During our review of the Internal Revenue Service’s (IRS) computation of restricted interest on business accounts, we identified a significant number of business income tax returns taxpayers sent to lockbox banks that were reportedly lost by the IRS before they could be processed. Because of the potential effect a significant number of "lost" returns could have on both the IRS and taxpayers, we immediately initiated a limited scope review in this area. The objective of this review was to determine why a significant number of tax returns mailed by taxpayers to lockbox banks were not processed, even though the payments associated with the tax returns were processed.

During the IRS’ 2000 and 2001 returns processing seasons, it processed thousands of payments submitted with business tax returns for which the associated business tax returns were not processed. Although we could not determine the volumes nationwide, we did find that many of these "lost" tax returns were actually returns that were unprocessable because information necessary to process them was missing. The IRS could reduce the number of these unprocessable tax returns by clarifying instructions to taxpayers, providing additional processing instructions to lockbox banks, and performing additional research to secure names, addresses, and taxpayer identification numbers on certain returns submitted without this information.

The following three problems resulted in the IRS classifying tax returns as unprocessable and destroying them.

• Taxpayers did not provide business names, addresses, and taxpayer identification numbers where required on their tax returns. Employer’s Quarterly Federal Tax Returns (Form 941) and Employer’s Annual Federal Unemployment Tax Returns (Forms 940 and 940-EZ) and their associated payment vouchers are designed in a manner that could confuse taxpayers regarding where to enter their names and other identifying information.
• IRS instructions do not require lockbox banks to record identifying information omitted by taxpayers on tax returns or to provide information to help the IRS record it. Processing procedures followed by lockbox banks are to detach payment vouchers for processing by the bank and to forward the associated tax returns to the IRS center for processing by the IRS. As a result, if taxpayers entered their names on payment vouchers but not on their tax returns, the returns were sent to the IRS without the information necessary to process them.
• The IRS did not use state information to obtain taxpayers’ names, addresses, and taxpayer identification numbers. Form 940-EZ instructions request taxpayers to provide both the state where they pay unemployment contributions and the state reporting numbers shown on their state unemployment tax returns. Although the state tax agencies have the taxpayer identifying information that would allow the IRS to process Forms 940-EZ, IRS employees were not required to contact the state tax agencies. We telephoned the state tax agencies listed on four tax returns and in three instances were able to get the taxpayers’ names and federal taxpayer identification numbers. The fourth state would provide us the information if our request was submitted in writing.

These problems resulted in unnecessary work for the IRS and burden on taxpayers, and can result in inaccurate amounts of tax being assessed. Employees at the IRS centers must perform research on tax returns sent from lockbox banks with no names, addresses, and taxpayer identification numbers. This additional research is usually unsuccessful. As a result, the tax returns are not processable and the IRS destroys them. The IRS subsequently contacts the taxpayers to advise them their tax returns were "lost" or were never received, and to ask them to send copies of their returns.

The Director, Tax Forms and Publications, Wage and Investment (W&I) Division, should modify tax forms and instructions to ensure that taxpayers understand that their names, addresses, and taxpayer identification numbers are required on both their tax forms and payment vouchers. The Director, Submission Processing, W&I Division, should ensure that lockbox banks identify when taxpayer identifying information is missing from tax returns and either enter the information from the payment voucher or copy the voucher and send it to the IRS with the tax return. The Director, Customer Account Services, Small Business/Self-Employed Division, should ensure that IRS employees contact state tax agencies when applicable to obtain missing taxpayer identifying information.

Management’s Response: The IRS will make changes to Forms 940, 940-EZ and 941 and the related instructions to ensure taxpayers understand their names, addresses, and taxpayer identification numbers are required on the tax returns themselves even if the taxpayers have completed the associated payment vouchers. The IRS will coordinate with the Financial Management Service to add procedures for the lockbox banks to copy payment vouchers and send these to IRS with returns which are missing taxpayer identifying information.