2017 Filing Season: New Wage Verification Process Holds Promise but IRS Faced Implementation Challenges
Released: 2017-04-26T00:00:00

Letter

IRS Performed Early W-2 Verification, but Faced Implementation Challenges

IRS Verified Wages and Withholding for Some Returns but Did Not Receive All W-2 Data before Releasing Refunds

Before the Protecting Americans from Tax Hikes Act was enacted, IRS did not receive the majority of W-2 data until after most refunds had been issued. As we reported in 2014, IDT refund fraud took advantage of IRS’s “look-back” compliance model. Under this model, rather than holding refunds until completing all compliance checks, IRS issued refunds after conducting selected reviews. Since IRS did not receive most employer- reported W-2 data until late in the filing season, IRS did not begin matching that data to tax returns until July, following the tax season. However, with the Act’s new reporting deadline, as of February 17, 2017, IRS received over 214 million W-2 forms from SSA, an increase of 125 percent from the same time last year (see fig. 1).

For the 2017 filing season, IRS used the W-2 data it had available to verify wages and withholding reported on all tax returns during initial processing. Under the new legal requirements of section 6402(m) of the tax code, IRS held refunds for returns claiming the EITC or ACTC (EITC/ACTC returns) until February 15 regardless of whether IRS had the W-2 data available to verify wage information and had determined the corresponding refund was valid (see fig. 2). IRS, in consultation with the Department of the Treasury (Treasury), elected not to hold any refunds for returns without EITC or ACTC (non-EITC/ACTC) because it was not required to do so, as discussed later in this testimony. However, all returns—with EITC or ACTC and without EITC or ACTC—are subject to IRS’s verification process as well as other fraud filters.

While IRS conducts quality and enforcement checks throughout return processing, preliminary data suggest that by using its W-2 systemic verification, including allowing time to input the data for matching, are important steps in IRS’s ability to determine whether the refund amount claimed and taxpayer are legitimate for returns with EITC/ACTC as well as for returns without those credits. Specifically, we found that:

For returns where the taxpayer claimed the EITC or ACTC, preliminary data show that IRS verified the wage information for over 35 percent of these returns before February 15. Moreover, the refund hold allowed IRS time to check returns using its systemic verification when it received more W-2 data. For example, IRS reported it reprocessed about 1 million returns during the hold period as more data became available. As a result, IRS said it identified approximately 162,000 returns claiming about $863 million in refunds as potentially fraudulent. According to IRS, those refunds were not allowed to be released on February 15, and the returns were directed for follow up. However, IRS was unable to verify wage information for over 58 percent (7.7 million) of tax returns with refunds claiming the EITC or ACTC—for a total of $38.1 billion—before February 15. This was in part due to the timing of when W-2 information was available, as discussed later in this statement.

IRS did not hold returns that did not claim the EITC or ACTC unless the return was selected by its other filters (such as for potential IDT refund fraud). On such returns, while IRS also used available W-2 information, it did not hold refunds solely because W-2 information was not available. Preliminary data show that using systemic verification, IRS verified wages of 8.6 million (41 percent) of returns that did not claim the EITC or ACTC before February 15. However, IRS was unable to verify wage information reported on over 58 percent (12.3 million) of these tax returns for a total of $28.1 billion, as not all W-2 data were available and IRS was not required to hold these returns.

IRS Faced Challenges with the W-2 Systemic Verification Process

IRS faced challenges related to the availability and timing of the W-2s while implementing its W-2 systemic verification process.

As noted previously, IRS was unable to verify wage income for the majority of both EITC/ACTC and non-EITC/ACTC returns received by February 14, because it did not have W-2 information available for those taxpayers. There were three reasons for this delay: 1. IRS received electronic W-2 data from SSA daily, but because IRS is using older technology in this instance (a legacy system), it could only load the data weekly. For EITC/ACTC returns, the law provided an approximate 2-week delay between the W-2 due date (January 31) and the refund release date (February 15), to allow time for IRS to load the data and verify wage information on the returns before releasing the refunds. 2. Some W-2 data were delayed past February 15 because employers requested extensions or missed the new deadline. This year, IRS allowed employers a one-time 30-day, non-automatic extension to file W-2 data if the deadline would cause undue hardship that would also prevent the employer from furnishing the W-2s to employees by January 31 (such as if a flood damaged the documentation and equipment needed to file). This is a change from prior years in which employers could request one 30-day extension from either the due date on the last day of February (if filing on paper) or last day of March (if filing electronically). 3. While SSA begins receiving W-2 forms on paper in December, it did not begin to transmit these data to IRS until March 2017. SSA officials reported that they cannot report the number of employers who filed paper W-2s until they complete transcribing those forms for tax year 2016. As of February 15, SSA estimated that it had approximately 17.4 million paper W-2s. As of March 31, 2017, SSA had processed and transmitted to IRS about 3.8 million of these. Consequently, IRS processed refunds without W-2 information for those taxpayers whose employers had submitted paper W-2s.

IRS Continues to Analyze Results of Systemic Verification

As of March 29, IRS officials were still assessing the W-2 systemic verification process and its outcomes. IRS does not yet know the full effect of its W-2 systemic verification process on the number of IDT fraudulent refunds it was able to prevent paying. However, as noted earlier, IRS officials reported that the initial review of the W-2 verification process for EITC/ACTC returns showed that IRS identified approximately 162,000 returns worth about $863 million as potentially fraudulent that it would not have identified without the early W-2 data coupled with the refund hold. IRS’s fraud filters did not select these returns for further review; however, the W-2 systemic verification process did because IRS received the W-2 data before it would have released the refunds on February 15.

IRS officials also reported a decrease in the number of IDT cases this filing season compared to last year. Through February 28, 2017, the number of new cases decreased by 51 percent compared to the same time last year (from 63,102 to 30,850). However, it is difficult to determine whether this decline is due to IRS’s efforts, fewer attempts by fraudsters, or other factors. IRS is continuing to review its verification process before determining what steps it needs to take, if any, to improve its fraud selection filters.

IRS officials stated that they are confident that IRS did not systematically release EITC/ACTC refunds covered by the new hold requirement prematurely. IRS said its pre-filing season testing confirmed that the holds would work as intended, and that it conducted individual reviews of EITC/ACTC cases in which data indicated that a refund may have been released early. IRS identified nine such cases, but the payouts occurred after February 15. IRS is considering a number of scenarios that may require legislative action, including adjusting the timing of holding refunds it has not yet verified, and releasing refunds for wages it has verified.

One concern that officials noted about the refund hold was the potential effect on the economy. According to IRS officials, in consultation with Treasury, IRS opted not to hold all refunds until February 15. Although IRS has authority to hold these refunds, officials explained that doing so would have too great of an effect on the economy on top of the refunds they were required to hold by law. For example, there could be impacts to business models of large retailers that rely on the cycle of federal income tax refund distribution, especially in communities with lower- income taxpayers, according to IRS officials. Even a short delay in a one- time cash infusion, especially if it represents a significant portion of some taxpayers’ income, can cause them to delay paying bills or making important spending decisions. In addition, IRS officials said that the surge in refunds released February 15 could have had a significant impact on check-cashing businesses and retailers and the amount of cash required on hand to pay refunds to taxpayers. For EITC/ACTC returns, IRS estimated the effect on the economy to be about $60 to $64 billion in total refunds that IRS would not release to taxpayers until February 15. If IRS also held non-EITC/ACTC returns, it estimated those refund amounts would affect the economy by an additional $40 billion.

IRS Improved Telephone Customer Service, Experienced Few Disruptions Processing Returns, and Added an Online Application While Suspending or Discontinuing Others

Telephone Service Improved in the 2017 Filing Season

While implementing tax law changes, it is important that IRS ensures timely and quality service. During the filing season, IRS enforces tax laws, provides service to tens of millions of taxpayers, and processes over 100 million tax returns. In recent years, IRS has experienced declining resources and an increased workload. We have reported that IRS’s budget declined by about $900 million between fiscal years 2011 and 2016. Furthermore, full-time equivalents (FTE) funded with annual appropriations declined by 12,000 (13 percent) between fiscal years 2011 and 2016. The President’s fiscal year 2018 “Budget Blueprint” released in March 2017 proposes funding IRS below the fiscal year 2000 level, after adjusting for inflation (see fig. 3).

The decline in IRS’s budget has contributed to fluctuations in service and longer telephone wait times. For example, in December 2015, we reported that IRS provided the lowest level of telephone service—the percentage of people who wanted to speak with an IRS assistor and were able to reach one—during fiscal year 2015 compared to prior years.

Callers experienced long wait times and difficulty in reaching an IRS assistor. IRS received additional funding for the 2016 filing season and service improved considerably. For instance, the 2016 level of service was the highest since 2011. Maintaining quality customer service is important because it helps taxpayers comply with the tax code.

We found that IRS’s telephone service continued to improve in the 2017 filing season. As shown in figure 4, from January 1 through March 25, 2017, IRS’s telephone level of service increased by almost 4 percentage points from the same time last year. In addition, the average wait time to speak to an assistor decreased from 9.7 to 6.8 minutes. IRS officials attributed the improvements to decreased telephone volume and its ability to hire more assistors before the filing season started and prior to the executive branch hiring freeze.

As of March 25, 2017, IRS had received about 30.7 million calls to its automated and live assistor-answered telephone lines, an almost 32 percent decrease from the same time in 2016 (see fig. 5). Accordingly, IRS assistors answered 6.9 million calls, approximately a 30 percent decrease from the 9.9 million calls answered during the same time last year. IRS officials told us they are still evaluating the reasons for the decrease in call demand.

During the 2017 tax filing season, IRS experienced a disruption in telephone service on one of its busiest days due to equipment issues. During an 11-hour period on February 21, the day after the President’s Day holiday, which is the single busiest day of the year to call IRS, IRS’s telephone equipment malfunctioned, resulting in about 775,000 calls that could not be completed or were disconnected. IRS officials explained that a workaround solution to manage a known bug in the telephone equipment failed to work. IRS officials told us that they are working with the telephone vendor to resolve the issue. In the meantime, IRS officials stated that they are monitoring telephone call volume manually to avoid a repeated failure. Officials explained that this bug will be fixed when IRS can upgrade its telephone equipment, which they expect to do by the end of calendar year 2017.

IRS officials noted that the lower call volume IRS has experienced this filing season has allowed assistors to work through more written correspondence inventory than in prior years rather than letting it build up while answering calls. As a result, through March 25, 2017, the overage rate of correspondence—the percentage of cases generally not processed within 45 days of receipt by IRS—had decreased to 31 percent compared to 46.3 percent at the same time last year.

IRS Experienced Few Processing Disruptions during the 2017 Filing Season

According to IRS officials, return processing during the 2017 filing season has proceeded as expected with a few minor challenges. As of April14, 2017, IRS had processed 115 million individual tax returns and issued 87.5 million refunds totaling $246 billion.

IRS’s electronic filing system experienced two periods of interruptions, but they were short in duration with one lasting about a day and the other including intermittent outages over the course of about a week. In addition, some return processing was delayed as a result of the hiring freeze. IRS officials stated that the hiring restriction did not significantly disrupt processing tax returns and refunds, in part because the number of returns filed in the beginning of the filing season was lower compared to last year. IRS officials stated that they authorized use of overtime to help facilitate processing and meet performance deadlines. Between October 1, 2016 through April 1, 2017, IRS used 23 FTEs of overtime and estimates that it will use about 106 FTEs through the fiscal year.

In addition to the W-2 systemic verification process, the Protecting Americans from Tax Hikes Act also required taxpayers that filed a U.S. federal tax return containing an Individual Taxpayer Identification Number (ITIN) to renew the number if the ITIN was not used on at least one tax return in the past 3 years or it was issued prior to 2013 and contained certain middle digits. IRS deactivated approximately 11.5 million ITINs and notified affected taxpayers via mail and public notices. If affected taxpayers did not renew their ITIN either before filing or in conjunction with filing, their refund may have been delayed. As of April 15, 2017, IRS had renewed over 130,000 ITINs and rejected approximately 16,300 ITIN renewal applications.

IRS Launched a New Online Application, but Others Were Unavailable or Discontinued

IRS established its new online application in November 2016, but other key applications were unavailable or discontinued. IRS’s new online application is designed to assist taxpayers with straightforward balance inquiries. It allows taxpayers to view their IRS account balance—including the amount they owe for tax, penalties, and interest—and take advantage of various online payment options. For example, through the online account application, taxpayers can access IRS’s Direct Pay application, which allows taxpayers to pay their individual tax bill or estimated tax payment directly from their checking or savings account at no cost. As of April 1, 2017, IRS’s new online account application had been accessed more than 550,000 times since its launch. In addition, IRS has processed over 35,000 Direct Pay transactions totaling $109.4 million since November 2016.

As we previously reported, in June 2016, IRS discontinued its e-file Personal Identification Number (PIN) tool, with which taxpayers could retrieve their e-file PINs online or via telephone. The e-File PIN served as an alternative signature verification method on the Form 1040 series and helped assist taxpayers with electronically filing their tax returns. Discontinuing this tool followed IRS’s announcement in February 2016 that cybercriminals had stolen more than 100,000 e-file PINs through the tool. In addition, in March 2017, IRS and the Department of Education responded to security concerns and removed access on fafsa.gov and StudentLoans.gov to IRS’s Data Retrieval Tool—the online process through which student financial aid applicants obtain their family’s tax information. IRS suspects that fraudsters used personal information obtained elsewhere to access the Data Retrieval Tool in an attempt to access tax information, particularly the adjusted gross income. As of April 6, IRS reported that fewer than 8,000 fraudulent returns from this incident had been filed, processed, and refunds issued but estimated that about 100,000 taxpayers may have been affected. IRS said that it expects the Data Retrieval Tool to be unavailable until October 2017 while IRS and the Department of Education make updates.

Implementing GAO’s Prior Open Recommendations Could Help IRS Improve Service

IRS is making progress implementing our prior recommendations to improve its service, particularly in the following areas:

Customer service strategy. We have made several recommendations for IRS to improve taxpayer service. For example, in 2012, we recommended that IRS outline a strategy that defines appropriate levels of telephone and correspondence service and wait time and lists specific steps to manage service based on an assessment of time frames, demand, capabilities, and resources. In 2014, we recommended that IRS systematically and periodically compare its telephone service to the best in business to identify gaps between actual and desired performance. Moreover, in December 2015, we suggested that Congress should consider requiring the Secretary of the Treasury to develop a comprehensive customer service strategy in consultation with IRS to enable the agency to make a more informed request to Congress about resource requirements needed to deliver specific levels of service, similar to what we recommended in December 2012. In February 2016, IRS announced a “Future State” initiative for agency-wide operations, which aims to improve services across different taxpayer interactions such as individual online account assistance, exams, and collections. As part of this initiative, IRS completed a study benchmarking its telephone performance against the best in the business, and we are reviewing the report to determine whether it addresses our December 2014 recommendation.

IRS officials have told us that many of our other service-related recommendations will ultimately be incorporated into IRS’s Future State initiative. However, it is unclear the extent to which and when our recommendations will be fulfilled by IRS’s initiative. For example, in November 2016, IRS provided us with documentation on the goals of the initiative, which included goals on improving taxpayer service. However, the documentation does not detail levels of telephone and correspondence service and wait times, as we recommended in December 2012. We will continue to assess the Future State initiative as IRS works to develop it. Finalizing a long-term, comprehensive strategy for customer service will help ensure IRS is maximizing the benefit to taxpayers and possibly reduce costs in other areas, such as for IRS’s telephone operations.

Online services. IRS has made progress in addressing our December 2011 and April 2013 recommendations to improve its online services strategy; however, as of March 2017, IRS had not yet completed its efforts. For example, IRS’s Future State initiative aims to improve services across different taxpayer interactions such as individual account assistance, exams, and collections. IRS also revised its business case template in 2014 for new online services to include, among other things, a discussion of costs, benefits, and risks of future projects, consistent with our April 2013 recommendation. However, we reviewed IRS documentation and found that the business case contained some of the information we recommended, such as high-level time frames, but was missing other information, such as the benefits and costs of the project. Further, it is unclear how IRS plans to use the business case to prioritize future projects. IRS told us it implemented a new process for online investments that requires details on expected benefits and costs to be reviewed by the senior executives for prioritization and follow-up. As of March 2017, IRS has not provided additional documentation concerning this process. Analyses of benefits and costs can help agencies decide which new projects to start in a manner that maximizes the benefits derived from agency resources. IRS also requested funding in the fiscal year 2017 budget justification to enhance web applications, including the online account previously discussed.

In conclusion, W-2 systemic verification shows promise of being a powerful tool for addressing IDT refund fraud and possibly other types of fraud. IRS has also continued to improve its telephone service, which is important in helping taxpayers comply with the tax code. Addressing our open recommendations—including developing long-term strategies for customer and online services to ensure that IRS is maximizing the benefit to taxpayers and reducing costs in other areas, such as for IRS’s telephone operations—could further help IRS in those endeavors.

Chairman Buchanan, Ranking Member Lewis, and Members of the Subcommittee, this concludes my prepared remarks. I look forward to answering any questions that you may have.

Contacts and Staff Acknowledgments

For questions regarding this statement, please contact me at (202) 512- 9110 or LucasJudyJ@gao.gov. Key contributors to this statement include Joanna M. Stamatiades (Assistant Director), Dawn Bidne, Jehan Chase, Heather A. Collins, James Cook, Felisa Garmon, Robert Gebhart, John Hussey, Melissa King, Kirsten Lauber, Robert MacKay, Donna Miller, and Erin Saunders Rath.

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