Tax Administration: Erroneous Penalties for Failure to File Returns or Pay Taxes Can Be Reduced

Published by the Government Accountability Office on 1990-04-13.

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

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                                                                                             TAX       -
1Ii                                                                                          ADMINISTRATION
                                                                                             Erroneous Penalties
                                                                                             for Failure to File
                                                                                             Returns or Pay Taxes
                                                                                             Can Be Reduced

                                                                                                                                                wI      141303

  (;iii ‘~iIl)-90-~0
                   United States
                   General Accounting Office
                   Washington, D.C. 20648

                   General Government Division


                   April 13, 1990

                   The Honorable Fred T. Goldberg, Jr.
                   Commissioner, Internal Revenue Service
                   Department of the Treasury

                   Dear Mr. Commissioner:

                   This report is one of a series we are doing on the Internal Revenue Ser-
                   vice’s (IRS) administration of civil tax penalties. It discusses whether IRS
                   assessment and abatement decisions for the failure to file a timely tax
                   return and failure to pay taxes due penalties were appropriate and suf-
                   ficiently documented. It also addresses the accuracy of IRS penalty sta-
                   tistics. It includes recommendations on how the administration of these
                   penalties can be improved.

                   Of the approximately 160 civil tax penalties in the Internal Revenue
                   Code (Code), the penalties for failure to file and pay are among those
                   most likely to affect the majority of taxpayers. During fiscal year 1988,
                   IRSassessed 2.9 million taxpayers the failure to file penalty and 8.4 mil-
                   lion taxpayers the failure to pay penalty. These penalties were assessed
                   against individual and corporate filers on income tax, excise tax,
                   employment tax, estate tax, and gift tax returns. The number of IRS
                   reported abatements’ equalled 14 percent and 13 percent of assessments
                   respectively for the failure to file and failure to pay penalties in fiscal
                   year 1988. The reported abatement rates have contributed to congres-
                   sional concern over the adequacy of IRS’ administration of these

                   Our review of a sample of taxpayer requested abatements of IRS failure
Results in Brief   to file and failure to pay penalty decisions revealed that over 90 percent
                   of the abatements made were appropriate based on IRS abatement crite-
                   ria. However, 29 percent of the abatements were necessary to correct
                   erroneous assessments. Failure to properly code income tax returns for
                   processing and problems with processing taxpayers’ extensions to file
                   their income tax returns caused most of the assessment errors.

                   A lack of documentation regarding why a penalty was abated in the
                   penalty case files prevents IRS managers from readily identifying and
                   correcting processing problems. Existing internal controls-specifically,
                   quality reviews- are also not designed to identify, summarize, and

                   ‘An abatementoccurswhen IRSforgives the penalty.

                   Page 1                                             GAO/GGDBO-SO
                                                                                 Tax Administration
             assess processing problems that lead to erroneous failure to file and pay

             IRS errors in making penalty assessment decisions can increase taxpayer
             frustration and generate an additional administrative burden for IRS.IRS
             should strengthen penalty internal controls by (1) requiring that tax
             examiners fully document the reasons for abating penalties and (2)
             design its internal controls to capture and summarize the causes of
             assessment errors so that managers can take corrective action.

             While our review of IRS penalty assessment and abatement decisions
             revealed a need for improvement in return processing to reduce errone-
             ous assessments, we also determined that IRSpenalty abatement statis-
             tics contain numerous computer-generated transactions that reflect
             adjustments to the taxpayer’s account. These transactions, which make
             up over 80 percent of the reported abatements, are not taxpayer
             requested abatements. They are typically computer-programmed recal-
             culations of the penalty based on a reduction of the associated tax liabil-
             ity, which may result from an IRS audit of a taxpayer’s return or, more
             often, a partial payment received on an overdue account. By including
             these computer adjustments in reported abatement statistics, IRS over-
             states the number and dollar value of actual abatements, and corre-
             spondingly, IRS forgiveness of taxpayer noncompliance.

             In providing informal comments on this report, IRS officials agreed with
             our results and recommendations on the need for better documentation
             on abatement decisions as well as strengthening internal controls to take
             corrective action to reduce the number of erroneous assessments. IRS
             officials also agreed that penalty abatement statistics could be catego-
             rized and better explained to differentiate between penalty adjustments
             and reasonable cause abatements.

             A penalty system must maintain credibility and confidence among tax-
Background   payers. In reviewing penalties, penalty policy and administration con-
             cerns need to be considered in determining the effectiveness of the
             overall structure of penalties, In our report, Tax Policy: Options for Civil
             Penalty Reform (GAO/GGD-SQ-SI), we examined the policy matters associ-
             ated with civil penalties. We recommended statutory changes to make
             civil penalties less complex, more equitable, and easier to administer
             without lessening their deterrent value. This report builds on our review
             of civil penalty policy by addressing IRS administration of two of the

             Page 2                                         GAO/GGMO-SOTax Administration
                           most commonly assessed penalties: those for failure to file a timely tax
                           return and for failure to pay taxes when due.

The Failure to File and    Income tax returns are the basic building blocks of our tax system. The
Failure to Pay Penalties   Code requires that tax returns be filed and taxes paid by prescribed
                           dates to accommodate the processing of returns and necessary flow of
                           funds into the Treasury. The returns also provide information essential
                           for IRS to track and detect nonfilers, underreporters, and nonpayers. The
                           penalties for failure to file a tax return and failure to pay taxes due are
                           intended to encourage taxpayers to meet these obligations.

                           The penalty for failure to file an income tax return is 6 percent of the
                           net tax due for each month or part of a month the return is late, not to
                           exceed a total of 26 percent. The penalty applies only when an
                           underpayment of tax occurs. A minimum failure to file penalty is
                           applied for returns with underpayment of tax filed more than 60 days
                           after the due date (considering any extensions granted by IRS). The mini-
                           mum penalty is the lesser of $100 or 100 percent of any unpaid tax.

                           If payment of the balance due as shown on the return is not made by the
                           return due date, the failure to pay penalty may be assessed. The penalty
                           is one-half of 1 percent of the amount due per month or part of a month
                           the taxes are not paid, up to a maximum of 26 percent. The penalty also
                           applies to taxpayers who owe taxes for which IRS has sent a notice for

                           If both the failure to file and failure to pay penalties are assessed on the
                           same return, under the statute the failure to file penalty is reduced so
                           that together the two penalties do not exceed 6 percent per month. The
                           penalties can be abated if the taxpayer demonstrates reasonable cause
                           for the delinquency.

Assessment and             IRS assesses these penalties by computer and manually. Computer
Abatement Procedures       assessments typically involve the taxpayer failing to take a required
                           action that the computer can identify, such as failing to file a return or
                           pay taxes by a specific date. The computer is programmed to look for
                           specific situations such as these and to assess the appropriate penalty
                           when warranted. In the case of failing to file a return on time, the com-
                           puter is also programmed to look for extensions posted on the tax-
                           payer’s account before assessing the penalty. IRS computers assessed

                           Page 3                                         GAO/GGD90-80Tax Administration

                        93 percent of the failure to file and more than 99 percent of the failure
                        to pay penalties in fiscal year 1988.

                        IRS examiners may manually assess a failure to file or pay penalty at the
                        completion of an audit. The examiner computes the penalties in addition
                        to the taxpayer’s tax liability, allowing the taxpayer to pay the defi-
                        ciency in full at the completion of the audit. Seven percent of the failure
                        to file and less than 1 percent of the failure to pay penalties were
                        assessed manually in fiscal year 1988.

                        IRS also abates failure to file and pay penalties by computer and manu-
                        ally. Computer abatements typically result from an adjustment that
                        reduces the taxpayer’s tax liability. When the tax liability is reduced,
                        the computer is programmed to recalculate a reduced penalty based on
                        the lower liability. This is done through a complete or partial abatement
                        of the original penalty. Computer abatements made up 67 percent of the
                        failure to file and 89 percent of the failure to pay penalty abatements in
                        fiscal year 1988.

                        Manual abatements are typically prompted by a taxpayer’s request for
                        reconsideration of the penalty due to reasonable cause. Upon reviewing
                        the taxpayer’s written statement, which is to fully explain the basis for
                        a reasonable cause abatement, IRS examiners may manually abate the
                        penalty, in whole or in part, or deny the abatement. The taxpayer is to
                        be notified in writing of the abatement decision; if the abatement is
                        denied, or abated in part, the taxpayer is to be given information on
                        further appeal rights. For fiscal year 1988, manual abatements were 43
                        percent of the total abatements for the failure to file penalty and 11
                        percent for the failure to pay penalty.

                        The objectives of our work were (1) to determine whether IRS’ decisions
Objectives, Scope,and   regarding the assessment and abatement of these penalties were appro-
Methodology             priate, i.e., consistent with IRS assessment and abatement criteria; (2) to
                        determine if the decisions were sufficiently documented; and (3) to
                        determine if IRS statistics relating to these penalties are accurate.

                        To determine how IRS assesses and abates the failure to file and failure
                        to pay penalties, we reviewed IRS written procedures for administering
                        the two penalties and discussed these procedures with IRS officials at the
                        National Office and the Cincinnati Service Center, where we did most of
                        our work.

                        Page 4                                         GAO/GGD-90-80Tax Administration

To determine whether IRS appropriately assesses and abates the two
penalties, we reviewed a random sample of penalty abatement case files.
We selected abatement cases because time and staff constraints limited
the number of cases we could review. Abatement case files provided the
opportunity to look at both an assessment and abatement decision in a
single file. We randomly sampled 626 manual penalty abatements made
during fiscal year 1987, the most recent year for which complete data
were available. Our sample was drawn from the IRS individual and busi-
ness master files. To provide a cross section of several different IRS
offices, our sample included abatements processed by three IRS service
centers-Andover,     Massachusetts; Cincinnati, Ohio; and Ogden, Utah.

Our sample was spread about equally among the service centers, and
included 310 failure to pay and 316 failure to file abatement cases. The
sample was further subdivided about equally into individual and corpo-
rate income tax return filers. The size of each sample component varied
slightly because some cases were not available from IRS files at the time
of our request.

In reviewing the case files of manual abatement decisions, we looked at
(1) the reasons for assessing and abating the penalty, (2) whether the
assessment and abatement decisions were consistent with IRS criteria,
and (3) whether the basis for the abatement decision was adequately
documented. If we disagreed with an abatement decision or were unsure
if the decision was consistent with IRS criteria, we consulted with IRS tax
examiners at IRS’ Cincinnati Service Center. We also discussed with man-
agers at the Andover, Cincinnati, and Ogden Service Centers our sample
results pertaining to errors in coding returns.

Because our samples were not designed to be aggregated, our sample
results are not projectable to each of the three centers or to IRS as a
whole. Our findings are directly applicable only to the case files we
reviewed. However, we discussed our results with IRS officials and they
said that, on the basis of our results, they believed there is a general
need for improvement, particularly in reducing the number of erroneous

We analyzed the procedures IRS computers use to assess and abate these
penalties and determined that, on the basis of our sample of com-
puter-generated abatements, they functioned properly in these cases.

Page 6                                        GAO/GGlMO-8OTax Administration

                      To determine if IRS reported statistics relating to failure to file/pay pen-
                      alty assessments and abatements are accurate, we analyzed and com-
                      pared the statistics published in the IRS Commissioner’s annual reports
                      with information IRS retrieved for us from the individual and business
                      master files of taxpayer accounts. The master file information included
                      the numbers of failure to file and pay penalty assessments and abate-
                      ments made during fiscal years 1986 through 1988, broken down by
                      computer- and manually-generated assessments and abatements.

                      The reported assessment statistics for fiscal year 1988 generally agreed
                      with the data on the number and dollar value of assessments retrieved
                      from the master file. However, while the abatement statistics were also
                      generally consistent, our analysis of the master file data showed that
                      about 80 percent of the abatements were generated by the computer.
                      This appeared incongruous because an abatement is generally expected
                      to reflect a judgmental decision on a taxpayer request for forgiveness of
                      the penalty because the taxpayer had “reasonable cause” for the delin-
                      quency or because the penalty was erroneous. These are not things a
                      computer can determine. Consequently, we reviewed 62 of the transac-
                      tions IRS calls computer-generated abatements. From these transactions
                      and discussions with IRS officials, we identified the circumstances that
                      lead to a computer abatement.

                      We did our work between February and November 1989 and in accor-
                      dance with generally accepted government auditing standards.

                      If taxpayers believe they have been improperly penalized, they may
Abatements Correct    request an abatement. IRS tax examiners are to evaluate the request
But Often Needed to   according to reasonable cause criteria set forth in the Internal Revenue
Correct Erroneous     Manual, and abate the penalty if the taxpayer’s explanation meets one
                      of the criteria. Acceptable explanations generally involve circumstances
Assessments           outside of a taxpayer’s control, such as serious illness, death, destruc-
                      tion of records by fire, certain mistakes or errors the taxpayer made
                      that caused the penalty to be assessed, or an erroneous IRS assessment.

                      Our analysis of a sample of taxpayer requested abatements revealed
                      that 91 percent were correctly abated. Of the 626 abatements we
                      reviewed, we determined that 671 were in accordance with the abate-
                      ment criteria contained in the Internal Revenue Manual, while 30 were

                      Page 6                                         GAO/GGD9O-S0Tax Administration

                                         not.’ We found that abatement decisions were correct at about the same
                                         level of appropriateness at all three service centers, for corporate and
                                         individual income tax filers, and for failure to file and failure to pay

                                         While the vast majority of abatements we reviewed were justified, we
                                         found that 29 percent (179 cases) were needed to correct IRS assessment
                                         errors. The erroneous assessments were the result of processing
                                         problems including tax examiners failing to properly code income tax
                                         returns for processing and problems with taxpayers’ extension to file
                                         applications not being posted to the master files. The abatements for the
                                         remaining cases in our sample occurred because taxpayers established
                                         reasonable cause for not timely filing and/or paying.

Processing Problems                      The erroneous assessments we identified were caused primarily by IRS
Causing Erroneous                        errors during the initial processing of tax returns or tax payments.
                                         These errors include the failure to code tax returns for computer
Assessments                              processing and the failure to process taxpayers’ applications for an
                                         extension to file their returns. Seventy-two percent of the assessment
                                         errors in our sample were against corporate filers and 28 percent
                                         against individual filers. Table 1 lists the problems we identified and the
                                         frequency of their occurrence in our sample.

Table 1: Types of Problems That Caused
Erroneous Assessments                                                                                                 Individual        Corporate
                                         Returns     not coded                                                                  19
                                                                                                                              -__..                45
                                         No record     of extenstons                                                             8                 35
                                         Other processing        errorsa                                                        16                 33
                                         Lost returns/payments                                                                     8               15
                                         Total                                                                                  51     ---7%
                                         aOther errors occur primarily during the initial processing of a tax return. Examples of these types of
                                         errors are posting payment to the wrong account, issuing a tax refund instead of applytng it to the
                                         appropriate account, or posting tax information to the wrong tax period.

                                         IRS tax examiners are to review every return and annotate, or “code,”
                                         returns that require special attention during computer processing. For
                                         example, code “R” is used to alert the computer that a late filer included
                                         a reasonable cause explanation with the return and the penalty for fail-
                                         ure to timely file should not be assessed. If a tax examiner fails to code a

                                         “For the remaining 26 abatement cases, we were unable to determine if the decision to abate the
                                         penalty was appropriate, because the files lacked sufficient information to make a determination.

                                         Page 7                                                            GAO/GGB90-80Tax Administration
return when required, or if a data transcriber fails to enter the code into
the computer, a penalty will be inappropriately assessed by IRS’ com-
puters. Forty-five of the 128 erroneous corporate assessments and 19 of
the 51 erroneous individual assessments were due to coding errors.

The coding errors occurred most frequently when corporate income tax
filers attached Form 8023 - Corporate Qualified Stock Purchase Elec-
tions. By so doing, the filer alerts IRS that they have been acquired by
another corporation and are exercising their right to change the due
date of their return and associated taxes to that of the new owner.
When the tax examiners see Form 8023, they should code the return to
prevent the computer from assessing a failure to file and/or failure to
pay penalty.

When we discussed this particular error with managers at the three ser-
vice centers involved in our case file review, we were told that they
were not aware of the requirement to code returns accompanied by
Form 8023 because the requirement was not clearly stated in the Inter-
nal Revenue Manual. As a result of our discussion, the managers said
they were alerting their tax examiners to the requirement and would
ask the IRSNational Office to clarify the manual.

The second most prevalent assessment problem was due to extension-to-
file applications not being posted to taxpayer accounts. Taxpayers are
entitled to file their return after the statutory due date with no filing
penalty if, by the due date, they submit an application for an extension
to file and at the same time pay the estimated tax due. If IRS does not
receive or fails to process the application and/or the accompanying pay-
ment, the computer will assess the taxpayer a failure to file and/or fail-
ure to pay penalty when they subsequently file their tax return.

Of the 179 erroneous assessments we identified in our sample, 43
occurred because IRS had no record of the taxpayers’ extension-to-file
application, although many of them later produced a copy of the appli-
cation that they purportedly submitted on time. IRS currently has no
way of determining whether the extension was actually requested.
Therefore, as a matter of policy it records these as assessment errors.
Even though we could not determine if an application had been received
and IRS was consequently at fault, we also categorized these as errone-
ous assessments to be consistent with IRS policy.

Page 8                                        GAO/GGD-90-80Tax Administration


                          IRS managers currently do not have the information needed to routinely
Better Documentation      identify and ultimately resolve processing problems leading to erroneous
and Internal Controls     failure to file and failure to pay penalty assessments. This is due in part
Could ReduceNumber        to a lack of adequate documentation in the case files regarding the rea-
                          son for the abatement as well as existing internal controls not being
of Erroneous              designed to routinely identify and summarize these problems and bring
Assessments               them to management’s attention.

F3etterDocumentation of   IRS procedures currently require that tax examiners document the rea-
Abatement Decisions       son for an abatement when they authorize one. However, our examina-
                          tion of abatement case files showed that examiners provided only very
Needed                    general explanations of their actions. These explanations were not use-
                          ful in determining the underlying reasons for the abatement. If the rea-
                          sons for the abatement were properly documented and provided to
                          responsible IRS managers, we believe such information would be useful
                          in identifying and correcting erroneous assessments such as those we
                          found in our sample. For example, if information were routinely col-
                          lected on why erroneous assessments occur, it could be used to deter-
                          mine the nature and extent of problems with extension applications and
                          would allow IRSto determine if changes to the program would be needed
                          to verify whether an extension had actually been requested by the

                          Our review of abatement case files demonstrates that the documentation
                          requirements are not being met. In our sample cases, tax examiners gen-
                          erally provided very limited explanations for abating penalties. Examin-
                          ers normally stated that the abatement was approved because the
                          taxpayer established “reasonable cause” without giving any further
                          details, such as the reason provided by the taxpayer for not filing or
                          paying on time or the cause of an erroneous assessment. Of the 626
                          abatement cases we reviewed, 560 cases lacked a detailed explanation of
                          the reason why the penalty was abated.

                          Without this documentation it is very difficult to determine if the abate-
                          ment resulted from the taxpayer providing an acceptable justification
                          for the noncompliance or was due to an erroneous assessment. To deter-
                          mine the underlying reason for the abatements in our sample, we had to
                          reconstruct these cases from taxpayer correspondence in the file and a
                          review of the filer’s tax records.3 This is a very time-consuming process.

                          3For 26 of the cases, the available information was so limited that we were unable to piece together
                          enough information to determine if the abatement decision was justified.

                          Page 9                                                         GAO/GGD-99430
                                                                                                     Tax Admtnbtration


                        We discussed the idea of requiring examiners to provide more of an
                        explanation for abatement decisions on the case file adjustment docu-
                        ment with program managers at the Cincinnati Service Center. They
                        acknowledged that the additional information would be of value in help-
                        ing to prevent erroneous assessments if recorded, collected, analyzed,
                        and fed back to responsible officials. However, they expressed reserva-
                        tions about requiring lengthy explanations that would be time consum-
                        ing to prepare. We believe, and they agreed, that a short explanation
                        should be enough to capture the necessary information. This type of
                        explanation was provided in 66 of the cases we analyzed, and generally
                        constituted no more than two or three sentences.

Internal Controls Not   Better documentation would also mitigate problems we found with IRS
Designed to Remedy      internal controls for these penalties. Internal controls include plans and
                        procedures adopted by an agency to assure that the goals of a program
Assessment Problems     are accomplished. However, current IRSinternal controls-quality       assur-
                        ance reviews-are not designed to identify and ultimately resolve the
                        types of problems found in our sample. As a result, IRS’ ability to effec-
                        tively administer the failure to file and failure to pay penalty program is

                        IRS internal controls include quality reviews of the service center func-
                        tions responsible for coding returns and abating penalties. Return coding
                        reviews are done before tax returns are processed and are designed to
                        ensure that the computer can process the tax returns. Coding reviews
                        generally do not involve verifying the accuracy of coding decisions
                        based on information in the tax returns.

                        Abatement reviews are confined to determining if the abatement actions
                        taken by the examiner are consistent with IRS criteria. The reviews do
                        not focus on the underlying causes of why a problem occurred. For
                        example, while the reviews may show that an abatement was justified
                        because of an erroneous assessment, it would not go further and address
                        the reason for the erroneous assessment.

                        IRS could strengthen its internal controls without changing the existing
                        quality review process, if the reasons behind erroneous assessments are
                        better documented by tax examiners and the information is provided to
                        the IRS managers responsible for returns processing, so that the process-
                        ing problems can be resolved where feasible.

                        Page 10                                       GAO/GGD-90-90Tax Administration

                     IRSerrors in making penalty assessment and abatement decisions can
Conclusions          increase taxpayer frustration and generate an additional administrative
                     burden for IRS. This is of particular concern in today’s environment of
                     growing taxpayer dissatisfaction and limited IRS resources. By taking
                     action to identify the causes of the assessment problems, IRS could alle-
                     viate taxpayer concerns and reduce the staff time spent abating the
                     erroneous assessments.

                     While IRS examiners appropriately abated the failure to file and failure
                     to pay penalties in 91 percent of the cases we analyzed, almost 30 per-
                     cent of the time their actions were necessary to reverse erroneous
                     assessments caused by problems in the processing of tax returns and
                     other documents. The information necessary to identify these erroneous
                     assessments and their causes was not generally documented in the case
                     files we reviewed. If accurate information about the reasons penalties
                     are abated were made available to IRS managers responsible for returns
                     processing, it would be valuable in reducing the number of penalty
                     assessments that subsequently require abatement.

                     We recommend that you
                 l   require IRS tax examiners to more fully document their penalty abate-
                     ment decisions. At a minimum the documentation should include the
                     basis for the abatement, including the cause of any erroneous

                 l   improve internal controls over the abatement of the failure to file and
                     pay penalties by requiring quality review to assess whether or not the
                     abatement decisions were adequately documented by the examiner.

                 . improve the internal controls over the assessment of the failure to file
                   and failure to pay penalties by providing for the collection of informa-
                   tion on the causes of erroneous penalty assessments from the abatement
                   process and by providing this information to the IRS managers responsi-
                   ble for correcting these problems.

                 l   clarify in the Internal Revenue Manual the requirements for coding tax
                     returns containing Form 8023 - Corporate Qualified Stock Purchase

                     Page 11                                       GAO/GGD-90-80Tax Admlnlstratlon

                             Penalty statistics can be a yardstick for measuring taxpayer compliance
Penalty Abatement            with various filing and paying requirements. However, to be of value,
Statistics Do Not            statistical information must be accurate and not misleading. In 1988, we
Accurately Reflect           testified that we had concerns about the quality of penalty statistics
                             available to IRS managers who oversee penalty administration.4
Noncompliance                IRS congressional oversight subcommittees have also voiced concern
                             with the reported abatement rate of the failure to file and pay penalties
                             (as well as other penalties). During fiscal year 1988, IRS reported that it
                             assessed 17.4 million failure to file and failure to pay penalties worth
                             $3.8 billion. During the same period, however, IRS reported abating
                             2.5 million failure to file and failure to pay penalties for $1.7 billion. The
                             extent of the abatements caused the subcommittees to question the ade-
                             quacy of IRS administration of the two penalties.

                             While our review of IRS assessment and abatement decisions revealed a
                             need for improvement in return processing to reduce erroneous assess-
                             ments, we also determined that IRS’ reported abatement statistics signifi-
                             cantly overstate the number and the dollar value of failure to file and
                             failure to pay abatements. Specifically, we found that a variety of com-
                             puter adjustments to taxpayer accounts are included in abatement sta-
                             tistics. These adjustments may overstate the number of abatements by
                             almost 80 percent and their dollar value by almost 40 percent.

Penalty Abatement            In addition to taxpayer requested or manual abatements, which require
                             examiners to review pertinent data to determine whether reasonable
Statistics Include Account   cause exists for forgiving the penalty, IRS also includes in its reported
Adjustments                  abatement counts certain computer-generated adjustments they make to
                             taxpayer accounts. These transactions are primarily reductions in the
                             amount of the penalty resulting from a reduction or elimination of the
                             underlying tax liability, rather than reductions or eliminations of penal-
                             ties requested by taxpayers. For example, if after assessing a failure to
                             pay or failure to file penalty, IRS identifies a credit on the taxpayer’s
                             account that reduces or eliminates the current year’s tax liability, a cor-
                             responding adjustment will be made to the penalty. This is coded and
                             counted in IRS statistics as an abatement. Or, if a taxpayer’s liability is
                             eliminated through an audit, IRS would subsequently adjust the account,
                             and any penalty that had been assessed would be automatically abated.

                             4Comprehensive Review of Civil Penalties Needed (T-GGD-88-55, Sept. 28, 1988).

                             Page 12                                                    GAO/GGD-9040Tax Administration

                                         Of the 2.5 million failure to file and pay penalty abatements reported by
                                         IRS during fiscal year 1988, about 2 million, or 80 percent, were com-
                                         puter adjustments worth $954 million. The remaining 500,000 abate-
                                         ments, worth about $1 billion, were taxpayer requested abatements
                                         which required IRS personnel to make a decision regarding whether to
                                         reverse, or “forgive”, the penalty assessment on the basis of information
                                         supplied by taxpayers. We believe the latter more accurately show
                                         abatement activity for these penalties. As shown in figure 1, most
                                         reported penalty abatements during fiscal years 1985 through 1988
                                         were computer-generated.

Figure 1: Proportion of Computer-
Oenerated and Manual Failure to File
and Failure to Pay Penalty Abatements,   ‘*’
Fiscal Years 1985 -1988

                                               All Pot-tatty Aktomonts   (bothFTF and FTP)

                                               I          Computer Abated
                                                          Manually Abated

                                         Note: These data combine Failure to File and Failure to Pay information for the fiscal years noted.

                                         As computer adjustments are not taxpayer requested abatements,
                                         including them in abatement statistics is misleading. To avoid this prob-
                                         lem and make the data more useful to IRS managers, Congress, and other
                                         interested parties, computer abatements should be captured separately
                                         and explained in published reports.

                                         Page 13                                                           GAO/GGD-99-80Tax Administration

                  Accurate statistical information on the number and amount of penalty
Conclusions       abatements can be a valuable management tool for IRS. However, infor-
                  mation currently available is subject to misinterpretation. Specifically,
                  because the statistics contain numerous computer-generated adjust-
                  ments to taxpayer accounts, data do not reflect actual abatements
                  requested by taxpayers.

                  In order for IRS statistics to more accurately reflect IRS forgiveness of
Recommendation    taxpayer noncompliance, we recommend that you isolate computer
                  adjustments from the numbers and dollar value of abatements prior to
                  publication for either internal or external use.

                  IRSofficials provided informal comments on this report. They also
Agency Comments   agreed with our recommendations. They agreed that strengthening pen-
                  alty internal controls by (1) requiring that tax examiners fully document
                  the reasons for abating penalties and (2) designing internal controls to
                  capture and summarize the causes of assessment errors is necessary so
                  that managers can take corrective action.

                  IRS agreed that penalty abatement statistics could be better defined and
                  reported. Two categories were suggested-“Penalty Adjustments” and
                  “Penalty Reasonable Cause Abatements.” This change would respond to
                  our recommendation.

                  We are sending copies of this report to the Joint Committee on Taxation;
                  the Subcommittee on Private Retirement Plans and Oversight of IRS, Sen-
                  ate Committee on Finance; Subcommittee on Oversight, House Commit-
                  tee on Ways and Means; and other interested parties. We will make
                  copies available to others on request.

                  Page 14                                       GAO/GGD90-90Tax Administration
Major contributors to this report are listed in appendix I. Please contact
me on 272-7904 if you have any questions concerning the report.

Sincerely yours,

Paul L. Posner
Associate Director, Tax Policy and
  Administration Issues

 Page 15                                        GAO/GGD4O-8OTax AdminIstration

Letter                                                                                             1

Appendix I                                                                                     18
Major Contributors to
This Report
Table                   Table 1: Types of Problems That Caused Erroneous                           7

Figure                  Figure 1: Proportion of Computer-Generated and Manual                  13
                             Failure to File and Failure to Pay Penalty
                             Abatements, Fiscal Years 1986 -1988


                        IRS       Internal Revenue Service

                        Page 10                                   GAO/GGD-90.80Tax Admhiatration


                Page 17   GAO/GGD90-80Tax Administration
Appendix I

Major Contributorsto This Report

                        Lynda Willis, Assistant Director, Tax Policy and Administration   Issues
General Government      Charlie Daniel, Assignment Manager
Division, Washington,
                        Deborah Smith, Deputy Project Manager
Cincinnati Regional     Michael Enriquez, Site Senior
Office                  Michael Hoffman, Technical Advisor
                        Mary Murphy, Evaluator
                        Marvin Bonner, Evaluator

                        Thomas Wolters, Project Manager
Kansas City Regional

(2im386,                Page 18                                      GAO/GGD-90440
                                                                                 Tax Administration
IIS. (;twwd    Awoant~ing       Offiw
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Gsit.htwtmrg,   Mi~rylitllti   20877

‘I‘ilt~ first. five copies of each rtqmrt. art’ frw.   Addit.i0llid   copies are
62.00 (‘idI.

‘I’lww is it 25”0 discount     on orcit~rs for 100 or mow cwpiths mailed t.0 a
singlth itddress.