oversight

Tax Administration: IRS Should Continue to Expand Reporting on Its Enforcement Efforts

Published by the Government Accountability Office on 2003-01-31.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

               United States General Accounting Office

GAO            Report to the Chairman, Subcommittee
               on Oversight, Committee on Ways and
               Means, House of Representatives


January 2003
               TAX
               ADMINISTRATION
               IRS Should Continue
               to Expand Reporting
               on Its Enforcement
               Efforts




GAO-03-378
                                               January 2003


                                               TAX ADMINISTRATION

                                               IRS Should Continue to Expand
Highlights of GAO-03-378, a report to the      Reporting on Its Enforcement Efforts
Subcommittee on Oversight, Committee
on Ways and Means, U.S. House of
Representatives




Reported declines in the rate at               IRS’s often-cited audit rate has been declining for several years, as shown
which the Internal Revenue Service             below. However, the audit rate portrays only a portion of IRS’s efforts to
(IRS) audits (also referred to as              enforce tax laws and not all of those efforts have been declining. For IRS’s
“examines”) individual income tax              three nonaudit enforcement programs, the contact rates in 2002 compared to
returns have raised concerns that              1993, after year to year variations, declined for one, essentially remained the
taxpayers may have a false
                                               same for one, and significantly increased for one—math error. A complete
perception of the true level of IRS’s
tax enforcement efforts. In                    math error contact trend is unavailable because IRS did not capture one type
addition, many observers are                   of data on a substantial number of contacts prior to 1997. For years where
concerned these reported declines              complete data are available, IRS has not included all math errors in external
may reduce taxpayers’ motivation               reports. IRS officials agreed that all types of errors are identified under the
to voluntarily pay their taxes.                same math error authority and should be similarly counted and reported.

Because of these concerns, GAO                 IRS annually reports extensive data on audits but only limited, or no, data on
was asked to review a number of                its other enforcement programs. This limited reporting does not provide
issues surrounding IRS’s                       policymakers or taxpayers information on the full extent of IRS’s
enforcement efforts. GAO                       enforcement efforts. To the extent that taxpayers do, as is widely believed,
determined the trends in the                   take the level of enforcement into account when self-reporting their tax
percent of returns filed that are
audited (contact rate) compared
                                               obligations, the audit rate alone may mislead them. IRS officials believe that
with similar data on taxpayer                  more reporting is desirable and intend to report readily available, but
contacts through other                         incomplete, information on nonaudit programs in future reports.
enforcement programs for fiscal
years 1993 through 2002. In                    IRS Enforcement Program Contact Rates, Fiscal Years 1993 through 2002.
addition, GAO reviewed whether
IRS’s reporting on its enforcement
programs should be expanded.



GAO recommends that IRS
determine whether future reporting
on its other enforcement programs
can be more complete and
comparable to reporting on audits.
GAO also recommends that IRS
correct underreporting of math
error contacts.

In commenting on a draft of this
report, IRS agreed with our
recommendations. It has already
begun to identify additional data to
report on its enforcement
programs.
www.gao.gov/cgi-bin/getrpt?GAO-03-378.

To view the full report, including the scope
and methodology, click on the link above.
For more information, contact Michael          Note: Data for revised math error contacts is not available for fiscal years 1993 to 1996. The
Brostek at (202) 512-9110 or                   revised math error line above includes all math error contacts by IRS for the relevant years.
BrostekM@gao.gov.
Contents


Letter                                                                                   1
               Results in Brief                                                          2
               Background                                                                5
               Scope and Methodology                                                     7
               Similarities and Differences among IRS Enforcement Programs
                 Depend on the Type of Audit                                             8
               Enforcement Program Contact Rates Did Not Follow Consistent
                 Patterns                                                              16
               Limited Evidence Suggests IRS Enforcement Programs Do
                 Increase Compliance; No Measures Available on Enforcement
                 Program Burden                                                        21
               IRS’s Public Reporting on Its Enforcement Programs Is Incomplete        22
               Conclusions                                                             28
               Recommendations to the Acting Commissioner of Internal
                 Revenue                                                               30
               Agency Comments                                                         30

Appendix I     Development of the Math Error Program                                    31



Appendix II    Use of Information Returns and Document
               Matching at IRS                                                          33



Appendix III   Individual Audit and Other Enforcement Program
               Data                                                                     38



Appendix IV    Soft Notices and Voluntary Compliance Agreements                         49



Appendix V     Comments from the Commissioner of Internal
               Revenue                                                                  52




               Page i                                 GAO-03-378 IRS Enforcement Reporting
Appendix VI            GAO Contacts and Staff Acknowledgments                                   54
                       GAO Contacts                                                            54
                       Staff Acknowledgments                                                   54

Related GAO Products                                                                            55



Tables
                       Table 1: Operational Dimensions of IRS Enforcement Contacts             12
                       Table 2: Data Published on IRS Enforcement Programs for
                                Individual Taxpayers, Fiscal Year 2001                         23
                       Table 3: Legislative Authority on Math Error Provisions for
                                Individual Tax Returns                                         31
                       Table 4: Major Legislation Affecting the Information Returns
                                Program                                                        34
                       Table 5: Major Types of Information Returns Filed for Tax Years
                                1983 and 2000                                                  36
                       Table 6: Number and Rates of Individual Audit and Other
                                Enforcement Contacts, Fiscal Years 1993 through 2002           38
                       Table 7: Number and Rates of Individual Audit and Document
                                Matching Contacts by Income Level, Fiscal Years 1993
                                through 2002                                                   42
                       Table 8: Number and Rates of Individual Audits by Type of Audit
                                and Income Level, Fiscal Years 1993 Through 2002               46
                       Table 9: Average Direct Staff Hours by Type of Audit and For
                                Document Matching Cases, Fiscal Years 1993 through 2002        48


Figures
                       Figure 1: Average Direct Staff Hours by Type of Audit and for
                                Document Matching Cases, Fiscal Years 1993 through
                                2002                                                           14
                       Figure 2: IRS Enforcement Contact Rates, Fiscal Years 1993
                                through 2002                                                   17
                       Figure 3: IRS Individual Audit and Document Matching Contact
                                Rates by Income Level, Fiscal Years 1993 through 2002          19
                       Figure 4: Individual Audit and Other Enforcement Contacts, Fiscal
                                Years 1993 through 2002                                        40
                       Figure 5: Number of Individual Audit and Document Matching
                                Contacts by Income Level, Fiscal Years 1993 through 2002       44


                       Page ii                                GAO-03-378 IRS Enforcement Reporting
Abbreviations

EmTRAC      Employer-designed Tip Reporting Alternative Commitment
GAO         General Accounting Office
IRC         Internal Revenue Code
IRS         Internal Revenue Service
MSA         Medical Savings Accounts
NRP         National Research Program
RRA         IRS Restructuring and Reform Act of 1998
SSA         Social Security Administration
TIN         Tax Identification Numbers
TRAC        Tip Reporting Alternative Commitment
TRDA        Tip Rate Determination Agreement




Page iii                           GAO-03-378 IRS Enforcement Reporting
United States General Accounting Office
Washington, DC 20548




                                    January 31, 2003

                                    The Honorable Amo Houghton
                                    Chairman, Subcommittee on Oversight
                                    Committee on Ways and Means
                                    House of Representatives

                                    Dear Mr. Chairman:

                                    The United States tax system is based on self-reporting and voluntary
                                    compliance by taxpayers. The Internal Revenue Service (IRS) uses various
                                    enforcement programs to check the accuracy of tax returns and contacts
                                    taxpayers if problems are found. IRS makes the contacts through four
                                    major enforcement programs that have existed for many years.

                                •   Math Error Program: While tax returns are being processed, this
                                    program uses IRS computers to identify and generate notices to contact
                                    taxpayers about obvious errors such as mathematical errors, omitted or
                                    inconsistent data, or other inconsistencies on the basis of other data
                                    reported on the return or to IRS. These errors must be corrected to
                                    process a tax return.

                                •   Document Matching Program: This program matches information on
                                    selected tax issues (usually income) reported on tax returns by individual
                                    taxpayers and reported on information returns by employers, banks, and
                                    other payers of income. Document matching also matches information
                                    returns (schedule K-1) filed by pass-through entities—such as
                                    partnerships, trusts and S-corporations—to individual tax returns. IRS
                                    may contact taxpayers about any reporting discrepancies.

                                •   Nonfiler Program: This program identifies and contacts potential
                                    nonfilers of tax returns by using data from information returns and
                                    previously filed income tax returns. The contacts can ask for the missing
                                    return or offer an IRS-generated return to substitute for the missing return.

                                •   Audit Program: Also referred to as “examination,” under this program, an
                                    IRS auditor checks compliance in reporting income, deductions, credits
                                    and other issues on tax returns, as well as in paying the correct tax
                                    liability. Audit contacts can be made through correspondence or in
                                    face-to-face meetings with taxpayers at an IRS office or a taxpayer
                                    location.



                                    Page 1                                    GAO-03-378 IRS Enforcement Reporting
                       Widely reported substantial declines in the rate at which IRS audits
                       income tax returns have triggered concern that the declines could reduce
                       taxpayers’ motivation to voluntarily pay their taxes. Many view IRS’s
                       enforcement programs as critical support to our voluntary system—they
                       help provide taxpayers with confidence that their friends, neighbors, and
                       business competitors are paying their share of taxes.

                       Because of your concerns that the declining audit rate may give taxpayers
                       a misleading perception of the true level of IRS’s tax enforcement efforts
                       and encourage some taxpayers not to comply, you requested that we
                       review a number of issues related to how IRS enforces tax laws and
                       publicly reports on those efforts. This report

                   •   compares IRS’s enforcement programs in terms of their legal authority,
                       and operational characteristics (including IRS staff time), and describes
                       what is known about taxpayer perceptions of the enforcement programs.
                   •   summarizes enforcement contact trends overall and by taxpayer income
                       and their causes from 1993 to 2002.
                   •   determines what IRS knows about the effect of its enforcement programs
                       on individual taxpayer compliance and the burdens taxpayers experience
                       when contacted under the programs.
                   •   assesses whether and, if so, how IRS should expand reporting on its
                       enforcement programs.

                       To address these objectives, our work included interviewing IRS officials
                       and reviewing documents on the similarities and differences across IRS
                       enforcement programs. To identify trends in IRS’s enforcement programs
                       including trends by taxpayer income levels, we analyzed IRS data from
                       fiscal years 1993 through 2002.1 To analyze impacts on taxpayers, and
                       tradeoffs of reporting more data about the enforcement programs, we
                       interviewed IRS officials and reviewed any available research on how the
                       programs affect individual taxpayers’ compliance and burden. (See our
                       scope and methodology section for details on our approach.) In addition,
                       you asked us to analyze trends in the number of contacts by the specific
                       programs. Appendix III provides this information.


                       Whether audits and other enforcement programs vary from each other
Results in Brief       depends on a number of factors. With regard to legal characteristics,


                       1
                        The fiscal 2002 data on number of tax returns filed by individuals had not been finalized
                       before we issued the report.




                       Page 2                                             GAO-03-378 IRS Enforcement Reporting
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. In general, audits done in taxpayer
locations and IRS offices are not similar operationally to other
enforcement programs. Audits done through correspondence with the
taxpayer, while still different, are more operationally similar to 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.

In fiscal years 1993 through 2002, the enforcement program contact rates
often did not follow consistent patterns from one program to another or
from year to year within programs.2 Comparing just fiscal years 1993 to
2002, the contact rates for the audit and document matching programs
dropped 38 percent and 45 percent, respectively, while the nonfiler
program contact rates stayed about the same. Only the math error
program had a contact rate significantly higher in 2002 than in 1993.
However, this growth covers only a portion of math error contacts
because data on one type of math error contact does not exist for years
before 1997, and have not been reported by IRS as math errors. These
unreported math error contacts total about 2 million annually. IRS officials
agreed that these other contacts should be counted and reported as math
errors. Excluding these contacts, the math error contact rate was
33 percent higher in 2002 than in 1993. For individuals, audit rates for
taxpayers in higher and middle-income ranges were significantly lower in
2002 than in 1993, while the rate for the lowest income range was virtually
the same in 2002 and 1993. Document matching program contact rates
ended significantly lower in 2002 than 1993 for taxpayers in all three



2
 This report refers to the portion of tax returns audited by IRS as the audit contact rate.
Similarly, the portion of tax returns for which IRS contacts taxpayers about possible
noncompliance is the contact rate for the math error, document matching, and nonfiler
programs.




Page 3                                              GAO-03-378 IRS Enforcement Reporting
income ranges. Income data for the contact rates in the math error and
nonfiler programs were not available.

The divergent trends among the enforcement programs in their contacts
with taxpayers are attributable to several factors, including statutory
changes that expanded the types of issues IRS could address with
nonaudit programs, declines in IRS enforcement staffing, and priorities in
using staff. For example, the rise in math error contacts is at least partly
attributable to a 1996 statutory change that enabled IRS to check hundreds
of thousands of missing or invalid social security numbers through the
math error program rather than audits. Declines in the audit program are
generally attributable to statutory changes that reduced the availability of
IRS staff to do audits and increased the time needed to do audits. In
addition, declines in the number of staff assigned to work enforcement
cases coupled with the priority IRS gives to staffing the math error
program—because such errors must be resolved before tax returns can be
processed—have contributed to declines in contacts with taxpayers in the
audit, nonfiler, and document matching programs.

IRS has limited evidence on the effects of its enforcement programs on
taxpayer compliance and no evidence on the burdens taxpayers
experience when contacted under the programs. Although widespread
agreement exists that enforcement programs are critical to ensuring
voluntary compliance, IRS officials only identified one study that
attempted to measure the effect of individual enforcement programs on
compliance. This IRS study, using various data for 1982 through 1991,
estimated that the audit and document matching programs had some
positive effects on whether taxpayers filed returns and reported relevant
information. No measures are available on the burdens placed on
individual taxpayers due to IRS’s enforcement contacts and IRS does not
currently plan to start any studies to measure these burdens.

IRS’s annual public reporting on its enforcement programs for individual
taxpayers does not provide a complete perspective on its efforts to
enforce the tax laws. IRS annually reports extensive data on audits but
limited or no data on other enforcement programs. This limited reporting
does not provide policymakers or taxpayers information on the full extent
of IRS’s enforcement efforts. To the extent policymakers and taxpayers
focus on audits due to IRS’s limited reporting, they may not understand
that long-term declines in the audit rate are in part due to the movement of
some tax issues from audits into other enforcement programs, and that
these programs contact far more taxpayers about compliance issues than
does the audit program. Of two options for expanding reporting that we


Page 4                                   GAO-03-378 IRS Enforcement Reporting
             identified, reporting more data on each enforcement program would avoid
             several disadvantages of combined reporting under an expanded definition
             of an audit. Expanding the definition of an audit would combine some
             enforcement activities that are so disparate—such as audits conducted at
             taxpayer locations of complex issues versus simple corrections of
             inadvertent math errors—that the consolidated reporting could be
             misleading. 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. They do not plan to determine
             whether IRS can cost effectively develop additional data to enable future
             reporting to more completely represent program results and to facilitate
             program comparisons.

             We are recommending that IRS determine whether data can be cost
             effectively developed to make future reporting on its other enforcement
             programs more complete and comparable to reporting on audits. We also
             recommend that IRS correct underreporting of math error contacts. In
             commenting on a draft of our report, IRS agreed with our
             recommendations and has already begun to identify additional data to
             report on its enforcement programs.


             Each year, IRS screens all individual tax returns and selects a small
Background   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.


             Page 5                                    GAO-03-378 IRS Enforcement Reporting
    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 1995.3 In 2001, we reported that audit rates had
    steadily dropped from 1996 to 2000, declining to 0.49 percent.4
•   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.5
•   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.6




    3
     U.S. General Accounting Office, Tax Administration: Audit Trends and Results for
    Individual Taxpayers, GAO/GGD-96-91 (Washington, D.C.: Apr. 26, 1996).
    4
     U.S. General Accounting Office, IRS Audit Rates: Rate for Individual Taxpayers Has
    Declined But Effect on Compliance Unknown, GAO-01-484 (Washington, D.C.: Apr. 25,
    2001).
    5
    U.S. General Accounting Office, Tax Administration: IRS’ Use of Nonaudit Contacts,
    GAO/GGD-00-7 (Washington, D.C.: Mar. 16, 2001).
    6
    U.S. General Accounting Office, Tax Administration: IRS Is Working to Improve Its
    Estimates of Compliance Burden, GAO/GGD-00-11 (Washington, D.C.: May 22, 2000).




    Page 6                                         GAO-03-378 IRS Enforcement Reporting
              To compare audit and other enforcement programs, we obtained
Scope and     information on their legal and operational characteristics. For legal
Methodology   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.


              Page 7                                    GAO-03-378 IRS Enforcement Reporting
                     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).



                     Whether audits and other enforcement programs vary from each other
Similarities and     depends on a number of factors. With regard to legal characteristics,
Differences among    audits and other enforcement programs are all authorized to contact
                     taxpayers about apparent noncompliance and to determine and adjust
IRS Enforcement      taxpayers’ tax liability. However, audits have the broadest authority to
Programs Depend on   detect possible noncompliance, significant powers to obtain information,
                     and the most restrictions on how IRS is to interact with taxpayers. With
the Type of Audit    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


                     Page 8                                   GAO-03-378 IRS Enforcement Reporting
                             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:       In a general sense, the IRC provisions for enforcement are similar in that
Audits Have the Broadest     they authorize IRS to contact taxpayers about apparent noncompliance
Scope, Significant Powers    and to determine and adjust taxpayers’ tax liability. However, the IRC
                             provisions grant IRS the authority to review all matters that may affect a
to Obtain Information, and   taxpayer’s tax liabilities under audits but only certain specified tax issues
the Most Detailed            under other enforcement programs. The IRC also establishes more rules—
Restrictions                 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.7 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 authority8 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).9 The IRC also specifically authorizes



                             7
                              For example, an audit might address unreported income, which is the focus of document
                             matching, because document matching can only verify individual income reported on
                             information returns. According to IRS, information returns only report 80 percent of all
                             individual income reported on tax returns.
                             8
                              IRC sec. 6213 grants math error authority for issues such as calculation errors, entries that
                             are inconsistent with or exceed statutory limits, various omissions of information, or
                             incorrect use of an IRS table.
                             9
                              IRC sec. 6041, 6044, 6045, 6049, 6050, and 6051, among others, authorize information
                             reporting to help identify a discrepancy on individual income such as wages, interest,
                             dividends, pension distributions, and gross proceeds from stock sales.




                             Page 9                                             GAO-03-378 IRS Enforcement Reporting
the nonfiler program to pursue unfiled tax returns that should have been
filed.10

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.11

Given these greater powers, the law also places more restrictions on
audits to protect taxpayer rights.12 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-




10
  IRC sec. 6020 grants this authority to IRS and allows IRS to prepare a return for a
taxpayer who did not file as required and process that return to assess taxes owed.
11
 IRC sections 7602 through 7606 and 7609 grant these powers.
12
 IRC sections 7602, 7605, 7609, and 7491 address these restrictions.




Page 10                                            GAO-03-378 IRS Enforcement Reporting
                             206) added several requirements, such as informing taxpayers of their
                             rights during audits.13

                             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 notice14
                             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                  The extent to which audits are operationally similar to or different from
Characteristics: Audits at   other enforcement programs varies depending on the type of audit.
IRS Offices or Taxpayer      Compared with other enforcement programs, audits done in taxpayers’
                             locations or IRS offices are more likely to deal with multiple and complex
Locations Differ the Most    issues, require more skill and judgment by IRS employees, require a
from Other Enforcement       greater number of interactions with taxpayers, and take more IRS staff
Programs                     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



                             13
                              The Restructuring Act also restricted the audit technique that can be used to identify
                             unreported income; requires IRS to explain taxpayer rights including the right to be
                             represented during audits; requires IRS to disclose the general criteria for why the return
                             was selected for audit; and restricts the ability to summon a third party for an audit.
                             14
                              Publication 1 (Your Rights as a Taxpayer) explains the rights that taxpayers have in
                             contacts with IRS.




                             Page 11                                            GAO-03-378 IRS Enforcement Reporting
                                                   taxpayers can be very similar in these characteristics. Table 1 provides an
                                                   overview of key operational dimensions across the enforcement programs.

Table 1: Operational Dimensions of IRS Enforcement Contacts

                                                             How many contacts          How much skill and
                                                             occur between IRS          judgment is required         When is the initial contact
 Contact            What triggers the contact?               and the taxpayer?          by IRS staff?                sent to the taxpayer?
 Audits             • computer analysis of potentially       likely requires multiple   skilled review of            usually within 1 year after the
                       noncompliant returns                  exchanges via              simpler issues and           return is filed but may occur
                    • referrals from inside or outside       notices/letters,           more sophisticated           later as long as IRS finishes
                       IRS                                   telephone, and/or          analysis of complex          the audit within
                    • projects on specific areas of          face-to-face meetings      issues                       3 years after the return is filed
                       known noncompliance
 Document           computer identification of error         one notice from IRS        some skill/judgment          within 1 year after the return
 Matching           based on information received from       and possible                                            was filed
                    third parties on income paid             exchanges via letters
                                                             or telephone
 Non-filer          •  computer identification of those      one notice from IRS        some skill/judgment          usually within 1 year after the
                       who did not file or who stopped       and probable                                            return was to be filed
                       filing                                exchanges via letters,
                    • referrals from inside or outside       telephone, or meetings
                       IRS
 Math Error         computer identification of error using   one notice from IRS        little skill/judgment        as part of the initial
                    taxpayer information on their tax                                                                processing for the tax return
                    returns or forms
Source: GAO analysis.

                                                   Note: Of the three types of audits, the simplest usually covers one to two tax issues handled by a
                                                   lower-graded auditor and correspondence. More complex audits are done by meeting with taxpayers
                                                   in IRS field offices. The most complex audits are done through field visits to taxpayer locations.


                                                   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




                                                   Page 12                                               GAO-03-378 IRS Enforcement Reporting
    return, or explaining why a return was not required.15 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.16 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.




    15
      Taxpayers are not always required to file a tax return such as when their income is too
    low.
    16
     Document matching staff time includes the time to resolve discrepancies before and after
    contacting taxpayers.




    Page 13                                           GAO-03-378 IRS Enforcement Reporting
Figure 1: Average Direct Staff Hours by Type of Audit and for Document Matching
Cases, Fiscal Years 1993 through 2002

 35     Hours

 30

 25

 20

 15

 10

  5




  2


  1


  0

      1993      1994          1995     1996   1997   1998    1999    2000     2001    2002
      Year

                   Field audit
                   Office audit
                   Correspondence audit
                   Document matching
 Source: GAO analysis of IRS data.

Note: Fiscal year 2002 data are estimated.


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


Page 14                                              GAO-03-378 IRS Enforcement Reporting
                           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     IRS officials were not aware of any research, and our search of the tax
Whether Taxpayers          literature and press did not uncover research, on whether taxpayers
Perceive Distinctions in   perceive distinctions between audits and other enforcement programs. Of
                           the four major enforcement program contacts, IRS officials said that they
Enforcement Programs but   could see how some taxpayers might view two types of contacts—
Officials Believe That     document matching and correspondence audits—as similar in that both
Distinctions May Not Be    tend to cover one or two tax issues that are fairly simple, contact
Made                       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.




                           Page 15                                    GAO-03-378 IRS Enforcement Reporting
                            From fiscal years 1993 through 2002, the rates for the four enforcement
Enforcement Program         programs often did not follow consistent patterns from one program to
Contact Rates Did Not       another or from year to year within programs. Comparing just 1993 with
                            2002, the contact rates for two programs—audits and document
Follow Consistent           matching—were significantly lower, the rate for math errors was
Patterns                    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         As figure 2 shows, the math error program contact rates rose or fell from
Contact Rates Varied from   year to year; however, it’s the only enforcement program that had a
Program to Program and      significantly higher contact rate in fiscal year 2002 than in 1993. This is
                            true even without counting certain math error contacts for which IRS
Often from Year to Year     lacks data over the 10-year period. Using only the math error count, which
within Programs             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.




                            Page 16                                   GAO-03-378 IRS Enforcement Reporting
Figure 2: IRS Enforcement Contact Rates, Fiscal Years 1993 through 2002

8     Rate (percent)


7


6


5


4


3


2


1


0

1993          1994          1995       1996   1997      1998       1999        2000       2001       2002
Year

                Math error (revised)
                Math error
                Nonfiler
                Document matching
                Audit
Source: GAO analysis of IRS data.




Notes: The math error (revised) line includes math error contacts from masterfile notices that IRS’s
reports had excluded. Data on such math errors were not available prior to fiscal year 1997. The
figure does not include additional contacts for math errors related to the rate reduction credit during
2002.

Fiscal year 2002 data is estimated.


The trend line in Figure 2 shows a revised math error contact rate that
includes masterfile17 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,18 IRS had excluded roughly 2 million masterfile




17
    The masterfile is IRS’s historical record of transactions involving each taxpayer’s account.
18
    IRS letter to respond to questions from the Senate Finance Committee, March 26, 2001.




Page 17                                                  GAO-03-378 IRS Enforcement Reporting
                          math error contacts annually for fiscal years 1997 through 2002.19 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.20 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        Figure 3 shows that the contact rates generally declined in the audit and
Matching Contact Rates    document matching programs for all taxpayer income levels between
Across Income Levels      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
Have Generally Declined   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.)




                          19
                           IRS had not collected data on these masterfile math errors prior to fiscal year 1997.
                          20
                            U.S. General Accounting Office, Tax Administration: Advance Tax Refund Program was
                          a Major Accomplishment, but Not Problem Free, GAO-02-827 (Washington, D.C.: Aug. 2,
                          2002), U.S. General Accounting Office, IRS’s 2002 Tax Filing Season: Returns and
                          Refunds Processed Smoothly; Quality of Assistance Improved GAO-03-314 (Washington,
                          D.C.: Dec. 20, 2002), and Internal Revenue Service, Tax Compliance Activities Report,
                          June 24, 2002, prepared in response to a directive in the House Report accompanying the
                          legislation (P.L. 107-67).




                          Page 18                                           GAO-03-378 IRS Enforcement Reporting
Figure 3: IRS Individual Audit and Document Matching Contact Rates by Income Level, Fiscal Years 1993 through 2002

5    Audit rates (percent)                                                              5      Document matching rates (percent)




4                                                                                       4




3                                                                                       3




2                                                                                       2




1                                                                                       1




0                                                                                       0

 1993    1994      1995      1996   1997   1998   1999    2000     2001   2002           1993     1994    1995    1996   1997      1998   1999   2000   2001   2002
 Year                                                                                    Year

                                                                   $100,000 and over
                                                                   $25,000 to under $100,000
                                                                   Under $25,000
Source: GAO analysis of IRS data.

                                                         Note: Data by income level for the math error and nonfiler programs are not available.


                                                         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                                 The divergent trends between the growing rate of math error contacts and
Staff, and Resource                                      the declining or relatively stable rates for the other enforcement programs
Priorities Explain Trends                                can be attributed to how the programs have been affected by statutory
                                                         changes, fewer enforcement staff, and priorities for using available staff.
in Math Error, and Other                                 Math error contacts grew over the fiscal year 1993 through 2002 period in
Enforcement Contact rates                                part because Congress expanded the types of tax issues covered by the
                                                         math error authority. For example, in 1996, Congress gave IRS authority to


                                                         Page 19                                                     GAO-03-378 IRS Enforcement Reporting
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.21 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.22 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.23




21
 Also see GAO-01-484.
22
 We did not analyze the portion of potentially noncompliant tax returns that IRS could not
check due to resource limitations. In its September 2002 progress report to the IRS
Oversight Board, IRS presented data showing that it is checking compliance on a
decreasing portion of potentially noncompliant returns.
23
 To ensure efficient returns processing, returns with small dollar value discrepancies are
accepted as filed and taxpayers are not sent math error notices.




Page 20                                           GAO-03-378 IRS Enforcement Reporting
                        Although widespread agreement exists that enforcement programs help
Limited Evidence        ensure voluntary tax compliance, evidence is limited about the degree to
Suggests IRS            which enforcement overall or by type of program affects taxpayer
                        compliance. No studies are available that measure the burdens that
Enforcement             taxpayers experience when contacted under IRS’s enforcement programs.
Programs Do Increase
                        Over the years, many tax practitioners and academics have suggested that
Compliance; No          enforcement programs are critical for ensuring voluntary compliance.
Measures Available on   However, measuring the effects of enforcement programs on compliance
Enforcement Program     is a difficult task. IRS officials identified only one study that attempted to
                        estimate the effects of its enforcement programs on compliance; no more
Burden                  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).24 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 2003.25 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




                        24
                         IRS had measured the voluntary compliance of individual taxpayers periodically, last
                        doing so for tax year 1988. IRS stopped because of various congressional and other
                        concerns about the measurement program.
                        25
                         See U.S. General Accounting Office, Tax Administration: New Compliance Research
                        Effort Is On Track, but Important Work Remains, GAO-02-769 (Washington, D.C.: June 27,
                        2002).




                        Page 21                                          GAO-03-378 IRS Enforcement Reporting
                         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 for individual
IRS’s Public Reporting   taxpayers does not provide a complete perspective on its efforts to
on Its Enforcement       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
Programs Is              and other debates concerning how well IRS is enforcing the tax laws.
Incomplete               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.




                         Page 22                                   GAO-03-378 IRS Enforcement Reporting
Limited Public Reporting   IRS publishes extensive data on audits but only limited data on other
on IRS’s Enforcement       enforcement programs in its Data Book.26 Table 2 summarizes the data
Programs                   annually published on the enforcement programs involving individual
                           taxpayers.

                           Table 2: Data Published on IRS Enforcement Programs for Individual Taxpayers,
                           Fiscal Year 2001

                            Enforcement program                       IRS published data
                            Audit                                     Number and/or rate of audits by
                                                                      • type of tax (e.g., individual income, gift)
                                                                      • type of return filed (e.g., Form 1040, Form 1040A)
                                                                      • taxpayer income class
                                                                      • type of audit (e.g., field, correspondence)
                                                                      • type of auditor (e.g., tax auditor, revenue agent)
                                                                      • whether the tax liability changed
                                                                      • total and average amount of recommended
                                                                        additional tax
                                                                      • whether taxapayers agreed with the recommended
                                                                        tax change
                                                                      Selected data on audits
                                                                      • resulting in tax refunds
                                                                      • preventing tax refunds on the basis of taxpayers’
                                                                        efforts to recoup taxes previously assessed or paid
                            Document Matching                         • number of information returns received
                                                                      • number of taxpayer contacts
                                                                      • amount of additional tax assessed
                            Nonfiler                                  • number of taxpayer delinquency investigations
                                                                        completed
                                                                      • number of initial nonfiler notices sent
                                                                      • additional assessments for the substitute for returns
                                                                        program
                            Math error                                No data are published
                           Source: IRS Data Book, fiscal year 2001.


                           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.




                           26
                            IRS annually compiles data about its enforcement activities in its Data Book. IRS also
                           publishes that data on its public Web site and may use some of that data in other
                           publications such as budget documents.




                           Page 23                                                   GAO-03-378 IRS Enforcement Reporting
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




Page 24                                  GAO-03-378 IRS Enforcement Reporting
                            Commissioner said that only focusing on audits substantially understates
                            IRS’s capacity to find errors.27

                            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            Of two options we identified for expanding public reporting on IRS’s
Reporting on Enforcement    enforcement efforts, providing data on each major program separately
Programs Does Not           avoids certain disadvantages of aggregating data into one broad audit
                            program. After we discussed the tradeoffs of these options with IRS
Require Redefining Audits   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


                            27
                             IRS’s letter dated March 26, 2001.




                            Page 25                                   GAO-03-378 IRS Enforcement Reporting
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




Page 26                                   GAO-03-378 IRS Enforcement Reporting
counting because taxpayers can be contacted through more than one
enforcement program for the same return.28

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.29 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



28
  IRS does not track how many taxpayers are contacted by more than one program for a
tax return.
29
 IRS’s letter dated March 26, 2001.




Page 27                                        GAO-03-378 IRS Enforcement Reporting
              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.


              Although research is not conclusive about the extent to which taxpayers
Conclusions   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


              Page 28                                   GAO-03-378 IRS Enforcement Reporting
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.




Page 29                                    GAO-03-378 IRS Enforcement Reporting
                         The Acting Commissioner of Internal Revenue should
Recommendations to
the Acting           •   determine whether additional data on each nonaudit program can be cost
                         effectively extracted or collected to make future annual reporting on
Commissioner of          enforcement programs more complete and comparable.
Internal Revenue
                     •   provide information on all types of math error contacts when publishing
                         data on IRS’s math error program.

                         The Acting Commissioner of Internal Revenue provided written comments
Agency 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.

                         Sincerely yours,




                         Michael Brostek
                         Director, Tax Issues




                         Page 30                                   GAO-03-378 IRS Enforcement Reporting
              Appendix I: Development of the Math Error
Appendix I: Development of the Math Error
              Program



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 deficiency1 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.

              Table 3: Legislative Authority on Math Error Provisions for Individual Tax Returns

                  Basis of Authority    Provision                                                     Year
                  Internal Revenue      Provided a basic “math error” exception to the             As early
                  Code                  deficiency procedures whereby the Service could            as 1939
                                        notify a taxpayer that on account of a mathematical
                                        error an amount of tax in excess of that shown on
                                        the return was due without first sending a notice of
                                        deficiency, which gives the taxpayer the right to
                                        judicial review.
                  Tax Reform Act of     Expanded the definition of math errors to include             1976
                  1976 (P.L. 94-455)    1. an error in addition, subtraction, multiplication, or
                                           division shown on the return;
                                        2. incorrect use of an IRS table if the error is
                                           apparent from the existence of other information
                                           on the return;
                                        3. inconsistent entries on the return;
                                        4. an omission of information required to be
                                           supplied on the return in order to substantiate an
                                           item on that return; and
                                        5. entry of a deduction or credit item in an amount
                                           which exceeds a statutory limit which is either
                                           (a) a specified monetary amount or (b) a
                                           percentage, ratio, or fraction if the items entering
                                           into the application of that limit appear on that
                                           return.
                  Small Business Job    Extended math error authority to the omission of a            1996
                  Protection Act of     correct Taxpayer Identification Number (TIN)
                  1996 (P.L. 104-188)   required for the dependent care credit or the
                                        deduction for personal exemptions.
                  Personal              Extended math error authority to the omission of a            1996
                  Responsibility and    TIN for the earned income tax credit.



              1
               In general, IRS sends taxpayers a written notice, called a statutory notice of deficiency,
              which states that additional tax will be assessed and provides 90 days for them to respond.
              The proposed tax is automatically assessed if the taxpayer does not respond or does not
              file an appeal.




              Page 31                                             GAO-03-378 IRS Enforcement Reporting
Appendix I: Development of the Math Error
Program




 Basis of Authority                    Provision                                                Year
 Work Opportunity
 Reconciliation Act of
 1996 (P.L. 104-193)
 Taxpayer Relief Act                   Extended math error authority to the omissions of        1997
 of 1997 (P.L. 105-34)                 correct TINs for the child tax credit and the higher
                                       education tuition tax credit, and to information
                                       required for the earned income tax credit for
                                       taxpayers who previously made improper claims.
 Tax and Trade Relief                  Extended math error authority to the inclusion of a      1999
 Extension Act (1999                   TIN on a return which allows IRS to determine
 Appropriations Act                    ineligibility for the dependent care credit, child tax
 (P.L. 105-277))                       credit, or earned income tax credit on the basis of
                                       the statutory age restrictions of those credits
 Economic Growth                       Extended math error authority to include an entry        2001
 and Tax                               on a return claiming the earned income tax credit
 Reconciliation Act of                 when, according to the Federal Registry of Child
 2001 (P.L. 107-16)                    Support Orders, the taxpayer is not the custodial
                                       parent of the child being claimed. This provision,
                                       effective January 1, 2004, includes a sunset
                                       provision of December 31, 2010.
Source: GAO analysis of legislation.


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.




Page 32                                                          GAO-03-378 IRS Enforcement Reporting
              Appendix II: Use of Information Returns and
Appendix II: Use of Information Returns and
              Document Matching at IRS



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. 1 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.




              1
               These payers file the information returns on income paid with IRS as well as the taxpayers
              receiving the income to induce their voluntary compliance in reporting the income on their
              tax returns.




              Page 33                                           GAO-03-378 IRS Enforcement Reporting
                                           Appendix II: Use of Information Returns and
                                           Document Matching at IRS




Table 4: Major Legislation Affecting the Information Returns Program

Statute                                    Description
Public Law 87-397 (enacted 1961)           Required taxpayers to provide IRS and payers of income with a TIN and established
                                           penalties for failure to do so.
Revenue Act of 1962 (P.L. 87-834)          Required information returns reporting for interest and dividend income.
                                           Required payers to furnish copies of the information returns to those receiving interest and
                                           dividend income.
Combined Old-Age, Survivors, and           Directed IRS and Social Security Administration (SSA) to implement an annual wage
Disability Insurance-Income Tax            reporting system, which enhanced IRS’s machine processing efficiency because SSA had
Reporting Amendments of 1975 (P.L. 94-     the equipment and capacity, which IRS did not, to process a large volume of Forms W-2.
202)
The Economic Recovery Tax Act of 1981      Expanded the requirement that payers furnish all types of information returns to the
(P.L. 97-34)                               taxpayer receiving a payment.
                                           Increased the penalties for failure to provide copies of such returns to the taxpayer and to
                                           IRS.
The Tax Equity and Fiscal Responsibility   Expanded information reporting to include state and local income tax refunds, and
Act of 1982 (P.L. 97-248)                  proceeds from brokers and barter exchanges.
                                           Mandated 10 percent withholding on interest, dividends, patronage dividends, and original
                                           issue discount.
                                           Expanded and increased penalties for failure to (1) file information returns, (2) provide
                                           copies to payees, and (3) provide a payer or payee TIN.
                                           Required backup withholding at a 15 percent rate in some instances where a payee failed
                                           to provide a correct TIN to a payer.
                                           Authorized the Secretary of the Treasury to prescribe regulations to define which returns
                                           are to be filed on magnetic media.
Interest and Dividend Tax Compliance       Repealed the mandatory withholding requirements of the Tax Equity and Fiscal
Act of 1983 (P.L. 98-67)                   Responsibility Act of 1982.
                                           Expanded and revised backup withholding to include a 20 percent rate if (1) the payee
                                           does not furnish the payer with a TIN, (2) IRS notifies the payer that the TIN is incorrect,
                                           (3) the payee underreports interest or dividend income and IRS notifies the payer, or
                                           (4) the payee does not properly certify that he or she is not subject to backup withholding
                                           for interest and dividend income and that the TIN provided to the payer is correct.
                                           Strengthened TIN and failure to file penalties.
                                           Expanded the magnetic media filing requirements.
Tax Reform Act of 1984 (P.L. 98-369)       Required information reporting for foreclosures and abandonments of property which
                                           secure indebtedness and for mortgage interest.
                                           Provided penalties for failure to file and furnish such information returns.
Tax Reform Act of 1986 (P.L. 99-514)       Required real estate brokers to file an information return on any real estate transactions.
                                           Required federal executive agencies to file information returns on persons receiving
                                           contracts from them.
                                           Required persons making royalty payments aggregating $10 or more during any calendar
                                           year to file information returns on such payments and provide a copy of such return to the
                                           taxpayer who receives such royalties.
                                           Required TINs for dependents claimed on tax returns.
                                           Increased maximum penalties for failure to file information returns and to provide copies to
                                           taxpayers from $50,000 to $100,000.
                                           Added penalty for including incorrect information or for omitting required information on
                                           information returns.




                                           Page 34                                           GAO-03-378 IRS Enforcement Reporting
                                             Appendix II: Use of Information Returns and
                                             Document Matching at IRS




 Statute                                     Description
 Technical Corrections to Tax Reform Act     Required that information returns filed by partnerships having tax-exempt partners to
 of 1986 (P.L. 100-647)                      include reporting of unrelated business taxable income.
 Omnibus Budget Reconciliation Act of        Imposed a uniform penalty of $50 per offense to a maximum of $250,000 per year on any
 1989 (P.L. 101-239)                         person who fails to file timely and correct information returns, and to a maximum of
                                             $100,000 per year on any person who fails to (1) furnish correct payee statements or (2)
                                             meet other requirements.
 Omnibus Budget Reconciliation Act of        Required certain financial entities (such as Federal Deposit Insurance Corporation,
 1993 (P.L. 103-66)                          Resolution Trust Corporation, and National Credit Union Administration) to file information
                                             returns on discharges of indebtedness of $600 or more.
 Health Insurance Portability and            Established Medical Savings Accounts (MSAs).
 Accountability Act of 1996 (P.L. 104-191)   Required information returns for MSAs.
                                             Provided penalties for failure to file/furnish the returns.
 Tax Relief Extension Act of 1999 (P.L.      Required information reporting for indebtedness discharged by any organization for which
 106-170)                                    a significant trade or business is the lending of money.
Source: GAO analysis.


                                             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
                                             2000.2




                                             2
                                              Among other reasons, we used 1983 because it was the first year after a major expansion
                                             of the information reporting requirements.




                                             Page 35                                           GAO-03-378 IRS Enforcement Reporting
                                                               Appendix II: Use of Information Returns and
                                                               Document Matching at IRS




Table 5: Major Types of Information Returns Filed for Tax Years 1983 and 2000

                                                                                                                               Information Returns Filed (millions)
 Form Number Title                                                    Source                                                               1983                     2000
                                                                                                                                               a
 1098        Mortgage Interest Statement                              Banks and Mortgage Companies                                                                   80.2
                                                                                                                                               a
 1098-E      Student Loan Interest                                    Educational Institutions and                                                                    9.6
             Statement                                                Financial Institutions
                                                                                                                                                        a
 1098-T      Tuition Payments Statement                               Educational Institutions                                                                                         19.8
                                                                                                                                                        a
 1099-A      Acquisition or Abandonment                               Various Entities                                                                                                  0.4
             of Secured Property
 1099-B      Proceeds from Broker and                                 Brokers                                                                      10.0                              329.4
             Barter Exchange Transactions
                                                                                                                                                        a
 1099-C      Cancellation of Debt                                     Various Entities                                                                                                  0.8
 1099-G      Certain Government and                                   State Governments                                                            36.0                                63.7
             Qualified State Tuition
             Program Payments
 1099-DIV    Dividends and Distribution                               Brokers, Corporations                                                       82.0                               130.6
 1099-INT    Interest Income                                          Banks                                                                      296.0                               261.1
 1099-MISC   Miscellaneous Income                                     Various Entities                                                            39.0                                77.7
 1099-OID    Original Issue Discount                                  Banks, Corporations, and Other                                               2.0                                 4.8
                                                                      Financial Institutions
 1099-PATR               Taxable Distributions                        Cooperatives                                                                   2.0                                 1.6
                         Received from Cooperatives
 1099-R                  Distributions from Pensions,                 Various Entities                                                               6.0                               65.8
                         Annuities, Retirement or
                         Profit-sharing Plans, IRAs,
                         Insurance Contracts, Etc.
                                                                                                                                                        a
 1099-S                  Proceeds from Real Estate                    Various Entities                                                                                                   2.9
                         Transactions
                                                                                                                                                        a
 1099-SSA                Social Security Benefits                     Social Security Administration                                                                                   48.4
                                                                                                                                                        a
 1099-RRB                Railroad Retirement Benefits                 Railroad Retirement Board                                                                                         0.6
 5498                    IRA Contribution Information                 Banks, Brokers, and Insurance                                                18.0                                94.9
                                                                      Companies
                                                                                                                                                        a
 5498-MSA                Medical Savings Accounts or                  Trustees or custodians of MSAs                                                                                     0.1
                         Medicare Plus Choice MSA                     or Medicare Plus Choice MSAs
                         Information
                                                                                                                                                        a
 CTR                     Currency Transaction Report                  Financial Institutions and                                                                                       14.4
                                                                      Shareholders and Beneficiaries
 K-1                     Partner’s Share of Income,                   Partnerships                                                                 15.0                                19.1
                         Credits, Deductions, Etc.
 W-2                     Wage and Tax Statement                       Employers                                                                  165.0                               247.2
 W-2G                    Certain Gambling Winnings                    Gaming Establishments                                                        1.0                                 5.8
 W-2P                    Annuities, Pensions, Retired                 Various Entities                                                            18.0                                 N/A
                         Pay, or IRA Payments
 Other                   Various                                      Various Entities                                                             1.0                                 1.7
 Total                                                                                                                                           691.0                             1,480.6
Source: IRS and Statement of Johnny C. Finch, Senior Associate Director, General Government Division, GAO, Before the Subcommittee on Commerce, Consumer, and Monetary Affairs, Committee on
Government Operations, House of Representatives, on IRS’ Information Returns Matching Program, April 29, 1986.
                                                               a
                                                                Information return not required for tax year 1983.




                                                               Page 36                                                              GAO-03-378 IRS Enforcement Reporting
Appendix II: Use of Information Returns and
Document Matching at IRS




In 2002, IRS re-instituted matching3 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.




3
 IRS had done very limited K-1 matching, relying on electronically filed schedules K-1, but
stopped this matching in the mid-1990s due to resource and other constraints.




Page 37                                           GAO-03-378 IRS Enforcement Reporting
                                         Appendix III: Individual Audit and Other
Appendix III: Individual Audit and Other Enforcement Program Data



Enforcement Program Data

Table 6: Number and Rates of Individual Audit and Other Enforcement Contacts, Fiscal Years 1993 through 2002

                                                   1993                    1994              1995                    1996
Audit contacts
Field audits                                  250,712                   364,016            338,605                 252,430
Office audits                                 505,539                   456,216            458,880                 509,434
Correspondence audits                         302,715                   405,475          1,121,952               1,179,696
                                                      a                        a                 a                       a
Revenue officer examiner audits
Total audits                                1,058,966                1,225,707          1,919,437                1,941,560
Returns filed (previous calendar year)    114,718,900              113,754,400        114,683,400              116,059,700
Audit rate                                       0.92                     1.08               1.67                     1.67
Other enforcement contacts
Math errors                                 4,088,000                 4,059,000          6,102,000               4,750,771
                                                      b                        b                 b                       b
Math errors (masterfile notices)
                                                      c                        c                 c                       c
Math errors (revised)
Document matching                           2,723,830                 2,645,075          2,711,086               1,930,326
Nonfiler                                    1,603,969                 1,931,781          1,756,325               1,302,432
Math error rate                                  3.59                      3.54               5.26                    4.01
                                                      d                        d                 d                       d
Math error rate (revised)
Document matching rate                             2.37                    2.33               2.36                    1.66
Nonfiler rate                                      1.40                    1.70               1.53                    1.12




                                         Page 38                                    GAO-03-378 IRS Enforcement Reporting
                                                  Appendix III: Individual Audit and Other
                                                  Enforcement Program Data




                       1997               1998                         1999                       2000                      2001                2002

                   209,781              168,054                    124,518                    91,586                    77,950               88,896
                   505,834              383,366                    235,625                   145,975                   115,971              111,695
                   803,628              625,021                    715,789                   366,657                   529,241              538,779
                             a
                                         16,339                     24,341                    13,547                     8,594                4,543
              1,519,243               1,192,780                  1,100,273                   617,765                   731,756              743,913
            118,362,600             120,342,400                122,546,900               124,887,100               127,097,400          129,948,400
                   1.28                    0.99                       0.90                      0.49                      0.58                 0.57

                5,983,944             5,668,906                   6,552,290                 5,751,462                 6,082,967            6,265,455
                1,834,232             1,894,170                   1,965,405                 2,010,514                 2,026,802            2,061,830
                7,818,176             7,563,076                   8,517,695                 7,761,976                 8,109,769            8,327,285
                  931,354             1,726,098                   1,770,695                 1,353,545                 1,161,901            1,687,800
                1,917,212             2,313,633                   1,890,794                 1,251,375                 1,371,401            1,882,475
                     4.97                  4.63                        5.25                      4.53                      4.68                 4.79
                     6.50                  6.17                        6.82                      6.11                      6.24                 6.36
                     0.79                  1.43                        1.44                      1.08                      0.91                 1.30
                     1.62                  1.92                        1.54                      1.00                      1.08                 1.45
Source: GAO analysis of IRS data.

                                                  Note: To compute individual audit and other enforcement rates, we used two methods. We used
                                                  IRS’s method for computing audit rates, which equals the proportion of IRS audits closed in a fiscal
                                                  year as compared to returns filed in the previous calendar year. For example, as shown in the table
                                                  above, the audit rate for 1993 is computed by dividing total audits (1,058,966) by the number of
                                                  returns filed in the previous calendar year (114,718,900) to compute the audit rate (0.92).
                                                  IRS has not stated a method for computing math error, document matching, and nonfiler rates. For
                                                  the document matching and nonfiler programs, we used the IRS audit rate method because
                                                  document matching and nonfiler contacts generally occur in the year after a return is filed. For the
                                                  math error program, we compared the math errors notices to the returns filed in that year because
                                                  identifying math errors is part of IRS’ returns processing system. For example, the math error rate for
                                                  1993 is computed by dividing the number of math errors (4,088,000) by the number of returns filed in
                                                  1993 (113,754,400) to compute the math error rate (3.59).
                                                  Note: IRS estimates that the number of returns filed in 2002 is about 130,905,000. Final data for fiscal
                                                  year 2002 were not available at the time of publication of this report. We used the estimate of
                                                  130,905,000 returns filed to compute the math error rate and the math error rate (revised) for fiscal
                                                  year 2002.
                                                  a
                                                      IRS did not publish data on revenue officer examiner audits prior to 1998.
                                                  b
                                                      Data for math error masterfile notices do not exist prior to fiscal year 1997.
                                                  c
                                                   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.
                                                  d
                                                   The math error (revised) contact rate is the same as the math error contact rate for fiscal years 1993
                                                  through 1996 because data for the number of masterfile notices does not exist for these years.




                                                  Page 39                                                      GAO-03-378 IRS Enforcement Reporting
Appendix III: Individual Audit and Other
Enforcement Program Data




Figure 4: Individual Audit and Other Enforcement Contacts, Fiscal Years 1993
through 2002




The absolute number of contacts with taxpayers under the four
enforcement programs follows the same general year-to-year and overall
pattern as for contact rates. Similarly, as with the contact rates, the
number of audits and the number of document matching contacts were
lower (30 and 38 percent, respectively) in fiscal year 2002 than in 1993.
The number of nonfiler contacts also was somewhat higher (17 percent) in
2002 than in 1993 and the number of math error contacts—not counting
math errors identified from masterfile comparisons—was significantly
higher (53 percent) in 2002 than in 1993.




Page 40                                      GAO-03-378 IRS Enforcement Reporting
Appendix III: Individual Audit and Other
Enforcement Program Data




Page 41                                    GAO-03-378 IRS Enforcement Reporting
                                       Appendix III: Individual Audit and Other
                                       Enforcement Program Data




Table 7: Number and Rates of Individual Audit and Document Matching Contacts by Income Level, Fiscal Years 1993 through
2002

                                             1993                      1994                1995                   1996
Audit contacts
$100,000 and over                         204,079                  172,483               179,871                210,032
$25,000 to under $100,000                 361,787                  347,200               510,764                552,011
Under $25,000                             493,100                  706,024             1,228,802              1,179,503
Document matching contacts
$100,000 and over                         213,070                   263,287              285,767                238,330
$25,000 to under $100,000               1,337,067                 1,378,983            1,339,480                914,540
Under $25,000                           1,173,693                 1,002,805            1,085,839                777,456
Returns filed
$100,000 and over                       5,240,200                5,635,300             6,058,100              6,546,700
$25,000 to under $100,000              45,333,900               45,640,000            46,506,400             47,865,000
Under $25,000                          64,144,800               62,479,100            62,118,900             61,648,000
Audit rate
$100,000 and over                            3.89                      3.06                 2.97                   3.21
$25,000 to under $100,000                    0.80                      0.76                 1.10                   1.15
Under $25,000                                0.77                      1.13                 1.98                   1.91
Document matching rate
$100,000 and over                            4.07                      4.67                 4.72                   3.64
$25,000 to under $100,000                    2.95                      3.02                 2.88                   1.91
Under $25,000                                1.83                      1.61                 1.75                   1.26




                                       Page 42                                     GAO-03-378 IRS Enforcement Reporting
                                                 Appendix III: Individual Audit and Other
                                                 Enforcement Program Data




                        1997             1998                       1999                     2000                     2001             2002

                   200,070            164,314                   128,398                   99,547                    91,550          112,266
                   423,548            349,378                   226,261                  148,306                   157,296          183,847
                   895,625            679,088                   745,614                  369,912                   482,910          447,800

                   131,348            228,934                   231,482                  208,839                   218,981          275,088
                   469,761            863,408                   891,237                  674,154                   597,034          786,172
                   330,449            633,756                   647,976                  470,552                   345,886          429,879

                7,301,900            8,156,600               9,178,000                10,368,600               11,610,500         13,020,183
               49,805,300           51,389,100              53,389,200                55,729,700               57,268,000         59,216,431
               61,255,400           60,796,700              59,979,700                58,788,800               58,218,900         57,208,333

                         2.74             2.01                      1.40                      0.96                     0.79             0.86
                         0.85             0.68                      0.42                      0.27                     0.27             0.31
                         1.46             1.12                      1.24                      0.63                     0.83             0.78

                         1.80             2.81                      2.52                      2.01                     1.89             2.11
                         0.94             1.68                      1.67                      1.21                     1.04             1.33
                         0.54             1.04                      1.08                      0.80                     0.59             0.75
Source: GAO analysis of IRS data.

                                                 Notes: Returns filed consists of previous calendar year data.
                                                 Number of returns filed in 2002 (calendar year 2001 data) is estimated.




                                                 Page 43                                                GAO-03-378 IRS Enforcement Reporting
                                                           Appendix III: Individual Audit and Other
                                                           Enforcement Program Data




Figure 5: Number of Individual Audit and Document Matching Contacts by Income Level, Fiscal Years 1993 through 2002

1,400,000      Audit                                                                        1,600,000     Document matching


1,200,000                                                                                   1,400,000


                                                                                            1,200,000
1,000,000

                                                                                            1,000,000
 800,000
                                                                                             800,000
 600,000
                                                                                             600,000

 400,000
                                                                                             400,000

 200,000                                                                                     200,000


         0                                                                                         0


             1993 1994     1995     1996   1997   1998   1999   2000    2001   2002                     1993 1994   1995    1996   1997   1998   1999   2000   2001   2002
             Year                                                                                       Year

                                                                       $100,000 and over
                                                                       $25,000 to under $100,000
                                                                       Under $25,000
Source: GAO analysis of IRS data.

                                                           Note: Fiscal year 2002 data is estimated.


                                                           The absolute number of audits by income group generally follows the
                                                           same year-to-year and overall pattern, as do the contact rates for the
                                                           income groups. However, the change in the number of audits conducted in
                                                           fiscal year 1993 compared to 2002 is not as dramatic for the upper and
                                                           middle-income groups as was the change in their audit rates. The number
                                                           of audits for the higher income group declined by 45 percent between 1993
                                                           and 2002 while the rate at which this group was audited declined
                                                           78 percent. The number of audits of the middle-income group declined
                                                           49 percent, while the rate at which this group was audited declined
                                                           61 percent. The rate at which these groups were audited fell more than did
                                                           the absolute number of audits because the number of taxpayers in each
                                                           group expanded over the 10-year period. Higher income taxpayers grew in
                                                           numbers by 148 percent between 1993 and 2002 and middle-income
                                                           taxpayers grew by 31 percent.

                                                           As with the absolute number of audits by income group, the number of
                                                           document matching contacts by income group generally follows the same



                                                           Page 44                                                         GAO-03-378 IRS Enforcement Reporting
Appendix III: Individual Audit and Other
Enforcement Program Data




year-to-year and overall pattern as do the document matching contact
rates. However, comparisons of the number of document matching
contacts in fiscal year 1993 to those in 2002 differ substantially from
comparisons of document matching contact rates for those years for one
income group—the higher income taxpayers. The number of document
matching contacts with the higher income taxpayers increased by 29
percent between 1993 and 2002, whereas the contact rate for this group
fell by 48 percent. The percentage changes in numbers and rates of
contacts for the other two groups were more similar. Middle-income
document matching contacts fell 41 percent between fiscal year 1993 and
2001 while their document matching contact rate declined 55 percent.
Lowest income taxpayer document matching contacts fell 63 percent,
while their contact rate declined 59 percent.




Page 45                                    GAO-03-378 IRS Enforcement Reporting
                                        Appendix III: Individual Audit and Other
                                        Enforcement Program Data




Table 8: Number and Rates of Individual Audits by Type of Audit and Income Level, Fiscal Years 1993 through 2002

                                              1993                1994               1995             1996             1997
Field audits
Under $25,000                                80,881            189,748             161,800          85,153            49,053
$25,000 to under $100,000                    82,731             98,393             100,501          80,509            66,558
$100,000 and over                            87,100             75,875              76,304          86,768            94,170
Office audits
Under $25,000                               248,704            244,952             250,656         238,561          231,944
$25,000 to under $100,000                   201,924            167,594             171,438         221,207          223,646
$100,000 and over                            54,911             43,670              36,786          49,652           50,244
Correspondence audits
Under $25,000                               163,515            271,324             816,346         855,789          614,628
$25,000 to under $100,000                    77,132             81,213             238,825         250,295          133,344
$100,000 and over                            62,068             52,938              66,781          73,612           55,656
Returns filed
Under $25,000                            64,144,800        62,479,100          62,118,900       61,648,000       61,255,400
$25,000 to under $100,000                45,333,900        45,640,000          46,506,400       47,865,000       49,805,300
$100,000 and over                         5,240,200         5,635,300           6,058,100        6,546,700        7,301,900
Field audit rate
Under $25,000                                  0.13               0.30                0.26            0.14              0.08
$25,000 to < $100,000                          0.18               0.22                0.22            0.17              0.13
$100,000 and over                              1.66               1.35                1.26            1.33              1.29
Office audit rate
Under $25,000                                  0.39               0.39                0.40            0.39              0.38
$25,000 to < $100,000                          0.45               0.37                0.37            0.46              0.45
$100,000 and over                              1.05               0.77                0.61            0.76              0.69
Correspondence audit rate
Under $25,000                                  0.25               0.43                1.31            1.39              1.00
$25,000 to < $100,000                          0.17               0.18                0.51            0.52              0.27
$100,000 and over                              1.18               0.94                1.10            1.12              0.76




                                        Page 46                                         GAO-03-378 IRS Enforcement Reporting
                                        Appendix III: Individual Audit and Other
                                        Enforcement Program Data




                              1998          1999                          2000                           2001                  2002

                            35,891        26,228                        21,433                         16,784                15,480
                            49,891        35,540                        28,666                         26,159                33,093
                            82,272        62,750                        41,487                         35,007                40,323

                          171,918        95,308                         57,017                         42,016                31,192
                          170,341       109,696                         68,740                         54,526                56,509
                           41,107        30,621                         20,218                         19,429                23,994

                          460,795       608,154                        284,981                       420,346                399,175
                          124,451        73,996                         45,346                        73,189                 92,293
                           39,775        33,639                         36,330                        35,706                 47,311

                     60,796,700       59,979,700                   58,788,800                     58,218,900             57,208,333
                     51,389,100       53,389,200                   55,729,700                     57,268,000             59,216,431
                      8,156,600        9,178,000                   10,368,600                     11,610,500             13,020,183

                               0.06         0.04                           0.04                          0.03                   0.03
                               0.10         0.07                           0.05                          0.05                   0.06
                               1.01         0.68                           0.40                          0.30                   0.31

                               0.28         0.16                           0.10                          0.07                   0.05
                               0.33         0.21                           0.12                          0.10                   0.10
                               0.50         0.33                           0.19                          0.17                   0.18

                               0.76         1.01                           0.48                          0.72                   0.70
                               0.24         0.14                           0.08                          0.13                   0.16
                               0.49         0.37                           0.35                          0.31                   0.36
Source: GAO analysis of IRS data.

                                        Note: Revenue officer examiner audits are not included. See table 6.




                                        Page 47                                                GAO-03-378 IRS Enforcement Reporting
                                               Appendix III: Individual Audit and Other
                                               Enforcement Program Data




Table 9: Average Direct Staff Hours by Type of Audit and For Document Matching Cases, Fiscal Years 1993 through 2002

 Program                            1993    1994      1995         1996        1997        1998        1999           2000    2001    2002
 Field audit                        17.81   12.69     13.99        20.21       21.84       22.08       24.84          27.64   30.83   28.87
 Office audit                        4.47    4.51      4.27         4.56        4.34        4.49        5.66           7.09    8.91    9.37
 Correspondence audit                1.43    1.15      0.74         0.73        0.83        0.91        1.08           1.80    1.79    1.71
 Document matching                   0.80    0.81      1.09         0.98        0.53        0.52        0.57           0.61    0.57    0.61
Source: GAO analysis of IRS data.

                                               Note: Revenue officer examiner audits are not included. See table 6.




                                               Page 48                                                GAO-03-378 IRS Enforcement Reporting
                 Appendix IV: Soft Notices and Voluntary
Appendix IV: Soft Notices and Voluntary
                 Compliance Agreements



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.




                 Page 49                                   GAO-03-378 IRS Enforcement Reporting
    Appendix IV: Soft Notices and Voluntary
    Compliance Agreements




    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.1 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.




    1
    GAO/GGD-00-7.




    Page 50                                   GAO-03-378 IRS Enforcement Reporting
    Appendix IV: Soft Notices and Voluntary
    Compliance Agreements




•   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.




    Page 51                                   GAO-03-378 IRS Enforcement Reporting
                             Appendix V: Comments from the
  Appendix V: Comments from the
                             Commissioner of Internal Revenue



  Commissioner of Internal Revenue




As part of its comments,
IRS included an
enclosure that provided
additional data on
nonaudit contacts. We did
not include this enclosure
as part of IRS’s written
comments because the
data provided did not
materially affect our
conclusions and
recommendations.




                             Page 52                            GAO-03-378 IRS Enforcement Reporting
Appendix V: Comments from the
Commissioner of Internal Revenue




Page 53                            GAO-03-378 IRS Enforcement Reporting
                  Appendix VI: GAO Contacts and Staff
Appendix VI: GAO Contacts and Staff
                  Acknowledgments



Acknowledgments

                  Michael Brostek, (202) 512-9110
GAO Contacts      Tom Short, (202) 512-9110


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




                  Page 54                                 GAO-03-378 IRS Enforcement Reporting
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             U.S. General Accounting Office. Tax Administration: Advance Tax
             Refund Program Was a Major Accomplishment, but Not Problem Free.
             GAO-02-827. Washington, D.C.: August 2, 2002.

             U.S. General Accounting Office. Tax Administration: New Compliance
             Research Effort Is on Track, but Important Work Remains. GAO-02-769.
             Washington, D.C.: June 27, 2002.

             U.S. General Accounting Office. Tax Administration: Impact of
             Compliance and Collection Program Declines on Taxpayers. GAO-02-674.
             Washington, D.C.: May 22, 2002.

             U.S. General Accounting Office. IRS Audit Rates: Rate for Individual
             Taxpayers Has Declined But Effect on Compliance Unknown. GAO-01-
             484. Washington, D.C.: April 25, 2001.

             U.S. General Accounting Office. Tax Administration: Information on
             Selected IRS Tax Enforcement and Collection Efforts. GAO-01-589T.
             Washington, D.C.: April 5, 2001.

             U.S. General Accounting Office. Tax Administration: IRS’ Use of
             Nonaudit Contacts. GAO/GGD-00-7. Washington, D.C.: March 16, 2000.

             U.S. General Accounting Office. Tax Administration: IRS Is Working to
             Improve Its Estimates of Compliance Burden. GAO/GGD-00-11.
             Washington, D.C.: May 22, 2000.

             U.S. General Accounting Office. IRS Audits: Weaknesses in Selecting and
             Conducting Correspondence Audits. GGD-99-48. Washington, D.C.: March
             31, 1999.

             U.S. General Accounting Office. Tax Administration: IRS’ Audit and
             Criminal Enforcement Rates for Individual Taxpayers Across the
             Country. GAO/GGD-99-19. Washington, D.C.: December 23, 1998.

             U.S. General Accounting Office. Internal Revenue Service: Results of
             Nonfiler Strategy and Opportunities to Improve Future Efforts.
             GAO/GGD-96-72. Washington, D.C.: May 13, 1996.

             U.S. General Accounting Office. Tax Administration: Audit Trends and
             Results for Individual Taxpayers. GAO/GGD-96-91. Washington, D.C.:
             April 26, 1996.



             Page 55                                 GAO-03-378 IRS Enforcement Reporting
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           Statement of Johnny C. Finch, Senior Associate Director, General
           Government Division, GAO, Before the Subcommittee on Commerce,
           Consumer, and Monetary Affairs, Committee on Government Operations,
           House of Representatives, on IRS’ Information Returns Matching Program,
           April 29, 1986.




(440155)
           Page 56                                GAO-03-378 IRS Enforcement Reporting
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