IRS engages in hundreds of data-sharing arrangements with state revenue, human services, and law enforcement agencies for tax compliance and other purposes. In a small portion of IRS’s federal-state data-sharing arrangements, states require federal tax compliance to qualify for a state business license. In some instances, state licensing agencies require compliance with both federal and state tax obligations, and requirements can vary among states. These arrangements can vary by industry; by type of taxes required for compliance, such as employment taxes or income taxes; and even by the type of documentation required to prove compliance. For example, in some states the businesses may self-certify that they are in compliance with taxes, and in others businesses must provide documentation from IRS or the state revenue agency that they are in compliance with tax requirements. IRS and California’s DLSE are engaged in an arrangement that requires compliance with federal employment taxes to operate a business in any one of three industries in California. An individual applying for a new business license or a renewal of his/her business license to operate a farm labor contracting, garment manufacturing, or car washing and polishing business must first prove full compliance with federal employment taxes by filing all required federal employment tax returns and resolving all outstanding federal employment taxes through full payment or appeal. Each business license applicant in the three industries requiring federal tax compliance must submit a state business license application and a signed IRS Form 8821, Tax Information Authorization, allowing IRS to disclose the applicant’s tax information to DLSE. IRS tax examiners in Ogden, Utah, review the tax information in IRS’s Integrated Data Retrieval System (IDRS) to check the employment tax status of the applicant. If the applicant is compliant, IRS provides DLSE and the applicant with a statement that the applicant has met all filing and payment requirements. If the applicant has an outstanding employment tax liability, has not filed a federal employment tax return, or both, the tax examiner prompts the system to generate a noncompliance letter, which is sent to the applicant. Applicants with outstanding tax liability can pay the amounts due or contact the IRS tax examiners for more information or to make arrangements for payment. IRS officials told us that IRS Ogden does not collect employment taxes from business applicants directly. Noncompliant business applicants may pay federal employment taxes they owe at local IRS offices or mail their payments to IRS. Ogden officials are notified by e- mail or phone when business applicants have paid the employment taxes identified in the noncompliance letter. IRS informs DLSE that an applicant has paid all employment taxes, is currently working with a revenue officer to pay all balances due, or is otherwise compliant. After notification, DLSE will issue the applicant’s business license. DLSE officials told us that for purposes of business licensing, California business applicants in the three industries have resolved their taxes if they have (1) paid their tax liability, (2) entered into installment agreements, or (3) completed offers in compromise with IRS. If an applicant’s tax case is in bankruptcy, California’s DLSE makes the decision on whether to issue the business license. If an applicant does not resolve his/her tax liability within 90 days of applying, IRS staff in Ogden send the cases to the IRS Agricultural Team in Fresno, where tax examiners open the case and do investigative work on collecting the balance due. See figure 1 on how data sharing between IRS and California operates. Section 6103 of the Internal Revenue Code (I.R.C.) prohibits the disclosure of tax returns and return information by IRS employees; other federal employees, state employees, or both; and certain others having access to the information except in specifically enumerated circumstances. Data sharing between IRS and California DLSE is authorized by a subsection of I.R.C. § 6103. Specifically, section 6103(c) authorizes IRS to disclose the return information of a taxpayer to any other person at the taxpayer’s request. State licensing entities that wish to review federal tax information or have IRS attest to tax compliance before issuing the license would need to require the applicant to provide a written request to IRS authorizing release of the information to the licensing entity. The data-sharing arrangement between IRS Ogden and California DLSE can be a valuable tool for improving compliance among certain businesses. According to IRS officials, this type of data-sharing arrangement has mutual benefits for IRS, by increasing filing and payment compliance with federal employment taxes, and for states, by minimizing concerns about the success of the business and its compliance with unemployment requirements. IRS officials noted that growth in this data- sharing arrangement can generate many compliance benefits with a relatively minimal resource allocation. According to a California DLSE official, this data-sharing arrangement is beneficial because it helps to ensure that businesses are competent and responsible and pay their taxes. The amount of revenue in federal employment taxes collected through this data-sharing arrangement appears to outweigh the cost of operating the data-sharing arrangement. Thousands of California businesses apply for a business license each year in order to operate a business in the three industries previously mentioned, and must provide documentation to DLSE to show that they are in compliance with federal employment taxes. Many of these businesses were not in compliance with employment taxes during the time of our analysis and, therefore, had to file tax returns or pay employment taxes to rectify their compliance status. According to the IRS Ogden database on business applicants, 7,194 businesses applied for a business license in the three industries one or more times from calendar years 2006 through 2008 and requested that IRS provide California with information on their compliance with federal employment taxes. About 24 percent of businesses (i.e., 1,726 of the 7,194 that applied) had to file employment tax returns or pay or otherwise resolve overdue taxes to come into compliance with federal employment taxes. IRS staff in Ogden use spreadsheets to track the number of federal tax returns filed by noncompliant California business license applicants and the amounts IRS collected from these businesses that are attributable to the data-sharing arrangement. The spreadsheets show that businesses not in compliance with federal employment taxes when they applied for California business licenses filed hundreds of tax returns in calendar years 2006 and 2007 and IRS collected millions in federal employment taxes. California businesses filed 441 employment tax returns to come into compliance to qualify for California business licenses and IRS collected nearly $7.4 million in employment taxes, according to IRS Ogden spreadsheets. IRS Ogden officials told us that the nearly $7.4 million in employment taxes collected represents the amount business applicants paid after receiving noncompliance letters related to their DLSE business license applications. Table 1 shows the number of tax returns filed and the amount IRS collected from these applicants during calendar years 2006 and 2007. Even though IRS did not track all of the costs it incurred for operating the data-sharing arrangement, IRS officials noted that the arrangement resulted in high revenues relative to costs. In order to get some perspective on how this data-sharing arrangement compares with other IRS enforcement efforts, we developed an estimate of the costs of the arrangement using cost categories provided and confirmed by IRS officials. The cost categories we considered included personnel costs and nonpersonnel costs, such as computers, telephones, and fax machines. We estimated that IRS incurred about $331,348 to operate the data-sharing arrangement in calendar years 2006 and 2007. Our cost estimate included personnel costs of about $202,125 in pay and about $61,042 in benefits for one General Schedule (GS) 5 clerk and two GS 7 tax examiners. We also included about $10,197 for three computers, $1,237 for one dedicated printer, $313 for one fax machine with a dedicated line and two dedicated phone lines with voice mail boxes, and approximately $56,435 for supplies, facilities, utilities, and supervision. These costs may be somewhat overstated because, for instance, we used approximate purchase costs for equipment and did not spread those costs over the useful life of the equipment or other uses of the equipment. Using our estimate, the ROI for this data-sharing arrangement is 22:1. IRS has not tracked the cost data needed to do a study comparing the ROI of the IRS Ogden/DLSE enforcement activity with those of other current enforcement activities to determine how the IRS Ogden/DLSE data-sharing arrangement ROI compares with those of IRS’s other enforcement activities. However, IRS has developed ROI estimates for five new direct revenue-producing enforcement initiatives it proposed in its fiscal year 2009 budget submission. IRS estimates that the average ROI for these activities at full performance (at the end of their second year of implementation) will be 7.1:1. IRS projects the highest ROI for one of the five new initiatives (expanded document matching) at 11.4:1. IRS officials told us that IRS calculates the ROI each year for the revenue-producing initiatives included in the President’s budget request. They also said that these ROI calculations are based on historical information in the Enforcement Revenue Information System and the annually updated unit cost rates used in budget formulation. We did not verify the accuracy of the data IRS provided or its estimate of the revenues and costs of its five new enforcement activities, including the estimated ROI of these activities. We identified the 2,017 businesses that applied for business licenses in calendar year 2006 only, and found that 315 of these businesses had unpaid assessments at the time of applying and that tax compliance improved for these 315 businesses. We identified the businesses that applied for a California business license in 2006 only so that we could follow the tax compliance of this set of specific businesses over time. We matched data of California business license applicants for calendar year 2006 from the IRS Ogden Access database with IRS’s Unpaid Assessments file at two points in time—for the week of September 18, 2006, and the week of August 18, 2008.