Small Business: Taxpayers Face Many Layers of Requirements
Published: 1999-04-12T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Pursuant to a congressional request, GAO discussed small business tax issues, focusing on the: (1) federal filing, reporting, and deposit requirements that apply to small businesses; (2) actual experience of small businesses in meeting these requirements, including their involvement in the Internal Revenue Service's (IRS) enforcement processes; (3) burden small businesses can face in complying; and (4) IRS' efforts to reduce small businesses' compliance burden and improve customer service, especially IRS' planned reorganization.
section_title: What GAO Found
paragraphs: GAO noted that: (1) small businesses are subject to multiple layers of filing, reporting, and deposit requirements; (2) GAO identified more than 200 different Internal Revenue Code (IRC) requirements that potentially apply to small businesses; (3) the requirements reflect IRS' administration of a variety of tax and other policies; (4) GAO also found that it is highly unlikely that any business would need to comply with all or even most of these requirements; (5) those that apply would depend on how the small business is organized; (6) limitations in IRS information systems prevented GAO from fully determining the extent to which small businesses filed the various forms and schedules or their involvement in key stages of IRS' enforcement processes; (7) IRS has dozens of discrete databases, so many that it is difficult to determine what data are in them; (8) many of the IRS databases do not allow for a detailed analysis of the information they contain; (9) the limitations hinder IRS' ability to effectively manage its activities and serve small businesses and, as IRS has acknowledged, will continue to be a serious impediment until the systems are improved; (10) although IRS does not have a reliable method to measure compliance burden, there is common agreement that the burden is significant for small businesses; (11) past GAO surveys and case studies illustrate that much of the burden can be traced to the IRC itself; (12) IRS has long tried to reduce small businesses' compliance burden and improve customer service to these taxpayers; (13) IRS also has worked to make filing and reporting easier and to increase IRS employees' expertise and understanding of small business tax issues and practices; (14) most recently, IRS has begun an extensive modernization effort that is intended to substantially improve customer service, thereby making it less burdensome for small businesses and other taxpayers to meet their tax obligations; (15) one of the most visible signs of IRS' commitment to improve its services to small businesses is the establishment of a separate operating unit dedicated to this group of taxpayers; (16) IRS will need to consistently follow results-oriented management principles, integrate the principles into its day-to-day activities and culture, and hold managers at every level accountable for doing the same; and (17) IRS must develop and use organizational and individual performance systems that support IRS' new mission statement and implement information systems that support customer service management in a reorganized environment.

section_title: Letter
paragraphs: Small businesses—a category that includes sole proprietorships, partnerships, S corporations, and corporations with assets less than $5 million—are an important segment of taxpayers that are subject to substantial federal tax requirements. Not only do they account for nearly half of all taxes the Internal Revenue Service (IRS) collects annually, but they also have extensive interactions with IRS about some very difficult and complex issues. many layers of complex and confusing regulation that attend such provisions.
IRS has long tried to reduce small businesses’ compliance burden and improve customer service to these taxpayers. For example, IRS has used targeted mailings, expanded toll-free telephone service, experimented with one-stop shopping, and sponsored seminars and other face-to-face educational outreach. IRS also has worked to make filing and reporting easier and to increase IRS employees’ expertise and understanding of small business tax issues and practices.
Most recently, IRS has begun an extensive modernization effort that, among other things, is intended to substantially improve customer service, thereby making it less burdensome for small businesses and other taxpayers to meet their tax obligations. One of the most visible signs of IRS’ commitment to improve its services to small businesses is the establishment of a separate operating unit dedicated to this group of taxpayers. However, as IRS has acknowledged, reorganization alone will not change IRS’ business practices or the way the agency treats taxpayers. As part of its reform efforts, IRS also will need to consistently follow results-oriented management principles, integrate the principles into its day-to-day activities and culture, and hold managers at every level accountable for doing the same. IRS also must develop and use organizational and individual performance systems that support IRS’ new mission statement and implement information systems that support customer service and management in a reorganized environment.
subsections: section_title: Small Business: Taxpayers Face Many Layers of Requirements
paragraphs: Mr. Chairman and Members of the Committee: I want to thank you for inviting me here today to discuss small business tax issues. As the Internal Revenue Service (IRS) is reorganizing into four operating units, one of which is dedicated to small businesses, the agency faces critical challenges in meeting the needs of taxpayers and its managers and employees.
As my testimony underscores, small businesses are an important category of taxpayers. Not only do they account for nearly half the total taxes collected annually, but they also have extensive interactions with IRS about some very difficult and complex tax issues. As you requested, we focused on federal taxes in relation to four types of small businesses (including farmers)—sole proprietorship, partnership, S corporation, and corporation. My remarks today concern (1) the federal filing, reporting, and deposit requirements that apply to small businesses; (2) the actual experience of small businesses in meeting these requirements, including their involvement in IRS’ enforcement processes; (3) the burden small businesses can face in complying; and (4) IRS’ efforts to reduce small businesses’ compliance burden and improve customer service, especially IRS’ planned reorganization.
My statement today is based on our ongoing small business tax work for the Committee. To develop the information, we reviewed IRS forms, publications, manuals, and related Internal Revenue Code (IRC) provisions; collected and analyzed relevant data; and interviewed agency officials who were cognizant of small business tax issues and IRS’ efforts to improve small business customer service and reduce compliance burden. We also drew from our past reports and testimonies and our current work related to small business tax issues.
We experienced several limitations during the course of our work. As described later in this statement, much of the data we sought to obtain were not collected in IRS information systems or were not sufficiently reliable. To obtain and analyze the available data, we often had to rely upon sampling, matching, and ad hoc techniques. In addition, data were not available for a single year across all variables, so we had to use data from different years as needed. We did not verify the reliability of IRS data used in this testimony, except for some limited checking described in the statement. Lastly, our review did not address IRS activities related to small business nonfilers.
subsections: section_title: Background
paragraphs: Businesses established in the United States (including farmers) are generally structured in one of four forms: sole proprietorship, partnership, S corporation, or corporation. The IRC distinguishes small businesses from larger businesses in a number of ways, and IRS has used different definitions of small business for different internal operating purposes.
Now, as part of its current reorganization effort, IRS is developing an agencywide definition of small business, which we have adopted for this testimony. Small businesses (including farmers) are sole proprietorships, partnerships, S corporations, and corporations that reported less than $5 million in assets. In this context, a large majority of all businesses are small businesses.
section_title: Small Businesses Face Multiple Layers of Tax Requirements
paragraphs: Small businesses, like large businesses, are subject to multiple layers of filing, reporting, and deposit requirements that reflect how the business is organized, whether it has employees, and the nature of its business operations. By our count, there are more than 200 requirements—which we grouped into four layers—that may apply to small businesses as well as larger businesses and other taxpayers. The requirements are designed to implement a variety of tax policies. Not only do they provide a way to collect taxes from businesses, but also to use businesses to collect taxes owed by third parties (e.g., employees’ personal income tax withholding and Social Security and Medicare (FICA) taxes).
In contemplating the significance of the total number, it is important to know that many of the requirements apply to businesses generally and that it is highly unlikely that any business would need to complete all 200 requirements. This is because the forms, schedules, and other requirements that apply to a particular small business reflect how the business is organized, whether it has employees, and the nature of its business operations. It is also important to note that although a few of the requirements must be submitted more frequently than once a year, the vast majority is submitted annually. Appendix I provides a listing of all the requirements that we identified. Also, as described later in this statement, the requirements reflect the decisions and compromises of Congress and Administrations in keeping with their policy goals and objectives.
subsections: section_title: Primary Income Tax Returns Represent One Layer of Requirements
paragraphs: The requirements with which a small business must comply depend upon how it is organized—sole proprietorship, partnership, S corporation, and corporation. Each business type has its own primary income tax return, some of which include a set of schedules embedded in the form. For example, the primary corporate income tax return, Form 1120, U.S. Corporation Income Tax Return, contains eight embedded schedules. To further support their primary income tax return, certain types of businesses and individuals with business income must also attach a mandatory schedule to their return. (See table 1.) For example, sole proprietorships must file Form 1040, U.S. Individual Income Tax Return and Schedule C, Profit or Loss from Business. As pass-through entities, partnerships and S corporations each have two separate sets of returns– one for the entity and one for its owners. In addition to the primary income tax return filed by the entity, each owner must file a Form 1040 and a Schedule E, Supplemental Income and Loss.
section_title: Employment Tax Adds a Second Layer of Requirements
paragraphs: A small business’ decision to hire employees adds a second layer of tax requirements. We identified more than 10 different federal employment tax requirements that potentially apply to small businesses. The number of employment tax filings and deposits depends on the number of employees and the resulting employment tax liability owed at a particular time. (See table 2.) For each employee, a small business is generally responsible for collecting and remitting several federal taxes with varying frequency stipulations–withholdings for employees’ personal income tax along with the employer’s matching amount, FICA, and federal unemployment tax (FUTA).
A small business employer must report quarterly the amount of personal income tax withheld and FICA paid for each employee on Form 941, Employer’s Quarterly Federal Tax Return. The employer must deposit income tax withheld, including the matching amount, and FICA taxes either by mail or electronically either quarterly, monthly, weekly, or the next business day, depending on the employers’ tax liability. If total deposits of withheld income taxes and FICA taxes were more than $50,000 in the preceding year, the employer must make electronic deposits using the Electronic Federal Tax Payment System (EFTPS). In addition, a small business employer must annually report and quarterly deposit FUTA taxes separately from FICA and withheld income tax. Lastly, an employer must send a federal Form W-2, Wage and Earnings Statement to each of its employees and file federal Forms W-3, Transmittal of Wage and Tax Statements and W-2 with the Social Security Administration. In sum, hiring employees—even just one employee—is a critical decision for small businesses in terms of their tax liability and the complexities of the tax administration processes that they face.
section_title: Offering Employee Benefits Adds a Third Layer of Requirements
paragraphs: The decision to offer employee pension, fringe, and welfare benefit plans adds another layer of requirements for a small business. Some benefit plans may substantially increase the number of filing requirements that small businesses face, while others are simplified and entail few if any filing requirements. We counted over 10 filing and reporting requirements pertaining to benefit plans, including requirements like the Form 5500 series and related schedules. filing and reporting requirements with IRS (Form 5500 series). In addition, most fringe and welfare benefit plans entail filing and reporting requirements with IRS (Form 5500 series). (For a complete list see table I.3 in app. I.)
section_title: Other Business Operations Add a Fourth Layer of Requirements
paragraphs: The remaining tax requirements that potentially apply to small businesses depend upon the nature of the business activities. A few of these secondary requirements are specific to a type of business, but most are generally applicable to all businesses. For example, there are requirements that pertain to the depreciation of assets, the sale of business property, and claims for a credit to increase research activities. These requirements, of which there are nearly 140, range across income taxes, excise taxes, and information reporting. (For a complete list see tables I.4, I.5, and I.6 in app. I.) Some of these requirements are used to implement provisions in the IRC (some of which were recently enacted) that can benefit small (and other) businesses. For example, businesses must complete Form 8861, Welfare-to-Work Credit, to receive a tax credit for hiring long-term family assistance recipients. Also, businesses must complete Form 4562 to claim deductions for depreciation and amortization of business assets or to make the election to immediately expense the cost of certain property. The election to expense property allows the taxpayer to take an immediate deduction instead of using the depreciation schedules to recover a portion of the costs annually over the property’s useful life. (The total cost that may be expensed is $18,500 for 1998).
Among excise taxes alone, we identified about 70 requirements that potentially apply to small businesses. (For a complete list see tables I.5 and I.6 in app. I.) Generally, though, most small businesses are not responsible for filing excise taxes. According to IRS, fewer than 800,000 small businesses filed excise tax returns in 1997. IRS and the Bureau of Alcohol, Tobacco and Firearms (ATF) administer many of the federal excise taxes. The excise taxes administered by IRS consist of several broad categories, including environmental taxes, communications taxes, fuel taxes, retail sale of heavy trucks and trailers, luxury taxes on passenger cars, and manufacturers’ taxes on a variety of different products. ATF administers excise taxes on the production, sale, or import of guns, tobacco, or alcohol products or the manufacture of equipment for their production.
section_title: Small Businesses’ Experience in Filing and Enforcement Processes Could Not Be Fully Determined
paragraphs: Limitations in IRS’ information systems prevented us from fully determining the extent to which small businesses actually filed various required forms and schedules and which businesses made deposits, or determine the extent of small businesses’ involvement in IRS’ enforcement processes. We were, however, able to obtain and analyze limited data on small business filings of income tax forms in 1995. As we discuss in detail in the final section of this statement, the data limitations currently hinder IRS’ ability to effectively manage its activities and serve small businesses and, as IRS has acknowledged, will continue to be a serious impediment until the systems are improved.
subsections: section_title: Information Systems Significantly Limit Access to Data
paragraphs: The first problem we encountered pertained to locating information that we needed. IRS has dozens of discrete databases -- so many that it is difficult to determine what data are in them, what the data mean, how the files are structured, or even how many files there might be. The databases are function-specific (e.g., Examination) and designed to reflect transactions at different points in the life of a return or information report—from its receipt to its disposition. As a consequence, IRS does not have any easy means to access comprehensive information about taxpayers or their accounts in order to provide high quality customer service.
Second, many of the IRS datasets do not allow for a detailed analysis of the information they contain. We were unable to separate out the four types of small businesses in some the datasets. For example, the Form 941 that employers are to use to file their employment taxes does not have information on business assets or gross receipts that would have allowed us to categorize employers by size. Without this information, our alternative was to use information from the Business Master File. Accessing the appropriate tax module in that file might have made it possible to capture information on assets. could have taken many months for the agency to complete. Thus, we decided not to request IRS to make the extractions.
section_title: Filing Experience of Small Businesses
subsections: section_title: Income Tax
paragraphs: Although we weren’t able to obtain data on most types of requirements, we were able to obtain information pertaining to small business income tax requirements. Our analysis of 1995 IRS data for approximately 44 forms and 46 related schedules that IRS believes are those most commonly filed showed that small businesses, on average, filed one secondary form in addition to their primary income tax return, with little variation among the different types of business. The most commonly filed secondary income tax form among the 44 was Form 4562, Depreciation and Amortization. Approximately 74 percent of farmers, 62 percent of partnerships, 69 percent of S corporations, and 73 percent of corporations filed the depreciation and amortization form in 1995. The returns for sole proprietorships were lower, with slightly less than 40 percent filing the depreciation and amortization form in 1995. corporations must file a Schedule K-1, Partner’s or Shareholder’s Share of Income, with IRS for each partner or shareholder. As a result, Schedule K-1 filings accounted for a significant proportion of the multiple schedules filed by partnerships and S corporations in that year.
section_title: Employment Tax and Pensions
paragraphs: IRS does have information on federal employment taxes, but it could not be broken out by small businesses. Further, IRS did not have sufficient and reliable data on the number of small businesses that filed pension forms in 1995.
section_title: Enforcement Experience of Small Businesses
paragraphs: IRS also did not have the data we needed on the extent to which small businesses are involved in both Examination and Collection activities. We did obtain limited data on audit rates and some aspects of how the audits concluded (i.e., with refunds, no change, or recommended changes).
When IRS has indications that a small business may have failed to meet one or more of the aforementioned requirements, the business can become involved in IRS’ enforcement processes. These processes are basically the same for small businesses as for other taxpayers.  They involve examining returns for potential errors or compliance problems, notifying taxpayers of suspected discrepancies, settling disputes over additional taxes recommended, and collecting taxes assessed. (App. 2 provides a simplified picture of IRS’ audit and dispute resolution process.)
subsections: section_title: Audits
paragraphs: IRS’ primary technique for assessing compliance with tax laws is to examine the accuracy of the tax reported on filed tax returns.
In selecting returns to be audited, IRS attempts to focus on those it believes are most likely to have compliance problems. IRS data showed that about 2.3 percent of the small business income tax returns filed by small businesses in 1997 were audited, generally through audits conducted by IRS’ district offices. By contrast, IRS audited 1.3 percent of all returns filed in 1997. The audit rate for sole proprietors (individuals filing Schedule C) was 3.2 percent compared to 1.2 percent for individuals not filing Schedule C.
According to IRS officials, the audit rate for small business taxpayers is higher than the overall rate because small businesses tend to have more compliance problems than other taxpayers. For example, in the area of employment tax audits, a small business could fall short of operating capital. As a consequence, it might divert some or all of its estimated tax deposits or employment tax withholdings to make up the shortfall, hoping to pay IRS at a later date. According to IRS officials, the amount of these unpaid taxes, penalties, and interest can pyramid quickly. The danger is that a business, which must rely on these funds for working capital, is likely to have other liabilities and delinquencies that reflect financial problems so severe that it cannot recover.
Table 3 provides detailed information on the audit rates for the four types of small businesses.
Statement Small Business:  Taxpayers Face Many Layers of Requirements Size Total  Gross receipts < $25,000  Gross receipts $25,000 < 100,000  Gross receipts $100,000 and over Total  Gross receipts < $100,000  Gross receipts $100,000 and over Total Total Total  Assets < $250,000  Assets $ 250,000 < $1 million  Assets $1 million < $5 million 3.2% 3.2 2.6 4.1 1.8 1.3 2.8 0.6 1.0 2.1 1.2 3.5 7.8 About 98 percent of S corporations and 94 percent of partnerships were small businesses in 1995 (i.e., they had less than $5 million in assets, based on GAO’s analysis of IRS’ Statistics of Income data).
section_title: Recommended Additional Taxes and Penalties
paragraphs: Small business audits often result in recommendations for the assessment of additional tax and penalties. For the small business audits closed in 1995, 67 percent resulted in some recommended change to the reported tax liability or refundable credits, while about 33 percent resulted in no such changes. Some audits resulting in no change to the reported tax liability did result in changes to other return items deemed significant by IRS examiners. For example, net loss, which can be carried forward and claimed in future years, may have been overstated on the return and adjusted by IRS. Table 4 provides more detailed information on small business audit results. In considering the information presented, it is important to note that the audit recommendations do not equate to final audit outcomes. For example, recommendations may be partially or fully overturned in IRS appeals or in court decisions.
section_title: Collections
paragraphs: IRS’ Collection process starts at the point IRS identifies a taxpayer as not having paid the amount of tax due as determined by the tax assessment.First, IRS is to send a notice (or series of notices) to the taxpayers informing them of the amount owed. If the amount is not paid, IRS is authorized to employ enforcement powers to collect what is owed.
IRS can refer the delinquency to an automated collection system call site where an employee calls the taxpayer by telephone, asking for payment. The payment arrangements may include installment agreements or an offer-in-compromise from the taxpayers if the full amount owed cannot be paid.
Information about large and chronic tax delinquencies can be referred directly to one of IRS’ 33 district offices where IRS revenue officers may contact the taxpayer in person.  According to IRS officials, small businesses’ audits involving employment taxes are often referred directly to district offices.  In addition to liens and levies, IRS Collection officials have authority to seize and sell taxpayers’ property, such as cars or real estate. Seizure is generally a last resort to get payment of the amount owed and the IRS Restructuring and Reform Act (RRA) now requires a district director’s approval. We were unable to obtain information on the number of small businesses undergoing enforced collection actions (i.e., liens, levies, or seizures).
section_title: Compliance Burden Is Hard to Measure, but Significant
paragraphs: Although IRS does not have a reliable way to measure tax compliance burden or the portion attributable to small business tax requirements, there is common agreement that the burden is significant. Employment taxes present a microcosm of these requirements, the tax provisions that underlie them, and an illustration of how burdensome the requirements can be.
subsections: section_title: IRS Does Not Have a Reliable Measure of Compliance Burden
paragraphs: IRS has acknowledged that the measure of burden that it now uses to meet requirements of the Paperwork Reduction Act is inadequate, and IRS is beginning work to change it. Until IRS develops such a measure, it will be difficult for IRS or others to assess the extent to which the compliance burdens of small businesses are being reduced or increased.
Developing such a measure, including that portion that IRS can influence, will not be easy. A key problem involves defining the set of activities that contributes to burden and figuring what portion of the resources expended are the result of federal tax regulations, state and local regulations, or are part of business operations that would have been done in the absence of the requirement. Although business officials and tax experts we have interviewed for past work identified considerable anecdotal examples of such compliance costs, the businesses told us that they did not routinely need, nor did they keep, information on these costs. A reason may be that business tax compliance strategies are usually not done in isolation of other business operations. Some business activities serve multiple purposes, and it is difficult to separate out the activities conducted primarily for tax reasons. For example, businesses told us that it would be difficult to take payroll expenditures and isolate those associated with tax compliance.
To be comprehensive, any measure of compliance burden would need to include more than the resources expended to fill in the returns, forms, and schedules that we identified as being required of small business. In addition to the time and resources that small businesses expend to complete a return or schedule are the resources they expend to learn of the form and determine whether and how it might apply to their facts and circumstances. They also expend resources to collect the information necessary to complete the form and store any supporting documentation that IRS later might ask to see in connection with an inquiry or audit.
section_title: Employment Tax Requirements Illustrate the Complexity and Burden Small Businesses Can Face
paragraphs: Employment taxes are a case in point. As discussed earlier, when a business hires an employee, the business generally becomes responsible for collecting and paying personal income taxes withheld, FICA, and FUTA. To meet these requirements, employers must answer four questions: (1) Is the worker an employee covered by the tax? (2) Are the compensation payments made to the employee to be considered wages for employment tax purposes? (3) What is the employer’s employment tax liability related to these wages? (4) What are the associated deposit and filing requirements?
The answers to these questions are not always clear-cut. For example, we have identified perennial problems and inconsistencies in IRS’ administration of common law rules governing whether a worker is an employee for employment tax purposes or is an independent contractor, who is responsible for payment of such taxes. Our reviews also have pointed out the complexities in determining whether the compensation paid to the employee fits the category of nontaxable compensation for such payments as fringe benefits.
Making proper calculations of the periodic tax liability of compensation payments and meeting filing and depositing requirements also can be difficult. For the federal income tax, wages are to be withheld for each payroll period; and the amount is to be based on the amount of wages and number of allowances claimed by the employee on his or her federal Form W-4, Employee’s Withholding Allowance Certificate. For FICA, the employer is to deduct a certain percentage of the employee’s wages up to a dollar limit and a lesser percentage of wages above that amount. FUTA is paid at a different rate, but the amount paid can be reduced with credit for payments to state unemployment tax. Added to all of this, in many cases, employers will also need to make an additional set of calculations and remittances for state employment taxes.
The complexities of employment taxes were not created by happenstance. They, like other tax requirements, reflect the compromises that have been made to address assorted tax policy issues.
section_title: IRS Has Tried Many Approaches to Reduce Compliance Burden
paragraphs: With tax laws and the ensuing regulations, forms, and instructions so complicated, it is not surprising that over the years IRS has tried many different approaches to reduce the compliance burden and make it less difficult for small businesses to meet their tax obligations. IRS has used targeted mailings, expanded toll-free telephone service, experimented with one-stop service facilities dedicated to small business clients, expanded its Web site, and sponsored seminars and other face-to-face educational programs in partnership with the Small Business Administration as means to educate small business taxpayers. IRS also has sought to make filing easier by encouraging electronic filing of information returns and by establishing a nationwide telephone service that these businesses can use to file their quarterly federal employment tax returns. Through programs such as the Market Segment Specialization Program, IRS has worked to improve its employees’ capacity to deal effectively and efficiently with business tax issues affecting specific industries or market segments, including small business issues, in its enforcement processes.
Other IRS programs, including the Simplified Tax and Wage Reporting System, have been intended to reduce burden by increasing opportunities to file tax and wage forms electronically and improving coordination among federal and state tax administrators. Still other IRS programs have focused on effective and timely identification of small businesses that have not paid their proper tax so that compliance problems are resolved before they become overwhelming.
While the benefits of such programs may not yet have been realized, the Commissioner of Internal Revenue has recognized the importance of IRS’ working with taxpayers in a more proactive manner to ease these compliance burdens. He also recognizes the importance of modernizing IRS’ information systems to allow for better informed, proactive interactions with taxpayers.
section_title: Reorganization and Other Reforms Show Promise
paragraphs: organizational blueprints for the small business unit are nearly complete, and implementation blueprints are in process.
The vision of a modernized IRS is compelling, but IRS’ agenda is formidable. As IRS has acknowledged, reorganization will not, in itself, change IRS’ business processes, its culture, or the way in which the agency deals with taxpayers. Management, performance, and information systems improvements will also be critical.
subsections: section_title: Managing for Results Is as Important as Organizational Structure
paragraphs: As our past work on the Government Performance and Results Act demonstrates, IRS should follow results-oriented management principles in addition to reorganizing its structure. Our case studies of leading organizations using performance and accountability principles found that the organizations had varied structures, but similar results-oriented management strategies. These organizations placed great emphasis on clearly defined missions and desired outcomes and measuring and using information on performance. Their leaders devolved decision making and accountability, developed incentives to achieve organizational objectives, built expertise, and used an integrated approach to manage reform. They made clear their commitment to the fundamental principles of this type of management and to steps to ensure that managers and staff at all levels of the organization recognized that they must do the same.
Driving a results orientation down through all levels of the organization can be particularly important because, traditionally, the danger to such reforms is that they become hollow, paper-filled exercises. By integrating results-oriented management into the day-to-day activities and culture of the organization and holding managers accountable for doing the same, leaders can help to avoid that danger. significant a reform effort. Some of our work is being done at the request of this committee. Because we believe that a results orientation will be critical to IRS’ success, we expect to pay close attention to how IRS is progressing in this area.
section_title: Organizational and Individual Performance Measurement Systems Could Change Incentives and Help Reinforce IRS’ New Mission
paragraphs: Performance measures can create powerful incentives to influence organizational and individual behavior. In this regard, IRS recently announced a new set of organizational performance measures that it believes reflect the agency’s new customer service emphasis, while also striking a balance between customer satisfaction, employee satisfaction, and business results. IRS is now in the process of further defining and implementing the measures for organizational performance, using a phased approach.
IRS has not yet announced its approach for applying the measures to individual performance. IRS does, however, list the establishment of a new employee evaluation system as one of more than 150 short-term customer service improvements it hopes to complete by mid-2000. Doing so will be important. Unless the performance of IRS employees is based on incentives that are in accord with the agency’s new mission statement and aligned with its organizational measures, managers and front-line workers might find it easy to fall back on measures such as enforcement results and other productivity statistics—measures that have created problems for IRS in the past. Alternately, if employees come to believe that they should place disproportionate value on customer satisfaction, they might not take enforcement actions, even where appropriate, because the perceived risks of taking action might be seen to outweigh the risks of not taking action. The potential for such a pendulum swing is an additional reason for putting the systems in place expeditiously. and whether the tone of some evaluative statements discourages customer service. If this concern were borne out, IRS would need to modify the system to achieve the types of cultural change to which Congress and IRS’ leadership are committed.
section_title: Success Will Also Depend on Implementation of Information Systems to Support Customer Service and Management Needs
paragraphs: As IRS has recognized, the information systems that it uses to keep records on taxpayers’ accounts are fundamentally deficient and thwart IRS’ ability to provide high-quality customer service. For years, IRS has struggled with this problem, and we have made numerous recommendations for actions that IRS could take. As IRS begins to implement aspects of its reorganization plans, in the near term, IRS also plans to modify its existing systems so that it can better identify taxpayers’ needs in each of the four operating units. In the long term, as part of its modernization blueprint, IRS is to develop new systems and databases. This long-term effort will take several years, and even near-term efforts will pose serious challenges. In the interim, the limitations will make it more difficult to manage and improve customer service, even in a reorganized environment.
Many of IRS’ current systems reflect the agency’s stovepipe structure and transaction-based business approach.  Now that IRS is to be structured along taxpayer lines, its information systems need to reflect the new environment. They should provide managers and employees with convenient access to reliable up-to-date information on all relevant transactions between taxpayers and IRS. For example, the type of information we sought presumably would be the type that managers would need to know about small business taxpayers and understand their problems—including the source of the problems. If this kind of information about small businesses is not readily available or in a form suitable for analysis, it will be more difficult for unit managers to devise effective strategies to target resources and improve service. several delinquencies have occurred. Confusion may result over what has been paid and what remains due. Such confusion may be particularly difficult to resolve if IRS and the taxpayer are corresponding over a protracted period. Also, interest on any tax liability due would continue to accrue and could eventually come to equal or exceed the amount owed.
Employment tax situations like this illustrate how fragmented account information can make it difficult for IRS to work with taxpayers to resolve their problems and can frustrate taxpayers seeking to settle their account by paying the taxes owed. Also, the extra time and energy that the taxpayer might spend due to IRS’ systems limitations is time away from income-producing activities that an already struggling business might ill afford to miss.
IRS has said it is taking interim steps to address some of its data problems. IRS expects to develop a way of linking a customer identifier to the case information in 35 of its most important information systems. When this “workaround” is complete, IRS managers and front-line workers should know whether the return or information report data they might be using are for a small sole proprietor, partnership, S corporation, or corporation.
However, the interim solution will not provide real-time information about the full range of transactions currently ongoing for a particular taxpayer. Nor will it be easy or inexpensive to put in place. As with IRS’ initiative to make its information systems Year 2000 compliant, the workaround will affect a large number of systems and involve many steps to program, implement, and validate. Nevertheless, IRS may not have a choice as it will remain hamstrung in its efforts to assist taxpayers in complying with tax laws until its systems are replaced. without adequate systems, IRS was forced to use ad hoc programming and substantial manual intervention to overcome pervasive internal control and systems weaknesses. However, these costly and time-consuming efforts could not be duplicated for fiscal year 1998 due to IRS’ loss of key Chief Financial Officer staff who were managing the preparation of its administrative financial statements. As a consequence, IRS has received a qualified opinion from us on most of its fiscal year 1998 administrative financial statements.
section_title: Concluding Observations
paragraphs: Small businesses, like large businesses, are subject to multiple layers of filing, reporting, and deposit requirements. Together, the requirements are intended to implement a complicated mix of fiscal and other policies— some of which benefit as well as burden businesses. Although IRS does not have a reliable way to measure the full extent of the compliance burden associated with the policies, the burden is significant.
The reforms underway at IRS hold promise for small businesses and all taxpayers. One of the most visible signs that IRS may be changing is its establishment of four new operating units. However, reorganization will not be enough. As my statement underscores, management, performance, and information systems improvements will also be critical.
Mr. Chairman, this concludes my prepared statement. I would be happy to answer any questions you or other Members of the Committee might have.
section_title: Tax Requirements that Potentially Apply to Small Businesses
paragraphs: TitleForm 1040 - U.S. Individual Income Tax Return Schedule C - Profit or Loss from a Business (Sole Proprietor) Schedule C-EZ - Net Profit from Business Form 1040 ES – Estimated Tax for Individuals Form 2210 - Underpayment of Estimated Tax by Individuals, Estates, and Trusts Form 1040 - U.S. Individual Income Tax Return Form 1065 - U.S. Partnership Return of Income Schedule F - Profit or Loss from Farming Schedule J - Farm Income Averaging Form 990C- Farmers' Cooperative Association Income Tax Return Form 1040 ES – Estimated Tax for Individuals Form 2210F - Underpayment of Estimated Tax by Farmers and Fisherman Form 1065 - U.S. Partnership Return (info return only)
Schedule K1 - (form 1065) Partners Share of Income, Credits, Deductions etc. Form 1040 - U.S. Individual Income Tax Return Schedule E - Supplemental Income and Loss (part II)
Form 1040 - U.S. Individual Income Tax Return Schedule E - Supplemental Income and Loss (part II)
If business has employees (must file on magnetic media if 250 or more Form W-2s)
Schedule H (Form 1120) - Section 280H Limitations for a Personal Service Corporation (PSC) Schedule PH (Form 1120) - U.S. Personal Holding Company (PHC) Tax Form 1118 - Foreign Tax Credit (form 1120); (attached to Form 1118 are schedule I - Reduction of Oil and Gas Extraction Taxes and Schedule J - Separate Limitation Loss Allocations) Form 2438 - Undistributed Capital Gains (attach to 1120-RIC or 1120-REIT) Form 4626 - Alternative Minimum Tax-- Corporations (file with Form 1120)
Annually (unless used for a partial year)
TitleTax Information Authorization Excise Tax Return Excise Tax Return – Alcohol and Tobacco (Puerto Rico) Excise Tax Return – Alcohol and Tobacco (Puerto Rico) Specific Transportation Bond-Distilled Spirits Or Wines Withdrawn for Transportation to Manufacturing Bonded Warehouse – Class Six Specific Export Bond – Distilled Spirits or Wine Application and Permit to Ship Puerto Rico Spirits to the United States Without Payment of Tax Certification of Tax Determination - Wine Drawback on Wine Exported Drawback on Beer Exported Beer for Exportation Application and Permit to Ship Liquors and Articles of Puerto Rico Manufacture Tax paid to the United States Bond - Drawback of Tax on Tobacco Products, Cigarette Papers or Tubes Monthly Report – Manufacturer of Tobacco Products Computation of Tax Agreement to Pay Tax on Puerto Rican Cigars or Cigarettes Inventory – Manufacturer of Tobacco Products Federal Firearms and Ammunition Excise Tax Deposit Claim for Drawback of Tax on Tobacco Products, Cigarette Papers, or Cigarette Tubes Claim – Alcohol, Tobacco, and Firearms Taxes Special Tax Registration and Return (Alcohol and Tobacco) Application for Tax Paid transfer and Registration of a Firearm Application for Tax-Exempt Transfer and Registration of a Firearm Special Occupational Tax Printing Request Continuing Export Bond- Distilled Spirits and Wine Continuing Transportation Bond Distilled Spirits Or Wines Withdrawn for Transportation to Manufacturing Bonded Warehouse – Class Six Drawback Bind – Distilled Spirits and Wine Tax Deferral Bond – Beer (Puerto Rico) Certification of Prepayment of Tax on Puerto Rico Cigars, Cigarettes, Cigarette Papers, or Cigarette Tubes Report of Multiple Sales or Other Disposition of Pistols and Revolvers Firearms Transaction Record Part I Over-the-Counter Firearms Transaction Record Part I – Low Volume – Over-the-Counter Firearms Transaction Record Part I - Intra-State Over-the-Counter (English-Spanish) Firearms Transaction Record Part II – Non-Over-the-Counter Firearms Transaction Record Part II – Low Volumne – Intra-State Non-Over-the-Counter Floor Stocks Tax Return 1993 Floor Stocks Tax Return (Cigarettes) Certificate of Taxpaid Alcohol Drawback on Distilled Spirits Exported Tax Deferred Bond – Distilled Spirits Floor Stocks Tax Return – Pipe Tobacco Federal Firearms and Ammunition Excise tax Return Application for Registration for Tax Free Transactions Under 26 USC 4221 (Firearms and Ammunition) Statement of Adjustment to the Puerto Rico or Virgin Islands Tax Account Tax Collection Waiver Certification of Ultimate Vendor for Use in Tax Refund Claim Under Section 6416 (b) (2) of the Internal Revenue Code (27 CFR 53.179 (b) (iii)) Purchaser’s Certificate of Tax Free Purchase for use as Supplies for Vessels and Aircraft (27 CFR 53.134 (d) (2)) Purchaser’s Certificate of Tax Free Purchase for State or Local Government Use (27 CFR 53.135 (c) (1)) Vendor’s Certificate of Tax-Free Purchase for Resale for Export (27 CFR 53.133 (d) (2)) Vendor’s Certificate of Tax-Free Purchase for Resale for Further Manufacture (27 CFR 53.132 (c) (2)) Application for Extension of Time for Payment of Excise Tax Consent to Extend the Time to Assess ATF Excise Tax Special Tax “Renewal” Registration and Return Special Tax Location Registration Listing Special Tax Stamp Special Tax Registration and Return National Firearms Act (NFA) Special Occupational Tax Inquiry Letter IRC Guideline/Worksheet for Late Excise Payment/Deposit or Tax Return Bond for Spirits or Distilled Spirits or Rum Brought into the US Free of Tax (Used by Virgin Islands) Bond for Articles Brought into the US Free of Tax (Used by Virgin Islands)
section_title: Simplified Audit and Dispute Resolution Processes
paragraphs: This appendix illustrates a simplified process for auditing tax returns, resolving disputed taxes, and collecting taxes owed. For the small percentage of returns that are audited, most tax issues are resolved during the audit process. However, some audited taxpayers dispute their additional taxes to Appeals, and a few seek to resolve their disputes with IRS in the courts.
The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. VISA and MasterCard credit cards are accepted, also. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent.
U.S. General Accounting Office P.O. Box 37050 Washington, DC 20013 Room 1100 700 4th St. NW (corner of 4th and G Sts. NW) U.S. General Accounting Office Washington, DC Orders may also be placed by calling (202) 512-6000 or by using fax number (202) 512-6061, or TDD (202) 512-2537.
Each day, GAO issues a list of newly available reports and testimony. To receive facsimile copies of the daily list or any list from the past 30 days, please call (202) 512-6000 using a touch-tone phone. A recorded menu will provide information on how to obtain these lists.