Tax Administration: IRS Should Evaluate Penalties and Develop a Plan to Focus Its Efforts
Published: 2009-06-05T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Civil tax penalties are an important tool for encouraging compliance with tax laws. It is important that the Internal Revenue Service (IRS) administers penalties properly and determines the effectiveness of penalties in encouraging compliance. In response to a congressional request, GAO determined (1) whether IRS is evaluating penalties in a manner that supports sound penalty administration and voluntary compliance and, if not, how IRS may be able to do so, and (2) whether IRS's guidance for a new penalty for failure to disclose reportable transactions was issued in a timely manner and was useful to affected parties, and whether and how IRS has assessed the penalty. GAO reviewed IRS documents and guidance, and interviewed IRS officials and tax practitioners.
section_title: What GAO Found
paragraphs: The Office of Servicewide Penalties (OSP) does not comprehensively evaluate the administration of civil tax penalties or their impact on voluntary compliance, but a plan could help it do so. OSP has responsibility for administering penalty programs and determining the action necessary to promote voluntary compliance. According to IRS policy, OSP should collect information to evaluate penalties and penalty administration and to determine the effectiveness of penalties in promoting voluntary compliance. This policy is consistent with positions expressed in 1989 by both an IRS Task Force report and by Congress when reforming penalties in 1989, and more recently by the National Taxpayer Advocate. OSP does not fulfill the responsibilities specified in IRS policy. Rather, OSP analysts focus on short-term issues, such as sudden spikes in assessments or abatements. OSP officials said that they have not done more to evaluate the administration of penalties and their effect on voluntary compliance because of resource constraints, methodological barriers, and limitations in available databases. A plan could help IRS focus its efforts and address the constraints to evaluating penalties. In developing a plan, IRS could identify the analyses it should do and the resources needed to do them. OSP could then determine what resources are available to assist it and what additional resources, if any, are needed. A plan also could lay out feasible research for evaluating the effect of penalties on voluntary compliance. For example, fairness is believed to undergird voluntary compliance. Thus, analyses that determine whether penalties are being consistently applied across IRS would provide pertinent information. Data limitations could be addressed in a plan, as well. The Enforcement Revenue Information System (ERIS) contains substantial data on IRS enforcement activities, but does not include all of the information recommended by the 1989 IRS Task Force report. For example, ERIS does not include readily usable information related to taxpayer income that could be used to determine equitable treatment of taxpayers. IRS issued guidance regarding its implementation of a penalty for failure to disclose reportable transactions-- transactions IRS identified as tax avoidance transactions--within 3 months of the provision's passage. IRS officials said that their criterion for issuing timely guidance is whether it was released in time to meet customers' needs. Tax practitioners from two leading practitioner organizations said the guidance was issued timely and included information they needed. However, the practitioners said more targeted outreach about the penalty was needed, specifically regarding reportable loss transactions caused bythe current economic climate in which many taxpayers may experience losses that could trigger the reportable transaction requirements. IRS officials recognize the need to further raise awareness of the penalty, but their planned efforts would reach only a small portion of tax return preparers and taxpayers. As of January 2009, IRS has assessed 98 penalties for $13.7 million.In addition, 1,188 returns had been assigned to field groups.

section_title: Letter
paragraphs: As a part of the Internal Revenue Service’s (IRS) enforcement programs  and activities, civil tax penalties are an important tool for encouraging  taxpayer compliance with tax laws. It is important that IRS administers  penalties properly and determines the effectiveness of penalties in  encouraging compliance. The Internal Revenue Code (I.R.C.) has more  than 150 penalties. In fiscal year 2007, IRS assessed more than 37.6 million  civil penalties, totaling more than $29.5 billion, while abating—that is,  rescinding in whole or in part—more than 4.9 million civil penalties for  more than $11.1 billion. Major reforms to civil tax penalties were last made  in 1989.
Your committee has expressed interest in the process IRS follows when  administering penalties and the effectiveness of the penalty regime, and  about the implementation of a penalty for failing to disclose reportable  transactions—transactions IRS has identified as tax avoidance  transactions or that are substantially similar thereto—and whether it was  being appropriately assessed. Therefore, we agreed to determine   (1) whether IRS is evaluating penalties in a manner that supports sound  penalty administration and voluntary compliance and, if not, how IRS may  be able to do so and (2) whether guidance for a new penalty for the failure  to disclose reportable transactions was issued in a timely manner and was  useful to affected parties, and whether and how IRS has assessed the new  penalty.
To determine whether IRS is evaluating penalties in a manner that  supports sound penalty administration and voluntary compliance, we  reviewed official documents and guidance, including the Internal Revenue  Manual. We interviewed officials from the IRS Office of Servicewide  Penalties (OSP) and the four IRS business divisions (Small Business/Self  Employed (SB/SE), Large & Mid-Size Business, Tax Exempt and  Government Entities, and Wage and Investment) to determine their roles  in penalty administration. In addition, we interviewed state officials and  reviewed academic studies regarding assessments of penalty effectiveness  and contacted the Federation of Tax Administrators (FTA) for  recommendations of states to contact. In all, we spoke with  representatives of 25 states. To determine whether IRS issued guidance  for a new penalty for failure to include reportable transactions information  with returns in a timely manner that was useful to affected parties and  whether and how IRS has assessed the new penalty, we reviewed IRS  documentation and guidance for implementing the penalty and  implementation action plans. We also interviewed officials from IRS’s  Office of Tax Shelter Analysis (OTSA), Office of Chief Counsel, and the  four business units about their roles in implementing the penalty, as well  as officials from the Department of the Treasury’s (Treasury) Office of Tax  Policy. Finally, because they collectively represent a significant portion of  tax preparers, we contacted the American Institute of Certified Public  Accountants (AICPA), the American Bar Association (ABA), and the  National Association of Enrolled Agents (NAEA) and asked to interview  members who were knowledgeable about the reportable transaction  penalty. We interviewed nine tax practitioners affiliated with the AICPA  and the ABA about the timeliness and usefulness of IRS outreach efforts  regarding the implementation of the reportable transaction penalty, as  well as their observations on IRS’s use of the penalty. The NAEA said that  its membership had little experience with the reportable transaction  penalty, and did not provide names of any members for us to contact.  Because we interviewed a nonprobability sample of practitioners, our  discussion about the effectiveness of IRS’s implementation of the  reportable transaction penalty cannot be used to generalize to any other  practitioners or group. Additionally, those we spoke with presented their  personal views, not those of the professional associations through which  they were contacted.
We conducted our work from October 2007 through May 2009 in  accordance with generally accepted government auditing standards. Those  standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and  conclusions based on our audit objectives. We believe that the evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives.
subsections: section_title: Background
paragraphs: The U.S. tax system depends on the principle of voluntary compliance,  that is, when taxpayers comply with the law without compulsion or threat.  Penalties are intended to encourage compliance by supporting the tax  reporting and remittance standards contained in the I.R.C. According to  IRS’s penalty handbook, in order to advance the fairness and effectiveness  of the tax system, penalties should be severe enough to deter  noncompliance, encourage noncompliant taxpayers to comply, be  objectively proportioned to the offense, and be used to educate taxpayers  and encourage their future compliance.
Penalties are assessed either automatically by IRS’s systems or as a result  of audits that reveal the compliance issues. For example, the penalty for  filing a tax return late is usually assessed automatically when IRS’s  computer system detects a return filed after the filing deadline. Penalties  such as those assessed against taxpayers involved with abusive tax  shelters are assessed as a result of audits. Supervisors must review and  approve the results of an audit to assess a penalty. Most penalties can be  abated for reasonable cause if IRS determines that the taxpayer exercised  ordinary business care and prudence in determining tax obligations but  nevertheless was unable to comply with those obligations. Examples of  reasonable cause include, but are not limited to, serious illness or an  inability to obtain records.
Following the release of an IRS Task Force report on civil tax penalties in  1989 Congress made its last major effort to reform the tax penalty regime  because of concerns that a piecemeal approach to legislating civil tax  penalties over the course of many years resulted in a complex penalty  system that was difficult for IRS to administer and the taxpayer to  comprehend. The legislation, the Improved Penalty Administration and  Compliance Tax Act, was enacted in large part to simplify civil tax  penalties. For example, the act consolidated into one part of the I.R.C. all  of the generally applicable penalties relating to the accuracy of tax returns  and reorganized accuracy penalties to eliminate situations where one  infraction could receive more than one penalty. Overall, the act reformed  information reporting penalties; accuracy-related penalties; preparer,  promoter, and protester penalties; and penalties for failure to file, pay,  withhold, and make timely tax deposits.
OSP is assigned overall responsibility for IRS’s penalty programs. As such,  OSP is charged with coordinating policy and procedures concerning the  administration of penalty programs, reviewing and analyzing penalty  information, researching taxpayer attitudes and opinions, and determining  appropriate action to promote voluntary compliance.
Current Treasury regulations state that every taxpayer that has  participated in a reportable transaction and that is required to file a tax  return must attach a disclosure statement to his or her return for the  taxable year and send a copy to OTSA. In 2004, the American Jobs  Creation Act created a new penalty for failing to disclose reportable  transactions with a tax return. The purpose of the reportable transaction  penalty is to promote compliance with taxpayers’ duty to disclose their  participation in transactions IRS has determined to have potential for tax  avoidance or evasion. For example, a taxpayer claiming a loss on their tax  return of at least $2 million in a single taxable year must separately  disclose the transaction to IRS. For most types of reportable transactions,  the penalty is $10,000 for an individual taxpayer’s return and $50,000 for  other returns, such as business returns and returns for benefit plans. For  one type of reportable transaction, a listed transaction, the amount of the  penalty is increased to $100,000 for individuals and $200,000 for other  returns. The Commissioner of Internal Revenue can abate the penalty for a  reportable transaction, other than a listed transaction, if abating the  penalty would promote compliance with the requirements of the I.R.C. and  effective tax administration. The decision to abate must include a record  describing the facts and reasons for the action and the amount abated, and  any decision to not abate the penalty is not subject to judicial review.
section_title: IRS Does Not Comprehensively Evaluate the Administration of Tax Penalties or Their Impact on Voluntary Compliance, but a Plan Could Help It Do So
paragraphs: Although IRS policies state that IRS should collect information to evaluate  the administration of penalties and their impact on voluntary compliance,  and IRS is collecting some relevant information, OSP is not  comprehensively evaluating penalty administration or penalties’ impact on  voluntary compliance. According to IRS policies, OSP is to do the  following:    Administer the penalty statutes in a manner that is fair and impartial to  both the government and the taxpayer, is consistent across taxpayers, and  ensures the accuracy of the penalty computation.
Collect statistical and demographic information to evaluate penalties and  penalty administration and to determine the effectiveness of penalties in  promoting voluntary compliance.
Design, administer, and evaluate penalty programs based on how those  programs can most efficiently encourage voluntary compliance.
Continually evaluate the impact of the penalty program on compliance and  recommend changes when the I.R.C. or penalty administration does not  effectively promote voluntary compliance.
These policies are consistent with positions expressed in the 1989 IRS  Task Force report and by Congress when reforming penalties in 1989 and  with more recent views expressed by the National Taxpayer Advocate. All  stressed the need for IRS to evaluate the administration of penalties and  their impact on voluntary compliance. For example, the task force’s report  and Congress in the conference report for the act that included the penalty  reform recommended that IRS analyze information concerning the  administration and impact of penalties for the purpose of suggesting  changes in compliance programs, educational programs, penalty design,  and penalty administration. The task force also recommended that IRS  analyze data to enable IRS, Treasury, and Congress to evaluate how well  penalties operate and what impact they have on voluntary compliance.  Similarly, in her 2008 annual report, the National Taxpayer Advocate  wrote that before serious penalty reform can occur, better data about  whether and how penalties promote voluntary compliance is needed.
However, OSP generally does not fulfill the responsibilities specified in  IRS policy or as envisioned by the 1989 IRS Task Force report, Congress,  or the National Taxpayer Advocate. Rather, OSP analysts focus most of  their efforts on addressing short-term issues, such as sudden spikes in  assessments or abatements. These analyses are useful and should  continue, as they could identify emerging problems with how penalties are  being administered, but they do not constitute a comprehensive  assessment of penalty administration.
OSP officials said that they have not done more to evaluate the  administration of penalties and their effect on voluntary compliance  primarily because of resource constraints both within OSP and IRS’s  various research units, methodological barriers that impede their ability to  research the effect of penalties on voluntary compliance, and limitations in  available databases.
subsections: section_title: A Plan Could Help Identify Needed Resources and Support Resource Requests
paragraphs: OSP does not have a plan for fulfilling its responsibilities. The Government  Performance and Results Act of 1993 may be a useful resource in  developing such a plan as it provides several key management principles  needed to effectively guide, monitor, and assess program implementation.  These principles include (1) general and long-term goals and objectives,  (2) a description of actions to support goals and objectives,   (3) performance measures to evaluate specific actions, (4) schedules and  milestones for meeting deadlines, (5) identification of resources needed,  and (6) evaluation of the program with processes to allow for adjustments  and changes. This approach is intended to ensure that agencies have  thought through how the activities and initiatives they are undertaking are  likely to add up to the meaningful result that their programs are intended  to accomplish.
A plan would help to identify resource requirements and support resource  requests. In developing a plan, OSP would need to identify the key penalty  issues on which to focus its efforts, the types of analyses that would best  address those key issues, and the type and amount of resources—whether  within OSP or elsewhere in IRS—needed to execute the plan. Thus, by  focusing on what it is attempting to accomplish by developing a plan, OSP  would be better positioned to determine what resources within IRS are  available to assist it. Further, a well-developed plan can provide  policymakers within the executive branch and Congress a better basis for  determining the appropriate level of resources for a program.
section_title: A Plan Could Lay Out Feasible Research for Evaluating the Effect of Penalties on Voluntary Compliance
paragraphs: Although OSP officials’ concerns about methodological barriers to  determining the effect of penalties on voluntary compliance are valid,  relevant analyses likely could be performed. Developing a plan would help  OSP officials determine which analyses could be useful for this purpose  and possible strategies for furthering the state of knowledge on the effect  of penalties on compliance.
OSP officials pointed to several examples of the methodological barriers  to determining the effect of penalties on voluntary compliance. For  example, increases in penalty amounts might be accompanied by other  changes in enforcement activities, such as a higher audit rate, and  separating the effect of these factors on voluntary compliance is difficult.  In addition, a number of issues other than IRS enforcement activities  affect a taxpayer’s behavior, including income, tax rates, demographics  and social factors, and the influence of tax practitioners. Another  complication is that a penalty set at a certain amount may effectively  encourage voluntary compliance for one type of taxpayer, such as  individuals, but not for another type of taxpayer, such as businesses.
Our discussions with state officials and review of academic studies raised  similar concerns about the methodological barriers. None of the 25 states  we contacted evaluate the impact of penalties on voluntary compliance,  and FTA was unaware of any states currently doing such evaluations. State  officials added that limited resources, political disinterest, and  technological barriers further constrain their penalty analysis capacities.  Some state officials said that they rely on IRS information and research to  establish state enforcement priorities and similarly would look to IRS for  penalty research. The academic studies we reviewed concluded,  consistent with OSP’s view, that measuring the impact of penalties on  voluntary compliance is difficult because numerous variables go into  determining a taxpayer’s decision to voluntarily comply with tax laws.  These variables include how risk averse a person is and how likely he or  she is to attempt to “get away” with not complying.
Nevertheless, some analyses likely would be useful for better  understanding the effect of IRS penalties on taxpayers’ voluntary  compliance. For example, it is widely believed that taxpayers are more  likely to comply voluntarily if they believe that the tax code is  implemented fairly and consistently across taxpayers. The 1989 IRS Task  Force noted that better knowledge of both penalty applications and the  perceptions of taxpayers that have been penalized were important in  ensuring that taxpayers feel they are being treated fairly. Thus, analyses  that determine whether penalties are being consistently applied across IRS  so that similarly situated taxpayers receive the same penalties could  provide pertinent information.
Penalties are also unlikely to have much effect on voluntary compliance if  they are not used. Treasury noted the importance of better understanding  the relationship between penalty administration and voluntary compliance  in its strategic plan for reducing the tax gap. The plan states that  Treasury wants penalties to be set at more appropriate levels because  some penalties may be too low to change behavior but others may be so high that examiners are reluctant to assess them.
The penalties for failure to provide appropriate information returns are an  example of penalties that do not appear to be properly calibrated to  influence compliance. The instructions for certain information returns  require that taxpayers submit the form printed with special ink. Those  that fail to do so are subject to a $50 penalty. IRS officials said that this  penalty and other format-related penalties are not assessed because the  cost of developing and asserting the penalty was not worth it. Instead, IRS  officials correct the forms manually. IRS officials said that the penalty  would have to be raised substantially to make it worthwhile to assess. The  decision to not assess penalties for this error based only on the revenue  received from those penalized may have actually undermined voluntary  compliance. A version of a popular tax preparation software package  informs taxpayers that IRS has accepted forms that are not printed with  the special ink.
In addition, IRS may be able to do certain longitudinal analyses of whether  taxpayers assessed a penalty in one year become more compliant in future  years. For example, IRS may be able to determine whether taxpayers that  were assessed an underpayment penalty one year were assessed the same  penalty in years that followed. Although multiple factors would influence  the result, the data might help IRS better understand whether the penalty  may have any effect on future compliance.
Currently, SB/SE’s Research group is working on a project reviewing the  First Time Abate policy that may provide some information related to  certain penalties’ effect on compliance. IRS did not know some  information about the results of the policy, including the number of  penalties abated under the policy, the amount of money involved, and the  number of taxpayers qualifying for the abatement but not receiving it.
Additionally, other questions have surfaced, including whether the policy  is fair, whether taxpayers receiving the abatement “game” the system by  complying for 3 years and then getting the abatement again, and,  ultimately, whether the policy should be continued. Results of the project  are expected in the summer of 2010.
In addition to analyses related to voluntary compliance that could be done  internally, by developing a plan, OSP may be able to identify other means  of developing information useful to gauging penalties’ effect on voluntary  compliance. Taxpayer surveys or focus groups, for instance, could provide  information on taxpayers’ perceptions about the fairness of penalties.
IRS could also explore other avenues for supporting research of penalty  effectiveness, such as encouraging others to examine the relationship  between penalties and voluntary compliance. For example, IRS hosts an  annual research conference and 6 forums across the country used to  discuss tax administration issues with experts and practitioners. These  conferences and forums have been used to discuss compliance issues. At  the 2008 IRS Research Conference, papers on measuring or improving tax  compliance were presented. These types of studies, done independently,  can potentially add valuable thoughts and information to the discussion on  how best to encourage and increase taxpayer compliance with tax laws.
section_title: Data Limitations Could Be Addressed in a Plan
paragraphs: Finally, in developing a plan, OSP could assess options for overcoming the  limitations in available data that officials say impede its ability to both  assess the effect of penalties on voluntary compliance and perform more  sophisticated reviews of IRS’s administration of penalties. The 1989 IRS  Task Force report said IRS needed to develop an interactive database  available for all management levels to perform ad hoc analysis of penalty  administration and voluntary compliance. One of the task force’s  recommendations was to develop a database that captured the maximum  amount of data in order to avoid the expense and delay for special master  file extracts. With this database, IRS would evaluate the equitable  treatment of taxpayers with respect to all aspects of penalties (e.g.,  penalty waivers and taxpayer demographic information, such as income).
The Enforcement Revenue Information System (ERIS) contains  substantial data on all IRS enforcement activities, including penalties.  However, ERIS does not meet several of the task force’s  recommendations. For example, ERIS does not include readily usable  information related to taxpayer income or practitioner representation that  could be used to determine equitable treatment, develop employee  training, or provide taxpayer education outreach. ERIS is not available at  all management levels. While the system is used to develop many standard  reports, officials say a lack of resources has prevented it from producing  additional reports that could increase understanding of penalties. For  example, the First Time Abate policy research project is using master file  extracts instead of ERIS.
In addition, IRS does not routinely use existing penalty data to evaluate  the administration of penalties. For example, IRS does not identify    penalties with low or high assessment and abatement rates,    whether significant differences exist in the abatement rate for high-income  taxpayers relative to lower-income taxpayers,    whether significant differences exist in penalty size between taxpayers  that negotiate an installment agreement relative to those who pay cash,    whether returns prepared by a paid preparer are more or less likely to    whether penalties are assessed or abated at different rates based on the  geographic location where the case is worked,    whether individual taxpayers receive more or fewer abatements than  businesses for the same penalties, and    whether the rate of erroneous penalty assessments is increasing or  decreasing.
Analyses of trends in penalty data could help IRS identify areas that need  further investigation and when penalties may not be applied consistently  and fairly. For example, a low assessment rate could indicate that a  penalty is effectively deterring noncompliance and that the infrequency of  its assessment is appropriate. However, a low assessment rate might also  indicate that a penalty has become outdated or is deemed too burdensome  to assess. Similarly, a high abatement rate could indicate that IRS officials  are hesitant to sustain a penalty because they deem it too harsh for the  infraction.
IRS changed the process it follows to assess the penalty for an employer’s  failure to deposit the correct amount of taxes for employees, known as the  Failure to Deposit (FTD) penalty, based on a trend analysis done by  others. The Taxpayer Advocate Service (TAS) noted in its 2003 report  that IRS abated a substantial number of FTD penalties and that the higher  the penalty, the more likely the penalty was to be abated. According to  IRS, 24 percent of FTD penalties had been abated in 2002 accounting for  62 percent of the assessed dollars. Based in part on TAS’s data analysis,  IRS changed the procedures it follows to assess the FTD penalty by  sending a notice to taxpayers warning them of possible assessment if they  did not deposit what they owed. According to a report by the Treasury  Inspector General for Tax Administration, this procedural change helped  lead to a decrease in penalty assessments and abatements.
section_title: Reportable Transaction Guidance Was Timely Issued, but Could Be More Useful to Affected Parties
paragraphs: IRS issued guidance to implement a new penalty for taxpayers that fail to  disclose a reportable transaction in a timely manner and began assessing  penalties after audits had been conducted. The reportable transaction  penalty was effective immediately after its passage in October 2004,  making the development of guidance on how IRS would interpret and  implement the law important. Within 3 months, in January 2005, IRS issued  interim guidance to alert taxpayers and practitioners to the reportable  transaction penalty and how IRS planned to implement it. For example,  the interim guidance explains the conditions under which IRS would  impose the penalty and how it would use the authority to abate the  penalty. Officials in the Office of Chief Counsel told us that their criterion  for issuing guidance successfully is whether it was released in time to  meet their customers’ needs. The practitioners we spoke with from two  leading practitioner organizations said that issuing the interim guidance in  only 3 months was quick and the guidance included the information they  needed to understand how IRS would implement the penalty.
Those same practitioners were concerned that other practitioners may  lack an understanding of all of the requirements for disclosing reportable  transactions and suggested that more targeted outreach regarding the  reportable transaction penalty was needed, since the penalty is large and  the process to get the penalty abated is difficult. As mentioned earlier, the  Commissioner of Internal Revenue, or the Commissioner’s delegate, can  abate the penalty for most types of reportable transactions, but if a  taxpayer is penalized for a listed transaction there is no abatement option.  These practitioners said that it would be easy to inadvertently violate the  provision because taxpayers and practitioners may not realize that  transactions that seem reasonable to them and have resulted in no net gain  are considered reportable. They noted that if some practitioners or  taxpayers are associating this penalty only with abusive tax shelters, they  may not realize all of the situations where the requirement to disclose a  transaction applies. They added that in the current economic climate there  are likely to be many transactions that result in a loss that do not get  disclosed on the required form. The practitioners said that they were  concerned because taxpayers and other practitioners may not have been  in such situations before, and it is likely that IRS will see a significant  increase in undisclosed transactions of this nature.
In the 2008 Annual Report, TAS also expressed concerns that the  reportable transaction penalty is being assessed against taxpayers for  which it was not intended and that the penalty is unfairly harsh. According  to TAS, the purpose of the penalty is to combat tax shelters by penalizing  taxpayers that failed to disclose that they have entered into transactions  deemed aggressive by IRS. Because the reportable transaction penalty  applies without exception to the failure to include disclosure on a return  when required, an improper tax benefit is not required as long as the tax  return reflects tax consequences or a tax strategy described in public  guidance.
IRS officials said they conducted standard educational outreach to the  practitioner community regarding the specifics of the reportable  transaction penalty. This included sending updates to e-mail groups  regarding notices and revenue procedures implementing the new penalty  requirements, postings of the latest news to IRS’s Web site, and requesting  comments on proposed regulations. In addition, officials in OTSA said that  they had presented information on the penalty to practitioner groups as  part of larger presentations on civil penalties. However, some of the  practitioners we spoke with said that in the current substantially altered  economic climate, some taxpayers may be caught unaware of the need to  disclose a reportable loss transaction and be penalized without a ready  avenue for relief. Further, there is little basis to reliably predict which  taxpayers might be caught in this situation.
IRS officials recognize the need to further raise awareness with taxpayers.  They plan to use the National Tax Forums during the summer of 2009 to  hold focus groups regarding the reportable transaction penalty. The goal  of the focus groups is to reach out to practitioners who may not  understand the disclosure requirements and get the thoughts of those who  have had experience with the reportable transaction penalty. However, at  best, IRS would only reach a small portion of the tax return preparer  community in this fashion even though many preparers may end up with  clients susceptible to the penalty. Using its standard, low-cost outreach  methods to again focus tax preparers and the public’s awareness on the  disclosure requirements for the reportable loss transaction could reach a  wider audience.
IRS officials said that the majority of tax returns eligible for assessment of  the penalty were not filed until fall 2005, well after the interim guidance  had been released, and would not have been audited until 2006. IRS  officials said that development of these cases takes time and that IRS  could not assess the penalty until there was sufficient basis to believe that  a taxpayer had participated in a reportable transaction during a specific  taxable year, had a disclosure requirement, and failed to complete the  required form. IRS receives the required forms at its Ogden facility but  does not assess penalties until after referring cases to an examiner. A  penalty is only assessed after an examiner reviews the case because  examiners develop related issues that may not be apparent from the face  of the form itself. If a taxpayer failed to report participation in a reportable  transaction, IRS would not know of the taxpayer’s participation until it  examined the tax return or investigated the promoter of the transaction.  Therefore, the majority of cases for which a penalty may have been  appropriate would not have been identified until late 2006 and 2007.  According to IRS officials, as of January 2009, IRS had assessed 98 of the  penalties for $13.7 million and collected $2.7 million. In addition, 1,188  returns had been assigned to field groups and 50 returns were being  reviewed by IRS’s Appeals Division.
section_title: Conclusions
paragraphs: Civil tax penalties play an important role in helping ensure that taxpayers  make an honest effort to pay the taxes that they owe. Twenty years after  Congress and an IRS Task Force said that IRS needs to conduct more  continuous and comprehensive analyses of the penalties it administers and  their effect on voluntary compliance, and after having designated an office  with those responsibilities, IRS is not meeting this expectation. IRS does  not have a plan that identifies how it will carry out these responsibilities  and address the resource, methodological, and data limitations that  officials say impede its progress. IRS should develop and execute such a  plan to better focus its efforts and ensure that penalties are being  administered efficiently, effectively, fairly, and consistent with  encouraging taxpayers’ voluntary compliance.
IRS issued guidance for the reportable transaction penalty in a timely  manner following its passage in 2004. However, in the current economic  climate certain transactions involving losses may subject many  unsuspecting taxpayers to a harsh penalty. They may be unaware of  reporting requirements because they have never been in such situations  before. IRS’s planned additional outreach on this penalty is not sufficient.  IRS should use its standard, low-cost outreach methods to alert as many  tax return preparers and taxpayers as possible about the need to properly  report loss transactions to avoid penalties.
section_title: Recommendations for Executive Action
paragraphs: In order to ensure the most efficient, fair, and consistent administration of  civil tax penalties, and that penalties are achieving their purpose of  encouraging voluntary compliance, the Commissioner of Internal Revenue  should direct OSP to evaluate penalty administration and penalties’ effect  on voluntary compliance. The Commissioner also should direct OSP to  develop and implement a plan to collect and analyze penalty-related data.  The plan should address the constraints officials have identified as  impeding progress in analyzing penalties.
In addition, the Commissioner of Internal Revenue should use IRS’s  standard, low-cost methods of outreach to again alert as many tax return  preparers and taxpayers as possible about the need to properly report loss  transactions to avoid penalties.
section_title: Agency Comments and Our Evaluation
paragraphs: The Deputy Commissioner for Services and Enforcement provided written  comments in a May 26, 2009, letter, which is reprinted in appendix I. IRS  staff also provided technical comments that we incorporated as  appropriate.
IRS agreed that OSP will develop a plan to comprehensively evaluate  penalty administration and the impact of penalties on voluntary  compliance. IRS said that such a plan was important in understanding the  relationship between penalty administration and voluntary compliance  and in identifying priorities and potential resource needs. Developing a  comprehensive plan may take time. In the interim, we believe that the data  IRS currently collects can be used to begin useful penalty analyses. For  example, IRS could evaluate whether penalties are assessed or abated at  different rates based on the geographic location of the office responsible  for the case or whether significant differences exist in the abatement rate  for high-income taxpayers relative to lower-income taxpayers. Such  analyses could be done now and help IRS determine whether penalties are  being applied consistently.
IRS also agreed to undertake outreach to ensure that taxpayers are again  alerted to the situations where disclosure of reportable transactions is  needed.
As agreed with your offices, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date. At that time, we will send copies to the Chairman and Ranking  Member, House Committee on Ways and Means; the Secretary of the  Treasury; the Commissioner of Internal Revenue; and other interested  parties. This report also will be available at no charge on the GAO Web site  at http://www.gao.gov.
If you or your staff have any questions concerning this report, please  contact me on (202) 512-9110 or brostekm@gao.gov. Contact points for  our Offices of Congressional Relations and Public Affairs may be found on  the last page of this report. Key contributors to this report are listed in  appendix II.
section_title: Appendix I: Comments from the Internal Revenue Service
section_title: Appendix II: GAO Contact and Staff Acknowledgments
subsections: section_title: Acknowledgments
paragraphs: In addition to the contact named above, Jonda R. Van Pelt, Assistant  Director; Julia T. Coulter; Benjamin C. Crawford; Alison Hoenk; Ellen M.  Rominger; Elwood D. White; and John M. Zombro made key contributions  to this report.