Tax Administration: IRS Should Continue to Expand Reporting on Its Enforcement Efforts
Released: 2003-02-28T00:00:00

Letter

Background

Each year, IRS screens all individual tax returns and selects a small percentage in which to contact taxpayers about potential noncompliance. Prior to doing automated checks of tax returns, IRS had relied on its audit program to contact taxpayers about apparent inaccuracies in reporting income, deductions, and other issues on their tax returns. For example, to verify interest income or dependent exemptions claimed by taxpayers, IRS auditors had to contact taxpayers, request and review documentation. Thus, if IRS audited the returns of 5 percent of all taxpayers, it could at most check on the accuracy of interest income for 5 percent of taxpayers.

Since the 1970s, IRS’s ability to verify some items on individual returns expanded as IRS’s capacity to use automated processes grew and as Congress enacted laws requiring third parties (like banks, mortgage finance firms, etc.) to provide information returns to taxpayers and IRS on income paid. These steps enabled IRS to more universally and efficiently check taxpayer compliance for those tax issues covered by information returns. For example, with the initiation of information returns for interest income and the development of IRS’s automated capacity, IRS began to check whether every taxpayer for whom it had received an applicable information return had accurately reported that interest on their tax return.

As a result, for some wage earners who claim no deductions, IRS can review the accuracy of all, or nearly all, items reported on their tax return to the extent that third parties correctly filed all information returns. In these cases, IRS effectively receives information that should be in taxpayers “books and records” and no longer needs to use auditors to obtain such information from taxpayers’ records for these selected issues.

Concurrent with these expansions in IRS’s ability to check the accuracy of certain issues on taxpayers’ returns, the number of taxpayer returns that IRS audited began to decline. For example, between fiscal years 1981 and 1992, the number of document matching contacts rose from 1.2 million to 3.8 million and the number of audits dropped from 2.5 million to 1.1 million.

Several GAO reports have discussed IRS audits, other enforcement contacts, and taxpayer burden as follows: In 1996, we reported that audit rates fell from 1988 to 1993 and then rose to a high of 1.67 percent in 1995. In 2001, we reported that audit rates had steadily dropped from 1996 to 2000, declining to 0.49 percent.

During 2000, we reported that IRS made almost 10 million nonaudit contacts of taxpayers in 1998 through about 6 million math error notices, 2 million document matching notices, and 2 million soft notices. We recommended that IRS analyze the data collected for each of the three major nonaudit contact programs to improve taxpayer compliance and taxpayer service.

During 2000, we reported on IRS’s efforts to estimate taxpayer compliance burden for prefiling, filing, and postfiling activities. We found that IRS was developing two models that, when combined, should provide more reliable estimates of compliance burden for wage earners.

Scope and Methodology

To compare audit and other enforcement programs, we obtained information on their legal and operational characteristics. For legal authority, we reviewed the Internal Revenue Code (IRC) and IRS documents. For program operations, we reviewed IRS documents and interviewed responsible IRS officials to understand how each program works. For the average time spent on each type of contact, we analyzed available IRS data for fiscal years 1993 through 2002. For how taxpayers perceive IRS’s enforcement programs, we interviewed IRS officials; reviewed tax research studies and press articles; and contacted four large national organizations representing attorneys, certified public accountants, enrolled agents, and tax preparers, as well as the largest tax return preparation firm, and IRS’s national taxpayer advocate.

To summarize trends in the number and rate of individual taxpayer audits and other enforcement contacts in total and by taxpayer income, we analyzed available IRS data from fiscal year 1993 to fiscal year 2002 on each type of contact. To compute the audit contact rate, we used IRS’s method, which equals the proportion of IRS audits closed in a fiscal year compared with returns filed in the previous calendar year. IRS has not stated a method for computing math error, document matching, and nonfiler rates. For the document matching and nonfiler programs, we compared the proportion of notices sent in a fiscal year to return filings in the previous year because these contacts generally occur in the year after a return is filed. For the math error program, we based the contact rate on the proportion of math error notices to the returns filed in that year because the notices are sent to taxpayers as IRS processes tax returns. For the math error, document matching, and nonfiler programs, we based the contact rate on the number of initial notices sent to taxpayers rather than closures because (1) it is the broadest measure of IRS’s enforcement efforts with taxpayers and (2) the math error and document matching programs usually conclude the contact with the taxpayer within a few months after the initial notice is sent. Nonfiler contacts can take considerably longer to close, making it difficult to know which tax year to use in computing a contact rate. We used the number of initial notices so that the nonfiler program could be measured on a consistent basis with the document matching and math error programs. To understand the reasons for the trends, we analyzed our previously issued reports and IRS reports and interviewed IRS staff for each enforcement program.

To determine how audit and other enforcement programs affect individual taxpayer compliance and burden, we obtained and reviewed available data such as IRS studies and reports, our previous reports, and other research. We also interviewed responsible IRS officials.

To assess whether IRS should expand reporting on its enforcement efforts, we analyzed the types of enforcement data already publicly reported on an annual basis by IRS. We also analyzed the tradeoffs for two options we identified—expanding the definition of audit to include the other enforcement programs and reporting more data on each program. We used much of the information from the previous objectives and interviews with IRS officials.

For all objectives, our work focused on the four major enforcement programs identified by IRS—math error, document matching, nonfiler, and audit. We attempted to verify the completeness and accuracy of IRS’s data but could not reconcile all differences given time constraints. As a result, we either did not report some data or disclosed limitations in the data being reported. Further, in analyzing audit and document matching rates by income level, we did not adjust the income levels for the effects of inflation over the 1993 to 2002 period because detailed data on taxpayer income was not available during the timeframes for the assignment. All data used in the report are final except for the number of tax returns filed in 2002. Because this number is preliminary, the final math error contact rate for fiscal year 2002 may differ somewhat from what we report. In addition, you asked us to analyze two newer IRS efforts—voluntary compliance agreements and soft notices. Appendix IV describes the two newer efforts.

We did our work at IRS’s national office in Washington, D.C., and offices in New Carrolton, Maryland, and Atlanta, Georgia, between August 2002 and December 2002 in accordance with generally accepted government accounting standards. We requested comments on a draft of this report from IRS (see app. V).

Similarities and Differences among IRS Enforcement Programs Depend on the Type of Audit

Whether audits and other enforcement programs vary from each other depends on a number of factors. With regard to legal characteristics, audits and other enforcement programs are all authorized to contact taxpayers about apparent noncompliance and to determine and adjust taxpayers’ tax liability. However, audits have the broadest authority to detect possible noncompliance, significant powers to obtain information, and the most restrictions on how IRS is to interact with taxpayers. With regard to operational characteristics, the extent to which audits are operationally similar to or different from other enforcement programs varies depending on the type of audit. Audits done in taxpayer locations and IRS offices are not similar operationally to other enforcement programs and audits done through correspondence with the taxpayer, while still different, are more operationally similar to some of the other programs. IRS officials were unaware of any research on whether taxpayers perceive differences among IRS’s enforcement programs. However, looking at audits and other enforcement programs from the taxpayers’ perspective, IRS officials and officials we interviewed who represent taxpayers believe that taxpayers may not perceive distinctions among many of the enforcement programs.

Legal Characteristics: Audits Have the Broadest Scope, Significant Powers to Obtain Information, and the Most Detailed Restrictions

In a general sense, the IRC provisions for enforcement are similar in that they authorize IRS to contact taxpayers about apparent noncompliance and to determine and adjust taxpayers’ tax liability. However, the IRC provisions grant IRS the authority to review all matters that may affect a taxpayer’s tax liabilities under audits but only certain specified tax issues under other enforcement programs. The IRC also establishes more rules— including significant powers to obtain information as well as restrictions on those powers—that govern the nature of audit contacts with taxpayers than for the other programs.

The IRC does not explicitly limit the tax issues to be covered by an audit, unlike for the other enforcement programs. Under the authority of section 7602, audits can cover any issue on a tax return, including those that the other programs cover. In contrast, the IRC specifies the scope of legal authority for the three other enforcement programs. For example, after five statutory expansions since 1976, math error authority now covers 11 tax issues (see app. I). Document matching—which grew primarily through the 1980s as Congress authorized more information reporting— now covers over 20 types of individual income as well as certain tax credits and deductions (see app. II). The IRC also specifically authorizes the nonfiler program to pursue unfiled tax returns that should have been filed.

The IRC also establishes more rules governing IRS’s contacts with individual taxpayers under the audit program than it does for the math error, document matching, and nonfiler programs. These rules give IRS significant powers to obtain information needed to determine an individual’s tax liabilities when doing an audit and, in turn, places restrictions on the use of those powers. If resolving issues raised under the other enforcement programs requires that IRS auditors become involved, the contacts with taxpayers become audits subject to these greater powers and restrictions. For example, if a taxpayer who receives a math error notice files a claim for IRS to abate the tax assessment, IRS could audit that claim. Similarly, if a taxpayer responds to a document matching notice with materials that cannot be readily and immediately used to settle the discrepancy, the case could be referred to audit staff.

The greater powers that IRS has under audit compared with the other programs include the authority to examine books and records and take testimony for purposes of determining the tax liability of a tax return. IRS also has the power to use a summons to compel taxpayers and third parties to provide books and records, and to enter premises to examine objects subject to taxation.

Given these greater powers, the law also places more restrictions on audits to protect taxpayer rights. For example, the law restricts IRS from doing unnecessary audits or generally doing more than one inspection of taxpayers’ books for each tax year. The law also governs the time and place of an audit and burden of proof on IRS. In addition, the Internal Revenue Service Restructuring and Reform Act (RRA) of 1998 (P.L. 105- 206) added several requirements, such as informing taxpayers of their rights during audits.

On the other hand, RRA also added a provision that creates a legal similarity for all four enforcement programs because it affects any IRS employee, including those making audit or nonaudit contacts. Section 1203 of RRA lays out the conditions under which any IRS employee is to be fired for any of 10 specific acts or omissions. Many of these conditions involve contacts with taxpayers—such as harassing taxpayers or taxpayer representatives, violating their civil rights, or threatening to audit a taxpayer for personal gain. These restrictions were intended to protect taxpayers in their interactions with IRS.

Another legal provision creates a similarity between audits and two of the three other programs. Except for the math error program, when IRS proposes a change in taxpayers’ liabilities, it is required to send a notice informing taxpayers of their rights, such as the right to appeal additional taxes that IRS proposes. The IRC does not provide taxpayers a right to appeal assessments created under math error authority because that authority generally applies to obvious errors made by taxpayers on their returns. However, IRS informs taxpayers receiving a math error notice that they may file a claim to ask IRS to abate (reduce) the tax assessment if they believe IRS erred.

Operational Characteristics: Audits at IRS Offices or Taxpayer Locations Differ the Most from Other Enforcement Programs

The extent to which audits are operationally similar to or different from other enforcement programs varies depending on the type of audit. Compared with other enforcement programs, audits done in taxpayers’ locations or IRS offices are more likely to deal with multiple and complex issues, require more skill and judgment by IRS employees, require a greater number of interactions with taxpayers, and take more IRS staff time. Correspondence audits also tend to differ from other enforcement programs in these operational characteristics but to a lesser degree, and in some cases correspondence audits and document matching contacts with taxpayers can be very similar in these characteristics. Table 1 provides an overview of key operational dimensions across the enforcement programs.

Reviewing these operational dimensions helps highlight similarities and differences across the four types of enforcement.

Contact triggers: All enforcement contacts use computers to identify a potential compliance issue. However, audits are more likely to be triggered by other means such as a special compliance project or referrals from inside or outside of IRS.

Number of contacts: Once any potential compliance issues are found, the fewest contacts with taxpayers to resolve the issues are likely under the math error and document matching programs because they have relatively simple issues. Correspondence audits might need more than one contact, depending on the complexity of the issue(s) being audited and taxpayers’ responses. The number of contacts in the nonfiler program can vary depending on whether taxpayers respond to an IRS notice by filing a return, or explaining why a return was not required. Some may not respond, possibly leading IRS to send a second notice or create a substitute return and send it to that taxpayer. Audits at IRS offices or taxpayer locations are likely to have the most contacts with taxpayers through meetings, notices, or the telephone because they tend to cover several, more complex issues.

IRS staff skill and judgment: Audit contacts—especially those done in IRS offices or in taxpayer locations—require the most staff skill and judgment to analyze taxpayers’ testimony and books and records. Being more automated and usually dealing with simpler issues, other enforcement programs rely on less staff skill and judgment. Document matching staff might have to analyze taxpayers’ explanations for why they do not owe more tax but are to refer the case to the audit program if an explanation requires detailed analysis or includes books and records. The nonfiler program requires limited skill and judgment when automated processes send the notices or generate substitute returns. More skill and judgment is required when IRS staff manually create substitute returns or when taxpayers respond to a notice by saying that they do not have to file a return.

Timing of initial contact: Math error contacts are made as the return is being processed and identify errors that must be corrected to finish processing the return. Document matching and nonfiler contacts usually occur within 1 year after the return is filed or is to be filed. Audits usually start within 1 year after a return is filed but can start later as long as IRS finishes the audit within 3 years after the return is filed.

Another operational characteristic is the average time spent by IRS staff. Figure 1 shows that audits use more staff time per case than document matching contacts. For fiscal years 1993 through 2002, the staff time ranged from roughly an hour per document matching case to up to 30 hours per field audit. (see Table 9 in app. III for details.) IRS does not separately track the time spent on math errors from the rest of the returns filing process or on nonfilers from other work done by collection staff.

Looking across all of these operational dimensions in general, audits that take place in IRS offices or in taxpayer locations differ the most from other enforcement programs. They differ primarily because they are more likely to deal with multiple complex tax issues, require more skill and judgment by IRS employees, require a greater number of interactions with taxpayers, and take more IRS staff time. Although correspondence audits do differ from other enforcement programs on these characteristics, they do not differ as much from other enforcement programs as do the audits in IRS field offices or taxpayer locations. The closest similarity between correspondence audits and the other programs is with the document- matching program. In comparison to the document matching program, correspondence audits in some cases may deal with about the same number of issues, have the same number of interactions with taxpayers, and require similar skill, judgment, and time on the part of IRS staff. Correspondence audits are less similar to contacts under the math error and nonfiler programs than to document matching. Math error contacts deal with straightforward issues that must be corrected as a return is processed as opposed to contacting the taxpayer up to one year later about issues in the return. Nonfiler contacts deal with taxpayers who have not filed a return at all as opposed to seeking to correct issues related to a filed return.

In addition to the four major enforcement programs, starting in the mid- 1990s, IRS created two new programs intended to help individual taxpayers file accurate tax returns. IRS sends so-called “soft notices” on duplicate claims for dependent exemptions and missing self-employment tax reporting. The soft notices do not require taxpayers to take action but are intended to educate them about the potential errors and encourage them to correct their returns, if necessary. The other new program is the voluntary compliance agreements program. These agreements are negotiated with certain employers with the goal of increasing their employees’ compliance in reporting tip income. As discussed in appendix IV, while these programs attempt to improve compliance, they have significant differences from the four major enforcement programs and IRS has little data on their use. However, IRS was able to provide us with data that it sent taxpayers 1.2 million soft notices on duplicate dependent claims in 2002.

No Research Identifies Whether Taxpayers Perceive Distinctions in Enforcement Programs but Officials Believe That Distinctions May Not Be Made

IRS officials were not aware of any research, and our search of the tax literature and press did not uncover research, on whether taxpayers perceive distinctions between audits and other enforcement programs. Of the four major enforcement program contacts, IRS officials said that they could see how some taxpayers might view two types of contacts— document matching and correspondence audits—as similar in that both tend to cover one or two tax issues that are fairly simple, contact taxpayers through the mail, and give taxpayers the same appeal rights. Otherwise, these officials did not see how taxpayers could view the enforcement contacts as similar, especially the math error contacts.

Although they had not surveyed taxpayers, officials we interviewed from six groups that represent taxpayers or help prepare their tax returns believed that many individuals perceive no distinction among the programs. For example, one representative attributed this to the conclusion that taxpayers view all IRS notices as stating the same thing—that the taxpayer owes more taxes.

Enforcement Program Contact Rates Did Not Follow Consistent Patterns

From fiscal years 1993 through 2002, the rates for the four enforcement programs often did not follow consistent patterns from one program to another or from year to year within programs. Comparing just 1993 with 2002, the contact rates for two programs—audits and document matching—were significantly lower, the rate for math errors was significantly higher, and the rate for nonfilers was essentially the same. By taxpayer income level, the audit rate for higher and middle income taxpayers generally declined over the 10-year period—with the sharpest declines for higher income taxpayers. The rate for the lowest income taxpayers increased sharply between 1993 and 1995 and then generally fell, ending virtually the same as in 1993. The document matching contact rate by income class followed very similar patterns with the rates for all income levels dropping over the 10-year period. The enforcement contacts increased or decreased because of several reasons, including statutory changes, staffing declines, and priorities in the use of staff among the programs.

Enforcement Program Contact Rates Varied from Program to Program and Often from Year to Year within Programs

As figure 2 shows, the math error program contact rates rose or fell from year to year; however, it’s the only enforcement program that had a significantly higher contact rate in fiscal year 2002 than in 1993. This is true even without counting certain math error contacts for which IRS lacks data over the 10-year period. Using only the math error count, which is consistent throughout the 10 years, the math error contact rate rose 33 percent (from 3.59 percent to 4.79 percent). Document matching contact rates went down and up at various times but ended 45 percent lower (from 2.37 percent to 1.30 percent) in 2002 compared to 1993. The nonfiler rates also went up and down but ended in 2002 about where they were in 1993. Comparing 1993 to 2002, the audit contact rate dropped 38 percent (from 0.92 percent to 0.57 percent), even though it rose significantly between 1993 and 1995. Over the 10 years, the math error rate exceeded the rate for each of the three other programs, and the audit rate was the lowest rate, except in fiscal years 1995, 1996, and 1997. The trends in the number of contacts in all four programs generally follow the trends in the rates. Appendix III provides details about the contact numbers and rates for all four programs.

The trend line in Figure 2 shows a revised math error contact rate that includes masterfile notices IRS had been sending throughout this period but had not been reporting as math errors. In data made publicly available on math error contacts, IRS had excluded roughly 2 million masterfile math error contacts annually for fiscal years 1997 through 2002. When included, the math error contact rate increases (e.g., from 4.97 percent to 6.5 percent in 1997). These math error contacts arise from IRS’s match of filed tax returns to its masterfile accounts to identify tax returns that misreport taxes already paid such as in previous years or estimated tax payments. IRS officials said that the masterfile errors were not reported as math errors because they are identified through a different process at a later time compared to other math errors during the processing of tax returns. In our discussions, these officials agreed that both types of errors are identified under the same math error authority, are indistinguishable to taxpayers being contacted, and should be similarly counted and reported.

IRS also did not include in its published report about 8 million notices sent in fiscal year 2002 to correct errors in tax returns reporting the rate reduction credit. If these notices had been included, the math error contact rate would have nearly doubled to 12.5 percent. The Economic Growth and Tax Relief Reconciliation Act of 2001 authorized tax rate reductions as well as an advance tax refund, called the rate reduction credit. Because the rate reduction credit applied for only 1 year, this error is unlikely to recur according to IRS officials. As a result, we did not include this information in figure 2.

Audit and Document Matching Contact Rates Across Income Levels Have Generally Declined

Figure 3 shows that the contact rates generally declined in the audit and document matching programs for all taxpayer income levels between fiscal years 1993 and 2002. For the math error and nonfiler programs, data on contact rates by income level were not available, and IRS officials said that it would take some time and effort to develop math error and nonfiler contact rates by income levels. (See table 7 in app. III for details on contact rates by income levels.)

As figure 3 shows, because the audit contact rate declined (from 3.89 percent to 0.86 percent) for higher income (more than $100,000) individuals and remained virtually the same (from 0.77 percent to 0.78 percent) for the lowest income (less than $25,000) individuals between fiscal years 1993 and 2002, the rates for the highest and lowest income individuals essentially converged in 2001 and 2002. Over the same time, the document matching contact rate generally declined for all three income groups with fairly similar year-to-year patterns and with higher income individuals being contacted at the higher rate.

Statutory Changes, Fewer Staff, and Resource Priorities Explain Trends in Math Error, and Other Enforcement Contact rates

The divergent trends between the growing rate of math error contacts and the declining or relatively stable rates for the other enforcement programs can be attributed to how the programs have been affected by statutory changes, fewer enforcement staff, and priorities for using available staff. Math error contacts grew over the fiscal year 1993 through 2002 period in part because Congress expanded the types of tax issues covered by the math error authority. For example, in 1996, Congress gave IRS authority to shift a number of earned income tax credit issues from its audit program to its math error program in that year. As a result, in 1997, IRS shifted over 700,000 cases involving missing or invalid social security numbers (SSN) on tax returns from the audit program to the math error program. Under this and other statutory expansions, IRS was making hundreds of thousands of math error contacts with taxpayers by 2002 that were not made in 1993.

A second statutory change played a role in the diverging trends among the enforcement programs. In RRA, Congress took steps to better ensure that taxpayer rights were protected by revising certain audit processes, such as informing taxpayers about their rights and generally how they were selected for audit. According to IRS officials, the changes contributed to the decline in audits because IRS auditors had to spend more time to handle nonaudit duties, to be trained in new procedures and taxpayers’ enhanced rights, and to do new tasks. Those changes contributed to reductions in the number of audits that each auditor completed, meaning they were less productive in closing audit cases.

Finally, declines in enforcement staffing and priorities for using staff also contributed to trends in enforcement program contacts. IRS has reported that from 1993 to 2001, enforcement staffing levels declined about 24 percent. These staffing declines affected not only the audit program but also the document matching and nonfiler programs because those programs require that IRS staff screen most notices before they are sent and follow up when taxpayers respond to notices. Given declining staff resources, IRS has restricted the number of notices sent when it finds probable noncompliance under the document matching and nonfiler programs. In contrast, IRS allocated enough resources over this period to the math error program to continue sending these notices. IRS officials said that IRS must resolve math errors to process tax returns and adjust the tax liability so that taxpayers are in compliance.

Limited Evidence Suggests IRS Enforcement Programs Do Increase Compliance; No Measures Available on Enforcement Program Burden

Although widespread agreement exists that enforcement programs help ensure voluntary tax compliance, evidence is limited about the degree to which enforcement overall or by type of program affects taxpayer compliance. No studies are available that measure the burdens that taxpayers experience when contacted under IRS’s enforcement programs.

Over the years, many tax practitioners and academics have suggested that enforcement programs are critical for ensuring voluntary compliance. However, measuring the effects of enforcement programs on compliance is a difficult task. IRS officials identified only one study that attempted to estimate the effects of its enforcement programs on compliance; no more recent work is underway or planned to measure these effects. Relying on an econometric analysis of taxpayer behavior—using various assumptions, IRS and non-IRS data for 1982 through 1991, and alternative measures of compliance—this IRS study estimated the effects of various IRS programs across the general taxpayer population. The study suggested that audits had a positive impact on compliance in reporting information on tax returns and that document matching had a positive effect on compliance in filing required returns. We did not have time to analyze the reasonableness of the study’s approach, assumptions, and results.

To obtain current information on taxpayers’ compliance in filing tax returns and reporting correctly on them, IRS developed its National Research Program (NRP). This program is designed to yield reliable estimates of the compliance levels of individual taxpayers while addressing concerns about the burden such a measurement program can impose on taxpayers. NRP’s design was completed in fiscal year 2002, and IRS will be auditing taxpayers’ returns under the program during fiscal year 2003. IRS plans to use the NRP results to update tools to select individual tax returns for audit, to allocate resources, to estimate the impacts of legislative and administrative changes on voluntary compliance and tax revenue, and to identify potential ways to improve voluntary compliance. Although NRP should yield useful data, it was not designed to measure the effect that each major enforcement program could have on voluntary compliance.

In addition, IRS has been working to produce more comprehensive estimates of burden that individual taxpayers face in meeting their tax obligations. IRS developed a system in 1984 for estimating the burdens taxpayers face in filing IRS forms, and began efforts during the 1990s to create a better model for estimating such compliance burdens. IRS recently announced that the new burden model is ready to be tested and likely will replace the old model during fiscal year 2003. Although the model should provide better estimates of individual taxpayer burdens in completing and filing tax returns, it is not designed to estimate the postfiling burdens related to IRS’s enforcement efforts. IRS expects to model these postfiling burdens but does not yet know when that phase of its burden estimation project will begin.

IRS’s Public Reporting on Its Enforcement Programs Is Incomplete

IRS’s public reporting on its enforcement programs for individual taxpayers does not provide a complete perspective on its efforts to enforce tax laws because that reporting heavily focuses on audits. IRS’s audit rate is often cited in the press and is often the focus of congressional and other debates concerning how well IRS is enforcing the tax laws. However, over time the audit rate has become increasingly less complete as a measure of IRS’s efforts to enforce tax laws because IRS’s other enforcement programs have expanded their coverage of issues once covered under audits.

At least two options exist for expanding reporting: changing the definition of audits to include other enforcement efforts and reporting more data on each enforcement program separately. The second option would achieve more complete and balanced reporting without incurring some of the disadvantages that could come from expanding the definition of audits. IRS officials plan to expand public reporting for fiscal year 2002 on IRS’s major enforcement programs to the extent that data are available and cost effective to extract.

Limited Public Reporting on IRS’s Enforcement Programs

IRS publishes extensive data on audits but only limited data on other enforcement programs in its Data Book. Table 2 summarizes the data annually published on the enforcement programs involving individual taxpayers.

As shown, IRS publishes no data on IRS’s math error program—which affects millions of individual taxpayers annually. Compared with audits, public reporting on the document matching and nonfiler programs is much more limited. IRS officials said that IRS publicly reports more data on audits because IRS has had a separate audit case-tracking system for many years that produces such data. Also, they said that requests to publicly report more data on the other programs had not been made.

IRS has not changed Data Book reporting on its enforcement programs to keep up with changes in its enforcement programs over the years. With its focus on audits, the reporting may lead others to focus on audits and thereby to have an incomplete understanding of IRS’s enforcement efforts. For example, trends in the audit rate alone are difficult to use to assess IRS’s enforcement presence because that rate does not measure the same phenomenon today as it did earlier. Even within the 10-year period we reviewed, some of the tax issues that formerly had been checked only under the audit program migrated into the other enforcement programs. This type of migration was more pronounced in the 1980s as the document matching program expanded substantially.

Although the scope of what IRS does under audits has changed considerably over the past few decades, and even within the past 10 years, the audit rate remains an often-cited statistic when Congress and others consider how well IRS is enforcing the tax laws. For instance, during annual oversight hearings on IRS’s performance, members of Congress often raise questions about changes in the audit rate. Over the past several years, these hearings have included concerns about the declining audit rate and its possible affect on taxpayers’ compliance. The IRS Commissioner also expressed concern about the decline in audits. However, the Commissioner said that he did not believe the audit rate needed to increase to the same level as a number of years ago because IRS has other programs to enforce the tax laws that were not available, or as broad in scope, in past years.

To the extent that IRS’s audit rate is the major source of information available to taxpayers on IRS’s enforcement efforts, the public cannot be fully aware of the extent to which IRS enforces tax laws and thus may misjudge the chances that noncompliance is likely to be detected. Taxpayers who are aware only of the audit rate would not be aware that IRS often contacts more taxpayers under each of its other enforcement programs—and IRS always contacts far more taxpayers in these other programs combined—than it does under the audit program. As discussed earlier, although the degree to which enforcement encourages voluntary compliance is difficult to measure, it is widely believed that public knowledge about enforcement efforts helps prompt higher levels of voluntary compliance. Although he did not specifically cite possible increases in voluntary compliance, in a letter issued in March 2001, the IRS Commissioner said that only focusing on audits substantially understates IRS’s capacity to find errors.

While greater awareness of the scope of IRS’s efforts to enforce the tax law may encourage compliance, it could also increase taxpayers’ awareness of the trends in these efforts. It is not clear how taxpayers would interpret and react to the differing trends among IRS’s enforcement programs. For the period from 1993 through 2002, trends in IRS’s individual enforcement programs often varied from year to year as well as between the programs. Therefore, the compliance signals to taxpayers from publicizing data on the trends in these other programs probably would be different—and more mixed—than the signal they receive based exclusively on the audit rate.

In addition, awareness of the fuller range of IRS’s enforcement efforts may not affect compliance of all groups of taxpayers equally. This could occur, for example, when the contact rates under the enforcement programs differ, as they do under the audit and document matching programs for different income groups. Further, to the extent that taxpayers know that IRS can only understand their tax situation through a traditional audit, their compliance might be less affected by fuller reporting on IRS’s other enforcement efforts. The IRS Commissioner has said that the decline in the traditional audit rate is of concern in part because a growing portion of taxpayers and a growing amount of income is not well identified through such programs as document matching and nonfiler.

Expanding Public Reporting on Enforcement Programs Does Not Require Redefining Audits

Of two options we identified for expanding public reporting on IRS’s enforcement efforts, providing data on each major program separately avoids certain disadvantages of aggregating data into one broad audit program. After we discussed the tradeoffs of these options with IRS officials, they said they plan to expand public reporting for each of the nonaudit enforcement programs.

One option for expanding reporting on IRS’s enforcement programs would be to define all of IRS’s enforcement programs to be audits for statistical reporting. If the programs were all defined to be audits, IRS might report a consolidated “audit rate” that would represent all of IRS’s contacts with taxpayers. Consolidated reporting might also be done on such things as the additional tax revenues identified through the contacts and the staff time invested by IRS.

This option could have several advantages. For instance, it would provide for more complete reporting on IRS’s overall enforcement efforts in a single “rate.” Another advantage to expanding the definition of an audit is that the major enforcement programs have an overall similarity in what they intend to achieve. Moreover, some document matching and math error checks now cover some tax issues that had been covered under audit authority. Thus, because audits do not measure the same thing over time, expanding the definition would create a more consistent measure of the extent to which IRS is enforcing tax laws.

However, combining all enforcement programs under one definition poses a number of potential disadvantages. For example, IRS’s legal authority and operational rules, as well as taxpayers’ rights, vary across enforcement programs. If all enforcement programs were called audits, IRS staff and taxpayers could become confused about the rights and restrictions that govern contacts with taxpayers. Labeling all enforcement programs as audits might confuse taxpayers about whether IRS could examine their books and records for a specific tax year (an action taken under IRS’s current audit authority) if they had already been contacted under document matching and/or math error programs.

If all enforcement programs were called audits and aggregate reporting was done, IRS would face a challenge in ensuring that taxpayers and others are not misled. For example, a single audit rate would cover the range from intense audits covering multiple tax issues to the correction of simple math errors arising from inadvertent miscalculations by taxpayers. Given the higher number of math errors being detected by IRS over time, if taxpayers interpreted a revised audit rate as representing the former rather than the latter situation, they would be misled about IRS’s true level of tax return scrutiny. Another challenge for IRS would be in reporting audit results like tax dollars assessed and time spent per audit. Considerable variability already exists in these results for audit—e.g., field audits take significantly more staff hours than correspondence audits. These differences would be more extreme under a consolidated audit reporting system that included document matching, nonfiler, and math error contacts. Finally, the IRS would need to account for potential double counting because taxpayers can be contacted through more than one enforcement program for the same return.

In addition, labeling all IRS enforcement programs as audits might suggest that the programs are in some sense substitutable in detecting noncompliance and encouraging voluntary compliance. Although the document matching and nonfiler programs do replace part of what had previously been done by auditors, these programs do not completely substitute for audits. Math error program contacts are even less of a substitute for audit. Combining all of these efforts suggests an equivalence—one math error contact with a taxpayer is equivalent to a complex, intense audit of a taxpayer books and records—that is not correct. Therefore, if audits dropped even further than they have in recent years, but math error contacts rose even faster, some might assume that IRS is doing better at enforcing tax laws while others might disagree.

Because of such disadvantages, IRS officials said that they do not favor changing the audit definition to include the other enforcement programs at this time. Specifically, they said any changes would create confusion about IRS’s enforcement activities and could distort any comparisons because the programs significantly differ.

Instead of expanding the audit definition, IRS has already expressed support for greater reporting on the full range of IRS’s enforcement efforts. For example, in 2001, the IRS Commissioner stated that IRS’s goal is to make public reporting on nonaudit enforcement efforts as informative and meaningful as possible. This approach generally avoids the disadvantages associated with reporting IRS’s enforcement efforts under one consolidated, redefined audit program. At the same time, it would provide more complete reporting to the public.

In December 2002, IRS officials told us that they plan to try to report more data on other enforcement programs to the extent that the data are available and cost-effective to extract. Officials expect that this expanded reporting will begin with the fiscal year 2003 Data Book if the necessary statistical tables cannot be produced in time for the 2002 edition that is to be published in early calendar year 2003. The expanded information will also be available on the IRS Web site.

These officials said that they would attempt to report the number of cases closed, the staff time expended, and the tax amounts adjusted for document matching and for the automated substitute for return program (ASFR) component of the nonfiler program. For document matching, IRS plans to account for not only the cases in which taxpayers were contacted but also in which IRS staff resolved the apparent income discrepancy without contacting taxpayers. For ASFR, IRS is planning to adjust the data for cases in which IRS abated the additional tax amounts assessed after taxpayers later filed a tax return. For both programs, IRS officials said that reporting the data by the taxpayer’s level of income is doubtful. For math errors, IRS officials said that they could report the number of notices, staff time, and tax amounts assessed but that reporting other data is questionable either because the data are not collected or are difficult or costly to extract. IRS has no plans to analyze whether changes could be made to cost-effectively extract or collect other data to facilitate understanding of and comparisons among these nonaudit enforcement programs.

Conclusions

Although research is not conclusive about the extent to which taxpayers comply with the law based on their perception of whether noncompliance will be caught, it is widely believed that those perceptions do contribute to the overall level of compliance by taxpayers. On the basis of this belief, observers in Congress and elsewhere have been concerned as IRS’s oft- cited audit rate has declined in recent years.

To an unknown, but real extent, the long-term decline in the audit rate is attributable to the movement of some tax issues from IRS’s audit program into its other enforcement programs. This movement has been facilitated by changes in technology, and has enabled IRS, for some tax issues, to more universally check whether taxpayers have accurately reported their tax liabilities. Although much of the movement of IRS’s audits into other programs occurred during the 1970s and 1980s, this trend continued during the fiscal year 1993 through 2002 period.

Given these changes in IRS’s enforcement operations, policymakers in Congress and elsewhere, as well as taxpayers, would be better informed about the scope of IRS’s efforts to enforce tax laws if IRS were to expand its annual public reporting to include the full range of its enforcement programs. Toward this end, some interest has been expressed in having IRS report a new audit rate that would aggregate IRS’s various enforcement programs into a total, revised audit rate. Although such a measure would attempt to provide a more comprehensive picture of IRS’s overall effort to detect compliance problems, the advantages of doing so do not clearly outweigh potential disadvantages. For instance, expanding the definition of an audit would package enforcement activities that are so disparate that the consolidated reporting could be misleading.

However, policymakers and taxpayers could be better informed about of the extent of IRS’s efforts to enforce the tax laws without combining data on all of IRS’s enforcement programs into one set of aggregate measures. IRS’s commissioner set fuller reporting of IRS’s enforcement efforts as an IRS goal, and IRS officials plan to move to fuller reporting of enforcement program results, perhaps as early as in the 2002 IRS Data Book, which will be published in early calendar year 2003. IRS officials expect that this expanded reporting will use only readily available data on the enforcement programs.

Because the document matching, math error, and nonfiler programs now cover many tax issues formerly covered by audits and they annually contact far more taxpayers than audits, expanded reporting on these programs, using readily available data, is an appropriate first step. However, the readily available data for the nonaudit programs is incomplete compared to data reported on audits. For example, the data do not cover all nonfiler contacts or the results of the programs by taxpayer income. IRS has no plans to determine whether it could cost-effectively extract or collect additional data in order to more completely present program results, and facilitate comparisons across the programs or with any new programs, as they evolve.

In the case of the math error program, total data that includes math errors identified during initial processing of tax returns as well as errors found in comparing tax return data to data in IRS’s masterfiles should be reported. Excluding data on math errors found in comparing returns to IRS’s masterfiles materially understates the volume of math error contacts with taxpayers.

Recommendations to the Acting Commissioner of Internal Revenue

The Acting Commissioner of Internal Revenue should determine whether additional data on each nonaudit program can be cost effectively extracted or collected to make future annual reporting on enforcement programs more complete and comparable. provide information on all types of math error contacts when publishing data on IRS’s math error program.

Agency Comments

The Acting Commissioner of Internal Revenue provided written comments on a draft of this report in a January 27, 2003, letter, which is reprinted in appendix V. The Commissioner agreed with our recommendations. We are heartened that IRS has already begun to identify additional data to report on its enforcement programs. Given the differing nature of IRS’s enforcement programs, we encourage IRS to provide information that is as comparable as possible among the programs.

As arranged with your office, we plan no further distribution of this report until 30 days from the date of its issue, unless you publicly announce its contents earlier. After that period we will send copies to the Chairman and Ranking Minority Member, House Committee on Ways and Means; and Chairman and Ranking Minority Member, Senate Committee on Finance. We will also send copies to the Acting Secretary of the Treasury; Acting Commissioner of Internal Revenue; the Director, Office of Management and Budget; and other interested parties. Copies of this report will be made available to others on request. In addition, the report will be made available at no charge on the GAO Web site at http://www.gao.gov.

If you have any questions, please contact me or Tom Short on (202) 512-9110. Key contributors to this report are acknowledged in appendix VI.

Appendix I: Development of the Math Error Program

As early as the first codification of the Internal Revenue law in 1939, Congress granted IRS “math error” authority so that IRS does not have to provide the taxpayer with a statutory notice of deficiency for math errors. In general, these are errors that must be corrected for IRS to process the tax return. A 1976 statutory revision defined the authority to include not only mathematical errors but other obvious errors such as omissions of data needed to substantiate an item on a return. In the 1990s, Congress extended the authority five times to help determine eligibility for certain tax exemptions and credits. Table 3 summarizes the legislative authority on math error provisions for individual tax returns.

According to IRS officials, math error authority applies to obvious errors where most taxpayers do not dispute IRS’s decisions. However, if taxpayers do disagree with the changes in taxes assessed, they can request an abatement (reduction) of the additional taxes. The math error process also generates lower administrative and other costs because it is highly automated and requires little contact with taxpayers, according to IRS officials.

Appendix II: Use of Information Returns and Document Matching at IRS

IRS has endorsed the concept of matching information returns to income tax returns for the purpose of identifying unreported income since the 1960s. Prior to the 1960s, employers had reported on wages paid to employees by the name of the employee. To facilitate matching, Congress required a TIN—generally a social security number for individual taxpayers—that is unique to each taxpayer, unlike a name. IRS and those filing information returns (i.e., payers of income) need accurate TINs for the system to work well. Filing of information returns on magnetic media or other electronic means combined with greater IRS computer capacity also has facilitated the matching process.

In 1962, Congress recognized that underreporting of nonwage income, such as interest and dividend income, was a serious problem. To correct it, Congress required information reporting on interest and dividend income. Congress substantially expanded information reporting requirements during the 1980s and added a few requirements during the 1990s. Table 4 lists each major statute expanding information returns authority.

IRS did not perform extensive document matching until 1974 when IRS established a program to match information returns against tax return data to identify potential income underreporting. Even so, IRS used labor- intensive, paper-driven methods. For example, clerks had to manually create case files for each potential underreporter, and IRS staff had to review the case files to determine if income was underreported. Clerks entered the results of these file reviews into systems, which generated notices to taxpayers. In 1987, IRS began to automate the document matching process. At that time IRS established the Automated Underreporter Program that allows access to computerized information, reducing the need for hard copy documents and clerks, and enabling a faster response to taxpayer inquiries.

By tax year 2000, almost 1.5 billion information returns were filed with IRS. Table 5 lists the major types of information returns filed for 1983 and 2000.

In 2002, IRS re-instituted matching of income reported by flow-through entities such as trusts, partnerships, and S-corporations on Schedule K-1 to income reported on tax returns by the related partners and beneficiaries. Schedule K-1 shows the income distributed to partners and beneficiaries, who receive a copy as well as IRS. According to IRS, information provided on Schedule K-1 is important for determining whether recipients of flow-through income have properly reported that income on their tax returns. IRS expects the matching of Schedule K-1 data to increase accurate reporting of trust income on future tax returns by providing information that IRS can use to detect possible unreported income and to induce taxpayers to voluntarily comply. Under K-1 matching, IRS sent 69,097 notices to taxpayers in 2002 for tax year 2000. In most cases, the taxpayers did not owe additional tax for various reasons (e.g., taxpayers reported the income differently than expected). IRS does not yet have complete results from this new matching program. IRS officials told us that K-1 matching has been suspended for one year to analyze the matching criteria and results.

Appendix III: Individual Audit and Other Enforcement Program Data

IRS did not publish data on revenue officer examiner audits prior to 1998.

Data for math error masterfile notices do not exist prior to fiscal year 1997.

The number of math error (revised) contacts are the same as the number of math error contacts for fiscal years 1993 through 1996 because data for the number of masterfile notices does not exist for these years.

Appendix IV: Soft Notices and Voluntary Compliance Agreements

In addition to the four major enforcement programs, IRS started two programs in the mid-1990s to help ensure that taxpayers file timely and accurate returns, and to minimize the need for enforcement.

Through the soft notice program, IRS has been sending notices for apparent errors on two tax issues—duplicate claims for one allowable dependent exemption and unfiled self-employment tax returns. IRS uses soft notices when it has information to indicate that some taxpayer made an error but not enough information to know for sure, such as which taxpayer overclaimed a dependent. Soft notices are intended to stimulate taxpayers to correct the error without IRS having to invest audit time.

In addition, IRS uses the voluntary compliance agreements program to address known compliance problems in reporting tip income. To improve compliance of employees in industries where tip income is a part of wages, IRS had been auditing the tax returns of tipped employees, which burdened the employees and employers as well as IRS. To minimize these burdens while also addressing the compliance problems, IRS began to explore new methods to achieve voluntary compliance by tipped employees, such as voluntary compliance agreements. IRS has negotiated three types of agreements with certain employers (e.g., restaurants) to improve compliance by their individual employees in reporting tip income. These three types of agreements follow.

The Tip Rate Determination Agreement (TRDA) requires that IRS and the business agree upon a tip rate for various occupations in the business and that at least 75 percent of employees in the business agree to report at that rate on their income tax return.

The Tip Reporting Alternative Commitment (TRAC) does not require a tip rate to be determined, but does require that the business create written statements to record employee tips and send the statements to IRS. This agreement covers all employees and requires that the business educate employees about their obligation to report their tip income.

The Employer-designed Tip Reporting Alternative Commitment Agreement (EmTRAC) requires that businesses establish tip reporting procedures and prepare a statement on a regular basis (no less than monthly) to reflect all tips for each employee. The business must establish an education program to train employees about their obligation to report tip income.

In general, these two programs are similar to the four major enforcement programs in that they attempt to correct noncompliance. They differ because, rather than enforcing the tax laws, both attempt to reduce the need for enforcement. In sum, their differences tend to outnumber their similarities, as discussed below.

Similar to the four enforcement programs, IRS sends soft notices to inform taxpayers of potential errors. However, the soft notice does not require taxpayers to take any action, and IRS takes no action to verify the error or assess tax. Instead, the notice asks taxpayers to examine the potential error and file an amended return if they confirm the error. Also, the notice informs taxpayers that IRS will monitor these types of errors and might contact them if they do not alter their reporting in the future.

The similarity between the voluntary compliance agreements and the other enforcement programs is that they attempt to correct noncompliance. Unlike the other programs, these agreements occur before a return is filed and do not involve sending any notices to taxpayers. IRS believes that these agreements enhance voluntary compliance so that IRS can avoid the need to take enforcement action and assess additional taxes after a return is filed. IRS assures the businesses that IRS will not audit their books and records as long as they abide by the agreement. However, IRS may still audit the books and records of a tipped employee and report any changes to the business. IRS officials said that current procedures require follow-up to check adherence to these agreements, but the officials were not sure about the extent to which this has been occurring.

IRS has limited data for the soft notice and voluntary compliance agreement programs, as follows.

In 2002, IRS sent 1.2 million soft notices to taxpayers on duplicate dependent claims on 2001 tax returns; in 1998, IRS sent 1.6 million soft notices on these duplicate claims and on self-employment tax for 1996 and 1997 returns. This involved 329,000 notices sent to taxpayers who reported self-employment income but had not filed a schedule SE or paid self-employment tax. IRS did not provide data on these notices for any later years.

Through 2001, TRDAs and TRACs covered 48,348 establishments in the casino, beauty, and food and beverage industries. IRS did not have data on the number of individual taxpayers covered by these agreements because the agreements are made with employers rather than directly with the individual taxpayers.

Appendix V: Comments from the Commissioner of Internal Revenue

Appendix VI: GAO Contacts and Staff Acknowledgments

GAO Contacts

Staff Acknowledgments

In addition to those named above Susan Baker, Grace Coleman, Susan Conlon, Brendan Culley, Michele Fejfar, Leon Green, Marshall Hamlett, Shirley Jones, and Jay Pelkofer made key contributions to this product.

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