oversight

Tax Administration: IRS' 1997 Tax Filing Season

Published by the Government Accountability Office on 1997-12-29.

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


December 1997
                TAX
                ADMINISTRATION
                IRS’ 1997 Tax Filing
                Season




GAO/GGD-98-33
                   United States
GAO                General Accounting Office
                   Washington, D.C. 20548

                   General Government Division

                   B-276564

                   December 29, 1997

                   The Honorable Nancy L. Johnson
                   Chairman, Subcommittee on Oversight
                   Committee on Ways and Means
                   House of Representatives

                   Dear Chairman Johnson:

                   This report responds to your request that we assess the Internal Revenue
                   Service’s (IRS) performance during the 1997 tax filing season. Besides
                   providing data on various indicators that IRS uses to measure its filing
                   season performance, we discuss five areas that have been problematic in
                   past filing seasons: (1) the ability of taxpayers seeking answers to
                   questions to reach IRS via the telephone, hereafter referred to as telephone
                   accessibility;1 (2) the number of returns filed by means other than the
                   traditional paper method; (3) IRS’ efforts to deal with returns that have
                   missing or incorrect Social Security Numbers (SSN); (4) the use of banks,
                   known as lockboxes, to process certain tax payments; and
                   (5) performance of the imaging system IRS uses to process certain tax
                   returns. In March 1997, we testified before the Oversight Subcommittee on
                   the interim results of our work.2


                   IRSmet or exceeded most of its 1997 filing season related performance
Results in Brief   goals. Of particular note is the substantial improvement in two important
                   areas where we have criticized IRS’ performance in past filing
                   seasons—telephone accessibility and the use of alternative filing methods.

                   According to IRS data, telephone accessibility increased from 20 percent
                   during the 1996 filing season to 51 percent during the 1997 filing season.
                   That improvement was due to an increase in the number of telephone calls
                   IRS answered and a decrease in the number of calls coming into IRS. IRS was
                   able to answer more telephone calls because it devoted more staff to do so
                   and revised its procedures for answering questions on more complex tax
                   issues. IRS’ ability to answer more calls also contributed to the decrease in
                   the number of calls coming into IRS by reducing the number of busy signals
                   and thus the need for redials.


                   1
                    Accessibility, as we have traditionally defined it, is the total number of calls answered divided by the
                   number of call attempts, which is the sum of the following: (1) calls answered, (2) busy signals, and
                   (3) calls abandoned by the caller before an IRS assistor got on the line.
                   2
                   Tax Administration: IRS’ Fiscal Year 1997 Spending, 1997 Filing Season, and Fiscal Year 1998 Budget
                   Request (GAO/T-GGD/AIMD-97-66, Mar. 18, 1997).



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The number of tax returns filed by means other than the traditional paper
method increased by 25 percent over last year, with the number of returns
filed by telephone (TeleFile) showing the most significant
increase—65 percent. One factor that most likely contributed to the
increase in TeleFile was IRS’ decision not to include a Form 1040EZ in the
tax package sent to taxpayers who appeared eligible to file using
TeleFile—the thinking being that if those taxpayers did not receive a form
that they could use to file on paper, they would be more inclined to file
using the telephone.

Although the revised tax package apparently contributed to an increase in
the use of TeleFile, it also apparently contributed to a decrease in the
performance of the Service Center Recognition/Image Processing System
(SCRIPS)—a document imaging and optical character recognition system
that IRS implemented in 1994 to process Forms 1040EZ and certain other
tax documents. In that regard, IRS data for the 1997 filing season show that
the number of Forms 1040EZ processed per hour on SCRIPS equipment
declined from the number processed per hour in 1996. According to IRS,
because taxpayers who were eligible to use TeleFile did not get a Form
1040EZ that they could use to file on paper, they also did not get a
preprinted address label to affix to a paper form. Thus, if they chose to file
on a Form 1040EZ, which many of them did, they had to write in their
names, addresses, and SSNs. The additional handwritten information on
those returns increased the amount of operator intervention needed to
process those returns through SCRIPS, which resulted in decreased
productivity.

Another major change during the 1997 filing season involved the
procedures IRS used to process returns that were filed with missing or
incorrect SSNs. In 1997, as authorized by the Welfare Reform Act of 1996,
IRS began treating missing or incorrect SSNs as math errors rather than as
issues that, in the past, had to be resolved through a lengthy notice
process.3 As of September 1, 1997, according to IRS, it had protected about
$1.46 billion in revenue through the disallowance of claimed credits or
dependent exemptions in 1997. That result more than doubled the amount
disallowed using the procedures IRS followed in 1996.


3
 Section 6213(g)(2) of the Internal Revenue Code specifies those conditions on a return that can be
treated as math errors. The conditions include such things as computational mistakes and missing or
incorrect SSNs. When IRS finds one of those conditions while processing a return, it can immediately
adjust the taxpayer’s return (by, for example, correcting the computation or disallowing the dependent
exemption, earned income credit, or child care credit associated with the missing or incorrect SSN)
and make appropriate changes to the taxpayer’s reported tax liability and refund, if any. IRS is to send
the taxpayer a notice explaining the change.



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                            One issue that we discussed in our report on the 1996 filing season4 and
                            that continues to concern us is the cost effectiveness of IRS’ use of
                            lockboxes to process Form 1040 tax payments. Additional information we
                            obtained this year heightened our concern by calling into question a key
                            assumption IRS and the Department of the Treasury’s Financial
                            Management Service (FMS) have used to calculate the interest cost savings
                            associated with this use of lockboxes. Although FMS had planned a study to
                            further assess interest cost savings, those plans have been deferred, and
                            there is no assurance when such a study will be done.


                            Our objective was to assess IRS’ performance during the 1997 filing season,
Objective, Scope, and       with particular emphasis on those areas that were identified as
Methodology                 problematic in our reviews of past filing seasons. To achieve our objective,
                            we

                        •   interviewed IRS National Office officials and IRS officials in the Atlanta,
                            Cincinnati, Fresno, and Kansas City service centers responsible for the
                            various activities we assessed;5
                        •   analyzed filing season related data from various management information
                            systems, including IRS’ Management Information System for Top Level
                            Executives;
                        •   analyzed IRS data relating to its telephone assistance and conducted a test
                            of IRS’ telephone accessibility during the last 2 weeks of the filing season
                            (see app. I for information on our test methodology);
                        •   analyzed IRS data on alternative filing methods, including IRS surveys of
                            TeleFile users and nonusers;
                        •   visited two lockbox banks, one in Atlanta and one in St. Louis, to review
                            remittance processing procedures; 6
                        •   interviewed staff from FMS, which is responsible for negotiating and
                            administering lockbox contracts, about the use of lockboxes to process
                            Form 1040 tax payments and analyzed cost/benefit data related to lockbox
                            processing;
                        •   interviewed officials from IRS’ Taxpayer Advocate’s Office about the
                            impact of various filing season activities on taxpayers;
                        •   analyzed activity data for IRS’ Internet World-Wide Web site and forms
                            distribution centers; and


                            4
                            IRS’ 1996 Tax Filing Season: Performance Goals Generally Met; Efforts to Modernize Had Mixed
                            Results (GAO/GGD-97-25, Dec. 18, 1996).
                            5
                             We selected these locations because we had staff available to do the work in those cities.
                            6
                             We selected these locations because we had staff available to do the work in those cities.



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                                            •   reviewed relevant IRS internal audit reports.

                                                We did our work from January through October 1997 in accordance with
                                                generally accepted government auditing standards. We obtained written
                                                comments on a draft of this report from the Deputy Commissioner of
                                                Internal Revenue. Those comments are discussed at the end of this letter
                                                and are reprinted in appendix II.


                                                IRSuses various indicators to measure its filing season performance. Those
Filing Season Goals                             indicators relate to workload, like the number of returns processed;
Were Generally Met                              timeliness, like the number of days needed to process and issue refunds;
                                                and quality, like the accuracy of IRS’ answers to taxpayers’ questions and
                                                the accuracy with which IRS processes individual income tax returns and
                                                refunds. As shown in table 1, those indicators show that IRS met or
                                                exceeded most of its performance goals for the 1997 filing season.7


Table 1: IRS’ Performance Goals and Related Accomplishments for the 1996 and 1997 Filing Seasons
                                                         1996a                                                             1997a
Indicator                                       Goal                       Accomplishment            Goal                      Accomplishment
Accuracy of individual income tax returns       Process 93%                94% were                  Process 95%               95% were
processed by Code and Edit staffb               accurately                 processed                 accurately                processed
                                                                           accurately                                          accurately
Accuracy of individual income tax returns       Process 93.0%              94.2% were                Process 95.0%             94.7% were
processed by data transcribers                  accurately                 processed                 accurately                processed
                                                                           accurately                                          accurately
Service center individual income tax returns    Process 10,000         12,174 returns were           Process 11,730         12,692 returns were
processing productivityc                        returns per staff year processed per staff           returns per staff year processed per staff
                                                                       year                                                 year
Individual income tax returns processing        11 days                    Various types of          Less than 16 days         Various types of
cycle timed                                                                1040s ranged                                        1040s ranged
                                                                           between 8 and 11                                    between 5 and 14
                                                                           days                                                days
Timeliness of processing tax payments           Payments received          All payments              Payments received         All payments
submitted with individual income tax returns    4/15/96 thru 5/1/96        received 4/15/96          4/15/97 thru 4/30/97      received 4/15/97
                                                were to be                 thru 5/1/96 were          were to be                thru 4/30/97 were
                                                deposited no later         deposited by              deposited no later        deposited by
                                                than 5/1/96                5/1/96                    than 4/30/97              5/2/97
Accuracy of individual income tax refunds on Process 98%                   99.6% were                Process 99.3%             99.4% were
paper returns                                accurately                    processed                 accurately                processed
                                                                           accurately                                          accurately
                                                                                                                                        (continued)



                                                7
                                                 The goals shown in table 1 are set by IRS; we did not assess their appropriateness.



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                                                                    1996a                                                1997a
Indicator                                     Goal                       Accomplishment            Goal                      Accomplishment
Timeliness of refund check for individual     Issue within an            Issued within an          Issue within an           Issued within an
income tax returns filed on papere            average of 40 days         average of 38 days        average of 40 days        average of 38 days
                                                                         as of 5/96                                          as of 5/97
Timeliness of refund for individual income tax Issue within an           Issued within an          Issue within an           Issued within an
returns filed electronicallyf                  average of 21 days        average of 16 days        average of 21 days        average of 15 days
                                                                         as of 5/96                                          as of 5/97
Level of access to taxpayer service           Provide 41.4% level        Provided 51% level        Provide 60.2% level       Provided 71% level
telephone systemg                             of access                  of access                 of access                 of access
Accuracy of tax law assistance                Answer 90%                 91% were answered Answer 92%                        95% were answered
                                              accurately                 accurately        accurately                        accurately
Level of access to forms ordering telephone   Provide 70% level of Provided 54.3%                  Provide 70% level of Provided 76.7%
systemh                                       access               level of access                 access               level of access
Accuracy of processing form orders            Process 96.5%              97.3% were                Process 96.5%             97.0% were
                                              accurately                 processed                 accurately                processed
                                                                         accurately                                          accurately

                                              a
                                              Data are as of April 1996 and April 1997, unless otherwise noted.
                                              b
                                               Code and Edit staff are to prepare returns for computer entry by, among other things, ensuring
                                              that all data are present and legible.
                                              c
                                               Returns processing productivity is based on the number of weighted returns processed, which
                                              includes all returns (whether processed manually, through scanning equipment, or electronically).
                                              The different types of returns are weighted to account for their differing processing impacts. For
                                              example, a paper Form 1040 has a higher weighting factor than a paper Form 1040EZ, which in
                                              turn has a higher weighting factor than electronically processed returns.
                                              d
                                               Cycle time is the average number of days it takes service centers to process returns for the
                                              entire filing season—January 1 through mid-April.
                                              e
                                               This indicator is based on a sample of paper returns and is an average calculated starting from
                                              the signature date on the return to the date the taxpayer should have received the refund,
                                              allowing 3 days after issuance for the refund to reach the taxpayer.
                                              f
                                               This indicator is based on a sample of electronically filed returns and is an average calculated
                                              from the date the return is received to the date the taxpayer should have received the refund,
                                              allowing 2 or 3 days after issuance (depending on whether the refund is by check or direct
                                              deposit) for the refund to the reach the taxpayer or the taxpayer’s bank account.
                                              g
                                               IRS defines this indicator as the number of calls answered divided by demand. Demand is the
                                              number of individual callers. As discussed later, we have traditionally used a different indicator to
                                              measure IRS’ performance in providing telephone service.
                                              h
                                               IRS defines this indicator as the number of calls answered divided by demand. Demand is the
                                              number of individual callers.

                                              Source: IRS data.




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                                 During each filing season, millions of taxpayers call IRS with questions
Accessibility to IRS’            about the tax law, their refunds, or their accounts. The number of callers
Telephone Assistance             who get through to an IRS assistor is an important indicator of filing season
Improved                         performance. According to IRS data, as shown in table 2, telephone
                                 accessibility, as we have defined it in the past, increased substantially
Substantially                    during the 1997 filing season. Results of our independent test also pointed
                                 to an improvement in accessibility. Despite the improvement, however,
                                 accessibility is still low.

Table 2: Accessibility of IRS’
Telephone Assistancea                                               Number of call           Number of calls
                                                                          attempts                 answered                     Percent
                                 Filing seasonb                       (in millions)             (in millions)               accessibility
                                 1997                                              62                         32                         51c
                                 1996                                             114                         23                         20
                                 1995                                             236                         19                             8
                                 a
                                  The percent accessibility presented in this table is the calculation we have traditionally used to
                                 measure IRS’ performance in providing telephone assistance. The calculation is the total number
                                 of calls answered divided by the total number of call attempts (the sum of calls answered, busy
                                 signals, and calls abandoned by the caller before an IRS assistor got on the line). Because the
                                 IRS indicator in table 1—level of access to taxpayer service telephone assistance—is based on
                                 the number of callers, it shows a higher level of performance than does our indicator, which is
                                 based on the number of call attempts.
                                 b
                                  These data are for January 1 through April 19, 1997, January 1 through April 20, 1996, and
                                 January 1 through April 15, 1995.
                                 c
                                     Numbers do not compute to this percent due to rounding.

                                 Source: GAO analysis of IRS data.



                                 To check whether accessibility had increased, we conducted an
                                 independent test to measure taxpayer access to IRS’ telephone system from
                                 March 31 through April 15, 1997. Our results,8 compared with the results of
                                 a similar test we conducted in 1995, showed that accessibility had
                                 improved. For example, during the 1997 test, we had to make 584 calls to
                                 gain access to a live assistor 211 times—a 36-percent accessibility rate.
                                 That was a significant improvement over 1995, when we had to make 1,655
                                 calls to gain access 98 times—a 6-percent accessibility rate. Also, of the
                                 584 calls placed during the 1997 test, 288 resulted in busy signals—a
                                 49-percent busy rate. That compares favorably with a 92-percent busy rate
                                 during the 1995 test. Our test methodology and detailed results are
                                 described in appendix I.



                                 8
                                  Our test was a nonstatistical sample. The results relate just to our test calls and cannot be projected.



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                        Despite the significant increase in 1997, telephone accessibility is still too
                        low. The National Commission on Restructuring IRS made that point in its
                        June 25, 1997, report. After noting how accessibility had improved to
                        51 percent, the Commission noted that “the level of access continues to be
                        unacceptable and inferior to service performance in private sector service
                        organizations.”

                        As table 2 showed, the increase in IRS’ telephone accessibility between the
                        1996 and 1997 filing seasons was due to a combination of more calls being
                        answered and fewer calls coming in (i.e., “call attempts”).


Increase in Number of   Two primary reasons for the increase in the number of calls answered
Calls Answered          were (1) a revision to IRS’ procedures for handling calls involving complex
                        tax issues and (2) more staff assigned to answer the telephone, some of
                        whom were detailed from other IRS functions. IRS’ decision to detail staff
                        from other functions resulted in some opportunity costs because these
                        staff were not available to perform their normal duties, such as auditing
                        tax returns.

                        In an effort to increase the number of calls answered, IRS conducted a
                        study to analyze the subject and length of taxpayer telephone calls.
                        According to IRS, the study showed that several areas of complicated tax
                        law involved 20- to 30-minute telephone conversations and that an assistor
                        could answer about 5 simpler calls within the same amount of time. Thus,
                        for the 1997 filing season, IRS revised its procedures so that callers with
                        questions in certain complex tax areas were automatically connected to a
                        voice messaging system.9 Those callers were asked to leave their name,
                        telephone number, and the best time for IRS to call back, and they were
                        told that someone would be calling back within 2 working days.

                        According to IRS, it received 619,310 calls to the voice messaging system
                        during the filing season and contacted 451,051 taxpayers in response to
                        those calls. IRS said that there are several reasons why it may not have
                        responded to a message. For example, the message may have been
                        garbled, thus preventing IRS from deciphering the caller’s telephone
                        number; callers may have failed to include an area code; or IRS attempts to
                        contact the caller may have gone unanswered.10


                        9
                         Some of the complicated tax areas involved the sale of a residence, self-employment income and tax,
                        rental property, and depreciation.
                        10
                            According to IRS, staff were to make at least two attempts to contact the caller.



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                            To help return calls to the messaging system, IRS detailed staff from the
                            Examination function, which is the IRS organization primarily responsible
                            for auditing tax returns. IRS data show that staff who were detailed from
                            the Examination function spent about 125 full-time-equivalent staff years
                            returning calls received by the messaging system. A cognizant official in
                            the Examination function estimated that the use of Examination staff to
                            answer taxpayer questions resulted in about $55 million in foregone
                            revenue because those staff were not available to audit returns. We did not
                            assess the validity of that estimate.

                            Another factor that contributed to the increase in the number of calls
                            answered was IRS’ decision to assign more staff to answer the telephone.
                            Nationwide, according to data provided by IRS’ Customer Service function,
                            IRS dedicated 2,546 full-time-equivalent staff years to answer taxpayers’
                            telephone calls between January 1 and April 30, 1997. This was an increase
                            of 605 staff years over the 1,941 staff years dedicated during the same
                            period in 1996. In addition, some field offices, including the three service
                            centers we visited, temporarily detailed staff to help answer the telephone,
                            some of whom came from functions other than Customer Service.
                            According to IRS, some of these staff were used only as needed, while
                            others were detailed for a few months.


Decrease in Call Attempts   The increase in the number of calls answered contributed to the decrease
                            in the number of call attempts. As IRS improves its ability to answer the
                            telephone, taxpayers should encounter fewer busy signals. Fewer busy
                            signals reduce the need for taxpayers to redial, which reduces the number
                            of call attempts. In that regard, IRS’ telephone data showed that the number
                            of busy signals dropped from 86.0 million during the 1996 filing season to
                            22.7 million during the 1997 filing season and that the average number of
                            call attempts per taxpayer dropped from 2.5 during the 1996 filing season
                            to 1.4 during the 1997 filing season.

                            IRS cited two other contributors to the decrease in call attempts—the
                            elimination of certain notices and the availability of information through
                            other IRS sources, such as the Internet. Before the 1997 filing season began,
                            IRS eliminated 23 notices that it deemed unnecessary, which, in turn,
                            reduced the need for persons to call IRS with questions about these
                            notices. IRS estimated that its action eliminated the issuance of about
                            7.5 million notices, but IRS could not estimate how many calls might have
                            been eliminated because every notice does not necessarily generate a
                            telephone call to IRS. IRS has a World-Wide Web site on the Internet that



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                      was first available during the 1996 filing season. The Web site provides,
                      among other things, some interactive applications that answer tax
                      questions, IRS regulations with “plain English” summaries, answers to the
                      most frequently asked tax questions, and tax forms. IRS data showed a
                      significant growth in the use of IRS’ Web site in 1997. For example,
                      taxpayers accessed the Web site about 117 million times between
                      January 1 and April 20, 1997, compared with about 102 million accesses
                      throughout 1996, and taxpayers downloaded about 6.3 million files during
                      the 1997 filing season compared with about 2.4 million files for the same
                      period in 1996.


Measuring Telephone   As noted earlier, the data in table 2 reflect our traditional way of
Accessibility         measuring telephone accessibility. Over the last few years, IRS has used
                      another indicator, which it calls “level of access,” to measure its
                      performance in providing telephone assistance to taxpayers. IRS defines
                      level of access as the number of calls answered divided by the number of
                      callers (i.e., the number of taxpayers seeking assistance). Because IRS’
                      indicator is based on the number of callers, it shows a higher level of
                      performance than does our indicator, which is based on the number of call
                      attempts. Nonetheless, IRS’ indicator, like ours, showed a significant
                      improvement in performance during the 1997 filing season. IRS reported its
                      level of access as 71 percent through April 19, 1997, compared with
                      51 percent during a comparable period in 1996.

                      We have been working with IRS to establish one mutually agreeable
                      measure of telephone accessibility. As a result, we have reached
                      agreement on a measure to be used in future filing seasons. That measure
                      defines accessibility as the number of calls that get into IRS’ automatic call
                      distribution system, including those that are answered and those that are
                      abandoned by the caller before getting assistance, divided by the total
                      number of call attempts, which would consist of calls answered, calls that
                      are abandoned, and calls that receive a busy signal. As part of that
                      measure, IRS agreed to show, for the calls that got into the automatic call
                      distribution system, how many were answered11 and how many were
                      abandoned by the caller before receiving assistance.

                      Using IRS data as of April 19, 1997, the new measure shows that taxpayers
                      calling IRS were able to gain access 64 percent of the time (39.8 million
                      calls that got into IRS’ automatic call distribution system divided by

                      11
                        For purposes of this measure, “answered calls” would include calls to the voice messaging system
                      that were subsequently answered by IRS.



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                                       62.4 million call attempts). Of the 39.8 million calls that got into IRS’
                                       system, 31.8 million (80 percent) were answered and 8 million (20 percent)
                                       were abandoned by the caller before getting assistance.


                                       As of October 31, 1997, IRS had received 120.9 million individual income
Number of Returns                      tax returns, an increase of 1.8 percent compared to the 118.8 million
Filed Through                          received at the same time last year. Although the increase in the overall
Alternative Methods                    number of returns filed was small, the increase in the number filed
                                       through alternative methods was significant—about 25 percent higher
Increased                              than last year. IRS offers three alternatives—electronic filing, TeleFile, and
                                       1040PC—to the filing of traditional paper returns.12 Among other benefits,
                                       returns filed through these alternatives involve fewer errors and are
                                       presumed to be less costly for IRS to process. As shown in table 3, of the
                                       three alternatives, TeleFile had the largest percentage change, by far, in
                                       1997.

Table 3: Number of Individual Income
Tax Returns Received Through                                   Number           Number            Number           Number           Percent
Alternative Filing Methods                                      filed in         filed in          filed in         filed in      change in
                                                              1994a (in        1995a (in         1996a (in        1997a (in       1997 from
                                       Type of return      thousands)       thousands)        thousands)       thousands)              1996
                                       TeleFile                      519              680            2,840            4,694                65%
                                       Electronic                13,510           11,144            12,140           14,457                19
                                       Form 1040PC                 4,193            2,917            7,042            8,427                20
                                       Total                     18,222           14,741            22,022           27,578                25%
                                       a
                                        Data are as of November 4, 1994, November 3, 1995, November 1, 1996, and October 31, 1997.

                                       Source: IRS’ Management Information System for Top Level Executives.




Telefile                               There were three changes to TeleFile in 1997 that most likely contributed
                                       to the large increase in filings: the eligibility criteria were expanded to
                                       include certain married persons filing joint returns, persons using TeleFile
                                       could request that any refund be directly deposited to their bank account,
                                       and IRS changed the tax package sent eligible TeleFile users in an attempt


                                       12
                                         Under electronic filing, returns are transmitted over communications lines through a third party
                                       (such as a tax return preparer or electronic return transmitter) to an IRS service center, where the
                                       data are automatically edited and processed. Under TeleFile, certain taxpayers who are eligible to file
                                       a Form 1040EZ are allowed to file using a toll-free number on Touch-Tone telephones. Once the return
                                       is filed, it is processed like an electronic return. Under the Form 1040PC method, a taxpayer or tax
                                       return preparer uses personal computer software that produces paper tax returns in an answer-sheet
                                       format. The Form 1040PC shows the tax return line number and the data (dollar amount, name, etc.)
                                       on that line. Only lines on which the taxpayer has made an entry are included on the Form 1040PC.



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to encourage their use of the system. IRS data show that about 191,000
TeleFile returns were filed jointly by married couples, thus accounting for
about 10 percent of the growth in 1997. The amount of growth due to the
other two changes could not be quantified.

IRS’ decision to change the TeleFile tax package was the subject of some
disagreement within IRS. In past years, IRS sent taxpayers who appeared
eligible to use TeleFile a package that included not only TeleFile materials
but also a Form 1040EZ and related instructions. Thus, taxpayers who
could not or did not want to use TeleFile had the materials they needed to
file on paper, assuming they were still eligible to file a Form 1040EZ. For
the 1997 filing season, IRS eliminated the Form 1040EZ and related
instructions from the package sent to taxpayers who were apparently
eligible to use TeleFile—hoping that more taxpayers would be inclined to
use TeleFile if they received only the TeleFile materials.

Officials from the Taxpayer Advocate’s Office said that they did not agree
with IRS’ decision. They said that they were originally led to believe that IRS
would be sending the revised TeleFile package only to persons who had
used TeleFile in 1996 and to a sample of other taxpayers. By the time they
learned that IRS was going to send the package to all apparently eligible
TeleFile users, it was too late to effect a change. According to the officials,
their concern centered on the extra burden the revised package would
impose on taxpayers who wanted a Form 1040EZ, as well as the extra
costs IRS might incur in filling additional mail and telephone orders for
Form 1040EZ from those taxpayers. Internal Audit expressed similar
reservations in communications with IRS management before the start of
the filing season. Management responded by saying that (1) their intent
was to increase the use of TeleFile, which would actually reduce taxpayer
burden for those who used it and (2) they expected few of the affected
taxpayers to contact IRS’ form distribution centers for copies of Form
1040EZ.

Officials from the Taxpayer Advocate’s Office told us that they did not
receive many complaints from taxpayers and found no evidence that the
number of taxpayer orders for Form 1040EZ was significantly higher than
in past years. Nonetheless, they said that they continue to be concerned
about this procedure, which IRS has indicated will remain unchanged for
the 1998 filing season.

For the 1997 filing season, IRS sent about 26 million TeleFile tax packages
to taxpayers who, based on the tax returns they filed in 1996, would be



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eligible to use TeleFile in 1997. After allowing for the fact that some of
those taxpayers might no longer be eligible to use TeleFile because they
no longer met the qualifying criteria, IRS estimated that about 15.6 million
of the taxpayers would be eligible to use TeleFile in 1997. As of
October 31, 1997, about 4.7 million taxpayers had filed their returns using
TeleFile (about 30 percent of the number IRS estimated to be eligible).
Assuming the validity of IRS’ estimate of eligible users, about 10.9 million of
those taxpayers chose not to use TeleFile in 1997.

IRSconducted three TeleFile surveys in 1997—one electronic and one
written survey of users and one written survey of nonusers—that shed
some light on taxpayers’ reactions to the revised tax package and the
reasons why more people did not use TeleFile.

Results of the electronic user survey showed that 30.3 percent of the
TeleFile users in 1997 were repeat customers, while the rest were using it
for the first time. The results also show that 84.5 percent of the users were
able to complete their filing with one call to IRS, and 98.8 percent would
use TeleFile again. When questioned about the new tax package,
85.2 percent of the respondents said that the package “encouraged” them
to use TeleFile, 2.9 percent said that it “frustrated” them, and 2.5 percent
said that it forced them to use TeleFile. Results of the written user survey
showed that 88 percent of the users were very satisfied with TeleFile and
another 10 percent were somewhat satisfied. Also, 97 percent of the users
said they would use TeleFile again if they could, and about 96 percent said
that they were very satisfied or somewhat satisfied with the new TeleFile
tax booklet.

Results from the nonuser survey are critical, in our opinion, if IRS is to
identify and effectively deal with barriers that are preventing eligible
taxpayers from using TeleFile. In past surveys, IRS learned that most
nonusers preferred filing on paper. But IRS did not solicit more specific
information on the reasons for that preference. In our report on the 1996
filing season, we recommended that IRS conduct a survey of nonusers
during the 1997 filing season that included some specific questions on why
they prefer to file on paper.13 The questionnaire IRS used for the nonuser
survey in 1997 solicited more specific data on why taxpayers did not use
TeleFile, which, we believe, make the results more useful than earlier
surveys.



13
  GAO/GGD-97-25.



Page 12                                  GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
                        B-276564




                        From a list of several potential reasons provided on the questionnaire,
                        respondents were asked to identify the main reason they did not use
                        TeleFile. The main reasons they cited were:

                    •   filed a Form 1040 or 1040A, which made them ineligible to use TeleFile
                        (25 percent);
                    •   did not receive the TeleFile tax package (17 percent);14
                    •   used a tax preparer or accountant (15 percent);
                    •   got help from a friend or family member in filing their return (15 percent);
                        and
                    •   preferred a paper copy of the return for their records (12 percent).

                        In response to questions about the revised TeleFile package and its
                        impact, 12 percent of the nonusers said that the package caused a great
                        deal of inconvenience. Remembering the Taxpayer Advocate’s concern
                        that the absence of a Form 1040EZ in the revised package might
                        significantly increase the number of mail and telephone orders for that
                        form, IRS also asked nonusers who prepared their own returns where or
                        how they got the tax form. Only 2 percent said that they called or wrote
                        IRS. The vast majority (about 82 percent) said that they got the form from a
                        post office, library, or bank. The remaining (about 16 percent) mentioned
                        other methods, such as visiting an IRS walk-in site or downloading a form
                        from IRS’ Internet World-Wide Web site.

                        IRS plans few changes to TeleFile for the 1998 filing season. For example,
                        the TeleFile package for 1998 will again not include a Form 1040EZ.
                        However, one change that might eventually make TeleFile more attractive
                        to taxpayers is a pilot program with Indiana and Kentucky that will allow
                        TeleFile users to submit their state returns at the same time they file their
                        federal return. In that regard, responses to the TeleFile nonuser survey
                        showed that about 44 percent of the nonusers might be encouraged to use
                        TeleFile if they could also use it to file their state tax returns.


Electronic Filing       Electronic filing began as a pilot test in 1986, and the number of individual
                        income tax returns filed electronically continued to grow each year until a
                        drop in 1995. IRS attributed that drop to the various steps it took to deal
                        with refund fraud. As shown in figure 1, electronic filing recovered
                        somewhat in 1996 and continued to grow in 1997, establishing a new high
                        of about 14.5 million returns as of October 31, 1997.

                        14
                          As of the date we completed our audit work, it was unclear why these persons would not have
                        received the TeleFile package.



                        Page 13                                             GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
                                        B-276564




Figure 1: Number of Individual Income
Tax Returns Filed Electronically        Number of tax returns (in millions)

                                        20




                                        15                                                                        14.5
                                                                                             13.5
                                                                                     12.3                  12.1
                                                                              10.9                  11.1

                                        10

                                                                     7.6



                                          5                   4.2


                                                       1.2
                                                 0.6
                                          0
                                                1988   1989   1990   1991     1992   1993    1994   1995   1996   1997
                                              Year

                                        Source: IRS data.




                                        One impediment to even more growth in electronic filing is the fact that
                                        the method is not completely paperless. Taxpayers must still send IRS their
                                        W-2s and a signature document (Form 8453) after their returns have been
                                        electronically transmitted. IRS must then manually input these data and
                                        match them to the electronic returns.

                                        In an attempt to eliminate the paper associated with electronic returns, IRS
                                        began testing the use of digitized signatures at three locations during the
                                        1996 filing season. IRS planned to expand the test to seven locations in
                                        1997. The seven locations included three private tax return preparation
                                        offices and four sites that were part of IRS’ Volunteer Income Tax
                                        Assistance Program. Because of some technical problems with the
                                        software, however, IRS delayed its distribution to the seven test sites until
                                        April 1, 1997. Because one of the four volunteer sites prepared very few
                                        returns after April 1, it did not participate in the test.




                                        Page 14                                             GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
                        B-276564




                        The test consisted of preparers offering eligible taxpayers the option of
                        signing with a stylus “pen” on an electronic signature pad in place of
                        signing a Form 8453.15 The electronic signature would then be attached to
                        the taxpayer’s electronic return and both would be transmitted to IRS.
                        From April 1 through April 17, 1997, the test generated 435 returns that
                        were submitted with electronic signatures. IRS did not collect information
                        on the number of taxpayers who were offered the chance to participate in
                        the test but declined. According to IRS, the six participating locations
                        provided feedback that was overwhelmingly positive, including the
                        reduced cost or burden from not having to store the Forms 8453 and not
                        having to pay someone to batch, mail, and track the forms. IRS plans to
                        conduct the test again in 1998 at the same seven locations.


                        An important change for the 1997 filing season involved IRS’
New Procedures          implementation of new procedures for handling returns filed with missing
Enable IRS to Protect   or incorrect SSNs. The amount of revenue protected as a result of these
More Revenue            new procedures greatly exceeded the amount protected under the
                        previous procedures.

                        Correct SSNs help ensure that taxpayers are entitled to the credits and
                        dependency exemptions they claim. While missing or incorrect SSNs are
                        often the result of honest taxpayer errors, they have also been linked to
                        fraudulent attempts to reduce tax liabilities and obtain refunds and/or
                        Earned Income Credits. Accordingly, over the last few years, IRS has
                        become more vigilant in checking SSNs.

                        During the last few filing seasons before 1997, when IRS identified a
                        missing or incorrect SSN, it was to delay the taxpayer’s refund and
                        correspond with the taxpayer to resolve the issue. This procedure often
                        required multiple correspondence and months to resolve. As we reported
                        in 1996, IRS did not have enough resources to pursue all of the cases
                        involving missing or incorrect SSNs and ended up releasing many of the
                        refunds associated with those cases.16




                        15
                          Eligible test participants whose returns did not include any attachments that had to be submitted on
                        paper were also granted a waiver from the requirement to submit W-2s. According to an IRS official,
                        tax return preparers participating in the test were instructed to review the paper W-2s and not prepare
                        electronic returns for taxpayers whose W-2s looked fraudulent.
                        16
                         Earned Income Credit: IRS’ 1995 Controls Stopped Some Noncompliance, But Not Without Problems
                        (GAO/GGD-96-172, Sept. 18, 1996) and IRS’ 1996 Tax Filing Season: Performance Goals Generally Met;
                        Efforts to Modernize Had Mixed Results (GAO/GGD-97-25, Dec. 18, 1996).



                        Page 15                                               GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
B-276564




IRS’ SSN error procedures changed in 1997 as a result of a provision in the
Welfare Reform Act of 1996. That provision authorized IRS to treat missing
or incorrect SSNs as math errors, similar to the way it has historically
handled computational mistakes. Under the new procedures, if IRS
identifies a missing or incorrect SSN while processing a return, it can
immediately adjust the return. For example, if a taxpayer claims one
dependent and the child care credit, but lists an incorrect SSN for the
dependent, IRS is to increase the taxable income by the personal
exemption amount claimed for the dependent and not allow the child care
credit. IRS then is to adjust the taxpayer’s tax liability and reduce the
taxpayer’s refund, if any. The taxpayer is to receive a notice explaining the
change to his or her tax liability and/or refund. The standard notice IRS
used in 1997 provided a special toll-free telephone number that taxpayers
could call if they wanted to discuss IRS’ changes and/or provide corrected
information to support their claims. Taxpayers could also write to IRS to
resolve the issue. If taxpayers do not respond to IRS’ notice, there is to be
no further correspondence unless they fail to pay any additional tax that
was assessed as a result of IRS’ change.

In planning for this new procedure, IRS estimated that it would send about
2.4 million notices to affected taxpayers in 1997 and that those notices
would generate about 1.68 million responses (telephone calls or letters)
from taxpayers. As of September 1, 1997, IRS had sent about 2.2 million
notices, which generated about 876,000 calls and letters. IRS said that
based on those responses, it subsequently allowed some of the claims it
had originally disallowed.17 As of September 1, after netting out
adjustments made in response to taxpayers’ calls and letters, IRS reported
that it had protected about $1.46 billion in revenue (i.e., claimed refunds or
credits not paid and additional taxes assessed). That is about 150 percent
more than the amount of revenue IRS reported as having been protected as
a result of the procedures used in 1996. That year, according to IRS, it sent
out about 629,000 notices that resulted in the protection of about
$590 million.

We asked officials in the Taxpayer Advocate’s Office whether the new SSN
error procedures posed any problems for IRS and/or taxpayers. They said
that they did have concerns about the procedures, which they voiced to IRS
management before the start of the filing season. They were concerned,
for example, that (1) the procedures may lead to an unmanageable

17
  If a taxpayer provided IRS with a missing SSN or corrected an inaccurate SSN, IRS would adjust its
change. However, not every taxpayer response resulted in an adjustment. In some cases, the taxpayer
may only have wanted IRS to explain the notice or may have decided, after discussing the law and the
facts with IRS, that IRS’ position was correct.



Page 16                                             GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
                      B-276564




                      workload for IRS and (2) the notices were not clear. According to the
                      officials, as a result of their input, some changes were made before the
                      filing season began. They also told us that they had not received a
                      significant number of complaints from taxpayers nor had there been an
                      increase in the number of problem resolution program cases or hardship
                      requests for refunds.

                      Even though significant problems did not arise, officials of the Taxpayer
                      Advocate’s Office believed that some additional changes are needed. For
                      example, they said that some individuals have problems obtaining an SSN
                      or some other taxpayer identification number either because of religious
                      affiliations or questionable alien status. Officials also think the notices
                      should be revised to provide the taxpayer with specific information about
                      the error.


                      In an effort to improve remittance processing and deposit tax receipts
Lockbox Processing    more timely, IRS has been using lockboxes to process tax payments,
for Form 1040         including the payments associated with individual income tax returns
Remittances May Not   (Forms 1040).18 IRS and FMS assume that the use of lockboxes is beneficial
                      to the government because, in general, banks can get the payment
Be Cost Effective     processed and the money deposited to a Treasury account quicker than
                      service centers can. This means that Treasury would not have to borrow
                      as much to pay government obligations, thereby avoiding interest charges.

                      In our report on the 1996 tax filing season, we expressed our concern
                      about the way IRS was using lockboxes for Form 1040 payments.19 Our
                      concern then was not with the processing of the payments but with IRS’
                      decision to have taxpayers send their tax returns along with their tax
                      payments to the lockboxes and to have the banks sort those returns before
                      shipping them to IRS service centers for processing. Information we
                      received from FMS, which has been paying the lockbox fees, and IRS
                      indicated that having banks sort and ship tax returns increased the cost of
                      the lockbox service by about $4.7 million during the first 8 months of 1996.
                      For example, FMS said that it paid the banks an average of 92 cents per
                      return to sort the 7 million returns received during those 8 months—a

                      18
                        Under the lockbox concept, taxpayers are to mail payments to a lockbox, which is a postal rental box
                      serviced by a commercial bank. The bank is to process the payments and transfer the funds to a
                      federal government account, record the payment and payer information on a computer tape, and
                      forward the tape to IRS for use in updating taxpayers’ accounts. In addition to Form 1040 payments,
                      tax remittances processed at lockbox banks include estimated tax payments; various business
                      payments, such as Federal Unemployment tax and Social Security tax; and certain vehicle use taxes.
                      19
                        GAO/GGD-97-25.



                      Page 17                                              GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
                          B-276564




                          function that, according to IRS, service centers performed at an average
                          cost of 37 cents per return. FMS also paid the banks 13 cents per return to
                          ship the tax returns to IRS for processing.20

                          Our concern about the Form 1040 lockbox program has intensified since
                          last year. We are no longer concerned only about having lockboxes receive
                          and sort tax returns but about the use of lockboxes to process the Form
                          1040 payments themselves. Information we obtained this year called into
                          question a key assumption used to calculate the interest cost avoidance
                          figures that IRS and FMS have cited to support the use of lockboxes to
                          process those payments.


IRS’ Decision to Have     For the last several years, IRS has been testing the use of lockboxes to
Taxpayers Send Their      process Form 1040 remittances. Those test results and various studies
Returns to Lockboxes Is   done for IRS led to the decision to have certain taxpayers send their returns
                          and tax payments to lockboxes. Under the current procedure, many
Based on Inconclusive     taxpayers receive a tax package with one envelope and two differently
Evidence                  colored mailing labels. If their return involves a payment, they are to use
                          one label that directs their return and payment to a lockbox. If their return
                          does not involve a payment, they are to use the other label that directs
                          their return to an IRS service center.

                          In explaining the decision to have persons who were making payments
                          send their returns along with their payments to a lockbox, IRS officials
                          responsible for the lockbox program said that they believed an increase in
                          taxpayer burden would result if taxpayers were required to separate their
                          payments from their returns and mail each to a different address. They
                          cited the results of taxpayer surveys done in 1993 and 1994, which, they
                          said, showed that taxpayers preferred to keep their payment and return
                          together. IRS interpreted this preference as an indicator that asking
                          taxpayers to separate their return from their payment would impose a
                          burden.

                          We reviewed the taxpayer surveys and considered the results to be
                          inconclusive as they relate to burden—45.9 percent of the taxpayers
                          surveyed said that they felt uneasy about mailing their checks and returns
                          in separate envelopes while 41.2 percent said that they did not feel uneasy
                          (the other 12.9 percent did not know). Even for those respondents who

                          20
                            According to IRS, the banks handled about 10 million returns through the first 11 months of fiscal
                          year 1997. According to FMS, it paid the banks an average of 86 cents per return to sort the returns and
                          13 cents per return to ship the returns to IRS (compared to averages of 92 cents and 13 cents,
                          respectively, in 1996).



                          Page 18                                               GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
B-276564




said they felt uneasy, it was unclear whether they considered the use of
separate envelopes an unreasonable burden when weighed against the
extra cost to the government associated with sending returns to
lockboxes.

We realized, in preparing our report on the 1996 filing season, that it was
too late to do anything to change IRS’ lockbox plans for the 1997 filing
season. Thus, we recommended that IRS take action that would be
effective for filing seasons after 1997. Specifically, we recommended that if
the government was unable to negotiate lockbox fees that were more
comparable to service center costs and in the absence of more compelling
data on taxpayer burden, IRS should either discontinue having returns
sorted by the banks or reconsider the decision to have taxpayers send
their tax returns to the lockboxes along with their tax payments. As noted
earlier, the combined fee paid banks for sorting and shipping tax returns
dropped only slightly from 1996. And, as discussed below, IRS still does not
have conclusive data on taxpayer burden.

In May 1997, an IRS/FMS task force that had been formed to identify a
solution to this issue for 1998 and beyond recommended that IRS have
taxpayers separate their returns from their payments—mailing the former
to an IRS service center and the latter to a lockbox. While recognizing the
extra burden on taxpayers (e.g., the extra postage associated with mailing
two envelopes and possible confusion over which envelope to use), the
task force said that such a procedure would minimize lockbox costs and
would enable the banks to deposit remittances faster because they would
no longer have to handle tax returns.

Despite the task force’s recommendation, IRS decided that lockboxes
would continue to receive and sort tax returns in 1998. The IRS official
responsible for the lockbox program told us that IRS continues to believe
that an increase in taxpayer burden would result if taxpayers were
required to separate their payments from their returns and mail each to a
different address, a view shared by representatives from the Taxpayer
Advocate’s Office. To support its position, IRS cited the results of several
focus groups that became available after the task force had completed its
work.

IRSheld 8 focus groups in 4 cities involving a total of 29 taxpayers who
prepared their own federal income tax returns and 31 tax practitioners.
According to IRS, “even though there was not a dominant trend from the
[focus groups], taxpayers noted the cost of two stamps and the confusion



Page 19                                 GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
B-276564




of two envelopes as burden issues.” Although focus groups are useful in
providing insight on a particular issue, they are not statistically
representative of the population and should not, in and of themselves,
provide the basis for far-reaching conclusions. Given that and after
reviewing transcripts of the focus groups and a July 7, 1997, summary
report on the focus group results, we believe that IRS still does not have
conclusive evidence that the additional taxpayer burden that may be
caused by requiring the use of two envelopes would outweigh the millions
of dollars in additional costs the government is incurring to have banks
sort and ship tax returns.

For example, although the report noted that participants were concerned
about the extra postage associated with using two envelopes, it went on to
say that taxpayers participating in the focus groups viewed the extra cost
“as something that would be accepted” and that “some taxpayers were
willing to accept additional burden so that IRS could operate more
effectively.” In that regard, focus group participants were not told about
the amount of additional cost being incurred by the government to have
banks sort and ship the tax returns. The report also said that “several
participants voiced concern about the check being separated from the
return prior to receipt by the IRS.” However, there is no evidence that
participants were told how the two-envelope procedure compares to the
current procedure and that, even under the current procedure, the tax
return and check get separated. Under the current procedure, even though
returns and payments are mailed in one envelope to one location (the
lockbox), they are separated at the bank. The return is shipped to IRS for
processing while the bank processes the payment.

In a July 15, 1997, memorandum to the then Acting Commissioner of
Internal Revenue, Treasury’s Fiscal Assistant Secretary provided his views
on the processing of Form 1040 tax payments. He noted that he had sought
IRS’ support for having taxpayers mail their returns and payments
separately but that IRS had rejected that option because of the perceived
taxpayer burden. That left only two viable options in the Assistant
Secretary’s opinion—continue the current arrangement or return the
processing of Form 1040 tax payments to IRS’ service centers. The
Assistant Secretary noted, however, that it was his understanding that
equipment, personnel, and space issues and the lack of sufficient planning
time made it infeasible to move processing back to the service centers for
fiscal year 1998. Thus, he concluded that it would be in the best interest of
the government to continue the current lockbox arrangement for at least 1
more year. He said that this issue should be reviewed in March/April 1998



Page 20                                 GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
                           B-276564




                           to make decisions about fiscal year 1999 and that IRS should continue to
                           seek ways to reduce the cost of this program, by either changing
                           processing procedures or by continuing its search for a resolution on how
                           to direct the Form 1040 returns to the service centers without causing
                           significant taxpayer burden.


IRS Study Calls Into       Our concerns about the Form 1040 lockbox program were heightened this
Question the Validity of   year by new information relating to the interest cost avoidance figures that
                           IRS and FMS have used to show the program’s cost effectiveness. This new
Interest Cost Savings
                           information calls into question not just the decision to have tax returns
                           sent to the banks but the more basic decision to use lockboxes to process
                           Form 1040 payments.

                           As part of its review, the lockbox task force compared how much various
                           procedural options for processing Form 1040 remittances would cost IRS
                           and FMS in 1998. Assuming a volume of 11,373,133 items, the task force
                           estimated that the current lockbox procedure would cost about
                           $23.3 million, compared with about $14.5 million if two envelopes were
                           used21 and about $12.8 million if IRS decided to stop using lockboxes to
                           process Form 1040 remittances and return that function to the service
                           centers. Although this comparison would seem to argue against the use of
                           lockboxes, IRS and FMS assume that having lockboxes process Form 1040
                           remittances generates savings, in the form of interest cost avoidance, that
                           more than offset the increased IRS and FMS costs.

                           According to FMS, for example, lockboxes processed about 9.7 million
                           Form 1040 tax payments from October 1996 through July 1997, which
                           resulted in an interest cost avoidance of about $23.8 million. As in past
                           years, the interest cost avoidance was calculated on the basis of a general
                           assumption that lockboxes can process and deposit tax payments an
                           average of 3 days faster than IRS service centers during peak workload
                           periods. The validity of that assumption is critical because, according to
                           the lockbox task force, if lockboxes are not processing payments at least 2
                           days faster than service centers, the amount of interest cost avoidance
                           would be insufficient to offset the additional costs associated with having
                           lockboxes handle tax returns.

                           In that regard, the results of an IRS-commissioned study, issued in
                           March 1997, show that, on average, lockboxes processed payments only

                           21
                            If the analysis were broadened to reflect the extra cost that taxpayers would have to incur to mail a
                           second envelope, the cost of this option would increase by $3.6 million (11,373,133 envelopes times 32
                           cents postage) to a total of about $18.1 million.



                           Page 21                                              GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
                    B-276564




                    about 1 day faster than service centers. However, that comparison covered
                    peak and nonpeak workload periods; there was not a similar comparison
                    just for the peak workload period (April 13 to May 1, 1995), when most of
                    the Form 1040 payments are received and when differences in processing
                    times might be more pronounced. Although the reported study results are
                    insufficient to make an informed judgment, they do raise questions about
                    the assumption that lockboxes process payments 3 days faster than
                    service centers. FMS had planned to commission another study to assess
                    the comparative processing times for lockboxes and service centers.
                    However, those plans have been deferred, and FMS could give us no
                    assurance when such a study would be done.


                    One of IRS’ major business objectives is to move away from a
SCRIPS Processing   labor-intensive tax return processing system that relies on thousands of
Rates Decline       employees transcribing data from paper tax returns and move to an
                    electronic system that reduces processing costs and eliminates
                    transcription errors. One strategy for achieving that objective is to reduce
                    the number of paper returns by increasing the number of returns filed
                    electronically. We discussed IRS’ progress in that area earlier in this report.
                    For returns that will continue to be filed on paper, IRS planned to achieve
                    its objective through document imaging and optical character recognition
                    systems. SCRIPS is one such system.

                    IRS uses SCRIPS, which was implemented in 1994, to process tax returns
                    filed on Form 1040EZ, Federal Tax Deposit (FTD) coupons, and
                    information returns (e.g., Forms 1099). In January 1997, we reported that
                    one of the major problems with SCRIPS was slow processing rates (i.e., the
                    number of documents processed per hour).22 As the data in table 4 show,
                    this problem intensified with respect to Forms 1040EZ and FTD coupons in
                    1997.




                    22
                     Tax Systems Modernization: Imaging System’s Performance Improving but Still Falls Short of
                    Expectations (GAO/GGD-97-29, Jan. 16, 1997).



                    Page 22                                            GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
                                      B-276564




Table 4: SCRIPS Processing Rates as
of September 30, 1996, and 1997                                              SCRIPS processing rate
                                                                              (documents per hour)
                                                                         Jan. 1 through        Jan. 1 through        Percent
                                      Form type                     September 30, 1996    September 30, 1997         change
                                      Form 1040EZ                                    67                     57           –15
                                      Information returns                           145                    145             0
                                      FTD coupons                                   722                    619           –14
                                      Source: GAO computations based on IRS data.



                                      An IRS official in the SCRIPS project office attributed the decline in the
                                      processing rate for Forms 1040EZ, at least in part, to IRS’ decision, as
                                      discussed earlier, to issue TeleFile packages that did not have a Form
                                      1040EZ. Because the package contained no form that the taxpayer could
                                      use to file on paper, it also contained no preprinted label for the taxpayer
                                      to affix to a paper form. Successful optical character recognition
                                      operations depend, in part, on the kind of clearly printed data provided by
                                      a label. In that regard, IRS estimated that about 95 percent of the Forms
                                      1040EZ processed through SCRIPS in 1997 did not have the scannable
                                      preprinted address label, compared with about 50 percent in 1996, causing
                                      a significant increase in the amount of data IRS had to manually transcribe.

                                      IRS attributed the decrease in the processing rate for FTD coupons to a
                                      problem associated with the way in which blocks of data are transferred
                                      throughout the system. In those instances where characters on the
                                      document cannot be identified correctly by the scanner, the electronic
                                      block of work that contains those documents is sent to a workstation
                                      operator. That operator retrieves the block of work, reviews the image of
                                      the document to determine what corrections are needed, then updates the
                                      file, which is sent back to the file server. Each time a block of work is
                                      moved from one component of SCRIPS to another, a time delay results.
                                      According to IRS, the contractor provided a software solution to this
                                      problem and, since then, processing times have improved, except on those
                                      days when the service centers have to process the largest volumes of FTD
                                      coupons.


                                      IRS made noteworthy progress in several critical areas during the 1997
Conclusions                           filing season. It achieved significant increases in telephone accessibility
                                      and alternative filings, and it implemented a major change in dealing with
                                      missing or incorrect SSNs, all without any noticeable major problems. A




                                      Page 23                                       GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
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couple of these successes involved trade-offs. By detailing staff to answer
telephone calls, IRS improved accessibility but, according to IRS, the
detailing of that staff caused it to forgo some enforcement revenue. By not
including a Form 1040EZ in the tax package sent potential TeleFile users,
IRS apparently encouraged some taxpayers to file their returns by
telephone. But, in doing so, IRS imposed some burden on recipients of the
TeleFile package who needed or wanted a Form 1040EZ and caused a
reduction in SCRIPS processing rates. Such trade-offs are inevitable, given
the fact that IRS does not have unlimited resources, and we saw nothing to
indicate that either trade-off was inappropriate.

We are concerned, however, about the cost effectiveness of IRS’ use of
lockboxes rather than service centers to receive and process Form 1040
tax payments. On the basis of the data currently available, we do not
believe IRS is in a position to make an informed decision on whether to
continue to use lockboxes for that purpose.

The results of an IRS-commissioned study suggest that the interest cost
avoidance figures IRS and FMS have cited to support the use of lockboxes to
process Form 1040 payments may not be valid. Although FMS had planned
another study to further assess the comparative processing times and
costs for lockboxes and service centers, those plans have been deferred,
and it is unclear when such a study will be done. As a result, it is unclear
whether the government actually realizes savings, and if so how much,
through the use of lockboxes.

Because IRS has decided to continue the use of lockboxes for the 1998
filing season and it is too late to alter that decision, it seems that IRS and
FMS have an opportunity during that filing season to develop the definitive
data needed to make more informed decisions on the future use of
lockboxes. Such data would include the average amount of time needed by
both banks and IRS to process Form 1040 tax payments during both peak
and off-peak periods and the average interest costs to the government of
borrowing during those periods. It seems that such data would be readily
available and there is still time to make any arrangements that might be
needed to capture these data during the 1998 filing season.

We are equally concerned that IRS’ decision to continue having taxpayers
send both tax returns and payments to lockboxes is also based on
inconclusive evidence. Another option would be to have taxpayers mail
their payments to a lockbox and their tax returns to IRS. An IRS/FMS task
force studied these two options and recommended the latter because it



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B-276564




would save the government millions of dollars in payments to banks for
processing the tax returns. Although Treasury’s Fiscal Assistant Secretary
also supported this recommendation, IRS decided against this change
because of the added taxpayer burden, including mailing cost.

However, our review indicated that IRS did not have persuasive evidence
on the amount of taxpayer burden, how this burden would compare with
the government’s savings, or whether taxpayers considered the burden to
be unreasonable. The new evidence available to IRS in making its decision
for the 1998 filing season was from taxpayer focus groups. The number of
taxpayers participating in the focus groups was small, and the information
they provided on burden was inconclusive. In that regard, the participants
were not provided all of the information needed to make an informed
response about the burden associated with mailing tax returns in one
envelope and tax payments in another. Specifically, they were not told that
mailing both tax returns and tax payments to lockboxes is costing the
government, and thus taxpayers, millions of extra dollars. Had the focus
group participants been informed about all the relevant factors—the
additional postage and burden involved in separating returns from
payments and mailing them in two envelopes versus the savings that
would accrue to taxpayers overall in the form of savings to the
government if this were done—we believe that they would have been in a
better position to assess the trade-offs involved in deciding on the
reasonableness of the burden involved.

IRShas three basic options concerning the use of lockboxes for Form 1040
tax payments: (1) continue the existing practice, (2) discontinue the use of
lockboxes altogether, or (3) revise the existing practice to have taxpayers
send their returns to service centers and their payments to lockboxes. In
deciding which option to select, IRS faces the following two basic issues.
First, in deciding between options 1 and 2, IRS needs to know whether
using lockboxes to process Form 1040 tax payments generates a net
savings to the government. Second, if the use of lockboxes generates
significant savings, which would remove option 2 from the equation, IRS
needs to know, in choosing between options 1 and 3, whether the
additional savings to the government of having taxpayers send their tax
returns to IRS service centers outweigh the taxpayer burden associated
with taxpayers sending two different envelopes to two locations. Although
these issues would involve different analyses, the results and related
decisions are intertwined. That is, if the analysis for the first issue shows
that using lockboxes for Form 1040 tax payments does not result in a




Page 25                                 GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
                      B-276564




                      significant net savings to the government and IRS decides to stop using
                      lockboxes, the second issue would become moot.


                      We recommend that the Commissioner of Internal Revenue require the
Recommendations to    appropriate IRS officials to conduct, during the 1998 tax filing season, the
the Commissioner of   analyses necessary to determine (1) whether there are net savings to the
Internal Revenue      government attributable to the use of lockboxes to process Form 1040 tax
                      payments and (2) whether the potential savings of requiring affected
                      taxpayers to mail their tax returns to IRS and their tax payments to
                      lockboxes in separate envelopes outweigh the estimated additional cost
                      and other burden that this could be expected to cause taxpayers. In doing
                      these analyses, the officials should collect definitive data on (1) the actual
                      time and interest cost differences between sending tax payments to
                      lockboxes and sending them to IRS during peak and off-peak periods and
                      (2) whether taxpayers believe, given the processing cost savings to the
                      government, that it would cause them an unreasonable burden to mail tax
                      returns and tax payments to different locations. If the analyses indicate
                      that using lockboxes does not produce a net savings to the government,
                      we recommend that the Commissioner take steps to have IRS service
                      centers process all Form 1040 payments starting with the 1999 tax filing
                      season. If the analyses indicate that the use of lockboxes produces savings
                      and that taxpayers would support the practice of mailing returns and
                      payments to different locations, we recommend that the Commissioner
                      change the current lockbox procedures as soon as possible and instruct
                      taxpayers to send their returns to IRS and their payments to lockboxes.


                      We obtained written comments on a draft of this report from the Deputy
Agency Comments       Commissioner of Internal Revenue (see app. II). He said that IRS generally
and Our Evaluation    agreed with our findings and recommendations and that the ultimate
                      determination of the benefit of using lockboxes to the taxpaying public
                      requires information and analysis by both IRS and FMS. He said that IRS
                      would pursue a study with FMS during fiscal year 1998 to reach a long-term
                      decision about lockbox processing and that IRS would welcome the
                      opportunity to assist FMS in analyzing the savings to the government
                      attributable to the use of lockboxes to process Form 1040 tax payments.

                      The Deputy Commissioner also said that (1) it would be impossible to
                      determine conclusively whether any savings from having taxpayers mail
                      their returns and payments in separate envelopes outweighed the
                      additional cost and other burden to taxpayers because “the perceived



                      Page 26                                 GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
B-276564




burden of this new way of paying and filing may involve intangibles which
cannot be measured (e.g., a negative reaction to changes in procedures)”
and (2) a broad-based study to determine taxpayers’ perception of burden
and their willingness to accept that burden would be necessary to satisfy
our recommendation. In addition, the Acting Chief of Customer Service, at
a meeting to discuss IRS’ comments, told us that IRS would always come
down on the side of reduced burden.

We agree that burden cannot be measured conclusively. However, it is not
necessary to conclusively measure burden before deciding whether to use
two envelopes. In fact, IRS has made other decisions involving new ways of
paying and filing without measurable data on burden. For example, the
decision to not include a Form 1040EZ in the TeleFile tax package
involved a change in procedures that caused additional taxpayer burden
by requiring taxpayers who could not or did not want to use TeleFile to
find a Form 1040EZ elsewhere. IRS made that decision although it could
not measure the impact of the additional burden on taxpayers. In the
TeleFile case, IRS did not come down on the side of reduced burden but
decided, instead, that the additional burden, though unmeasured, was
acceptable given the expected benefits. In fact, IRS plans to send out the
same kind of abbreviated TeleFile tax package for the 1998 filing season
even though 12 percent of the TeleFile nonusers indicated that the
package IRS sent out for the 1997 filing season caused a great deal of
inconvenience. We believe that asking taxpayers to use two envelopes
might be another instance where IRS might accept a small amount of
burden, if the potential savings to the government are significant.

It is unclear what, if anything, IRS intends to do to get better information on
burden. However, if it decides to obtain more definitive data, it is
important that it structure its data collection to get specific input from
taxpayers on their willingness to assume the additional burden of dealing
with two envelopes in light of the savings to the government. Among other
things, that would mean asking them to compare the two-envelope
approach with the current approach and making sure, for both
approaches, that they know the government’s costs and benefits.

With respect to our second recommendation, the Deputy Commissioner
indicated that necessary studies could not be done and analyzed in time to
make changes for the 1999 filing season, given the lead time needed in
awarding contracts for the printing of tax packages. We do not understand
why this would be the case. It seems to us that at least the first stage of the
analysis sought by our recommendation—whether the government saves



Page 27                                  GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
B-276564




money by using lockboxes—can be made in time. Our prior analyses of IRS
data indicate that the key data needed to make that determination—the
comparative time it takes lockboxes and service centers to process and
deposit Form 1040 payments—should be readily available and can be
compiled and analyzed relatively quickly. There is no reason we are aware
of that such analysis could not be done using data from the 1997 filing
season, rather than waiting for new data from the 1998 filing season. Thus,
if the analysis shows that the government is not benefiting from the use of
lockboxes, IRS should have time to make the necessary changes to the tax
packages for 1999.

The second part of the analysis, which considers burden, would only be
needed if the first part shows that using lockboxes to process Form 1040
payments saves the government money. If the analysis shows that it does
not save the government money, IRS could change the procedure for
handling Form 1040 tax payments without further analyzing burden. The
revised procedure would still involve one envelope, but the envelope
would be mailed to a service center rather than a lockbox. Since that
change would result in all returns (remittance and nonremittance) being
mailed to IRS, it would not only avoid the additional burden of having
taxpayers deal with two envelopes but also reduce existing burden by
negating the need for taxpayers to deal with two mailing labels.

We revised our second recommendation to recognize the different
decisions that will confront IRS depending on the results of the analyses
called for in our first recommendation. As part of that revision, the
reference to the 1999 filing season now applies only if the first part of the
analysis shows that the government is not saving money by using
lockboxes to process Form 1040 payments.

In commenting on this report, the Deputy Commissioner identified a
number of actions IRS took during the 1997 filing season and asked that we
include the information in our report (see app. II). Some of the actions
identified by the Deputy Commissioner, such as those relating to
electronic tax administration, level of access, and complex tax law
questions, are discussed in our report. However, we did no audit work on
several other actions mentioned by the Deputy Commissioner and thus
cannot comment on their effectiveness.


We are sending copies of this report to the Subcommittee’s Ranking
Minority Member, the Chairmen and Ranking Minority Members of the



Page 28                                  GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
B-276564




House Committee on Ways and Means and the Senate Committee on
Finance, various other congressional committees, the Secretary of the
Treasury, the Commissioner of Internal Revenue, the Director of the Office
of Management and Budget, and other interested parties.

Major contributors to this report are listed in appendix III. Please contact
me on (202) 512-9110 if you have any questions.

Sincerely yours,




Lynda D. Willis
Director, Tax Policy and
  Administration Issues




Page 29                                 GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
Contents



Letter                                                                                              1


Appendix I                                                                                         32

Toll-Free Telephone
Accessibility Test
Appendix II                                                                                        33

Comments From the
Internal Revenue
Service
Appendix III                                                                                       42

Major Contributors to
This Report
Tables                  Table 1: IRS’ Performance Goals and Related Accomplishments                 4
                          for the 1996 and 1997 Filing Seasons
                        Table 2: Accessibility of IRS’ Telephone Assistance                         6
                        Table 3: Number of Individual Income Tax Returns Received                  10
                          Through Alternative Filing Methods
                        Table 4: SCRIPS Processing Rates as of September 30, 1996, and             23
                          1997

Figure                  Figure 1: Number of Individual Income Tax Returns Filed                    14
                          Electronically




                        Abbreviations

                        FMS       Financial Management Service
                        FTD       Federal Tax Deposit
                        IRS       Internal Revenue Service
                        SCRIPS    Service Center Recognition/Image Processing System
                        SSN       Social Security Number


                        Page 30                              GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
Page 31   GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
Appendix I

Toll-Free Telephone Accessibility Test


               To assess the ability of taxpayers to reach IRS by telephone to ask a
               question about the tax law or their accounts, we conducted a
               nonstatistical test of IRS’ toll-free telephone assistance system. Our results
               relate just to the test calls; they cannot be projected. To conduct the test,
               we placed telephone calls at various times during each workday from
               March 31 through April 15, 1997. We made our calls from five metropolitan
               areas—Atlanta, Chicago, Kansas City, San Francisco, and Washington,
               D.C. Each attempt to contact IRS consisted of up to five calls spaced 1
               minute apart. If we reached IRS during any of the five calls and made
               contact with an assistor, we considered the attempt successful. If we
               reached IRS during any of the five calls but were put on hold for more than
               7 minutes without talking to an assistor, we abandoned the call, did not
               dial again, and considered the attempt unsuccessful (abandoned). If we
               received a busy signal, we hung up, waited 1 minute, and then redialed. If
               after four redials (five calls in total) we had not reached IRS, we considered
               the attempt unsuccessful. In conducting our test, we did not ask questions
               of the assistors because it was not our intent to assess the accuracy of
               their assistance.

               We attempted to contact IRS 330 times. Of 330 attempts to contact an
               assistor, 211 (64 percent) were successful—162 on the first call, 22 on the
               second call, and 27 after 3 to 5 calls. When the 16 calls that resulted in
               access to IRS’ voice messaging system were added, accessibility to IRS
               assistance increased to 69 percent. In another 69 cases (21 percent), we
               accessed IRS’ system but were put on hold more than 7 minutes and thus
               hung up before making contact with an assistor. The remaining 34
               attempts (10 percent) were aborted after we received busy signals on each
               of our 5 dialing attempts. Our 330 attempts to contact an assistor required
               a total of 584 calls to IRS’ toll-free telephone number. Of those 584 calls, we
               succeeded in contacting an IRS assistor 211 times—a 36-percent
               accessibility rate.

               We followed the above methodology to conduct our 1995 test, but we
               placed telephone calls from two additional metropolitan areas (Cincinnati
               and New York) and for two separate 2-week periods (January 30 through
               February 11, 1995, and April 3 through April 15, 1995). Results of the 1995
               test cited in the body of this report are only for the 2-week period from
               April 3 through April 15, 1995.




               Page 32                                  GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
Appendix II

Comments From the Internal Revenue
Service

Note: GAO comments
supplementing those in
the report text appear at
the end of this appendix.




                            Page 33   GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
Appendix II
Comments From the Internal Revenue
Service




Page 34                              GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
Appendix II
Comments From the Internal Revenue
Service




Page 35                              GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
Appendix II
Comments From the Internal Revenue
Service




Page 36                              GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
                 Appendix II
                 Comments From the Internal Revenue
                 Service




See comment 1.




See comment 2.




                 Page 37                              GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
                 Appendix II
                 Comments From the Internal Revenue
                 Service




See comment 3.




See comment 4.




                 Page 38                              GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
Appendix II
Comments From the Internal Revenue
Service




Page 39                              GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
Appendix II
Comments From the Internal Revenue
Service




Page 40                              GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
               Appendix II
               Comments From the Internal Revenue
               Service




               The following are GAO’s comments on IRS’ letter dated November 26, 1997.


               1. IRS says that lockbox payments of $213 billion were deposited during
GAO Comments   fiscal year 1997. That figure covers all tax payments processed by the
               lockbox banks. The lockbox discussion in our report focuses only on the
               processing of Form 1040 tax payments.

               2. IRS says that the SCRIPS sites succeeded in processing over 90 percent of
               the Forms 1040EZ through SCRIPS. However, only 5 of IRS’ 10 service
               centers have SCRIPS. The 90-percent figure cited by IRS means that SCRIPS
               was used to process 90 percent of the Forms 1040EZ filed at those 5
               centers. The other five centers used the traditional keypunching system to
               process the Forms 1040EZ they received. Also, as noted in our report,
               while the 5 SCRIPS centers may have processed 90 percent of the Forms
               1040EZ they received, they did so at a slower rate than in 1996.

               3. IRS says that the number of telephone calls answered increased from
               99.2 million in fiscal year 1996 to 103.9 million in fiscal year 1997. These
               numbers differ from the numbers cited in table 2 of our report because
               (1) our numbers are for the filing season (January 1 through mid-April)
               while IRS’ numbers are for the fiscal year (October 1 through
               September 30) and (2) our numbers include just those calls answered by
               IRS assistors, while IRS’ numbers include calls answered by assistors and by
               automated systems, such as TeleTax (a system that has prerecorded
               information on about 150 topics).

               4. IRS cites an initial contact resolution rate of above 95 percent. However,
               as IRS says, that rate only covers walk-in contacts and correspondence. It
               does not reflect the extent to which telephone inquiries are resolved with
               one contact.




               Page 41                                 GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
Appendix III

Major Contributors to This Report


                        David J. Attianese, Assistant Director, Tax Policy and Administration
General Government      Issues
Division, Washington,   Robert L. Giusti, Senior Evaluator
D.C.                    Monika R. Gomez, Evaluator
                        Christopher E. Hess, Senior Evaluator
                        John Lesser, Senior Evaluator


                        Royce L. Baker, Issue Area Manager
Kansas City Office      Doris J. Hynes, Evaluator-in-Charge
                        Marvin G. McGill, Evaluator


                        Jyoti Gupta, Evaluator
Atlanta Office          Kim Rogers, Evaluator


                        Sharon K. Caporale, Evaluator
San Francisco Office    Suzy Foster, Senior Evaluator




(268779)                Page 42                                GAO/GGD-98-33 IRS’ 1997 Tax Filing Season
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