Internal Revenue Service: Opportunities to Improve the Taxpayer Experience and Voluntary Compliance
Released: 2012-04-26T00:00:00

Letter

Taxpayers Have Benefitted from Improved Processing, but IRS’s Service to Taxpayers Has Declined

Taxpayers’ experience depends heavily on IRS’s performance during the tax filing season, roughly mid-January through mid-April. During this period, millions of taxpayers who are trying to fulfill their tax obligations contact IRS over the phone, face-to-face, and via the Internet to obtain answers to tax law questions and information about their tax accounts. This period is also when IRS processes the bulk of the approximate 140 million returns it will receive, runs initial compliance screens, and issues over 100 million refunds. In recent years, IRS has improved its returns processing but has seen its taxpayer service performance deteriorate.

Increased Electronic Filing Contributes to Greater Return Accuracy and Faster Processing

For years we have reported that electronic filing (e-filing) has many benefits for taxpayers, such as higher accuracy rates and faster refunds compared to filing on paper. So far in 2012, the percentage of e-filed returns has increased by 1.9 percentage points to 88.8 percent since about the same time last year (a 2.2 percent increase), as table 1 shows. Since the same time in 2007, the percentage of e-filed returns has increased from 72.3 percent to 88.8 percent. This year, IRS may meet its long-held goal of having 80 percent of individual tax returns e-filed. However, the overall e-file percentage is likely to decline as the tax filing season ends since IRS typically receives more returns filed on paper later in the filing season. In addition, IRS is in the midst of a multi-phase modernization project, known to as the Customer Account Data Engine (CADE) 2, which will fundamentally change how it processes returns. With CADE 2, IRS also expects to be able to issue refunds in 4 business days for direct deposit and 6 business days for paper checks after IRS processes the return and posts the return data to the taxpayer’s account.

Early in the 2012 filing season, IRS experienced two processing problems that delayed refunds to millions of taxpayers, and reported the problems had been resolved by mid-February. We summarized these problems in an interim report on the 2012 filing season.

Taxpayer Service Has Declined

Providing good taxpayer service is important because, without it, taxpayers may not be able to obtain necessary and accurate information they need to comply with tax laws. In addition, more and more, taxpayers are relying on IRS’s website to obtain information and execute transactions, making it important that IRS have a modern website. However, as we have reported, IRS has experienced declines in performance in selected taxpayer service areas, most notably with respect to providing live telephone assistance and timely responses to taxpayers’ correspondence.from IRS to paper correspondence or have access to information online, they call IRS, correspond again, or seek face-to-face assistance—all of which are costly to IRS and burdensome to the taxpayer. Table 2 shows the declines in telephone service and paper correspondence and the goals for 2012 and 2013. Additional performance data is shown in appendix I.

Opportunities Exist to Improve the Taxpayer Experience and Voluntary Compliance

To improve the taxpayer experience and voluntary compliance, IRS has a range of options. Some of its options could provide taxpayers with better information to accurately fulfill their tax obligations. Other options would allow IRS to take enforcement actions sooner and with less burden on taxpayers. Simplifying the tax code could reduce unintentional errors and make intentional tax evasion harder.

IRS Can Provide More Self- Service Tools to Give Taxpayers Better Access to Information

GAO-12-176. develop an online locator tool listing volunteer tax preparation sites— and IRS introduced an enhanced volunteer site locator tool in 2012;complete an Internet strategy that provides a justification for online self-service tools as IRS expands its capacity to introduce such tools.

In addition to actions we recommended, IRS is also studying ways to better communicate with taxpayers and determine which self-service tools would be the most beneficial to taxpayers. According to IRS officials, the study should be completed later this year. Identifying more efficient ways to provide service also benefits IRS because it is able to make better use of scarce resources.

Better Leveraging of Third Parties Could Provide Taxpayers With Other Avenues to Receive Service

Paid Preparer Regulations

GAO-12-176. most effective for improving the quality of tax returns prepared by different types of paid preparers. Likewise, IRS has discussed how to measure the effect of the requirements such as requiring continuing education and testing on tax return accuracy. It will take years to implement the approach as it will likely evolve over time and become more detailed.

Tax preparation software is another critical part of tax administration. Almost 30 percent of taxpayers use such software to prepare their returns and, in the process, understand their tax obligations, learn about tax law changes, and get questions answered. Many also electronically file through their software provider. Consequently, tax software companies are another important intermediary between taxpayers and IRS. We have reported that IRS has made considerable progress in working with tax software companies to provide, for example, clearer information about why an e-filed return was not accepted, require additional information on returns to allow for IRS to better identify the software used, and enhance security requirements for e-filing. To illustrate the potential for leveraging tax software companies to improve taxpayer compliance, 4 years ago we recommended and IRS agreed to expand outreach efforts to external stakeholders and include software companies as part of an effort to reduce common types of misreporting related to rental real estate. In another report, we discussed the value of research to better understand how tax software influences compliance.

IRS has volunteer partners, often nonprofit organizations or universities, that staff over 12,000 volunteer sites. Volunteers at these sites prepare several million tax returns for traditionally underserved taxpayers, including the elderly, low-income, disabled, and those with limited English proficiency. In recent reports we have made recommendations about estimating of the effectiveness of targeting underserved populations at such sites and making it easier for taxpayers to find the locations of nearby sites.to work with these volunteer partners to help improve assistance to taxpayers with the goal of improving compliance.

Expanded Information Reporting Could Reduce Taxpayer Burden and Improve Accuracy

Information reporting is a proven tool that reduces tax evasion, reduces taxpayer burden, and helps taxpayers voluntarily comply. This is, in part, because taxpayers have more accurate information to complete their returns and do not have to keep records themselves. In addition, IRS research shows that when taxpayers know that IRS is receiving data from third parties, they are more likely to correctly report the income or expenses to IRS. As part of its recent update of its tax gap estimates, IRS estimated that income subject to substantial information reporting, such as pension, dividend, interest, unemployment, and Social Security income, was misreported at an 8 percent rate compared to a 56 percent misreporting rate for income with little or no information reporting, such as sole proprietor, rent, and royalty income.

GAO, Tax Administration: Costs and Uses of Third-Party Information Returns, GAO-08-266 (Washington, D.C.: Nov. 20, 2007). have not entered into an agreement with IRS to report details on U.S. account holders to IRS.

As these three sets of information reporting requirements have only recently taken effect, it is too soon to tell the impact they are having on taxpayer compliance.

We have made recommendations or suggested possible legislative changes in several other areas in which IRS could benefit from additional information reporting. They include the following:

Service payments made by landlords. Taxpayers who rent out real estate are required to report to IRS expense payments for certain services, such as payments for property repairs, only if their rental activity is considered a trade or business. However, the law does not clearly spell out how to determine when rental real estate activity is considered a trade or business.

Service payments to corporations. Currently, businesses must report to IRS payments for services they make to unincorporated persons or businesses, but payments to corporations generally do not have to be reported.

Broader requirements for these two forms of information reporting, covering goods in addition to services, were enacted into law in 2010, but later repealed. We believe the more narrow extensions of information reporting to include services, but not goods, remain important options for improving compliance.

Additionally, we have identified existing information reporting requirements that could be enhanced. Examples include the following:

Mortgage interest and rental real estate. We recommended requiring information return providers to report the address of a property securing a mortgage, mortgage balances, and an indicator of whether the mortgage is for a current year refinancing when filing mortgage interest statements (Form 1098) could help taxpayers comply with and IRS enforce rules associated with the mortgage interest deduction. We have reported that collecting the address of the secured property on Form 1098 would help taxpayers better understand and IRS better enforce requirements for reporting income from rental real estate.

Higher education expenses. Eligible educational institutions are currently required to report information on qualified tuition and related expenses for higher education so that taxpayers can determine the amount of educational tax benefits they can claim. However, the reporting does not always separate eligible from ineligible expenses. We recommended revising the information reporting form could improve the usefulness of reported information.

Identifying additional third-party reporting opportunities is challenging. Considerations include whether third parties exist that have accurate information available in a timely manner, the burden of reporting, and whether IRS can enforce the reporting requirement. We have noted, for example, that the reason there is little third-party reporting on sole proprietor expenses is because of the difficulty of identifying third parties that could report on expense like the business use of cars.

Implementing Modernized Systems Should Provide for Faster Refunds and Account Updates

Modernized systems should better position IRS to conduct more accurate and faster compliance checks, which benefits taxpayers by detecting errors before interest and penalties accrue. In addition, modernized systems should result in more up-to-date account information, faster refunds, and other benefits, such as clearer notices so that taxpayers can better understand why a return was not accepted by IRS. Two new, modernized systems IRS is implementing include the following:

Customer Account Data Engine (CADE) 2. For the 2012 filing season, IRS implemented the first of three phases to introduce modernized tax return processing systems. Specifically, IRS introduced a modernized taxpayer account database, called CADE 2, and moved the processing of individual taxpayer accounts from a weekly to a daily processing cycle. IRS expects that completing this first phase will provide taxpayers with benefits such as faster refunds and notices and updated account information. IRS initially expected to implement phase two of CADE 2 implementation by 2014. However, IRS reported that it did not receive funding in fiscal year 2011 that would have allowed it to meet the 2014 time frame.

Modernized e-File (MeF). IRS is in the final stages of retiring its legacy e-file system, which preparers and others use to transmit e- filed returns to IRS, and replacing it with MeF. Early in the 2012 filing season, IRS experienced problems transferring data from MeF to other IRS systems. IRS officials said that they solved the problem in early February. IRS officials recently reiterated their intention to turn off the legacy e-file in October 2012 as planned. However, more recently, IRS processing officials told us they would reevaluate the situation after the 2012 filing season. MeF’s benefits include allowing taxpayers to provide additional documentation via portable document files (PDF), as opposed to filing on paper. In addition, MeF should generate clearer notices to taxpayers when a return is rejected by IRS compared to the legacy e-file system.

Expanding Pre-Refund Compliance Checks Could Result in More Efficient Error Correction

The Commissioner of Internal Revenue has talked about a long-term vision to increase pre-refund compliance checks before refunds are sent to taxpayers. As previously noted, early error correction can benefit taxpayers by preventing interest and penalties from accumulating. In one example, IRS is exploring a process where third parties would send information returns to IRS earlier so they could be matched against taxpayers’ returns when the taxpayer files the return as opposed to the current requirement that some information returns go to taxpayers before being sent to IRS. The intent is to allow IRS to match those information returns to tax returns during the filing season rather than after refunds have been issued.

Another option for expanding pre-refund compliance checks is additional math error authority (MEA) that Congress would need to grant IRS through statute. MEA allows IRS to correct calculation errors and check for obvious noncompliance, such as claims above income and credit limits. Despite its name, MEA encompasses much more than simple arithmetic errors. It also includes, for instance, identifying incorrect Social Security numbers or missing forms. The errors being corrected can either be in the taxpayers’ favor or result in additional tax being owed.

MEA is less intrusive and burdensome to taxpayers than audits and reduces costs to IRS. It also generally allows taxpayers who make errors on their returns to receive refunds faster than if they are audited. This is due, in part, to the fact that IRS does not have to follow its standard deficiency procedures when using MEA—it must only notify the taxpayer that the assessment has been made and provide an explanation of the error. Taxpayers have 60 days after the notice is sent to request an abatement.

Although IRS has MEA to correct certain errors on a case-by-case basis, it does not have broad authority to do so. In 2010, we suggested that Congress consider broadening IRS’s MEA with appropriate safeguards against the misuse of that authority. In the absence of broader MEA, we have identified specific cases where IRS could benefit from additional MEA that have yet to be enacted. These include authority to: use prior years’ tax return information to ensure that taxpayers do not improperly claim credits or deductions in excess of applicable lifetime limits, use prior years’ tax return information to automatically verify taxpayers’ compliance with the number of years the Hope credit can be claimed, and identify and correct returns with ineligible (1) individual retirement account (IRA) “catch-up” contributions and (2) contributions to traditional IRAs from taxpayers over age 70½.

In 2009, Congress enacted our suggestion that IRS use MEA to ensure that taxpayers do not improperly claim the First-Time Homebuyer Credit in multiple years, which we estimate resulted in savings of about $95 million.

Reducing Tax Code Complexity Could Ease Taxpayer Burden and Make It Easier to Comply

Tax code complexity can make it difficult for taxpayers to voluntarily comply. Efforts to simplify or reform the tax code may help reduce burdensome record keeping requirements for taxpayers and make it easier for individuals and businesses to understand and voluntarily comply with their tax obligations. For example, eliminating or combining tax expenditures, such as exemptions, deductions, and credits, could help taxpayers reduce unintentional errors and limit opportunities for tax evasion.

Frequent changes in the tax code also reduce its stability, making tax planning more difficult and increasing uncertainty about future tax liabilities. Limiting the frequency of changes to the tax code could also help reduce calls to IRS with questions about the changes. We have reported that IRS annually receives millions of calls about tax law changes.

Reducing complexity in the tax code could take a variety of forms, ranging from comprehensive tax reform to a more incremental approach focusing on specific tax provisions. Policymakers may find it useful to compare any proposed changes to the tax code based on a set of widely accepted criteria for assessing alternative tax proposals. These criteria include the equity, or fairness, of the tax system; the economic efficiency, or neutrality, of the system; and the simplicity, transparency, and administrability of the system. These criteria can sometimes conflict, and the weight one places on each criterion will vary among individuals. Our publication Understanding the Tax Reform Debate: Background, Criteria, & Questions may be useful in guiding policymakers as they consider tax reform proposals.

In closing, improving the taxpayer experience and increasing voluntary compliance will not be achieved through a single solution. Because voluntary compliance is influenced by so many factors, multiple approaches, such as those listed here, will be needed.

Chairman Baucus, Ranking Member Hatch, and Members of the Committee, this completes my prepared statement. I would be happy to respond to any questions you and Members of the Committee may have at this time.

Contacts and Acknowledgments

For further information regarding this testimony, please contact James R. White, Director, Strategic Issues, at (202) 512-9110 or whitej@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this statement. Individuals making key contributions to this statement include Joanna Stamatiades, Assistant Director; LaKeshia Allen; David Fox; Tom Gilbert; Kirsten Lauber; Sabrina Streagle, and Weifei Zheng.

Appendix I: Selected Internal Revenue Service (IRS) Taxpayer Service Performance Data, Fiscal Years 2007 through 2013

As shown in table 3, in recent years, the level of access to telephone assistors has declined and average wait time has increased. In addition, the volume of overage correspondence has steadily increased. On a positive note, tax law and account accuracy remains high.

Appendix II: Internal Revenue Service (IRS) Telephone Performance Data, January 1 through Early April, 2008 through 2012

As shown in table 4, access to IRS assistors has declined over the last few years. IRS officials attribute the higher-than-planned level of service so far this year to a slight decline in the demand for live assistance. At the same time, the number of automated calls has significantly increased which IRS officials attributed in part to taxpayers calling about refunds, and requesting transcripts (i.e., a copy of their tax return information).