IRS’s key filing season efforts are processing electronic and paper individual income tax returns and issuing refunds, as well as providing assistance or services to taxpayers. As already noted, processing and assistance were complicated this year by three tax system changes: TETR, the split refund option, and enactment in December 2006 of tax law changes. From January 1 through March 30, 2007, IRS processed 76.8 million returns, about the same number as last year, and issued 68.3 million refunds for $163.4 billion compared to 66.7 million refunds for $154.4 billion at the same time last year. Over 69.3 percent of all refunds were directly deposited into taxpayers’ accounts, up 6.2 percent over the same time last year. Direct deposits are faster and more convenient for taxpayers than mailing paper checks. According to IRS data and officials, performance is comparable to last year. IRS is meeting most of its performance goals, including deposit error rate, which is the percentage of deposits applied in error, such as being posted to the wrong tax year. Groups and organizations we spoke with, including the National Association of Enrolled Agents, the American Institute of Certified Public Accountants, and a large tax preparation company, corroborated IRS’s view that filing season performance is comparable to last year. IRS uses two systems for storing taxpayer account information—the antiquated Master File legacy system and CADE. The latest release of CADE became operational in early March, 2 months behind schedule because of problems identified during testing. IRS had originally planned to post 33 million taxpayer returns to CADE and the remaining 100 million individual returns on the legacy system. However, as a result of the delay, officials expect to post approximately 17 -19 million taxpayer returns to CADE. Although this is significantly less than planned, it is almost two and a half times the approximate 7.4 million taxpayer accounts posted last year on CADE. Taxpayers eligible for a refund this year whose returns are posted to CADE will benefit from CADE’s faster processing, receiving their refunds 1-5 days faster for direct deposit and 4-8 days faster for paper checks than if their return had been processed on the legacy system. The remaining 14 – 16 million returns that were to have been processed on CADE were instead processed by the legacy system and thus did not receive the benefit of faster refunds. The CADE setback may impact IRS’s ability to deliver the expanded functionality of future versions of CADE, thus delaying the transition to the new processing system (discussed further in the BSM section of this testimony). The growth rate for electronic filing is up from the same period last year. As of March 30, over 56.9 million (74.1 percent) of all individual income tax returns were filed electronically. This is up 5.8 percent over the same time last year, and an increase over the previous years’ growth of 3.3 percent. We previously reported that state mandates for electronic filing of state tax returns also encourage electronic filing of both state and federal tax returns and last year, we suggested that Congress consider mandating electronic filing by paid tax preparers meeting criteria such as a threshold for number of returns filed. Last year, electronic filing of federal returns increased 27 percent for the three states (New York, Connecticut, and Utah) with new 2006 mandates. This year, state mandates are likely to continue to show a positive effect on federal electronic filing because, with the addition of West Virginia, 13 states now have state mandates. Compared to processing paper returns, electronic filing reduces IRS’s costs by reducing staff devoted to processing. In 2006, IRS used almost 1,700 (36 percent) fewer staff years for processing paper tax returns than in 1999, shown in figure 1. IRS estimates this saved the agency $78 million in salary, benefits, and overtime in 2006. Electronic filing also improves service to taxpayers. Returns are more accurate because of built-in computer checks and reduced transcription errors (paper returns must be transcribed in IRS’s computers—a process that inevitably introduces errors). Electronic filing also provides faster refunds. Although electronic filing continues to grow, taxpayers’ use of the Free File program continues to decline. The Free File program, accessible through IRS’s Web site, is an alliance of companies that have an agreement with IRS to provide free on-line tax preparation and electronic filing on their Web sites for taxpayers below an adjusted gross income ceiling of $52,000 in 2007. About 95 million (70 percent) of all taxpayers are eligible for free file. Under the agreement, companies are not allowed to offer refund anticipation loans and checks, or other ancillary products, to free file participants. Although IRS has increased its marketing efforts, the agency has not been successful in increasing free file use. As of March 17, 2007, IRS processed about 2.6 million free file returns, which is a decrease of 5.2 percent from the same period last year. While all 19 companies participating in the Free File program allow for TETR requests, only 3 of the 19 companies offer Form 1040 EZ-T requests. We recently reported to this Committee on states’ experience with return preparation and electronic filing on their Web sites. These systems, called I-file, provide taxpayers with another option for preparing and electronically filing their tax returns. To the extent that the I-file systems convert taxpayers from paper to electronic filing, the costs of processing returns are reduced. For the eight states we profiled, I-file benefits and costs were relatively modest. While state I-file systems generated benefits, such as increased electronic filing, the overall benefits were limited by low usage, which ranged from about 1 percent to just over 5 percent of eligible taxpayers. Restrictions on taxpayer eligibility and system features helped keep costs modest. States varied in whether they used contractors to develop and operate the I-file system. For the states we profiled, it is unclear whether benefits were greater than costs, in part, because of the low number of taxpayers who converted from paper to electronic filing. IRS’s potential to realize net cost savings from an I-file system depends on the costs of developing the system and the number of taxpayers converted from paper. IRS’s costs to provide a new I-file service could be higher than states’ for several reasons: (1) the federal tax system is more complex, (2) unlike some states that already had transactional Web sites, IRS would need to develop the capability to receive tax returns on its Web site, and (3) developing an I-file system could further stretch IRS’s capability to manage systems development, an area we have designated high risk since 1995. The key to IRS achieving a net cost savings depends on the number of individuals converted from paper to electronic filing and the savings per return estimated to be $2.36 by IRS. It is uncertain how many of the 58 million taxpayers who filed on paper would convert. The over 13 million taxpayers who self-prepare their returns on a computer but print them out and mail them to IRS are an attractive target for I-file because they already have access to a computer and may be more willing to try I-file. However, IRS’s Free File program, designed to attract similar taxpayers, had low use in 2006, with only 4 million users (about 3 percent of total taxpayers and 4 percent of eligible taxpayers). TETR and split refund volume have been less than IRS projected. Almost 69 percent of individuals who filed individual income tax returns by the end of March have requested TETR, although all who paid the excise tax were eligible for the refund. IRS projected that 10 to 30 million individuals who did not have a tax filing obligation could claim TETR. Approximately 410,000 individuals from this group have asked for a TETR refund (2.8 percent of the 14.5 million IRS expected by this time). As of March 24, fewer than 61,000 individual taxpayers chose to split their refunds into different accounts out of the 44.8 million taxpayers who had their refunds directly deposited. This volume compares to the 3.8 million IRS projected for the filing season. IRS delayed processing a small number of returns claiming tax extender provisions until February 3 to complete changes to its tax processing systems. The number of calls to IRS’s toll-free telephone lines has been less than last year and is significantly less than in 2002 for both automated and live assistance (see table 1). Similar to last year, IRS assistors answered about 40 percent of the total calls, while the rest of the calls were answered by an automated menu of recordings. Taxpayers’ ability to access IRS’s telephone assistors is somewhat less than last year, but IRS is meeting its goals. As shown in table 2, the percentage of taxpayers who attempted to reach an assistor and actually got through and received services—referred to as the level of service— was one percentage point less than the same time period last year. This level of performance is slightly greater than IRS’s fiscal year goal of 82 percent which is the same as last year’s goal. Average speed of answer, which is the length of time taxpayers wait to get their calls answered, is just over 4 minutes, almost 40 percent longer than last year, but is better than IRS’s annual goal of 4.3 minutes. Taxpayer disconnects, which is the rate at which taxpayers waiting to speak with an assistor abandoned their calls to IRS, increased to 12.3 percent to about 1.4 million calls compared to the same time period last year. While IRS disconnects are a smaller percentage of all calls it receives, those disconnects were down from approximately 491,000 at this time last year to 148,000 (a 70 percent decline). Using a statistical sampling process, IRS estimates that the accuracy of telephone assistors’ responses to tax law and account questions to be comparable to the same time period last year.