for implementation or time frame for when this solution will  be followed up. IRS officials said they intend to follow up on lessons  learned within the next milestone, and that each program office is  responsible for ensuring that cited improvements are implemented.  Without documentation of responsibilities and follow-up on lessons  learned, program officials risk missing opportunities for improvement.
section_title: IRDM Developed Preliminary Performance Measures, but Needs a Plan to Ensure Necessary Data Collection and Effectiveness of Measures
paragraphs: IRDM planning documents list 31 preliminary performance measures for  the program. IRDM has not yet committed to a final set of performance  measures because, according to IRDM officials, they are determining how  they will use the new information.  Four of the measures are finalized.  According to an IRDM plan, they expect to have some more finalized by  August 2011, and others finalized by December 2011.
A prior assessment we did of program implementation at IRS emphasizes  the importance of developing evaluation plans prior to full project  implementation in order to ensure that the data necessary for evaluation  are collected in an efficient and timely way. Developing a written plan,  including tasks to be completed, is an important step in assuring that  necessary systems and resources are available for timely data collection.  Although IRDM has identified dates on which to begin collecting  performance measure data, officials did not provide a plan to develop and  finalize the measures. If measures are not developed early, program  managers run the risk that the necessary data for evaluation cannot be  collected, which could limit the potential for meaningful performance  management. Although developing measures early is important to most  effectively utilize performance data, we recognize that measures may  evolve over time and that the process to develop the measures may be  challenging.
The preliminary IRDM performance measures demonstrate two attributes  of effective performance measures as identified in our prior work. For  example, successful performance measures are linked with the agency’s  goals and mission.  The IRDM measures are linked to an IRDM strategy  and outcome, as well as to IRS goals.  Successful performance measures  should also be designed, where appropriate, to meet a numerical goal and  have an office or individual accountable for meeting that goal. Almost all  of the IRDM measures are quantifiable and IRDM plans assign each  measure to an organization that will be responsible for collecting and  analyzing data, such as RAS.
IRDM has not fully documented its preliminary performance measures,  making it difficult to determine whether the measures meet other  attributes of successful performance measures.  IRS could further leverage  IRDM performance measures by incorporating additional key attributes of  successful performance measurement into IRDM plans.  For example, the  current list of measures does not contain definitions for each measure.   One proposed performance measure is “taxpayer satisfaction for the  Business Master File system,” but no details are provided on how taxpayer  satisfaction will be gauged or used.  It is unclear from this description  what data IRS will be assessing and how the data will be interpreted.   IRDM plans should clearly state the name and include a description of  each measure that is consistent with the methodology that will be used to  calculate it.
IRDM planning documents do not explain how the preliminary measures  were developed. Well-designed evaluation plans should be properly  documented and consider the kind of information to be acquired, the  sources of information, the methods to be used for sampling from data  sources and for collecting information, the timing and frequency of  information collection, and the basis for comparing outcomes. IRDM has  a framework and process for how performance measures should be  defined, how to describe scope, data sources, methodology, and data  reliability. IRDM has implemented some elements of their plan for some of  the preliminary measures.  For example, six of the performance measures  have documentation that includes methodology. However, IRDM does not  identify how baseline data for any of the measures will be collected.
In addition to measuring the outcomes of IRDM, performance data are  needed to contribute to IRS’s planned efforts to measure whether cost  basis and transaction settlement reporting increases revenue and  voluntary compliance, and therefore decreases the tax gap. As of May  2011, IRDM officials have identified one preliminary performance measure  to capture the effect of the legislation on revenue, and one preliminary  measure of voluntary compliance.  According to IRS officials, it will be  challenging to isolate the effects of the legislation on both revenue and  voluntary compliance and they have not yet determined how this will be  done.  In particular, as of December 2010, they noted the challenges of  taking into account other factors that are not easily measured.  For  example, when attempting to measure the effect of the legislation on  voluntary compliance, it may be difficult for researchers to account for a  taxpayer who, for example, fails to accurately report capital gains from  non-securities investments in an effort to offset reporting the capital gains  identified on the new information returns.  IRS officials have said RAS is  working on how to capture changes in compliance behavior in response to  the new information reporting requirements.
section_title: Conclusions
paragraphs: The two new information returns have the potential to improve taxpayer  compliance. The new IRDM program could enhance IRS’s ability to use  these and other information returns and more precisely target resources  for compliance, thereby reducing the tax gap. Opportunities for  improvement exist in IRDM that could help the program achieve these  goals. For example, documenting IRDM coordination with related  servicewide projects can help prevent inefficiencies and duplicated  efforts.  In addition, reliable cost estimates can help ensure that funding  levels match the program’s needs. Moreover, clearly documenting the  assumptions and methodology for data used to inform planning decisions,  such as form volume projections, can support reliable decision making.
IRS and the cost basis and transaction settlement industries had just over  2 years to implement the reporting requirements, which made timely  communication from IRS critical. Incomplete information about the  regulations, forms, and guidance for the new requirements could adversely  affect the quality of data provided by the industries and undermine efforts  to identify noncompliance. IRS made a noteworthy effort to communicate  with industry. However, IRS could adopt additional communication  approaches.
Performance management provides a means to evaluate program  outcomes, identify improvement opportunities, and maintain  accountability. Lessons learned, which are identified at the end of each  IRDM milestone, provide ongoing opportunities to enhance the program. It  is important that IRS document its plans to follow up on these lessons so  that improvements are implemented. Further, to the extent possible, IRS  should ensure that its performance measures for IRDM have the attributes  of effective measures and that procedures to collect data are timely  developed.  A plan to establish and implement IRDM’s performance  measures would allow IRDM to move forward with fully documenting the  methodology and data sources needed to measure the impact of the IRDM  program.
section_title: Recommendations for Executive Action
paragraphs: To improve implementation of cost basis and transaction settlement  reporting, we recommend that the Commissioner of Internal Revenue take  the following seven actions:  1.  Document in IRDM plans any coordination between IRDM and the  Workforce of Tomorrow and Nonfiler Strategy projects.  IRS should  develop procedures or requirements to incorporate in IRDM planning  documents the integration between IRDM and any other servicewide  projects which could affect IRDM.  2.  For future updates to MITS’s IRDM cost estimate, ensure that the  revised estimate is developed in a manner that reflects the four  characteristics of a reliable estimate discussed in this report.  3.  Clearly document the assumptions and rationale for Form 1099 volume  projections used in resource planning decisions, and consult with RAS  when developing projections.  4.  Work with Treasury to share with the public its plans and expected  release dates for IRDM regulations and formal guidance.  IRS could  consider including information similar to what is posed on the  Department of Transportation’s or the Financial Industry Regulatory  Authority Web sites.  IRS should also include other pertinent  information regarding IRDM implementation, such as upcoming  informal guidance, including FAQs, upcoming outreach, and  description of the letter ruling process.    5.  For future releases of new or significantly revised forms, whenever  possible, release draft instructions to facilitate the most useful  comments.   6.  Document a plan to assign responsibility and establish a procedure to  follow up on the lessons learned identified after each milestone phase.  7.  Develop a plan to establish and implement IRDM performance  measures. The plan should include documentation of the process and  rationale for developing and using IRDM performance measures,  including information such as the methodology, data sources, and  targets, in order to establish that the performance measures have the  necessary attributes of efficient measures.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to the Commissioner of Internal  Revenue for his review and comment. We received written comments from  the Deputy Commissioner for Services and Enforcement, which are  reprinted in appendix V. IRS also provided us with technical comments,  which we incorporated into the report as appropriate.
IRS said it has taken actions consistent with our recommendations to  improve its implementation plans. Of our seven recommendations, IRS  explicitly agreed with three; without explicit agreement, described steps it  is taking to address two; agreed in principle with another; and neither  agreed nor disagreed with a final recommendation.
IRS explicitly agreed with our recommendations regarding its cost  estimate, form volume projections, and lessons learned. In agreement with  the recommendation to ensure that a revised MITS IRDM cost estimate  reflects GAO’s four characteristics of a reliable estimate, IRS said it  intends to update the estimate in a manner consistent with the GAO Cost  Estimating and Assessment Guide. In response to our recommendation  to clearly document the assumptions and rationale for Form 1099 volume  projections, IRS agreed that additional documentation for the 125 million  projection would have been helpful. IRS said that RAS will provide  updated estimates for use in decision making, and that it will continue to  consult with RAS when developing and documenting projections. IRS also  agreed to assign responsibility and establish a procedure to follow up on  lessons learned. In its response, IRS said it has taken steps to improve  lessons learned reports by assigning responsibility and due dates for each  lesson, which will facilitate their periodic review.
While not directly saying if it agreed with our recommendation on  documenting coordination between IRDM and servicewide projects, IRS  said it has taken steps to document coordination in the IRDM Strategic  Roadmap. Similarly, in response to our performance measurement  recommendation, IRS said that it will fine tune its current performance  measurement plan by drafting definitions for IRDM’s performance  measures and will include methodology, data sources, and targets to  ensure all necessary attributes of performance measures are captured.
IRS agreed in principle with our recommendation to, whenever possible,  release draft instructions of new or significantly revised forms.  Recognizing the value of obtaining feedback on draft instructions, IRS said  that it strives to release draft instructions as quickly as possible, but needs  to release forms early so that software developers and IRS technology  specialists can begin programming activities. We agree it is not always  possible to release draft instructions with new or revised forms, but doing  so whenever possible can help stakeholders ensure that the data reported  on such forms are appropriate and also help minimize the burden of  developing systems to report data to IRS.
IRS did not explicitly agree or disagree with our recommendation that it  share, with the public, plans and expected release dates for IRDM  outreach, regulations, and formal and informal guidance. IRS agreed that  continuous engagement of stakeholders is important and highlighted that  its Web site contains information reporting guidance, which IRS staff are  available to discuss. However, IRS said that it cannot accurately predict  release dates for formal guidance published in the Federal Register or  Internal Revenue Bulletin. IRS counsel told us this was because Treasury  reviews formal guidance, including regulations. IRS also said, as we note  in our report, that IRDM guidance projects were listed in an annual  Priority Guidance Plan published by IRS and Treasury. However, the plan  only lists projects to be completed in the coming year, without more  specific projected release dates and, for cost basis and transaction  settlement reporting, the plan provides information on regulations but not  guidance and outreach. We recognize that predicting release dates is  difficult. In a Web-based environment IRS could both note this uncertainty  and change estimated dates as necessary. Using the IRS Web site to post  expected release dates for outreach, regulations, and guidance would help  external stakeholders anticipate IRS actions and plan their  implementation of the laws.
As agreed with your offices, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date.  At that time, we will send copies of this report to the  Chairmen and Ranking Members of other Senate and House committees  and subcommittees that have appropriation, authorization, and oversight  responsibilities for IRS. We will also send copies to the Commissioner of  Internal Revenue, the Secretary of the Treasury, the Chairman of the IRS  Oversight Board, and the Director of the Office of Management and  Budget. Copies are also available at no charge on the GAO Web site at  http://www.gao.gov.
If you or your staffs have any questions or wish to discuss the material in  this report further, please contact me at (202) 512-9039 or  brostekm@gao.gov.  Contact points for our offices of Congressional  Relations and Public Affairs may be found on the last page of this report.  GAO staff members who made major contributions to this report are listed  in appendix VI.
section_title: Appendix I: Scope and Methodology
paragraphs: To address the four o Information Reporting and Document Matching (IRDM) program because  it is the program responsible for implementing cost basis and transaction  settlement reporting.  bjectives of this report, we focused on the  To assess IRS’s implementation plans for the new requirements, we  compared the Internal Revenue Service’s (IRS) plans, such as the IRDM  Strategic Roadmap and the IRDM Program Management Plan, to criteria  from prior GAO reports, the Internal Revenue Manual, and other  sources.  When possible, we looked for evidence of IRS following its  plans, but we did not broadly evaluate whether these plans and actions are  contributing to the program’s goals of increasing compliance. Because  most components of IRDM were still being developed, we used dates in  IRDM planning documents to gauge whether established time frames had  been met and IRS was meeting planned time frames.  To assess IRS’s cost  estimates to implement the new requirements, we compared IRS cost  estimates and budget plans for the implementation with GAO’s cost  estimating criteria.  To determine to what extent the estimate adheres to  the characteristics of a high-quality cost estimate, we evaluated the  Modernization and Information Technology Services (MITS) division’s  IRDM life-cycle cost estimate to assess whether it met key characteristics  identified in the GAO Cost Estimating and Assessment Guide. Our guide,  which is based on extensive research of best practices for estimating  program schedules and costs, indicates that a high-quality, valid, and  reliable cost estimate should be well documented, comprehensive,  accurate, and credible. We analyzed the cost estimating practices used by  MITS against these best practices to determine whether the IRDM cost  estimate is comprehensive, accurate, well-documented, and credible. We  then characterized the extent to which each of these four characteristics  of reliable cost estimates were met; that is, we rated each characteristic as  being either: Met, Substantially Met, Partially Met, Minimally Met, or Not  Met. To do so, we scored each of the individual key practices associated  with cost and scheduling best practices on a scale of 1-5 (Does n 1, Minimally Meets = 2, Partially Meets = 3, Substantially Meets = 4, and  Meets = 5), and then averaged the individual practice scores associated  with a given best prac cost guide, the criteria against which we evaluated the program’s cost    We  estimates, as well as our preliminary findings with program officials. then discussed our preliminary assessment results with IRDM officials an cost estimators.  When warranted, we updated our analyses based on the  agency response and additional documentation provided to us.  tice to determine the overall rating. We shared our  To determine the extent to which IRS has issued timely regulations and  guidance and undertaken outreach efforts, we interviewed IRS o the Office of Chief Counsel about the rulemaking process for both laws.  We analyzed the timing of the regulations and communication from IRS  relative to the enactment dates and effective dates of both laws.  In o to identify key issues, we examined the comment letters IRS received i response to the proposed regulations for both laws. We also reviewe Stakeholder Management and Communication Plan, which is a plan  er  developed by IRDM to manage communication with industry and oth stakeholders. We met with representatives of the Information Reporting Program Advisory Committee (IRPAC), an IRS advisory group made up of  tax professionals, as well as four private industry groups which represent  ew  companies that will be required to file information returns under the n cost basis and transaction settlement provisions; the Electronic  Transactions Association (ETA), which represents the payment card industry and third-party payment networks; the Securities Industry and  Financial Markets Association (SIFMA); the Financial Information Foru (FIF), which represents the financial technology industry; and the  Investment Company Institute (ICI), which represents the mutual fund  industry to discuss their communications with IRS and possible data  quality issues.
To examine how IRS will use the new returns to improve compliance, and  the possible effects of the implementation, we examined IRS plans  depicting the future information technology systems and IRDM business  processes for using information returns in compliance efforts, and  discussed the plans with IRS officials. To gauge whether IRS plans  consider potential data accuracy issues, we compared IRDM plans for  using the new data to GAO criteria for controlling data quality.
To analyze IRS’s plans to assess the implementation process, we reviewed the existing lessons learned documentation. To determine IRS’s plans to  assess program outcomes, we reviewed the preliminary performance  measures found in documents such the IRDM Program Management Plan  and the IRDM Strategic Roadmap. To the extent possible, we assessed thepreliminary measures against GAO’s performance measurement program evaluation criteria. We also interviewed IRS officials from the  o  Research Analysis and Statistics (RAS) division to identify efforts made t develop performance measures and measure the outcome of the program.
For each objective, we shared our assessment criteria with IRS officials,  who agreed with their relevance.  We also interviewed IRS officials in the  Small Business/Self Employed (SB/SE) division, MITS, and Forms and  Publications. We gave IRS officials an interim briefing on some of the  findings in this report.  Our work was done mainly at IRS Headquarters in  Washington, D.C. and its division office in New Carrollton, Maryland,  where the officials responsible for implementing the information returns  programs were located. To assess the reliability of the cost estimate data  that we used to support findings in this report, we reviewed relevant  program documentation, such as cost estimation spreadsheets and a  report explaining the estimate, to substantiate evidence obtained through  interviews with knowledgeable agency officials, where available. We  found the data we used to be sufficiently reliable for the purposes of our  report. We also made appropriate attribution indicating the sources of the  data.
We conducted this performance audit from June 2010 through May 20 accordance with standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and  nce  conclusions based on our audit objectives. We believe that the evide 11 in   generally accepted government auditing standards. Those  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives.
section_title: Appendix II: Changes to Cost Basis Tracking and Calculations
paragraphs: Table 4 identifies six changes to reporting requirements affecting both  brokers and issuers of stock. These changes were highlighted in comment  letters submitted by industry in response to proposed regulations.  Prior to  the legislation, brokers were required to provide some information,  including gross sales of securities, to the Internal Revenue Service (IRS)  on the Form 1099-B.  The new legislation requires that in addition to this  information, brokers are responsible for reporting adjusted cost basis  information and whether a gain or loss is long term or short term.  Major  changes to reporting requirements can be categorized as either a tracking  change or a calculation change. The tracking rules allow brokers to track  events affecting the basis amount of a security over the period of  ownership and to pass that information among other brokers, IRS, and  taxpayers. The calculation rules instruct brokers on which of the various  methodologies should be used to calculate basis and when to take into  account other tax rules that affect basis.
section_title: Appendix III: Assessment of MITS’s IRDM Cost Estimate
paragraphs: We assessed the Modernization and Information Technology Service  (MITS) group’s Information Reporting and Document Matching (IRDM)  program cost estimate to determine the extent to which it meets best  practices established by the GAO Cost Estimating and Assessment  Guide. We found that the cost estimate meets one, substantially meets  three, partially meets nine, minimally meets four, and does not meet two  best practices. Table 5 shows the extent to which the MITS IRDM Cost  Estimate meets practices.
section_title: Appendix IV: IRS’s Planned Use of Cost Basis and Transaction Settlement Data
subsections: section_title: Submissions Processing
paragraphs: Tax returns are submitted to IRS, and data from the forms are trans to the appropriate account master file. A master file contains tax data  related information pertaining to certain forms or taxpayers; the IMF  contains data on individuals, the BMF contains data on business income  taxpayers.  Information returns are submitted to IRS through the Web- based Filing Information Returns Electronically system and, eventually,  transmitted to the IRMF.  This process will be same as before IRDM was  implemented.  Master file data are then consolidated into the IPM  database.
section_title: Matching and Case Selection
paragraphs: Tax and information return data go through the assimilation process,  which does basic checks on the forms to identify basic errors such as  blank boxes on returns, or invalid Taxpayer Identification Numbers (TIN).  If a TIN is determined to be incorrect, IRS contacts the payer who must  check the TIN with records and attempt to correct the information return,  which may include notifying the taxpayer.  If the issue is not resolved, the  payer must begin backup withholding.  Next, correlation—or matching—is  done to identify discrepancies between the BMF or IMF, and IRMF data.   Under IRDM, for the first time, IRS will be matching BMF data to the  IRMF.  The matching results in a first list of potential cases, that are  grouped as underreporters or nonfilers.  For each potential case, a revenue  estimate for the case is calculated, and the master files are updated to  indicate a mismatch.  The potential case list is further refined when  statistical software and criteria for selecting the cases with the  postrevenue potential are applied.  IRDM will allow for more frequent  updates of these criteria and for information from prior cases to inform  the case selection process, which results in a final case list.  Certain cases  are sent to Large Business and International division, Examination, or  other functions.
section_title: Case Management
paragraphs: Cases are batched and given to tax examiners for a manual review, and  master files are updated.  Based on the review, the taxpayer may receive  notices from IRS asking for explanations of discrepancies between income  reported on their tax return and the information return.  In initial years of  IRDM, notices for business taxpayers will be generated by a tax examiner  or other staff; eventually those notices will be generated automatically  based on a tax examiner’s case review.  Depending on the taxpayer’s  response, a case could be resolved.
section_title: Appendix V: Comments from the Internal Revenue Service
section_title: Appendix VI: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Libby Mixon, Assistant Director;  Laurel Ball; Mary Coyle; Jennifer Echard; Ioan Ifrim; Donna Miller; Cynthia  Saunders; Stacey Steele; A.J. Stephens; and Lindsay Welter made key  contributions to this report.