Internal Revenue Service: Procedural Changes Could Enhance Tax Collections
Published: 2006-11-15T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: GAO previously testified that federal contractors abused the tax system with little consequence. While performing those audits, GAO noted that the Internal Revenue Service (IRS) records sometimes contained inaccurate or outdated tax information that prevented IRS from taking appropriate collection actions against those contractors, including submitting their tax debt to the Federal Payment Levy Program (FPLP) for collection. As a result, GAO was asked to review IRS's coding of tax debt excluded from the FPLP to determine whether (1) IRS tax records contain inaccurate status or transaction codes that exclude tax debt from the FPLP, (2) IRS's monitoring could be strengthened to ensure the accuracy of its status and transaction codes, and (3) other opportunities exist to increase the amount of tax debt included in the FPLP.
section_title: What GAO Found
paragraphs: IRS tax records had inaccurate information that resulted in it erroneously excluding cases from the FPLP and other tax collection actions. The FPLP is a cost-effective automated system used to collect unpaid taxes from certain federal payments. GAO estimates that as of September 30, 2005, over 500,000 tax records' equating to about $2.4 billion in tax debt--contained inaccurate codes that IRS systems used to exclude tax debts from the FPLP. Inaccuracies included tax debts coded as having active installment agreements even though the tax debtor had stopped making payments. IRS's monitoring of cases was insufficient to identify and correct the coding errors GAO identified. Additionally, IRS's monitoring of financial hardship cases is not sufficient to ensure their ongoing accuracy. IRS grants tax debtors experiencing financial difficulty a hardship designation that excludes them from the FPLP and other tax collection activities until their income increases. To measure this, IRS solely uses the income reported on the tax debtor's annual tax returns. However, IRS does not monitor those tax debtors to ensure they are filing and paying current taxes. For 31 financial hardship cases GAO examined, 24 had ceased to file tax returns. Although IRS has increased the amount of tax debt it submits to the FPLP, additional policy changes could further improve the program's effectiveness. Since 1992, IRS has almost tripled the maximum income it allows tax debtors in financial hardship to earn; raising it to $84,000 in 2004--almost double the national median income. As a result, whereas in 1992 no one earning above the median income was considered to be in financial hardship (and therefore excluded from the FPLP), in 2005 almost two-thirds of the tax debt in financial hardship was owed by individuals earning over the median income. Although a financial hardship designation may be appropriate in many situations, allowing relatively high-income tax debtors to avoid tax collection action, including the FPLP, calls into question the fair application of the tax system and may contribute to noncompliance. IRS policy also limits the amount of tax debt in the FPLP by excluding $5 billion in tax debt from the program while IRS is pursuing levies from other assets or income sources. Additionally, during notification IRS excludes individuals' tax debt from the FPLP about twice as long as legally necessary.

section_title: Letter
paragraphs: As the nation’s tax collector, the Internal Revenue Service (IRS) collects  approximately $2 trillion in taxes from businesses and individuals  annually. The vast majority of the tax revenues flow into the federal  government by voluntary payments from compliant taxpayers. However,  while most taxpayers comply with the tax laws and pay their taxes as  required, a significant number do not. At September 30, 2005, IRS’s records  reflected about $250 billion of unpaid taxes. In addition, IRS estimates that  about $300 billion in additional taxes go unassessed and therefore  uncollected every year.
IRS’s collection process is heavily dependent upon its automated  computer systems and the information that resides within these systems.  In particular, the status and transaction codes in each taxpayer’s account  in IRS’s master file taxpayer database are critical to IRS in tracking the  collection actions it has taken against a tax debtor and in determining  what, if any, additional actions should be pursued. For example, IRS uses  a specific transaction code to identify tax debtors it has designated as  being in financial hardship and who are thus unable to pay their tax debt.  IRS uses these status and transaction codes to identify cases it should  exclude from the Federal Payment Levy Program (FPLP), which is an  automated method of collecting tax debt by offsetting federal payments  made to individuals and businesses, as well as from other collection  actions.
In congressional hearings held in February 2004 and June 2005, we  testified that Department of Defense and civilian agency federal  contractors abused the federal tax system with little consequence. In those  hearings, we noted that IRS excluded significant amounts of tax debt from  the FPLP for either statutory or policy reasons, thus limiting opportunities  to automatically collect from those who had not paid their federal taxes.  While performing those audits, we noted that IRS records sometimes  contained inaccurate or outdated tax information that prevented it from  taking certain collection actions against those contractors, including using  the FPLP to collect at least some of the outstanding tax debt.
On the basis of those audits and your request, we initiated a review of the  status and transaction codes within IRS’s master file database of taxpayer  accounts to assess the accuracy of these codes and the effect inaccurate  or outdated codes in the master file database could have on the FPLP and  IRS’s other collection efforts. The specific objectives of this report were to  determine (1) whether and to what extent IRS tax records contain  inaccurate or out-of-date status or transaction codes that exclude  collection of tax debt through the FPLP; (2) whether IRS’s monitoring  policies, procedures, and practices could be strengthened to ensure the  accuracy and timely updating of its status and transaction codes; and   (3) whether opportunities exist to increase the amount of tax debt subject  to collection through the FPLP.
Tax debts may be excluded from the FPLP for either policy or statutory  reasons. To meet our objectives, we selected statistical samples of IRS’s  outstanding tax-due accounts that were excluded from the FPLP as of  September 30, 2005. We examined the underlying records to determine  whether or not IRS had documentation supporting the accuracy of the  status and transaction codes both when they were originally entered in  IRS’s systems and at the point in time of our review. We supplemented our  review of IRS records with information gathered through data mining. For  those sample items for which we determined the codes were inaccurate or  out of date, we reviewed IRS’s policies and procedures related to the FPLP  to determine whether and how IRS policies, procedures, or practices  could be strengthened to improve the ongoing accuracy of those codes  and thus increase the volume of tax debt that would be included in the  FPLP. Finally, we reviewed IRS’s exclusion categories to identify  opportunities for IRS to modify its exclusion criteria so that more tax debt  is subject to collection through the FPLP. See appendix I for more detailed  information on the scope and methodology of our work.
Our work was performed from November 2005 through September 2006 in  accordance with generally accepted government auditing standards.
subsections: section_title: Background
paragraphs: In its role as the nation’s tax collector, IRS is responsible for collecting  taxes, processing tax returns, and enforcing the nation’s tax laws. Since  1990, we have designated IRS’s enforcement of tax laws as a  governmentwide high-risk area. In attempting to ensure that taxpayers  fulfill their obligations, IRS is challenged on virtually every front. While  IRS’s enforcement workload—measured by the number of tax returns  filed—has continually increased, only recently have the resources IRS has  been able to dedicate to enforcing the tax laws begun to increase. IRS  estimates that the annual gross tax gap, that is, the difference between  what taxpayers should pay on a timely basis and what they actually pay, is  about $345 billion. IRS has reported that its enforcement activities,  coupled with late payments, recover about $55 billion of that amount,  leaving an annual net tax gap of almost $300 billion. IRS has a statutory  limitation on the length of time it can pursue unpaid taxes, generally 10  years from the date of the assessment.
The amount of cumulative outstanding tax debt that IRS has identified  either through taxpayer reporting or through its various compliance  programs is also substantial. As of September 30, 2005, IRS’s master file  database of taxpayer accounts reflected about $250 billion in cumulative  outstanding taxes owed by businesses and individuals. The amount of  unpaid taxes ranges from small amounts owed by individuals for a single  tax period to millions of dollars owed by businesses. The taxes owed  include individual income, corporate income, payroll, and other types of  taxes, as shown in figure 1.
As a part of its tax administration, IRS maintains over 24 million separate  tax debt account records in its master file database for businesses and  individuals. Within the master file database, IRS records collection actions  and the current status of tax debts through a series of codes. The codes,  referred to as status or transaction codes, display a host of information,  including the stage of the collection process the tax debt is in; the capacity  of a tax debtor to pay, such as whether a tax debtor is considered to be  experiencing financial hardship; or other data such as whether the tax  debtor is under an arrangement with the IRS to pay the tax debt in  installments. IRS uses these codes to monitor and manage its inventory of  outstanding tax debt and its tax collection efforts.
subsections: section_title: Federal Payment Levy Program
paragraphs: To improve the collection of unpaid taxes, the Congress, in the Taxpayer  Relief Act of 1997, authorized IRS to collect delinquent tax debt by  continuously levying (offsetting) up to 15 percent of certain federal  payments made to tax debtors. The payments include federal employee  retirement payments, certain Social Security payments, selected federal  salaries, and contractor and other vendor payments. Subsequent  legislation increased the maximum allowable levy amount to 100 percent  for payments to federal contractors and other vendors for goods or  services sold or leased to the federal government. The continuous levy  program, now referred to as the Federal Payment Levy Program (FPLP),  was implemented in 2000. Under the FPLP, each week IRS sends the  Department of the Treasury’s Financial Management Service (FMS) an  extract of its tax debt files. These files are uploaded into the Treasury  Offset Program. FMS sends payment data to this offset program to be  matched against unpaid federal taxes. The program electronically  compares the names and taxpayer identification numbers on the payment  files to the control names (first four characters of the names) and taxpayer  identification numbers of the debtors listed in the offset program. If there  is a match and IRS has updated the weekly data sent to the offset program  to reflect that it has completed all statutory notifications, the federal  payment owed to the debtor is reduced (levied) to help satisfy the unpaid  federal taxes.
In creating the weekly extracts of tax debt to forward to FMS for inclusion  in the offset program, IRS uses the status and transaction codes in the  master file database to determine which tax debts are to be included in or  excluded from the FPLP. For example, IRS cannot levy the assets of  individuals and businesses to recover tax debts while the tax debtor is  involved in a bankruptcy proceeding. In such cases, IRS uses the  bankruptcy status code in the master file to block the tax debt from being  submitted to the FPLP. Under other circumstances, IRS collection  personnel can enter a transaction code into the tax debtor’s tax account to  block the debt from being levied through the FPLP. Consequently, the  accuracy and appropriateness of status and transaction codes is vital to  the effective operation of the FPLP. We reported in 2004 that incorrect or  out-of-date IRS status and transaction codes in IRS’s records had  inappropriately blocked delinquent tax debt from being referred to the  FPLP.
IRS currently excludes 62 percent of all tax debt from the FPLP because of  either statutory or policy reasons. As shown in figure 2, at September 30,  2005, IRS excluded over $73 billion (29 percent) from the FPLP for  statutory reasons and about $82 billion (33 percent) for policy reasons.
Cases excluded from the FPLP for statutory reasons include tax debt that  had not completed IRS’s notification process, or tax debtors who filed for  bankruptcy protection or other litigation, who agreed to pay their tax debt  through monthly installment payments, or who requested to pay less than  the full amount owed through an offer in compromise.
Cases excluded from the FPLP for policy reasons include those tax  debtors whom IRS has determined to be in financial hardship, those filing  an amended return, certain cases under criminal investigation, and those  cases in which IRS has determined that the specific circumstances of the  cases warrant excluding it from the FPLP.
section_title: Improvements in the Levy Program
paragraphs: Since the inception of the FPLP, we have identified numerous issues that  have impeded the levy program from achieving its full potential. In  response to many of the issues we raised, IRS and other agencies have  made numerous improvements to the levy program that have contributed  to increased tax collections. IRS and FMS officials, along with Department  of Defense, General Services Administration, Office of Management and  Budget, and Department of Justice officials, created a multiagency task  force—referred to as the Federal Contractor Tax Compliance Task  Force—in 2004, primarily to address the issues raised in our 2004 report  related to defense contractors and the FPLP. The multiagency nature of  the task force reflected that the involvement of several agencies was  required for the FPLP to reach its full potential. The task force, which has  now become a semipermanent body, has worked toward its stated goals  and, along with the efforts of the individual agencies, has been  instrumental in making significant improvements in the program. For  example, the task force has achieved its goal of adding most of the  Department of Defense’s payment systems to the FPLP.
IRS, in conjunction with the task force, has made several policy changes  directed toward increasing the amount of unpaid tax debt that it is  submitting to the FPLP. For example, IRS altered its policies to include the  following tax debt in the levy program that had previously been excluded:    cases waiting in a “queue” to be actively worked by an IRS collections  official—formerly IRS blocked such cases from the FPLP for a year  each time a case entered the queue;    nearly half of the cases assigned to its Automated Collection System    most cases in the field that are being worked by an IRS revenue officer;    cases that have low dollar balances and cases for which the IRS has  been unable to locate or contact the tax debtor.
IRS has also worked with FMS to improve the process of matching tax  debtor names between FMS’s payment files and IRS’s tax debt files to  increase the number of payments and debts that are matched. This work  was important because the FPLP relies on matching both the tax  identification number and the control name in the payment to those in the  tax files to identify a federal payment for levy.
The FPLP has proved to be a cost-effective means of collecting  outstanding tax debt from tax debtors who receive payments from the  federal government, and the improvements IRS and other agencies have  made in the program have significantly increased tax collections since  2003, as shown in figure 3.
Although the FPLP collected almost $300 billion dollars in previously  unpaid taxes during fiscal year 2006, the program has an even greater  effect on total tax collections. In previous reports, we have estimated that  IRS collects three times the amount of the direct levy collections through  voluntary revenues received as a result of taxpayers responding to IRS’s  notice that their federal payments would be levied.
section_title: Coding Errors Excluded Tax Debt from the FPLP
paragraphs: To maximize the effectiveness of the FPLP as a tool to collect outstanding  federal taxes, it is crucial that IRS record and maintain accurate status  codes for all tax debt within its systems. To test the accuracy of the codes,  we selected statistical samples of tax debt excluded from the FPLP for  both statutory and policy reasons to determine if these status codes  appropriately reflected the current condition of the tax debt. Our testing of  IRS’s exclusion codes consisted of samples of 100 tax debts excluded for  statutory reasons, and 100 tax debts excluded for policy reasons as of  September 30, 2005. While our review of the sample of tax debts excluded  for policy reasons did not identify a significant number of coding errors  that would affect the FPLP, our review of the sample of tax debts excluded  for statutory reasons did. On the basis of our samples, we estimate that  over a half-million tax records with over $2.4 billion in tax debt were  erroneously excluded from the FPLP.
subsections: section_title: Errors in Statutory Exclusion Codes
paragraphs: At September 30, 2005, IRS had about $73 billion of outstanding tax debt  associated with about 9 million tax records that were excluded for  statutory reasons. As shown in figure 4, these tax records were almost  exclusively in four statutory exclusion categories: notice, bankruptcy,  offers in compromise, and installment agreements.
In reviewing the 100 tax records coded as statutorily excluded tax debt,  we identified six instances in which the records were incorrectly coded.  Table 1 presents the number of errors we found by exclusion category.
As indicated in table 1, four of the errors we identified involved tax  debtors erroneously coded as paying on an installment agreement and  thus excluded from the FPLP. In each of the four cases, IRS had not  terminated the installment agreement within 5 months after the tax debtor  stopped making agreed-to payments. Although IRS’s guidance on the  installment agreement termination process does not contain a specific  time frame, 5 months is the minimum amount of time that would elapse if  IRS’s Internal Revenue Manual requirements on terminating installment  agreements were laid out in a timeline. In one of the cases, IRS took 23  months to terminate the agreement after the tax debtor had stopped  making payments.
One error involved tax debt that had been erroneously kept in IRS’s notice  phase. The notice phase is IRS’s first phase in the tax debt collection  process and consists of a series of letters IRS sends to tax debtors  informing them of the tax debt and requesting payment. Each letter is  represented by a specific status code. The one error we identified in this  exclusion category resulted when an IRS computer programming change  in 2005 inadvertently blocked certain status codes from being updated and  thus prevented the related tax debt from exiting the notice phase. IRS  personnel took action to correct this systemic error after we informed  them of the issue.
We also found one bankruptcy-related case erroneously excluded from the  FPLP due to IRS failing to reverse a bankruptcy transaction code after the  bankruptcy had ended. According to IRS officials, IRS’s time frame for  initiating action to reverse a bankruptcy code is 30 days after bankruptcy  actions have been completed. However, in this case, the bankruptcy had  ended almost a year before the time of our review, yet IRS had not  updated the status code in the tax debtor’s account. IRS reversed the  bankruptcy code after we informed IRS personnel of the issue. However,  as a result of the error, the tax debt had been erroneously excluded from  the FPLP and all other collection action for almost a year. We found no  errors in the status codes for the five offer in compromise cases we  reviewed.
In total, the errors we found in the sample of tax records excluded for  statutory reasons equate to a 6 percent projected error rate. As a result of  these errors, we estimate that over a half-million tax records containing  about $2.4 billion in uncollected tax debt were erroneously excluded from  the FPLP.
section_title: Errors in Policy Exclusion Codes
paragraphs: At September 30, 2005, IRS had about $82 billion of outstanding tax debt  associated with about 7 million tax-period records that were excluded for  policy reasons. As shown in figure 5, tax records were excluded primarily  for three reasons: cases designated as financial hardship, cases currently  in or awaiting assignment to IRS’s collection function, and cases  designated as currently not collectible for reasons other than financial  hardship, including low-dollar cases.
IRS is authorized to exclude tax debt from the FPLP based on a policy  determination of financial hardship. Tax debt in the other two categories  is excluded on a case-by-case basis. In other words, the categories,  themselves, are not explicitly excluded from the FPLP, but individual  cases in those categories may be excluded by IRS personnel based on the  circumstances of the particular case. For example, cases that are in IRS’s  field collection status being worked by a revenue officer are generally  eligible for the FPLP; however, the revenue officer can block the tax debt  from inclusion in the FPLP when the officer determines that pursuing  other collection actions may be more effective.
In reviewing the 100 tax records coded as excluded for policy reasons, we  identified one instance in which the records were incorrectly coded. Table  2 presents the results of our review of the sampled cases.
The one coding error we found involved a tax debtor who defaulted on an  offer in compromise, but IRS did not put the tax debt into the FPLP.  Although IRS correctly coded the tax debtor as having defaulted on the  agreed-to payment terms of the offer, IRS’s system had not been  programmed to reverse the original “pending” code that IRS personnel  placed in the tax debt record while IRS was considering the tax debtor’s  offer. Even though the tax debtor had defaulted on the offer, the  unreversed pending offer code continued to exclude the case from the  FPLP. On the basis of our finding, IRS implemented a computer  programming change to reverse existing pending codes for defaulted offer  in compromise cases.
We found no errors in the cases that IRS had designated as currently not  collectible for reasons other than financial hardship. Although IRS is not  going to actively seek collection from them, these cases are generally  included in the FPLP. However, IRS tax collections personnel can exclude  these cases from the FPLP on a case-by-case basis.
Our review of the limited data IRS retains related to financial hardship  cases and our own review of the tax debtor’s financial condition using  available IRS information and outside data sources did not identify any  cases in which we believe IRS had erroneously coded a tax debtor as being  in financial hardship. However, as discussed later, we do believe that IRS’s  existing processes increase the risk that outdated status codes related to  financial hardship cases could occur and not be detected.
In total, the errors we found in the sample of tax records excluded for  policy reasons equate to a 1 percent projected error rate.
section_title: More Effective Monitoring Could Prevent Errors and Help Ensure Ongoing Accuracy of Account Status
paragraphs: IRS’s current monitoring of the ongoing status of accounts did not identify  and correct the errors in our sample. In addition, although we found no  errors in the coding of financial hardship cases, our analysis revealed that  the design of IRS’s policies for monitoring the status of such cases is not  sufficient to ensure the ongoing accuracy of hardship designations.
subsections: section_title: Monitoring Did Not Identify Tax Debt That Should Have Been Eligible for Levy
paragraphs: The coding errors we identified in our samples of tax debts excluded from  the levy program for statutory and policy reasons could have been avoided  if IRS had more effectively monitored the ongoing status of accounts to  detect and prevent delays in putting tax debt into the FPLP.
In the one case from our sample of statutory exclusions involving a  bankruptcy-related coding error, the transaction code blocking the case  from inclusion in the FPLP was not reversed within IRS’s stated time  frame. IRS policy is that bankruptcy codes should be reversed within 30  days after a bankruptcy judge has dismissed the case. In such cases, the  tax debtor again becomes liable for repaying the tax debt. IRS did not  reverse the bankruptcy code in a timely manner because the case was  repeatedly transferred to different IRS personnel without anyone taking  action to reverse the code. As a result of confusion caused by the repeated  transfer of the case within IRS and no one person having responsibility for  monitoring the disposition of the case, IRS did not recognize that the  bankruptcy code had not been reversed until we notified IRS officials  during our review of the case.
In the four coding errors we identified involving installment agreement  cases, the errors were caused by a computer programming problem— corrected in January 2006—that prevented the installment agreement  codes from automatically reversing within IRS’s systems. Generally, IRS’s  computer systems automatically begin the process to reverse an active  installment agreement code after a tax debtor fails to make two scheduled  monthly payments, but that did not happen in these cases. IRS officials  were unable to determine specifically why this occurred, and stated that  they do not monitor whether installment agreement transaction codes are  reversed within the 5-month time frame indicated by IRS’s Internal  Revenue Manual for terminating installment agreements. Until the  installment agreement code is reversed in the system, the tax debt remains  excluded from the FPLP. Had IRS been monitoring the timely termination  of installment agreements, these cases would have come to IRS’s attention  and afforded it an opportunity to investigate the cause.
Two coding errors—one statutory exclusion case and the other a policy  exclusion case—were also caused by deficiencies in IRS’s computer  programs. In the statutory exclusion case, the tax debt did not  automatically move through the notice process because IRS did not  include one of its several notice status codes in a computer programming  change. As a result, when the programming change was implemented, the  existing cases in that notice status were prevented from automatically  continuing their movement through the notice phase and into collection.
As a result, these cases remained excluded from the FPLP and other  collection actions. After we brought this case to IRS’s attention, it took  corrective action to address this programming deficiency. In the second  case, involving a policy exclusion related to a defaulted offer in  compromise, IRS continued to exclude the tax debt from the FPLP  because, although IRS personnel properly entered a code indicating a  default on an offer in compromise, IRS’s systems did not reverse the code  indicating the case had an initial pending offer. IRS had recently  implemented a programming change to the way it processes offer in  compromise-related transaction codes so that the code that reverses an  active offer in compromise transaction code also reverses any pending  offer in compromise codes related to the same tax case. However, the  programming change only affected offer in compromise cases occurring  subsequent to the date the change was implemented; it did not affect  pending offer codes that existed prior to the programming change. After  we notified IRS personnel of the error we identified, they took corrective  action to reverse the status code in this and similar cases.
section_title: Monitoring of Financial Hardship Cases Does Not Consider Tax Debtors Who Fail to File Tax Returns or Pay Current Taxes
paragraphs: As discussed earlier, in our sample of tax debt cases excluded from the  FPLP for policy reasons, we found that all 31 cases that were excluded  due to the tax debtor being designated by IRS as being in financial  hardship were correctly coded based on IRS’s existing policy and our  review of the limited documentation IRS maintained regarding the tax  debtor’s income. However, we found deficiencies in IRS’s procedures for  monitoring the ongoing status of financial hardship cases, which hinders  IRS’s ability to ensure the ongoing accuracy of the financial hardship  designation. This, in turn, could result in additional tax debt that should be  eligible for levy not being forwarded to the FPLP.
To make the determination of whether a tax debtor is facing financial  hardship and thus does not have the means to pay the tax debt, IRS  analyzes the tax debtor’s financial condition using guidelines for allowable  costs. On the basis of these guidelines, IRS officials place individuals in  one of nine income categories, or income thresholds. These thresholds  represent income level ceilings above which the tax debtor again becomes  subject to IRS’s collection actions, including forwarding of the tax debt to  the FPLP. Once IRS designates a tax debtor as being in financial hardship,  it performs an automated evaluation of the debtor’s income based upon  their annual tax return filings. Specifically, IRS compares the income  reported on the tax debtor’s tax return to the threshold level assigned to  the tax debtor. If the reported income exceeds the threshold, the financial  hardship designation is terminated and the tax debt becomes subject to  collection and can be put into the FPLP.
IRS policy discourages any other monitoring or follow-up of financial  hardship cases beyond the automated match. IRS does not routinely  update the tax debtor’s allowable expenses or perform a periodic review— such as once every 3 years—of the tax debtor’s overall financial condition.  In fact, the Internal Revenue Manual directs IRS personnel working  financial hardship cases to not request future follow-up reviews to check  on compliance with future income tax filing requirements or to update a  tax debtor’s financial condition.
Consequently, IRS relies only on the accuracy of the information reported  in the tax return filed by the tax debtor, with no review of income  information reported to IRS by third parties, such as Form W-2 and Form  1099 information reports, to assess the ongoing accuracy of hardship  designations. IRS’s procedures do not require it to remove a tax debtor  from the financial hardship status if the tax debtor fails to file a tax return,  and failing to file does not flag the case for IRS personnel to perform a  review of the financial hardship designation. Because of its monitoring  policy, when a tax debtor with a financial hardship designation does not  subsequently file an annual income tax return, IRS has no means of  determining whether the tax debtor’s financial condition has improved and  the hardship designation should be terminated. Since individuals  designated as being in financial hardship are excluded from the FPLP—as  well as all other tax collection actions—not knowing whether the hardship  designation remains valid can result in IRS inappropriately excluding the  tax debt from the FPLP.
Generally, individuals with a financial hardship designation who do not file  a tax return are treated like other nonfilers: they can be eventually subject  to review by IRS’s automated substitute-for-return process. In that review,  IRS examines other available data on the taxpayer, assesses whether a tax  return should have been filed, and estimates the amount of tax due.  However, that process generally does not occur for more than a year after  the failure to file, and only individuals who meet certain criteria are  reviewed. A financial hardship designation is not one of the criteria and,  therefore, these cases do not have a high priority.
On the basis of our review of the sample cases, ceasing to file is not an  uncommon occurrence for tax debtors with hardship designations.  Twenty-four of the 31 tax debtors designated as financial hardship in our  sample cases had ceased filing tax returns after IRS had determined the  tax debtor was in financial hardship.
IRS’s current practices also do not prevent tax debtors with a financial  hardship designation from accumulating additional tax debt by not paying  their current taxes. A financial hardship designation puts a tax debtor’s  past debt in abeyance, but the hardship designation does not automatically  exempt the tax debtor from paying current taxes. However, we found that  IRS does little to prevent the further accumulation of tax debt by these tax  debtors. Of the 31 tax debtors with financial hardship designations in our  sample cases, we found that 4 filed but had not paid income taxes  subsequent to being identified as a financial hardship case. As with not  filing a tax return, accumulating new tax debt does not cause IRS to  automatically terminate the financial hardship designation, and IRS’s  procedures allow IRS personnel to include the newly acquired tax debt  into the hardship designation, sometimes without any additional analysis  of the tax debtor’s financial condition. Thus, a tax debtor’s ever-increasing  tax debt can remain excluded from the FPLP as well as other collection  actions.
The effect of IRS’s collection policy regarding financial hardship tax  debtors who accumulate new debt is essentially to both cease collection of  old debt and not require tax debtors to pay the current taxes they owe.  Allowing such tax debtors to continually not pay current taxes without  consequence appears to be giving tax debtors with financial hardship  designations an additional exemption from paying current taxes as well as  old tax debt and may contribute to the noncompliance of other taxpayers.
In fiscal year 2006, IRS initiated a withholding compliance program that  has potential to help prevent wage-earning tax debtors from accumulating  more unpaid tax debt. The program is designed to identify individuals who  incur tax debt because they did not have their employer withhold  sufficient wages to cover their taxes due for the current year. The program  identifies those debtors and requires their employers to increase the  withholdings. However, due to resource constraints, IRS actively pursues  only a small portion of the tax debtors who underwithhold. Additionally,  while the program prioritizes cases for review, a financial hardship  designation is not a prioritization criterion.
section_title: Policy Changes Could Allow Billions of Dollars in Tax Debt to Enter the FPLP
paragraphs: IRS has significantly improved the effectiveness of the FPLP by making an  additional $28 billion in unpaid tax debt eligible for the program since  2004. However, certain changes in IRS’s policies could result in additional  billions of dollars in tax debt entering the levy program for potential  collection or entering the program earlier. Under current IRS policy, all tax  debt for which the debtor is designated as being in financial hardship,  including those debts associated with tax debtors earning relatively high  income levels, are excluded from the levy program. In addition, half of the  cases in IRS’s ACS are excluded from the program, as are all cases  throughout IRS’s notification process.
subsections: section_title: IRS Excludes Many Cases from the FPLP with Incomes Exceeding the National Median Income
paragraphs: IRS has established policies that allow it to designate tax debtors earning  up to $84,000—nearly twice the national median income of about  $44,000—as being in financial hardship. IRS is authorized to grant tax  debtors a designation of financial hardship when collection of the tax debt  would cause the tax debtor to be unable to pay his or her reasonable basic  living expenses. IRS’s Internal Revenue Manual provides examples of  financial hardship cases, such as a disabled taxpayer who lives in a modest  house that has been equipped to accommodate the disability and whose  fixed income is not sufficient to both meet his or her living expenses and  pay the tax debt. IRS has the authority to determine allowable living  expenses according to the unique circumstances of individual tax debtors;  however, unique circumstances do not include the maintenance of an  affluent or luxurious standard of living.
Once designated as being in financial hardship, the tax debtors are  excluded from the FPLP and are also exempt from any other IRS  collection action until their self-reported income rises above one of nine  designated income thresholds. Since 1992, IRS has almost tripled the  income it allows tax debtors in financial hardship to earn without pursuing  collection, but IRS does not have documentation of any data analysis that  justified the large increases. Consequently, as of September 30, 2005, about  65 percent of the tax debt in the financial hardship category was owed by  tax debtors who were allowed to earn more than the national median  income before being subject to collection actions. Of the $247 billion total  tax debt in IRS’s records, IRS is not pursuing collection of almost 10  percent of that amount—$22.6 billion—as a result of its financial hardship  determinations.
As discussed previously, IRS makes a determination as to whether a tax  debtor qualifies as a financial hardship case based on an analysis of the  amount of income earned and the allowable expenses owed by the tax  debtor. If IRS determines that a tax debtor is unable to pay the  outstanding tax liability due to financial hardship, it places a financial  hardship transaction code in the tax debtor’s account. The transaction  code is assigned one of nine subcodes (called closing codes) indicating the  income threshold level ceilings at which IRS has determined that the tax  debtor should be able to begin repaying the tax debt. Tax debtors will not  face any IRS collection action until their total positive income—roughly  equivalent to adjusted gross income—exceeds the designated income  threshold ceiling. IRS’s financial hardship income thresholds range in  $8,000 increments from $20,000 to $84,000, as depicted in table 3.
Five of the nine income thresholds included in IRS’s financial hardship  designation have upper range ceilings above the 2004 national median  household income of $44,389. Of the approximately 1.8 million tax debt  records designated as financial hardship in IRS’s unpaid assessments  database at September 30, 2005, approximately half—about 900,000—were  debts owed by tax debtors in one of the five income threshold categories  above the national median. Over 286,000 tax records—with associated tax  debt of about $6.4 billion—were for tax debtors in the top income level  threshold for financial hardship of up to $84,000.
The exclusion of tax debt from collection actions may be appropriate in  many circumstances to provide relief for those experiencing financial  difficulty. However, as shown in figure 6, $14.8 billion in tax debt (65  percent of the tax debt) in financial hardship is owed by tax debtors whom  IRS will allow to earn more than the national median household income  before they have to begin repaying their tax debt.
As shown in table 4, IRS’s income thresholds used to determine whether  tax debtors are experiencing financial hardship and therefore cannot  currently pay their outstanding tax debt have not always been this high.  IRS significantly increased each of the nine income thresholds in 1997 and  again in 2004. IRS had previously set rates in 1992. The 2004 increases  averaged 77 percent but the individual threshold increases ranged from  100 percent for the lowest threshold to 68 percent for the highest.
In justifying the large increases from previous threshold ceilings, IRS  stated that the new 2004 thresholds more accurately reflected current  economic conditions and that the new values were supported by Bureau of  Labor Statistics data and were consistent with the allowable expenses in  IRS guidance. IRS also stated that the revised income thresholds were  based on an analysis of allowable expense standards for high-cost  geographic areas considered in conjunction with current Bureau of Labor  Statistics poverty levels. Though it raised the top threshold to $84,000, IRS  had considered raising its top threshold for financial hardship to $100,000.
Other than the above statements, IRS could not provide documentation of  any data analysis that supported its reasons for the large increases since  1992. However, measures of median income raise questions about the size  of the increases to the income thresholds for financial hardship  determinations. As table 5 depicts, IRS’s increases in the financial hardship  income thresholds has had the effect of raising the maximum income  threshold from about equivalent to the national median income in 1992 to  almost twice the median income in 2004. With respect to high-cost areas,  New Jersey’s $61,359, the highest state median income in 2004, was well  below IRS’s 2004 top three income threshold levels. The lowest state  median income in 2004 was $31,500.
As a result of these large increases, almost two-thirds of all tax debtors  with IRS financial hardship designations are allowed to earn more than the  national median household income in 2004 before their unpaid tax debt  again becomes subject to IRS collection action. In contrast, in 1992, no tax  debtor with a financial hardship designation was allowed to earn more  than the median income without becoming subject to collection action.
Measures of inflation also raise questions about the size of IRS’s increases.  Bureau of Labor Statistics national inflation rate data indicate that the  effects of inflation would have justified lower increases. For example,  using inflation data from 1997 to 2004, the top 2004 threshold would have  been about $60,000, far below IRS’s $84,000 level, and would have kept  the top threshold at roughly 35 percent above the national median income  as it was in 1997.
Exacerbating the effect of IRS’s increases in its hardship thresholds was  the policy it used to implement the increases. IRS did not change the  subcodes indicating the income threshold ceilings or reexamine the  financial condition of tax debtors when it raised the income thresholds  ceilings. For example, the IRS subcodes indicating that tax debtors were in  the highest income threshold of $50,000 prior to the threshold increases  were not updated to reflect the new thresholds. Thus the tax debtors  remained in the highest income threshold and were allowed to earn up to  $84,000 before IRS would begin taking collection action. Therefore, after  the 2004 increases, the tax debtors in the top income threshold category  were allowed to earn $34,000 more annually before IRS would remove the  tax debtor from the financial hardship exclusion category and begin  pursuing collection of the outstanding tax debt. IRS neither reassessed the  financial condition of tax debtors with existing financial hardship  designations nor changed their existing designation to one that closely  matched their original income threshold amount.
Allowing relatively high income tax debtors, such as those earning $84,000,  to avoid tax collection action calls into question the fair application of the  tax system and may contribute to noncompliance by other taxpayers. In  addition, dramatically increasing the financial hardship income threshold  ceilings has effectively resulted in increasing the number of tax debtors  IRS classifies as being in financial hardship. This, in turn, reduces the  portion of IRS’s inventory of tax debt under active collection and reduces  the portion eligible for inclusion in the FPLP.
section_title: IRS Continues to Exclude Substantial Tax Debt in ACS from the FPLP
paragraphs: Although IRS made policy changes in 2004 to allow about 40 percent of the  tax debt in ACS to enter the FPLP, IRS continues to exclude the other 60  percent. The ACS is an automated call system designed to schedule and  follow up on IRS’s outgoing calls to, and incoming calls from, tax debtors.  ACS personnel’s primary activity is to contact tax debtors by phone to  attempt to collect outstanding tax debt. At September 30, 2005, the ACS  contained an inventory of about $8 billion of unpaid tax debt. To manage  the large inventory of tax debt in ACS, IRS has divided the ACS inventory  into 40 subcategories. In general, those subcategories describe the status  of IRS collection actions within ACS, such as indicating that an installment  agreement is pending or specifying a collection action that is awaiting  approval by a supervisor.
Prior to 2005, all the tax debt in ACS was excluded from the FPLP. In 2005,  in response to issues raised in our 2004 review of Department of Defense  contractors with outstanding tax debt, IRS changed its policies to allow  some of the tax debt assigned to ACS to enter the FPLP. However, IRS has  continued to exclude tax debt in 19 of the 40 ACS subcategories from the  FPLP. Those 19 subcategories contain 60 percent, or about $5 billion, of  the total tax debt in the ACS inventory. Two of the excluded  subcategories, which IRS calls R-5 and I-6, contain approximately $3.9  billion of tax debt, and involve cases in which IRS is placing a levy against  a tax debtor’s assets. These “paper” levies, as IRS refers to them to  distinguish them from automated FPLP levies, are generally one-time  levies placed against a tax debtor’s bank accounts or other financial  assets, although they can also be an ongoing garnishment of wages. FPLP  levies, in contrast, are continuous levies of all federal payments, including  federal salaries, pensions, social security, and contractor-related  payments.
IRS has the authority to levy a tax debtor’s assets to collect outstanding  tax debt. Therefore, simultaneously levying through both the paper levy  process and the FPLP would seem to be appropriate, especially since  many paper levies are one-time levies of a tax debtor’s assets. Additionally,  the FPLP is a cost-effective means of collecting from tax debtors. By  excluding tax debt from the FPLP while IRS personnel are working on a  paper levy, IRS is relegating the FPLP to a secondary role in the tax  collection process. Because of its potential, we have previously  recommended that IRS use the FPLP as one of the first steps in the IRS  collection process and keep the debt in the levy program until the taxes  are fully paid.
section_title: IRS Excludes All Tax Debt from Levy during the Notification Process
paragraphs: At September 30, 2005, IRS had excluded $25.1 billion from the FPLP  because it was in the process of notifying the tax debtor of the taxes owed.  The Internal Revenue Code prohibits IRS from levying a tax debtor’s  assets, including doing so through the FPLP, until the tax debtor has been  given time to respond to a notice from IRS that a tax debt exists. IRS’s  process of issuing a series of notice letters and waiting for the tax debtor  to respond can take 6 months for individuals. IRS excludes tax debt from  the FPLP during the entire notice phase.
For individuals, the notification process consists of sending a series of  three or four computer-generated letters with increasingly urgent language  notifying the tax debtor of the debt and requesting payment. Per the  Internal Revenue Manual, IRS waits 5 weeks between letters and up to 10  weeks after the last letter before moving the tax debt into one of IRS’s  active collection statuses such as ACS. Consequently, the notification  process can take up to 6 months or longer to complete, during which time  IRS excludes the tax debt from other collection activity, including the  FPLP.
Although IRS excludes all tax debt from the FPLP during the entire notice  process, legally, tax debt could be included in the FPLP in about 3  months—about half way through the general notice process for  individuals. IRS must allow the tax debtor 90 days after notification of a  potential tax debt liability to respond. If IRS does not receive a response  within that period, it can issue a notice of tax deficiency and demand for  payment. If the tax debt is not paid within 10 days after notice and demand  for payment, IRS can initiate the procedures for levy, including forwarding  the tax debt to the FPLP. Under this scenario, IRS could forward tax debt  to the FPLP about 14 to 15 weeks after the first notice is sent to the tax  debtor, and IRS could fulfill its statutory requirement with only two  notices before initiating the levy process. For business tax debt, IRS  essentially follows this sequence. The notice process for business tax debt  consists of only two notices and is generally completed in about 15 weeks,  at which time the tax debt can be included in the FPLP.
In addition to putting tax debt into the FPLP sooner in the overall tax  collection process, IRS could potentially enhance the tax collection  potential of notices by informing the tax debtor early in the process of  sending notice letters that unpaid tax debt can be subject to levy. As  shown in figure 7, about 70 percent of tax collections resulting from notice  letters are received as a result of IRS’s first notice letter. Very little is  collected from subsequent notices until the last notice letter, which  includes specific language of IRS’s authority to levy or place a lien on the  tax debtor’s property.
The FPLP is a powerful tool for encouraging collection that goes beyond  the direct taxes collected through federal payment levies. We have  previously estimated that the threat of a levy brings in over three times  more collections than the levy itself. IRS could take advantage of this  potential during the notice phase if it were to inform tax debtors early in  the notice process that their tax debt could be included in the FPLP.
section_title: Conclusions
paragraphs: Although the collection of taxes is always important, it takes on added  prominence in times of severe budgetary uncertainty. As the nation’s tax  collector, IRS must seek out and utilize the most cost-effective means of  collection at its disposal and apply those means to the broadest  application of tax debt. The FPLP is a cost-effective program that has  enabled IRS to greatly increase collection. The program’s full success is  dependent on the accuracy of IRS’s status and transaction codes as well as  the appropriateness of IRS’s policies, procedures, and practices regarding  the exclusion of tax debt from the FPLP. Improvements are needed in both  arenas. The errors we identified in the status and transaction codes of tax  debt cases highlight potential problem areas that have led to tax debt  being inappropriately excluded from levy action and therefore require  IRS’s attention. With regard to its current policies, IRS continues to  exclude over 60 percent of all tax debt from the FPLP and does not appear  to have fully adopted our previous recommendation to use the FPLP as  one of the first steps in the tax collection process. Viewing the FPLP as a  primary and efficient collection tool could lead IRS to reevaluate its FPLP  exclusion policies and to reduce the extent and length of time tax debt is  excluded. Such changes hold the potential to subject billions of dollars in  additional tax debt to the FPLP, thus increasing the government’s chances  of collecting some of this tax debt.
IRS faces tough challenges in balancing its tax collection activities against  its available resources. In times of tough budgetary constraints, this can  provide an incentive to close cases quickly or otherwise reduce the active  tax collection inventory, possibly at the expense of maximizing tax  collections. While reducing the number of active cases does, in fact,  reduce the resources required, it can also have the effect of reducing  collections, diminishing compliance, and eroding the public’s confidence  in the fairness of the tax system. For instance, in financial hardship cases,  beyond those tax debtors granted relief from paying tax debt due to  unexpected financial difficulty, each tax debtor who is allowed to avoid  filing required tax returns or paying current taxes, or who is perceived to  live well while facing little tax collection consequence, represents not only  less money for vital federal programs but one more advertisement for  others to do the same. Therefore, in setting financial hardship or other tax  collection policies, it is incumbent upon IRS to be particularly judicious in  setting income threshold levels and monitoring tax debt to ensure that it is  acting fairly toward all taxpayers.
section_title: Recommendations for Executive Action
paragraphs: To increase the amount of tax debt eligible for, and to expedite the entry  of tax debt into, the FPLP, we recommend that the Commissioner of  Internal Revenue take the following actions:    monitor the timely termination of defaulted installment agreements to  help ensure tax debt is made available to the FPLP as soon as possible;    place tax debt in the notice phase into the FPLP as soon as legally    consider adding language to IRS’s second communication in the notice  process informing the tax debtor that IRS has the authority to collect  the debt by levying the tax debtor’s income and assets if the tax debt is  not paid voluntarily; and    modify FPLP exclusion policy to allow tax debt in ACS subcategories  R-5 and I-6 that is being considered for a levy on financial assets  through paper levies to be concurrently included in the FPLP.
To help ensure that IRS’s financial hardship FPLP exclusions are  appropriate, we recommend that the Commissioner of Internal Revenue  take the following actions:  reevaluate whether the dollar ranges for existing financial hardship  income thresholds, especially those that exceed the national median  income, are appropriate and reasonable;    consider changing the financial hardship closing codes for tax debtors  designated as being in financial hardship prior to the 2004 income  threshold increases to a closing code that most closely corresponds to  the originally designated income threshold—for example, tax debtors  who were in a threshold of $50,000 prior to the change would be given  a different subcode (closing code) so that the tax debtor’s income  ceiling stays as close to the original $50,000 ceiling as possible under  the new income thresholds;    establish a policy so that in implementing future financial hardship  income threshold changes, tax debtors’ financial hardship subcodes  (closing codes) are changed to ones that maintain the tax debtor’s  income ceiling as close as possible to the ceiling prior to the change;    establish a policy to review tax debtors’ financial condition periodically  to verify the continued validity of the financial hardship designation;    evaluate the ongoing validity of the financial hardship designations  whenever tax debtors fail to file their annual tax returns by comparing  third-party income information to the tax debtors’ designated financial  hardship income threshold ceilings; and  refer tax debtors with a financial hardship designation to IRS’s  withholding compliance program for special attention if those tax  debtors do not pay their current income tax obligations.
section_title: Agency Comments and Our Evaluation
paragraphs: In commenting on a draft of this report, IRS noted improvements made to  the FPLP and the extent to which such improvements have resulted in  increased collections while at the same time ensuring that taxpayer rights  have been protected. IRS also described several initiatives it had  undertaken to improve its program for taxpayer accounts classified as  currently not collectible, including a study to determine whether changes  to IRS’s allowable living expense tables, used in the determination of  financial hardship status, would be appropriate given the availability of  additional economic data. We made 10 recommendations: IRS agreed with  5, partially agreed with 2, and disagreed with 3. We modified the 2  recommendations with which IRS partially agreed in order to address  issues raised by IRS while retaining the intent of our recommendations.
With respect to the four recommendations we made to either increase the  amount of tax debt eligible for the FPLP or expedite the entry of tax debt  into the FPLP, IRS agreed with one recommendation, partially agreed with  another, and disagreed with the remaining two recommendations. IRS  agreed with our recommendation that it monitor the timely termination of  defaulted installment agreements, and noted it would identify those  taxpayer accounts in installment agreement status but which show no  payment activity within the last 60 days and determine if it needs to  change the way it monitors installment agreements. While IRS disagreed  with our recommendation that it add language about its legal authority to  levy income and assets to its first notice letter, it stated that it would  consider adding stronger language regarding possible enforcement activity  in subsequent collection notices. As an explanation for its reluctance to  include this course of action in the event of nonpayment, IRS noted that it  had received criticism in the past for early aggressiveness and not  affording taxpayers an opportunity to voluntarily satisfy their liability.  While IRS is not legally precluded from providing language concerning its  enforcement powers in the initial taxpayer notice, we understand IRS’s  desire to attempt to provide sufficient opportunity for taxpayers to  voluntarily comply with their tax obligations without threat of  enforcement action. Accordingly, we have modified our recommendation  to add informative language about IRS’s levy starting with the second  taxpayer notice rather than the first. The important point to us is that IRS  inform the tax debtor of its levy authority earlier in the process.
IRS disagreed with our recommendation that it place tax debt in the notice  phase into the FPLP as soon as legally possible, stating that it believed its  current notification process was the most cost effective. In stating its  position, IRS noted that over three-fourths of tax debtors pay their tax  debt after receiving the first notice, and that it believed the action  recommended is not appropriate for individual taxpayers who have a high  payment rate during the notice process. We do not believe that our  recommendation would diminish the effectiveness of IRS’s notice process,  especially the voluntary tax collections resulting from the first notice. In  fact, those tax debtors who would typically pay their debt upon receipt of  the initial notice would be unaffected by the action we are recommending.  Although implementing our recommendation would allow IRS to begin  levy procedures during the notice phase, in practice, the tax debt generally  would not be levied before IRS completes the notice phase. As we discuss  in our report, tax debt could be included in the FPLP about three months  after IRS notifies the tax debtor of the tax liability, giving the tax debtor  sufficient time to respond to both the first and second notices before the  levy process would actually commence. Additionally, once the levy  process begins, IRS must still send the tax debtor a Collection Due  Process notice and wait about two and one-half months before levying a  payment through the FPLP. Consequently, tax debt would not generally be  levied before the notice phase is completed. However, by starting the levy  process during the notice phase, IRS would be able to begin levying  payments earlier than would otherwise be the case if the tax debtor does  not voluntarily fully pay or otherwise resolve the tax debt during the  notice phase because IRS would not have to continue to delay levy action  while it issues the Collection Due Process notice and waits for the tax  debtor to respond.
IRS also disagreed with our recommendation that it modify its FPLP  exclusion policy to allow tax debt in two subcategories of its ACS to be  eligible for the FPLP, citing concern that this could result in duplicate  levies and thereby create unanticipated hardships for taxpayers. IRS also  noted that it attempts to issue levies on cases within these ACS  subcategories that could generate more in collections than would be  collected through the FPLP due to the program’s limit of 15 percent of  each federal payment made to the tax debtor. We do not believe these  concerns have merit. We believe that IRS’s current process for manually  blocking tax debt from the FPLP would provide a sufficient safeguard  against duplicate levies while at the same time preserving adequate  flexibility for other collection actions. As we discuss in our report, IRS has  the ability to block, and, on a case by case basis, does block individual tax  debt accounts from levy through the FPLP. IRS could apply this same  approach to these two ACS subcategories. To manually block tax debt  from the FPLP, IRS can place a transaction code in the tax debtor’s  account that blocks the FPLP from automatically levying the tax debt. The  same transaction code can be placed in the tax record if IRS wants to levy  more than the 15 percent allowable under the FPLP. This process would  allow IRS to increase the effectiveness of the FPLP while preserving its  ability to use paper levies when appropriate and minimizing the risk of  duplicate levies.
With respect to the six recommendations we made to help ensure that  IRS’s financial hardship FPLP exclusions are appropriate, IRS agreed with  four recommendations, partially agreed with one recommendation, and  disagreed with the remaining recommendation. Specifically, IRS agreed  with our recommendations to (1) reevaluate whether the dollar ranges for  existing financial hardship income thresholds are appropriate and  reasonable; (2) establish a policy that when future financial hardship  thresholds are changed, tax debtors’ hardship closing codes are changed  to ones that maintain the tax debtor’s original income ceiling; (3) evaluate  the ongoing validity of financial hardship designations whenever tax  debtors fail to file their annual tax returns; and (4) refer tax debtors with a  financial hardship designation to IRS’s withholding compliance program  for special attention if those tax debtors do not pay their current income  tax obligations. Although IRS agreed to reevaluate whether the dollar  ranges for existing financial hardship income thresholds are appropriate  and reasonable, it raised concerns that imposing a rigid national median  amount would disregard circumstances such as family size, medical needs,  and geographic variations in average income. It is important to note that  our recommendation does not advocate imposing the national median  amount as a rigid maximum threshold limit. We recognize that IRS  attempts to accommodate the needs of tax debtors with varying family  sizes, geographical locations, and various other circumstances. However,  as our report discusses, between 1992 and 2004, IRS raised its top financial  hardship income threshold ceiling from an amount equal to the median  national household income to an amount almost twice the median income  without any detailed analysis supporting either the large increases or the  deviation in the relationship of these thresholds from the national median  income.
While IRS disagreed with our recommendation that it establish a policy to  review tax debtors’ financial condition every 3 years to verify the  continued validity of the financial hardship designation, IRS did agree to  consider including a time factor. Specifically, IRS noted that as part of its  initiatives to improve its program for taxpayer accounts classified as  currently not collectible, of which financial hardship is a significant  aspect, it will consider including a time factor. Accordingly, we have  modified our recommendation, replacing “every 3 years” with  “periodically” to reflect IRS’s willingness to consider including a time  factor for reviewing a tax debtor’s financial condition. However, in  deciding upon the time factor to use, we believe that IRS should take into  account that tax debt is typically only legally available for collection for 10  years. Thus, implementing a time period of greater than 3 years could  result in IRS affording itself only one opportunity to reconsider the validity  of the financial hardship designation.
Finally, IRS stated that it could not agree with our recommendation that it  consider changing the financial hardship closing codes for tax debtors  designated as being in financial hardship prior to the 2004 increases it  implemented in the income thresholds until it has determined how many  tax debt accounts would be affected by the recommendation. IRS said that  implementing the recommendation to change existing closing codes would  require significant computer programming and system changes that it may  not be able to implement, and which may not be cost effective. Our  recommendation is for IRS to consider changing the hardship closing  codes for the affected accounts; we are not recommending that IRS must  do so. Implicit in our use of the word “consider” in our recommendation is  a cost-benefit determination. In considering whether to change the  hardship closing codes, IRS should take into account the work and cost  involved in making this change as well as the potential for increased  collections in determining the cost effectiveness of any modifications.  However, we do believe that IRS erred in not changing the financial  hardship closing codes for existing cases when it implemented the 2004  increases in the income thresholds. As discussed in our report, by not  changing the closing codes, IRS allowed tax debtors who it previously  believed could begin paying off their tax debt at a certain income  threshold to immediately begin earning up to, on average, 77 percent more  before IRS would hold them liable for their tax obligations. This created  the potential for inequitable treatment between taxpayers in these same  income brackets who pay their taxes and tax debtors who do not,  especially when some of those tax debtors, on the day IRS changed the  thresholds, were thereafter allowed to earn up to $34,000 more income  without IRS considering whether they continued to warrant the hardship  designation. Consequently, in considering whether or not it is cost  effective to implement a change in the closing codes of the effected  accounts, IRS should also consider the issue of fairness with respect to the  taxpayer population as a whole.
We are sending copies of this report to the congressional committees with  jurisdiction over IRS and its activities, the Secretary of the Treasury, the  Commissioner of Internal Revenue, and interested congressional  committees and members. We will also make copies available to others  upon request. In addition, this report will be available at no charge on the  GAO Web site at http://www.gao.gov.
If you have any questions about this report, please contact me at (202) 512- 3406 or sebastians@gao.gov. Key contributors to this report are listed in  appendix III. Contact points for our Offices of Congressional Relations and  Public Affairs may be found on the last page of this report.
section_title: Appendix I: Scope and Methodology
paragraphs: To determine whether and to what extent Internal Revenue Service (IRS)  tax records contain inaccurate or out-of-date status or transaction codes  that exclude them from the Federal Payment Levy Program (FPLP), we  used IRS’s unpaid assessments database as of September 30, 2005, to  select two statistical samples. We used IRS’s criteria for the statutory and  policy exclusions from the FPLP to segment the tax records in the unpaid  assessments database into the two categories. The population of statutory  exclusions consisted of 9,068,508 tax records that contained tax debt of  $72,167,432,455. The population of policy exclusions consisted of 7,183,880  tax records that contained tax debt of $81,492,531,369. We selected a  statistical sample of 100 tax debts that were excluded from the levy  program based on IRS’s designation of their tax record as being excluded  because of a legal—statutory—requirement of the Internal Revenue Code.  We also selected a statistical sample of 100 tax debts that were excluded  from the levy program based on IRS’s policy determinations.
We randomly selected probability samples from the populations of tax  debt accounts excluded from the FPLP for statutory reasons and policy  reasons. With these probability samples, each tax account in each of the  populations had a nonzero probability of being included and that  probability could be computed for any account. Each sample tax account  selected was subsequently weighted in the analysis to account statistically  for all the tax accounts of its respective population. The sample we  selected from each population was only one of a large number of samples  that we might have drawn because for each sample we followed a  probability procedure based on random selections. Since each sample  could have provided different estimates, we express our confidence in the  precision of each sample’s result as 95 percent confidence intervals, which  are intervals that would contain the actual population value for 95 percent  of the samples we could have drawn. As a result, we are 95 percent  confident that the confidence intervals presented in this report will  include the true values in the respective study populations. For the  statistical error rate projection, we used a point estimate with a 95 percent  confidence interval. The projected point estimate combined with the  confidence interval surrounding the point estimate means that although  we estimate the error rate to be at the point, we are 95 percent confident  that the true error rate is somewhere between the interval’s lower and  upper limits.
For each sampled tax period, we obtained and reviewed IRS records on  the status and history of tax collection action with particular emphasis on  actions that affected the FPLP status of the tax debt. We performed  additional searches of criminal, financial, and public records. We  compared each sampled tax debt to IRS’s FPLP exclusion and inclusion  criteria and determined the accuracy of the status or transaction code that  excluded the tax debt from the FPLP. We categorized a sample tax debt as  an error if the tax period did not meet at least one exclusion criterion or  had exceeded IRS’s time frame for ending an exclusion, such as the time  frame for terminating an installment agreement. In some cases, the time  frame for terminating an installment agreement was exceeded at the time  IRS provided us records to review rather than at the September 30, 2005,  date of the unpaid assessments database.
To determine whether IRS’s policies, procedures, and practices could be  strengthened to ensure the accuracy and timeliness of its status and  transaction codes, we reviewed IRS’s Internal Revenue Manual and  interviewed IRS officials to obtain criteria, guidance, and internal controls  on (1) coding cases for inclusion and exclusion from the FPLP   (2) processing cases in the notice phase; and (3) processing and  terminating cases in installment agreements, offers in compromise, and  financial hardship.
To determine whether opportunities exist to increase the amount of tax  debt included in the FPLP, we analyzed the effect of IRS’s exclusion  criteria as well as the potential effect of changes in the exclusion criteria  on the amount of tax debt included in the FPLP. In assessing the effect of  potential changes in the statutory exclusions, we compared the potential  for modifying IRS’s existing FPLP exclusion criteria within the exclusion’s  legal framework, and we discussed the potential changes with cognizant  IRS officials.
subsections: section_title: Data Reliability Assessment
paragraphs: For the IRS database we used, we relied on the work we perform during  our annual audit of IRS’s financial statements. While our financial  statement audits have identified some data reliability problems associated  with the coding of some of the fields in IRS’s tax records, including errors  and delays in recording taxpayer information and payments, we  determined that the data were sufficiently reliable to address this report’s  objectives. Our financial audit procedures, including the reconciliation of  the value of unpaid taxes recorded in IRS’s master file to IRS’s general  ledger, identified no material differences.
section_title: Appendix II: Comments from the Internal Revenue Service
section_title: Appendix III: GAO Contact and Staff Acknowledgments
subsections: section_title: Acknowledgements
paragraphs: The following individuals made major contributions to this report: William  J. Cordrey, Amy Bowser, Ray Bush, Kenneth Hill, Inna Livits, Dave  Shoemaker, Sidney Schwartz, and Mark Yoder.