Improvements to the Questionable Form W‑4 Program Are
Needed to Determine Program Impact on Taxpayer Compliance
October 2002
Reference
Number: 2003-40-006
This report has cleared the Treasury
Inspector General for Tax Administration disclosure review process and
information determined to be restricted from public release has been redacted
from this document.
October
30, 2002
MEMORANDUM FOR
COMMISSIONER, WAGE AND INVESTMENT DIVISION
FROM: Pamela J. Gardiner /s/ Pamela J. Gardiner
Acting Inspector General
SUBJECT: Final Audit Report – Improvements to the
Questionable Form W‑4 Program Are Needed to Determine Program Impact on
Taxpayer Compliance (Audit # 200240013)
This
report presents the results of our review to determine whether the Internal Revenue
Service’s (IRS) Questionable Form W‑4 (QW-4) Program productively
identifies instances of taxpayers inappropriately claiming either excessive
withholding allowances or exemption from withholding on their Employee’s
Withholding Allowance Certificate, Form W‑4.
We
conducted this review as a part of the Treasury Inspector General for Tax
Administration’s Fiscal Year 2002 discretionary audit coverage concerning
revenue protection in the Wage and Investment (W&I) Division. Properly claiming the correct withholding
allowance ensures that taxpayers are meeting their obligation for income tax
withholding from wages and other forms of income.
In summary, although the QW‑4
Program’s current measures are insufficient to determine the effectiveness of
the Program, management is working toward improvements. One improvement, in the form of a computer‑programming
enhancement, should enable staff hours to be used more productively. However, the QW‑4 Program currently
has no established outcome measures that effectively identify productivity and
its contribution to the IRS’ goal of improving compliance. Management cannot determine whether
employers are complying with directives to change the amount of tax withholding
and QW‑4 management information reports do not aid management in
identifying the most productive cases.
Management’s
Response: IRS management responded favorably and
agreed with the information included in our report. Specifically, they stated that our report accurately identified
the need for changes in the QW-4 process.
Management will redesign the screening process and develop new inventory
sources through database matching.
Management’s
complete response to the draft report is included as Appendix V.
Copies of this
report are also being sent to the IRS managers who are affected by the report
recommendations. Please contact me at
(202) 622-6510 if you have questions or Michael R. Phillips, Assistant
Inspector General for Audit (Wage and Investment Income Programs), at
(202) 927‑0597.
Current Program Measures Are Insufficient to Determine the Effectiveness of the Program
Appendix I – Detailed Objective, Scope, and Methodology
Appendix II – Major Contributors to This Report
Appendix III – Report Distribution List
Appendix IV – Processing the Questionable Forms W-4
Appendix V – Management’s Response to the Draft Report
Federal income tax is collected on a pay-as-you-go basis. Taxpayers must pay the tax as they earn or receive income during the year. The Internal Revenue Service (IRS) collected $1.1 trillion from individual taxpayers during Fiscal Year (FY) 2000. During this same year, income taxes paid by individual taxpayers accounted for over half of all taxes collected by the IRS, and the majority (69 percent) of the individual income taxes were collected through employee withholding.
Internal Revenue Code (I.R.C.) § 3402 provides the legal authority for income tax withholding from wages and other forms of income. It specifies the general form and content of the Employee’s Withholding Allowance Certificate (Form W‑4) and outlines the basis for claiming withholding allowances or exemption from withholding. Properly claiming the correct withholding allowance ensures that taxpayers are meeting their obligation for income tax withholding from wages and other forms of income. I.R.C. § 3403 provides that the employer is liable for tax imposed under law and the related tax regulations and is liable for the appropriate amount of withholding whether or not it is actually deducted from the employee’s (taxpayer’s) pay. IRS forms and publications provide these requirements and instructions on how to complete the forms.
The IRS reported that $4.6 billion due (owed by taxpayers) in Tax Year 1998 was a result of under withholding, partly due to questionable Forms W‑4. The IRS defines a questionable Form W‑4 as any Form W‑4 where the taxpayer is claiming more than 10 withholding allowances or any Form W‑4 where the taxpayer’s wages are over $200 per week and the taxpayer is claiming exemption from withholding. Each withholding allowance reduces the amount of federal income tax withheld from the taxpayer’s wages; the amount of withholding depends on the taxpayers’ wages and allowances and can range from zero to hundreds of dollars. Form W‑4 has worksheets to help taxpayers calculate how many withholding allowances they should claim. The worksheets are for the taxpayers’ own records.
The Questionable Form W-4 (QW‑4) Program is part of the Wage and Investment (W&I) Division, and its mission is to promote compliance with the tax and withholding system by taxpayers who reduce or eliminate tax withheld from their wages by filing an incorrect Form W‑4. To accomplish this mission, the IRS requires employers who receive questionable Forms W‑4 from taxpayers to submit these forms for review. The IRS’ QW‑4 Program employees (tax examiners) examine the forms and, where appropriate, the tax examiners require employers to increase taxpayers’ tax withholding. The IRS can also assess civil penalties against taxpayers. See Appendix IV for details on how the IRS processes questionable Forms W‑4.
During FY 2001, the QW‑4 Program received approximately 63,800 cases for tax examiners to work. Tax examiners closed 60,226 cases.
The chart was removed due
to its size. To see the chart, please
go to the Adobe PDF version of the report on the TIGTA Public Web Page.
Approximately 42,000 of the 60,226 cases were initially screened and closed with no change to the number of exemptions allowed. Approximately 14,100 cases were closed with adjustments to the number of exemptions claimed (referred to as lock-in); 600 were closed with penalties; and 3,600 were classified as “other.”
The QW‑4 Program has undergone several reorganizations since the early 1980’s. It has moved from a manual process with employees throughout the IRS to a more automated process with 27 employees centralized in 1 office. With the IRS’ reorganization in FY 2001, the Program centralized to the Fresno Compliance Campus (FCC).
We performed the audit in the FCC, the Detroit Computing
Center (DCC), Martinsburg Computing Center (MCC), and the W&I’s Headquarters
Office between October 2001 and July 2002.
The audit was conducted in accordance with Government Auditing Standards. Detailed
information on our audit objective, scope, and methodology is presented in
Appendix I. Major contributors to the
report are listed in Appendix II.
The QW-4 Program is not effectively identifying instances when employers and taxpayers do not comply with its directives to change withholding allowances claimed on Forms W-4. In addition, its management information reports do not identify the most productive cases. This occurs because the QW‑4 Program currently has no established outcome measures that effectively identify productivity and its contribution to the IRS’ goals of improving compliance.
Specifically:
· Management reports do not identify the most productive cases.
Sound management practices require the IRS to set performance goals for organizational units and to measure the results achieved by those organizations with respect to those goals. Without appropriate performance measures and indicators, the IRS is not able to determine the impact its QW‑4 Program is having on compliance.
IRS management has conducted studies of this Program. A 1998 compliance impact study found that, when implemented, Letter 2800 is an effective tool in increasing withholding and moving taxpayers from a balance due position to a fully paid or overpaid position at the time of filing. In addition, in December 2000, the IRS conducted a redesign study of the QW‑4 Program. The study found that the IRS is only able to work 10 percent of the questionable Forms W‑4 received. The study also identified several limitations of the current process. One recommendation of the study was for a trial implementation of the redesigned QW‑4 process. The study identified 31 tasks that are needed to implement the redesigned process.
The IRS has taken some steps to implement the recommendations of these studies. However, the IRS has not had the resources to complete all of the actions recommended in the studies.
The Program has no method to determine if employers are
complying with its directives to change taxpayers’
withholding amounts
Although the mission of the QW‑4 Program is to promote compliance, the Program has not established procedures to determine if employers are complying with its directives to change the withholding amounts. They have not done this because IRS Program management believes there is a 90 percent compliance rate among employers; however, management did not have any data to substantiate this opinion. In addition, they have concerns that any added procedures might place additional burdens on employers.
Without a means to determine if the Form W‑4 is revised and the proper amount withheld, the IRS has no means to determine the impact of the QW‑4 Program on taxpayers’ compliance. If the withholding is not appropriate, taxpayers might not file or might owe money when they file. The IRS has determined that balance due returns are less likely than fully pre‑paid returns to be filed timely, if filed at all. In addition, the January 2002 W&I Trends, Issues, and Problems report states that about 17 percent of balance due returns are not paid when the return is filed.
QW‑4 Program management information reports do not present available information in a way that is useful in identifying the most productive cases
Currently, management information reports focus mainly on identifying the number of cases loaded to the Questionable W-4 Case Control (QW‑4) system and closed during the initial screening process or with lock‑in letters. The reports were not designed to identify the categories of the cases worked or closed.
For example, IRS management uses two reports to determine the productivity of the QW‑4 Program, the caseload report and the case disposition report. The caseload report shows the volume of cases loaded to the QW‑4 system. The disposition report shows the number of cases closed and how the cases were closed (i.e., lock‑in letter, no change, etc.).
· The FY 2001 caseload report shows that 63,826 cases, approximately 10 percent of the total inventory of cases received, were loaded to the FCC, and the FY 2001 case disposition summary report shows that tax examiners closed 60,226 cases.
· The FY 2001 case disposition report shows that 41,892 (70 percent) of the 60,226 cases closed by tax examiners were accepted with no changes to the number of withholding allowances and 14,112 (23 percent) were issued lock‑in letters.
However, neither report shows the categories assigned to the closed cases.
A third report, the case code closure summary report, is also available to management but it is not used to measure productivity. This report provides the monthly volume of closed cases by category, but it does not show how the cases were closed (i.e., lock‑in letter, no change, etc.).
Merging data from the case disposition report and the case code closure summary report would provide management with a QW-4 Program overview of the number of cases by category that were closed by quick screening, adjusted by the QW‑4 unit, or assessed a civil penalty. Management could use the report to identify which categories of cases are most productive, i.e., cases where tax examiners determined the withholding allowances or exemption claimed were incorrect. Having this additional information would allow management to select those cases in specific categories that would have the greatest chance of making a positive impact on taxpayer compliance with the tax withholding system.
Though management could not identify which categories of cases were closed during the initial screening, they have determined that some of the initial case review actions taken by the tax examiners can be automated. In August 2001, QW‑4 management completed an in‑depth study of the QW-4 Program in partnership with the Small Business/Self-Employed Division, Criminal Investigation, Chief Counsel, the Michigan DORA Process Redesign Study team, and others. As a result of the task force, several recommendations were made. One of the recommendations was for management to automate some of the processes performed during the initial screening of the QW-4 cases.
On March 19, 2002, the Director, W&I Filing and Payment Compliance, submitted a formal request for a programming change to automate the initial screening process of QW‑4 cases. The MCC will identify cases meeting historically nonproductive criteria and place them into a designated category, eliminating manual screening. Some of the research that tax examiners completed in the past will be accomplished through computer analysis.
By automating the initial screening procedures, the QW‑4 Program should be able to use more of its limited resources to work the more productive cases. The QW-4 Program change planned for implementation by October 2002 will limit the number of cases reviewed by tax examiners that require no change to the number of withholding allowances claimed. Since the IRS is already taking action, we are not making any recommendations on the initial screening process at this time.
The Commissioner, W&I Division, should:
1. Develop measures to identify the impact of the QW‑4 Program on taxpayer compliance with the tax and withholding system.
Management’s Response: The FCC will work with W&I Headquarters to develop a report
that tracks the percentage of accounts that result in a lock-in letter. In addition, the FCC will keep the lock-in
cases on the system for up to 10 years.
2. Develop a method to determine if the employers complied with the lock-in letters and withheld the appropriate amount from the employees’ wages.
Management’s Response: The FCC is developing a follow-up system that will allow them to determine if employers have complied with the lock-in letters they issue. The FCC is asking the DCC to maintain lock-in cases for 10 years and to generate a listing if a case has been on the system for 30 months. The information will help the FCC to monitor cases that have lock-in letters to determine if employers are honoring withholding requirements.
3. Revise management information reports to identify which categories of questionable Forms W‑4 cases are productive and impact compliance.
Management’s Response: FCC management has identified the categories of questionable Form W-4 cases that will be productive by using criteria to download only those accounts that have not been filed or paid. The FCC will include those categories in the screening process changes that they will add to the Request for Information Services submitted on March 19, 2002. Following the changes, FCC management will work with the DCC to revise the management reports to allow them to track the percentage of lock-in letters in each category.
Appendix I
Detailed Objective, Scope, and Methodology
The overall objective of this review was to determine whether the Internal Revenue Service’s (IRS) Questionable Form W‑4 (QW‑4) Program productively identifies instances of taxpayers inappropriately claiming either excessive withholding allowances or exemption from withholding on their Employee’s Withholding Allowance Certificate, Form W‑4. We performed the following tests:
I.
Determined whether adequate
managerial oversight and monitoring of the questionable Form W‑4 case
selection process exist to ensure that the most productive cases are identified
for review.
A.
Interviewed the Director,
Filing and Payment Compliance, and reviewed Program guidelines to determine the
overall goals and objectives of both the QW‑4 Program and the
questionable Form W‑4 case selection process.
B.
Interviewed managers and
employees in the QW‑4 Program, the Detroit Computing Center, and the
Martinsburg Computing Center to understand the case selection process.
C.
Evaluated the basis and
purpose of the questionable Form W‑4 case selection criteria.
D.
Determined what reports are
available for managerial oversight and monitoring of the QW‑4 Program
case selection process and how the reports are used in selecting cases for
review.
II.
Determined whether the
current questionable Form W‑4 case selection process identifies the most
productive cases for review.
A.
Reviewed the Fiscal Year (FY)
2001 load reports identified in Step I.D. to determine the volume of cases
available for the QW‑4 Program employees to work.
B.
Reviewed the FY 2001 case
disposition report identified in Step I.D. to determine the volume of cases
with no changes to the exemptions claimed and the volume of cases with
adjustments to the exemptions claimed.
C.
Reviewed the FY 2001 case
closure report to determine whether information available on the report could
be used by management to identify productive cases.
Appendix II
Major Contributors to This Report
Michael R. Phillips, Assistant Inspector
General for Audit (Wage and Investment Income Programs)
Augusta R. Cook, Director
Anthony W. Anneski, Acting Audit Manager
Paula W. Johnson, Audit Manager
Alan Lund, Senior Auditor
Martha J. Bell, Auditor
Gwendolyn M. Green, Auditor
Appendix III
Commissioner N:C
Deputy Commissioner
N:DC
Commissioner, Wage and Investment Division W
Director, Strategy and Finance W:S
Director, Compliance
W:CP
Director, Filing and Payment Compliance W:CP:FPC
Chief Counsel CC
National Taxpayer Advocate
TA
Director, Legislative Affairs CL:LA
Director, Office of Program Evaluation and Risk
Analysis N:ADC:R:O
Office of Management Controls N:CFO:F:M
Audit Liaison:
Program/Process Assistant Coordinator, Wage and Investment Division H:WR
Appendix IV
Processing
the Questionable Forms W-4
The Internal Revenue Service (IRS) defines as questionable any Employee’s Withholding Allowance Certificate (FormW‑4) where the taxpayer is claiming more than 10 withholding allowances or any Form W‑4 where the taxpayer’s wages are over $200 per week and the taxpayer is claiming exemption from withholding.
The processing of the questionable Form W‑4 begins at the IRS’ 10 campuses and is then transmitted to the IRS’ computers at the Detroit Computing Center (DCC) and Martinsburg Computing Center (MCC) for further processing. The MCC assigns each questionable Form W‑4 (case) to 1 of 30 category codes based on the taxpayer’s historical tax account data as well as whether the employee claimed exemption from withholding or claimed more than 10 withholding allowances.
This information is transmitted to the DCC and loaded to the Questionable W‑4 Case Control System (QW‑4 system). Cases in 13 of the 30 categories are then loaded to the Fresno Computing Center (FCC) open inventory for tax examiners to work. The remaining cases are archived at the DCC and are not worked by the tax examiners.
Tax examiners initially screen questionable Form W‑4 cases by researching the QW‑4 system and the IRS’ main computer system for filing history. The tax examiners try to determine if the withholding allowances claimed by the taxpayers on Forms W‑4 appear appropriate. When additional information is needed from the taxpayers, the tax examiners issue Letter 2773, Initial Contact Letter. Letter 2773 asks the taxpayer to substantiate the withholding allowance claimed.
The IRS reports that most cases are closed at this point with no change to the amount of withholding allowances claimed. This happens if it appears that the withholding is appropriate based on the taxpayer’s filing history or if the taxpayer is able to provide supporting documentation.
If the tax examiners determine the withholding allowances claimed are incorrect or the taxpayers do not respond to IRS contact attempts, the tax examiners mail the taxpayers’ employers Letter 2800, Lock‑In (Employer). Letter 2800 directs the employers to disregard the taxpayers’ Forms W‑4 as filed and to instead withhold at the rate for a single person with zero allowances or at some other rate determined by the tax examiners. The cases are closed after the letter is issued.
Appendix V
The response was removed due to its size. To see the complete response, please go to the Adobe PDF version of the report on the TIGTA Public Web Page.