While Progress Toward Earlier Intervention With Delinquent Taxpayers Has Been Made, Action Is Needed to Prevent Noncompliance With Estimated Tax Payment Requirements

 

February 2004

 

Reference Number: 2004-30-040

 

 

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.

 

February 17, 2004

 

 

MEMORANDUM FOR COMMISSIONER, SMALL BUSINESS/SELF-EMPLOYED DIVISION

                                         COMMISSIONER, WAGE AND INVESTMENT DIVISION

 

FROM:     Gordon C. Milbourn III /s/ Gordon C. Milbourn III

                 Acting Deputy Inspector General for Audit

 

SUBJECT:     Final Audit Report - While Progress Toward Earlier Intervention With Delinquent Taxpayers Has Been Made, Action Is Needed to Prevent Noncompliance With Estimated Tax Payment Requirements  (Audit # 200230041)

 

This report presents the results of our review to determine whether the Internal Revenue Service (IRS) has effective processes for achieving timely intervention when an underpayment or nonpayment of income taxes, Federal Tax Deposits (FTD), and/or estimated taxes is identified.  Early intervention is critical for the IRS, as the nation’s tax collection agency, because collection theory holds that the earlier a debtor is contacted for payment, the greater the likelihood that all or some of the debt will be paid.  Early intervention to encourage and assist taxpayers to more promptly resolve their tax liabilities was one of the goals of the former IRS Commissioner, as he tried to address the amount of outstanding tax liabilities that had grown to $287 billion as of December 2002.

In summary, over the course of nearly the past decade, the IRS has taken a number of actions, and is planning still others, to improve its ability to react more quickly to an actual or potential tax debt.  The completed actions include shortening the collection notices cycle, implementing predictive dialing technology for making outbound telephone calls on tax delinquencies, and completing a major reorganization to align with the IRS’ major customer segments.  Other actions in progress include migrating toward a risk-based approach to collecting delinquent taxes and modifying the FTD Alert criteria to focus on fewer, better-targeted taxpayer contacts.

For two reasons, however, it is difficult, if not impossible, to assess the cumulative effect that these actions have had on the IRS’ Collection operations.  The first reason is the decrease in Collection function staffing.  The Full-Time Equivalents (FTE) allocated to Collection function operations declined from 12,950 in Fiscal Year (FY) 1997 to 11,349 in FY 2002.  Second, collection enforcement activities were significantly affected by the enactment of the IRS Restructuring and Reform Act of 1998 (RRA 98).  Between FYs 1997 and 1999, for example, the number of liens filed declined from about 544,000 to about 168,000; the number of levies declined from almost 3.7 million to about 500,000; and the number of seizures declined from about 10,000 to only 161.  Although enforcement activity was increasing by FY 2002, only the number of liens filed was approaching the pre-RRA 98 levels.

Estimated tax is the method used by individual taxpayers to pay taxes on nonwage income on a quarterly basis.  About 12 million taxpayers made estimated tax payments totaling $183 billion for Tax Year (TY) 2001.  However, there is significant taxpayer noncompliance with estimated tax requirements. For each tax year from 1995 through 2000, between 5.7 million and 6.8 million individual taxpayers were assessed penalties for making insufficient or late estimated tax payments.  Many of these taxpayers also filed tax returns reporting unpaid taxes that resulted in the IRS having to take costly collection actions.

Five factors contribute to this noncompliance.  First, the tax law does not require tax withholding on nonwage sources of income.  Second, the quarterly due dates prescribed by law for making estimated tax payments do not consistently coincide with the calendar quarters and are irregularly spaced from 61 to 122 days apart.  Third, the estimated tax penalty rate, which is currently only 4 percent, may not sufficiently deter payment noncompliance.  Fourth, the IRS has no early intervention programs to identify taxpayers that stop making estimated tax payments or that make insufficient or untimely payments. Finally, the IRS has experienced little success (i.e., only about 1 in 200 taxpayers) in encouraging the use of electronic payment options for making estimated tax payments.  Without proactive efforts by the IRS, the noncompliance with estimated taxes can be expected to worsen in the years to come, since the amount of income from nonwage sources of income is growing significantly faster than that from wages.

As a long-term solution to the estimated tax payment noncompliance, we recommended the Commissioners of the Large and Mid-Size Business (LMSB), Small Business/Self-Employed (SB/SE), and Wage and Investment (W&I) Divisions explore developing a system of mandatory withholding of income taxes from nonemployee compensation paid to independent contractors by certain types of businesses for possible inclusion in a legislative proposal to the Department of the Treasury.  We also recommended legislative proposals to require estimated tax payments to be made on a monthly basis and to change the manner in which the estimated tax penalty rate is determined to ensure it serves as a more effective deterrent to noncompliance with estimated tax payment requirements.

For the near term, we recommended the Directors, Compliance, SB/SE and W&I Divisions, and the Director, Customer Assistance, Relationships, and Education, W&I Division, develop an estimated tax payment reminder notice that can be sent at midyear to those taxpayers that were assessed estimated tax penalties in the prior tax year and had made no estimated tax payments for the first 6 months of the current tax year or that had made substantially smaller or untimely payments during the first 6 months.  We also recommended the Director, Taxpayer Education and Communication, SB/SE Division, improve the promotion of electronic tax payments by including the enrollment form for the Electronic Federal Tax Payment System (EFTPS) in the estimated tax packages mailed to taxpayers, expanding the brief explanation of the EFTPS in Tax Withholding and Estimated Tax (Publication 505), and amending those IRS instructions and publications applicable to estimated tax payments that do not sufficiently emphasize that the EFTPS is offered to taxpayers as a free service by the Department of the Treasury.

Management’s Response:  The Commissioner, SB/SE Division, provided a detailed response to our draft report, advising that the Director, Field Specialists, LMSB Division, had agreed to explore the feasibility of developing a system of mandatory withholding of income taxes from nonemployee compensation paid to independent contractors in large and mid-size businesses.  The Director, Field Specialists, will explore this action in coordination with program managers in the SB/SE and W&I Divisions and the LMSB Division Counsel.  If developing a system of mandatory withholding is feasible, the Director, Field Specialists, will draft and coordinate a legislative proposal with the Office of Legislative Affairs for consideration by the Department of the Treasury.

The Commissioner, SB/SE Division, agreed with our recommendation to consider improving the promotion of the electronic tax payments.  An E-Submissions Messaging Team is currently reviewing IRS products to ensure EFTPS benefits are specifically detailed and highlighted as a “free” service offered by the Department of the Treasury. This group will continue to review new ways to enhance Estimated Tax for Individuals (Form 1040-ES) taxpayer compliance, including a proposal to add a coded enrollment form for the EFTPS in the U.S. Individual Income Tax Return (Form 1040) tax package to track the number of enrollments submitted through the paper enrollment process.

The Commissioner, SB/SE Division, disagreed with our recommendation to submit a legislative proposal requiring monthly estimated tax payments on the 15th day of each month.  The Commissioner stated that, although there may be some benefit to establishing regular quarterly time periods for individual estimated tax payments, monthly estimated tax payments would increase burden and complexity for both compliant and noncompliant taxpayers.  The Commissioner added that increasing the number of payments would increase both the complexity of Underpayment of Estimated Tax by Individuals, Estates, and Trusts (Form 2210) and the difficulty of computing estimated tax penalties for noncompliant taxpayers.

The Commissioner, SB/SE Division, disagreed with our recommendation to submit a legislative proposal to change the manner in which the estimated tax penalty rate is determined, stating the IRS had developed a legislative proposal concerning the estimated tax penalty in July 2001.  The proposal recommended the Congress raise the minimum underpayment amount on which penalties are assessed for failure to make estimated tax payments.  It also proposed to change the rate at which the estimated penalty is determined.  The proposed changes would apply to tax years beginning after December 31, 2003.

The Commissioner, SB/SE Division, disagreed with our recommendation to develop an estimated tax reminder notice that can be sent at midyear to those taxpayers that were assessed estimated tax penalties in the prior tax year and were falling behind with estimated tax payment requirements. The Commissioner stated the IRS had initiated a project in 2000 to determine whether a “soft letter” would significantly increase FTD payment compliance.  Based on the results of that study, the Commissioner believes a reminder notice would have little or no impact on estimated tax payment compliance.

Finally, the Commissioner, SB/SE Division, disagreed with our estimate that penalty and interest could be reduced by $2.1 billion over 5 years if a 25 percent increase in payment compliance was achieved, stating this percentage was not based on any empirical data.  The Commissioner also disagreed with our estimate that sending reminder notices to taxpayers assessed estimated tax penalties could reduce collection costs by $12.9 million over 5 years, stating that, based on the results of the FTD “soft letter” study, there would be no collection cost savings.  The Commissioner added that our estimate did not reflect the administrative cost related to adding a midyear reminder notice. Management’s complete response to the draft report is included as Appendix V.

Office of Audit Comment:  Given the significant increase in nonwage income and the extensive noncompliance with making estimated tax payments, we continue to believe taxpayers could benefit from a system of regularly scheduled monthly payment dates.  The fact that nearly one-third of the taxpayers that make estimated tax payments incur penalties strongly suggests the current quarterly payment system, in place since 1943, is not working effectively.  Monthly payment intervals are an established and common business practice in the private sector.  Most Americans are already used to making monthly payments on their home mortgages, rent, car loans, credit cards, and utilities.  In addition, many homeowners have mortgage escrow accounts set up to have money held to pay property taxes and insurance premiums so they do not have to worry about coming up with several large lump sum payments, each with different due dates, throughout the year.  Also, taxpayers that cannot pay the full amount with their individual income tax returns can make arrangements with the IRS to make monthly installment payments.  We believe the Commissioner’s concern with the taxpayer burden associated with a monthly payment system would be alleviated with the successful promotion of electronic payments. In addition, the IRS instructions for Form 2210 state that taxpayers do not need to file Form 2210 in most cases if an estimated tax penalty is due and that, because the Form is complicated, the IRS strongly encourages the taxpayer to let the IRS figure the penalty. Finally, substantial taxpayer burden would be reduced if the monthly payment system helped taxpayers avoid estimated tax penalties.

We also believe our recommendation to change the manner in which the estimated tax penalty rate is determined has merit to ensure the penalty serves as a more effective deterrent to noncompliance with estimated tax payment requirements.  The legislative proposal cited by the Commissioner, SB/SE Division, would raise the minimum underpayment amount on which penalties are assessed for failure to make estimated tax payments and would apply the underpayment rate on a daily basis.  While applying the underpayment rate on a daily basis would slightly increase the amount of the penalty, the increase would not be sufficient to serve as an effective deterrent to avoiding estimated tax payments.

We believe the concept of a midyear reminder notice to taxpayers that have stopped making estimated tax payments should, at a minimum, be tested.  The Commissioner, SB/SE Division, cited the results of an FTD “soft letter” project as evidence that a reminder notice would have little or no impact on estimated tax payment compliance.  However, the IRS’ own final report, dated March 2003, on the results of that project recommended “further study about the effectiveness of the ‘soft letter’ as an early intervention tool to improve filing and payment compliance may be warranted.”  Further, the FTD “soft letter” was directed to businesses responsible for paying employment taxes.  This customer segment differs from individual taxpayers that are responsible for making estimated tax payments on their nonwage income.

While the Commissioner, SB/SE Division, is correct that there are no empirical data to support our assumption that a midyear reminder notice would improve payment compliance by 25 percent, our estimate that penalties and interest could be reduced by $412.7 million per year, or $2.1 billion over 5 years, was based on 285,400 taxpayers becoming payment compliant.  These 285,400 taxpayers represented only about 5 percent of the 5.7 million noncompliant taxpayers that incurred estimated tax penalties in TY 1998.  Similarly, our estimate of the cost savings that could be realized through a 25 percent improvement in payment compliance was based on avoiding collection action on 204,000 taxpayers.  Our estimate of the collection cost savings was reduced by the estimated cost to mail the reminder notices.

While we still believe all of our recommendations are worthwhile, we do not intend to elevate our disagreement concerning these matters to the Department of the Treasury for resolution.

Copies of this report are also being sent to the IRS managers affected by the report recommendations.  Please contact me at (202) 622-6510 if you have questions or Richard J. Dagliolo, Acting Assistant Inspector General for Audit (Small Business and Corporate Programs), at (631) 654-6028.     

 

Table of Contents

Background

Numerous Changes Have Been Made to Achieve Earlier Intervention With Delinquent Taxpayers

Actions Are Needed to Prevent Noncompliance With Estimated Tax Payment Requirements

Recommendation 1:

Recommendation 2:

Recommendation 3:

Recommendation 4:

Recommendation 5:

Appendix I – Detailed Objective, Scope, and Methodology

Appendix II – Major Contributors to This Report

Appendix III – Report Distribution List

Appendix IV – Outcome Measures

Appendix V – Management’s Response to the Draft Report

 

Background

The Internal Revenue Service (IRS) is the nation’s tax collection agency.  Its mission is to provide America’s taxpayers with top-quality service by helping them understand and meet their tax responsibilities and by applying the tax law with integrity and fairness to all.

Collecting taxes due the Federal Government has always been a challenge for the IRS, but in recent years the challenge has grown.  In various testimonies and audit reports, the General Accounting Office (GAO) and Treasury Inspector General for Tax Administration (TIGTA) have highlighted large and pervasive declines in the IRS Compliance and Collection programs. Between Fiscal Years (FY) 1996 and 2001, these programs generally experienced larger workloads, less staffing, and fewer numbers of cases closed per employee.  By the end of FY 2001, the IRS was deferring collection action on about one out of every three tax delinquency cases assigned to the Collection program.

As of December 2002, the total amount of outstanding tax liabilities was $287 billion.  Approximately $13 billion of this total has been designated as uncollectible due to the IRS’ collection and resource priorities, although many of these accounts could be collected if the taxpayers were contacted and offered the opportunity to pay either in full or in installments.

Collection theory holds that the earlier a debtor is contacted for payment, the greater the likelihood that all or some of the debt will be paid.  Early intervention to encourage and assist taxpayers to more promptly resolve their tax liabilities was one of the goals of the former IRS Commissioner.

To perform this audit, we interviewed management officials in the Small Business/Self-Employed (SB/SE) Division offices in New Carrollton, Maryland, and Oxon Hill, Maryland; analyzed taxpayer account information; reviewed various IRS reports and studies; and sent questionnaires to nine state governments concerning their tax collection techniques and early intervention practices.  The responses received did not reveal any unique practices or techniques that would benefit the IRS operations.

The audit was performed from November 2002 through March 2003 and in accordance with Government Auditing Standards.  Some of the data used in this report came from various IRS reports.  We did not verify the accuracy of the information from those sources.  Detailed information on our audit objective, scope, and methodology is presented in Appendix I.  Major contributors to the report are listed in Appendix II.

Numerous Changes Have Been Made to Achieve Earlier Intervention With Delinquent Taxpayers

Historically, delinquent accounts have generally followed the same treatment path at the IRS.  The collection process generally began with a series of notices that were sent to taxpayers that did not pay all of their tax liabilities when they filed their tax returns.  If the unpaid taxes were not resolved during the notice process, the case was sent to the Automated Collection System (ACS) function where Customer Service Representatives (CSR) initiated and responded to telephone and/or correspondence contacts with the taxpayers and third parties, filed liens, and/or took levy actions to resolve the delinquencies.  If the ACS function was unable to resolve the delinquencies, the cases were moved to the Collection Field function (CFf) where, when resources became available, they were assigned to revenue officers for face-to-face contact with the taxpayers.

Over the course of nearly the past decade, the IRS has taken a number of actions, and is planning still others, to improve its ability to respond more quickly to an actual or potential tax debt.  For two reasons, however, it is difficult, if not impossible, to assess the cumulative effect these actions have had on the effectiveness of the IRS Collection operations. 

The first reason is the decrease in Collection function staffing.  For example, the Full-Time Equivalents (FTE) allocated to the Collection function declined from 12,950 in FY 1997 to 11,349 in FY 2002.  Second, collection enforcement activities were significantly affected by the enactment of the IRS Restructuring and Reform Act of 1998 (RRA 98).  Between FYs 1997 and 1999, for example, the number of liens filed declined from about 544,000 to about 168,000; the number of levies declined from almost 3.7 million to about 500,000; and the number of seizures declined from about 10,000 to only 161.  Although enforcement activity was increasing by FY 2002, only the number of liens filed was approaching the pre-RRA 98 levels. 

A formal Early Intervention Program was implemented

In January 1995, the IRS implemented in the ACS function a formal Early Intervention Program that used both a shortened notice process and earlier taxpayer contact.  In the Early Intervention Program, the collection process was shortened by eliminating two notices for taxpayers filing individual income tax returns and by eliminating one notice for taxpayers filing business returns.  At each ACS call site, special teams of CSRs were designated to work the Early Intervention Program inventory.  For cases with telephone numbers, the procedures for the Early Intervention Program required that up to four outbound calls be made by the second week.

Later in Calendar Year (CY) 1995, the ACS function resources were reduced and applied to other priority work and, as a result, a formal Early Intervention Program no longer exists.  However, the IRS has maintained the same shorter notice process that the Early Intervention Program used, and outbound call attempts are still being made on most new cases that have an available telephone number.

Predictive dialing technology was deployed for making outbound telephone calls

The IRS began testing a predictive dialer at its ACS call site in Buffalo, New York, in CY 1996. The IRS’ evaluation showed the predictive dialer increased outgoing call productivity and decreased the inventory in the ACS Contact function.  In June 1999, the Buffalo site began supporting the outbound call “campaigns” from other ACS call sites.  This consolidation was completed in January 2000, and in February 2002, a weekly rotational schedule was implemented that provided for outbound calls to be made for each of the ACS call sites.

The IRS still uses its original predictive dialer system for making outbound calls on new cases coming into the ACS function and for making outbound calls as a last attempt to contact taxpayers prior to issuing a Notice of Levy.  A vendor provides telephone number research for cases coming into the ACS function.  A recent analysis showed approximately 57 percent of these incoming cases have a telephone number.  During FY 2002, the ACS function used the predictive dialer to make 1.3 million outbound call attempts on 1.2 million taxpayer accounts.

The current IRS predictive dialer system is outdated, is no longer supported by the vendor, and is beginning to experience frequent downtime.  In a separate audit report, we recommended the IRS (1) pursue additional human capital or reallocate Compliance resources to enable the operation of present and future predictive dialer systems at full capacity, and (2) pursue a budget solution that would allow the IRS to replace the current predictive dialer system with a state-of-the-art system with sufficient capacity.

The IRS completed a major reorganization based on customer segments

The RRA 98 mandated that the IRS do a better job of meeting the needs of its customers.  To comply with this Congressional mandate, the IRS revised its mission statement to refocus its emphasis on helping taxpayers understand and meet their tax responsibilities.  On October 2, 2000, the IRS also modernized its organizational structure from one that was based on function and geography to one that is aligned with its major customer segments.  Four new customer-focused business operating divisions were created with full end-to-end responsibility for serving distinct groups of taxpayers with similar needs.

The new organizational structure is designed to provide more-focused customer service and enhance accessibility to IRS information and personnel that can resolve issues more quickly and consistently within that operating division.  The new structure was built around specific taxpayer needs that will enable the IRS to tailor its products, services, and compliance approaches to business practices and strategies.  In this way, the IRS can develop a comprehensive and focused approach to tax administration, allocate the necessary resources, and shift to problem prevention and early intervention initiatives.

In October 2001, the SB/SE Division implemented changes to the inventory delivery system to alter the mix of cases assigned to revenue officers.  The changes delivered younger, predominately in-business trust fund cases to revenue officers to be worked as the highest priority.  The expected benefits of this plan were:

·        Higher collectibility than other cases.

·        High compliance impact with opportunities to stop the noncompliance since the taxpayers are still in business.

Through the reorganization, the IRS expects to achieve, over time, improved compliance through faster intervention in collection and through a more effective risk-based approach in all Compliance activities.  This approach will allow the IRS to more clearly differentiate between those taxpayers that are attempting to comply but need assistance and those that potentially require enforcement action (a smaller segment).

The IRS is migrating toward a risk-based approach to collecting delinquent taxes and contracting out the collection of some delinquent taxes

Under this approach, taxpayer characteristics are analyzed to determine the most appropriate treatment rather than having all delinquent accounts follow the same treatment path.  While some cases may follow the normal treatment path, others may be accelerated to the ACS function or the CFf.

For example, a Filing and Payment Compliance (F&PC) Model in the Business Systems Modernization effort has a goal to shorten the payment compliance life cycle to 6 months.  All balance due cases will receive the statutory first notice. However, cases will not receive a “one size fits all” compliance approach but rather a tailored treatment, as the taxpayer may receive one notice or a series of notices.  Outbound calls will also be emphasized. 

Although a pilot was planned for April 2004, the Office of Management and Budget has not approved further funding due to budgetary constraints.  At the time we completed our review, the project remained on hold.

Another initiative is a legislative proposal to contract with private agencies to assist in the IRS’ collection of delinquent taxes.  This proposal, which requires the approval of the Congress, would expand the IRS’ capacity to collect delinquent taxes by authorizing private tax collection agencies to pursue lower-priority, less-complex, unresolved tax delinquency cases that accumulate in inventory and might not otherwise be addressed because of limited resources.  At the time we completed our review, the Congress had not acted on this proposal.

The FTD Alert criteria are being modified

The Federal Tax Deposit (FTD) Alert Program is an existing early intervention process which identifies taxpayers that appear to be behind in their deposits of trust fund taxes before their quarterly employment tax returns are due to be filed.  The FTD Alerts are computer generated on a quarterly basis for those businesses that appear to be making insufficient FTD payments when compared to those made in prior quarters. The FTD Alerts are assigned to revenue officers in the CFf for contact with the business taxpayers.

FTD Alerts can protect the Federal Government’s interest by the early identification of potential delinquent employment tax accounts.  They also serve the taxpayers’ interests by allowing IRS involvement before enforced collection action or bankruptcy become the two remaining alternatives.

During CY 2002, 135,187 FTD Alerts were created.  Of these, 45,675 were mandatory alerts and 89,512 were optional alerts.  Due to resource limitations and workload priorities, the CFf did not work all of the mandatory alerts and did not work any of the optional alerts.

At the time we performed this review, the IRS was in the process of significantly changing the FTD Alert Program to address recommendations from internal research studies and audit reports issued by the former IRS Inspection function and the TIGTA.  The IRS expected to complete the testing of the new FTD Alert criteria by January 2004.

The IRS has delayed taking action on one previous audit recommendation to look at alternate functions, such as the ACS function, for working FTD Alerts.  The IRS was evaluating the feasibility of issuing a “soft letter” to taxpayers on some FTD Alert cases and expected a decision by August 2003.

Actions Are Needed to Prevent Noncompliance With Estimated Tax Payment Requirements

Approximately 12 million taxpayers made estimated tax payments totaling $183 billion for Tax Year (TY) 2001.  The tax law generally requires taxpayers to make estimated tax payments if (1) they expect to owe at least $1,000 in tax, after subtracting their withholding and credits, and (2) they expect their withholding and credits to be less than the smaller of 90 percent of the current year tax liability or 100 percent of the prior year tax liability.  The estimated tax system supports the “pay as you go” concept of paying taxes on nonwage sources of income.  For estimated tax purposes, the year is divided into four payment periods with specific payment due dates.

The IRS may assess an estimated tax penalty if a taxpayer did not pay enough taxes through withholding or estimated tax payments.  An estimated penalty may also be assessed if a taxpayer does not pay enough tax by the due date of each of the four quarterly payment periods. 

There is significant noncompliance with estimated tax payment requirements

Understanding estimated tax payments is one of the most serious problems encountered by taxpayers, according to the National Taxpayer Advocate FY 2001 Annual Report to Congress.  The estimated tax penalty is the second most frequently assessed penalty against individual taxpayers. 

An IRS study showed 31 percent of the taxpayers that either made, or were required to make, estimated tax payments for TY 1999 were assessed the estimated tax penalty.  In contrast, only about 3.2 percent of individual taxpayers that had not made estimated tax payments were penalized for the late filing of returns or the late payment of taxes in TY 1998. 

Figure 1 shows that, for each tax year from 1995 through 2000, the IRS penalized between 5.7 million and 6.8 million taxpayers for making late or insufficient estimated tax payments.  For these 6 years, the net estimated tax penalties totaled almost $7.5 billion and averaged more than $1.2 billion per year.

Figure 1:  Number of Estimated Tax Penalties:  TYs 1995 - 2000

Figure 1 was removed due to its size. To see Figure 1, please go to the Adobe PDF version of the report on the TIGTA Public Web Page.

 

Noncompliance with estimated taxes is costly for the Federal Government

Not only is noncompliance with estimated tax payment requirements costly for those taxpayers assessed penalties, it also delays the flow of tax revenues to the Federal Government and often requires the IRS to take costly collection actions.  For example, we analyzed the accounts of more than 2 million of the 5.7 million individual taxpayers that were assessed estimated tax penalties for TY 1998.  Approximately 58 percent of these taxpayers had made no estimated tax payments. These 2 million taxpayers had tax liabilities totaling $5.9 billion that were not fully paid when their tax returns were filed, resulting in the issuance of 2.7 million collection notices for more than 1.5 million taxpayers.  About 331,000 of these accounts ultimately reached Taxpayer Delinquent Account (TDA) status that often requires the IRS to take stronger, more labor-intensive actions to collect the debts.

We estimate the IRS incurred more than $18 million in collection costs for these 1.5 million noncompliant taxpayers.  Approximately 1 million of these taxpayers were self-employed.

Several factors contribute to taxpayer noncompliance in making estimated tax payments

Several factors contribute to the significant noncompliance with estimated tax requirements:

·        At the root of the issue is that the tax law does not require payers to withhold taxes from nonwage payments.  Nonwage sources of income continue to grow as a proportion of total income.

·        While the IRS is working on improving its alert system for employment tax deposits, there are no parallel early intervention programs to identify individual taxpayers that stop making quarterly estimated tax payments or that may be making insufficient or untimely payments.

Nonwage income is not subject to mandatory tax withholding

The law requires employers to withhold income taxes and Social Security/Medicare contributions from their employees’ wages and send the withheld taxes to the IRS. Withholding is a fundamental premise of the voluntary compliance system for individual taxpayers in that it provides for a gradual and systematic method to pay taxes.

In 1999, the GAO reported the tax compliance rate for wage earners was 99 percent.  However, the compliance rate is much lower for taxpayers with nonwage sources of income, such as self-employment, capital gains, interest, and dividends, for which taxes are generally not withheld. 

When there is no withholding, taxpayers are required to make quarterly estimated tax payments.  Self-employed taxpayers must make sufficient estimated tax payments to cover both their income taxes and Social Security/Medicare taxes, which since TY 1990 have been 15.3 percent of the net self-employment income.

IRS Statistics of Income (SOI) data for individual income tax returns filed during 1997 showed 2.3 million (26 percent) of the 8.8 million unpaid balance due returns involved taxpayers that had no withholding.  An IRS analysis of the 122 million individual income tax returns filed in CY 1998 found that over 30.5 million (25 percent) involved insufficient tax prepayments and reported a balance due with filing.  In 1999, the GAO reported the compliance rate for self-employed individuals was 80 percent.  As of December 31, 2000, self-employed taxpayers owed the IRS approximately $25 billion in delinquent taxes, interest, and penalties.

Nonwage income continues to increase as a percentage of total income

In 1996, the GAO reported nonwage income had been a growing proportion of individual taxpayers’ total incomes from 1970 through the 1980s, peaking in 1989.  As shown in Figure 2, the percentage of nonwage income to total income leveled off between 1990 and 1995 but had significantly increased by 2000, the last year for which information was available.

Figure 2: Growth in Nonwage Income from 1975 to 2000

Figure 2 was removed due to its size.  To see Figure 2, please go to the Adobe PDF version of the report on the TIGTA Public Web Page.

Between 1975 and 2000, nonwage income grew significantly, from 17.4 percent of total income ($167 billion) to 30.6 percent of total income (nearly $2 trillion).  This represents a 76 percent increase in the proportion of nonwage income to total income and an approximately 12-fold growth in total nonwage income.

As shown in Figure 3, the growth of nonwage income can also be illustrated by the increase in the percentage of individual income tax returns filed that report only nonwage income.  Overall, the returns reporting only nonwage income increased from 10.6 percent (8.7 million of 82 million income tax returns filed in 1975) to 14.8 percent (19.2 million of 129 million income tax returns filed in 2000).

Figure 3:  Growth of Tax Returns With Only Nonwage Income

Figure 3 was removed due to its size.  To see Figure 3, please go to the Adobe PDF version of the report on the TIGTA Public Web Page.

Figure 4 compares the growth in the largest nonwage sources of income to the growth in income from wages for the 25-year period from 1975 to 2000. Except for interest, each nonwage source had increased from about three to eight times more than wages.

Figure 4: Growth in Tax Returns With Wages and Nonwage Income

Figure 4 was removed due to its size.  To see Figure 4, please go to the Adobe PDF version of the report on the TIGTA Public Web Page.

 

Past efforts to mandate withholding on nonwage sources of income have failed

As early as 1979, the GAO concluded noncompliance among independent contractors was serious enough to warrant some form of tax withholding on the payments made to them.  During the 1990s, at least two GAO reports and Congressional testimonies suggested withholding taxes from payments to independent contractors.  To support this position, the GAO cited various IRS studies and data that showed a significantly lower level of compliance among independent contractors as compared to employees.

A 1992 report by the Joint Committee on Taxation also acknowledged the revenue loss associated with the lower compliance rates of independent contractors and made suggestions to improve compliance and enforcement.  One suggestion was to require businesses to withhold income and employment taxes from payments to independent contractors.

In 2001, we reported that, for TYs 1995 through 1998, the IRS had received about 9.6 million Statements for Recipients of Miscellaneous Income (Form 1099-MISC), reporting approximately $204 billion in nonemployee compensation to independent contractors, that either did not contain a Taxpayer Identification Number (TIN) for the payee or match the IRS records of assigned TINs.  Consequently, the IRS could not use these information documents in its computer-matching programs to determine whether the recipients of this compensation filed tax returns and/or reported all of the income.

Our report recommended the IRS propose changes to the tax law to require the mandatory withholding of income taxes on nonemployee compensation payments.  However, the IRS took no action on this recommendation.  The IRS responded it had previously submitted proposals for legislative changes to the Department of the Treasury that would require mandatory withholding of income taxes on nonemployee compensation payments and, in the past, the Department of the Treasury had chosen not to forward these proposals to the Congress.

The due dates for making estimated tax payments do not consistently coincide with the calendar quarters

The Current Tax Payment Act of 1943 established the statutory requirements for making estimated tax payments.  At the time this law was enacted, the due date for filing individual income tax returns was March 15.  The Congress originally established the estimated tax payment due dates as the 15th day of the third month of each quarter (i.e., March 15, June 15, September 15, and December 15).

The Congress amended the law the following year to change the due date for the fourth estimated tax payment to January 15, to provide taxpayers the opportunity to file their returns with payment in lieu of making a fourth quarterly estimated tax payment.  In 1954, the Congress amended the tax code to change the due date for filing an individual income tax return and for making the first estimated tax payment from March 15 to April 15.  However, the Congress did not revise the due dates for the other quarterly estimated tax payments to coincide with this change.

Thus, for nearly 50 years, taxpayers have been required to comply with the confusing estimated tax payment schedule shown in Table 1.

Table 1: Estimated Tax Payment Schedule

Payment
Due Date

For Income
Received

Calendar Days Since Last Payment Due Date

April 15

January 1 through March 31

  90

June 15

April 1 through
May 31

  61

September 15

June 1 through August 31

  92

January 15

September 1 through December 31

122

Source:  Tax Withholding and Estimated Tax (Publication 505).

The risk for skipped or late estimated tax payments is increased because the quarterly due dates prescribed by law for making the payments do not consistently coincide with the calendar quarters.  As a result, two estimated payments are required to be made during the second quarter (i.e., April - June) of each year while none are required to be made during the fourth quarter (i.e., October - December).  In addition, the number of calendar days between the estimated tax payment due dates ranges from 61 to 122.

In 2002, the IRS conducted a series of focus groups with practitioners to gather suggestions for improving communication with taxpayers and practitioners and for reducing the burden on small business taxpayers.  When asked about the most burdensome tax issues facing the small business taxpayer, several participants stated:

The timing of the estimated payments does not make sense.  The due dates create problems for a business working on a quarterly basis.  It is difficult to estimate taxes before a quarter has ended.  For example, estimating the appropriate payment on June 15, when earnings will continue until June 30, presents a dilemma for the taxpayer.

The estimated tax penalty is not providing a sufficient deterrent to payment noncompliance

The estimated tax penalty is computed by applying an underpayment rate to the amount of the underpayment for the period of the underpayment.  The estimated tax penalty amount is equivalent to the dollar amount of interest on the unpaid amount for the period of the underpayment.  The Internal Revenue Code (I.R.C.) specifies that the underpayment rate is the sum of the Federal Government short-term interest rate plus three percentage points.  The rate of interest is determined on a quarterly basis. 

For TY 1999, when an IRS study showed 31 percent of the taxpayers that either made, or were required to make, estimated tax payments were assessed estimated tax penalties, the penalty rate was 8 percent.  The study also showed 60 percent of the taxpayers that were assessed estimated tax penalties for TY 1999 were charged less than $100.

The estimated tax penalty rate, which has subsequently dropped to very low levels, may not provide a sufficient deterrent for not making timely, appropriate estimated tax payments.  As of October 1, 2003, the Federal Government short-term interest rate was only 1 percent, its lowest level in 45 years.  Therefore, the penalty for missing an estimated tax payment for the October 1 through December 31, 2003, quarter would have been 4 percent of the underpaid amount for the 3-month period.

There are no early intervention programs to identify taxpayers that are not making estimated tax payments

The significant noncompliance in making quarterly estimated tax payments on nonwage income, evidenced by the millions of estimated tax penalties assessed by the IRS each year and the amount of unpaid taxes that requires costly collection action by the IRS, demonstrates that the current system is not adequately serving taxpayers or the IRS.  We believe these taxpayer and Federal Government costs could be significantly reduced if the IRS used its available taxpayer account information to more timely assist taxpayers in properly making their estimated tax payments.

The IRS runs computer programs at different times of the year to identify the approximately 20.8 million taxpayers that are sent estimated tax payment vouchers by mail.

While the IRS makes significant efforts to ensure estimated tax payment vouchers are provided to those taxpayers that need them, it takes no action to monitor payment compliance until the taxpayers file their returns 12 to 15 months later.  If the taxpayers misplace the annual estimated tax package with the four payment vouchers, forget to make the estimated tax payments throughout the year, do not know in advance the amount of their final tax liability, or do not know how much they paid in estimated taxes the previous year, they will likely be penalized for skipped, late, or insufficient estimated tax payments.

In 1999, the GAO recommended the IRS test the feasibility of sending reminder notices to self-employed taxpayers that were assessed an estimated tax penalty in the prior year and had made no estimated tax payments in the current year.  The IRS initially requested computer programming to develop the reminder notices for 2000, but, due to limited resources, management decided to delay implementation until 2001.  The IRS subsequently closed this recommendation without any action based on information from a June 2000 initiative that tested the effect of a prefiling notice on repeat high-income nonfilers.  Currently, there are no reminder notices sent for estimated taxes.

Sending reminder notices shortly before the estimated tax payments are due was also suggested to the IRS during a July 2001 study to determine taxpayer attitudes toward paying estimated tax payments through electronic methods.  Focus group participants were asked about anything additional the IRS could do to encourage use of automatic funds withdrawal or credit cards to pay estimated taxes.  One of their suggestions stated:

The participants in our focus groups like to be notified of upcoming liability payments of any kind.  Therefore, complete a cost benefit analysis to determine the most effective way to send taxpayers a reminder notice about their upcoming quarterly estimated tax payments.  Reminder notices could be accomplished through direct mailings, newspapers, public service announcements, advertisements in retirement magazines and reminders in bank or stockbroker statements to name a few.

At the time we completed our review, the IRS had taken no action toward adopting this suggestion.

We believe the IRS should reconsider the reminder notice concept as a strategy for improving estimated tax payment compliance and reducing its collection costs.  Based on our computer analysis of the TY 1998 accounts of 2,025,189 taxpayers that had been assessed estimated tax penalties, we believe 1,141,599 (56 percent) of these taxpayers could have benefited from midyear reminder notices from the IRS as a potential means to prevent or minimize future estimated tax penalties, future balance due returns, and future accounts receivables.  These 1,141,599 taxpayers owed $3.8 billion in taxes after filing their TY 1998 returns and had been assessed estimated tax penalties totaling $412 million, other penalties totaling  $756 million, and interest totaling $732 million.  These 1,141,599 taxpayers included:

·        603,533 taxpayers that were assessed estimated tax penalties for TY 1997 but made no estimated tax payments for TY 1998.

·        111,913 taxpayers that made estimated tax payments for TY 1997 but made none for TY 1998.

The IRS’ cost for the current annual mail-out of estimated tax packages each January is approximately $5 million.  We estimate the additional IRS costs to mail estimated tax payment reminder notices to the 1,141,599 taxpayers in our sample that could have benefited from a reminder notice would have been $194,000.  Assuming that 25 percent of these taxpayers became payment compliant as a result of the reminder notice, these taxpayers could avoid approximately $413 million in penalties and interest and the IRS could reduce its collection costs by $2.6 million.  See Appendix IV for details.

Compliance could be improved by encouraging more taxpayers to make estimated tax payments electronically

The IRS encourages taxpayers to pay their taxes through electronic funds withdrawals and credit cards as alternatives to writing checks and mailing payment vouchers.  However, IRS data show the overwhelming majority of the estimated tax payments the IRS receives are in the form of traditional paper payment vouchers and taxpayer checks.  For example, a profile of taxpayers that made estimated tax payments for TY 1999 showed less than one-half of 1 percent (i.e., 1 in 200) of the 13 million taxpayers had used electronic methods for making their payments.  A second profile for TY 2001 showed 38,766,000 (99.9 percent) of the 38,819,000 estimated tax payments received were made via paper.

The IRS has studied how to increase taxpayer usage of electronic estimated tax payments.  For example, a focus group study was performed in July 2001 to determine taxpayer attitudes toward paying estimated taxes through electronic methods.  The general consensus across the group of participants was that they would not use credit cards to make their estimated tax payments as long as the credit card companies continued to charge a convenience fee.

For the past several years, the IRS has also provided taxpayers with an Electronic Federal Tax Payment System (EFTPS) for making tax payments electronically using the Internet, computer software, or telephone. The EFTPS is offered free by the Department of the Treasury to both business and individual taxpayers.

Taxpayers must enroll in the EFTPS.  Estimated tax filers may call a toll-free number to request an Individual Enrollment Form for EFTPS (Tax Form 9783) or enroll through the Internet.  Within 15 business days, the taxpayer is mailed a Personal Identification Number and confirmation materials that include instructions on obtaining a password for secure use of the EFTPS Internet site. At least 1 calendar day prior to the estimated tax payment due date, the taxpayer can access the EFTPS by telephone or on-line.  The system will prompt the taxpayer for the necessary information to complete the payment. The system processes the information and, once the tax payment is accepted, a withdrawal is initiated from the taxpayer’s bank account, the funds are transferred to the Treasury account, and the payment information is reported to the IRS to update the taxpayer’s account.

Until recently, however, taxpayers could use the EFTPS to schedule only one estimated tax payment at a time.  In July 2003, the IRS enhanced the EFTPS so taxpayers can schedule all four quarterly estimated tax payments at the same time.

Information about the EFTPS is contained in the general tax package instructions and several other IRS publications.  However, the fact that the EFTPS is offered as a “free” service by the Department of the Treasury is not covered in several key IRS publications such as the Estimated Tax for Individuals (Form 1040-ES and Form 1040-ES/V (OCR)) instructions and Tax Withholding and Estimated Tax (Publication 505).  The EFTPS is only briefly described in these documents. For example, in Publication 505 (Rev. December 2002), the reference to the EFTPS is limited to two sentences on page 24.

Recommendations

To address the significant noncompliance in paying estimated taxes, the Commissioners, Large and Mid-Size Business (LMSB), SB/SE, and W&I Divisions, should work with the IRS Office of Legislative Affairs to: 

1.      Explore the development of a system of mandatory withholding of income taxes from nonemployee compensation paid to independent contractors for possible inclusion in a legislative proposal, similar to the one we previously recommended in 2001, for submission to the Department of the Treasury.  To avoid placing undue burden on small businesses, the IRS should limit the requirement to withhold taxes on nonemployee compensation to large and mid-size businesses.

Management’s Response:  The Director, Field Specialists, LMSB Division, agreed to explore the feasibility of developing a system of mandatory withholding of income taxes from nonemployee compensation paid to independent contractors in large and mid-size businesses.  The Director, Field Specialists, will explore this action in coordination with program managers in the SB/SE and W&I Divisions and the LMSB Division Counsel.  If developing and implementing a system of mandatory withholding for these taxpayers is feasible, the Director, Field Specialists, will draft and coordinate a legislative proposal with the Office of Legislative Affairs for consideration by the Department of the Treasury.

To minimize taxpayer confusion with the estimated tax payment due dates and increase the effectiveness of the estimated tax penalty as a deterrent to payment noncompliance, the Commissioners, SB/SE and W&I Divisions, should work with the IRS Office of Legislative Affairs to: 

2.      Develop a legislative proposal, for submission to the Department of the Treasury, to change the estimated tax payment due dates from the current irregular schedule, which requires 4 payments that are spaced from 61 to 122 days apart, to a regular monthly schedule with payments due on the 15th day of each month and with the last payment due January 15.  We believe this change would promote payment compliance by evenly spacing the due dates approximately 90 days apart, requiring smaller individual payments by the taxpayer, and encourage use of the EFTPS for making electronic payments. The increased frequency of estimated payments would also expedite the flow of revenue into the Treasury in comparison to the existing system.  Taxpayers would also benefit because the estimated tax penalty for a skipped or late monthly payment would be less than that for a skipped or late payment under the existing system.

Management’s Response:  The Commissioner, SB/SE Division, disagreed with this recommendation, stating that, although there may be some benefit to establishing regular quarterly time periods for individual estimated tax payments, monthly estimated tax payments would increase burden and complexity for both compliant and noncompliant taxpayers. The Commissioner added that increasing the number of payments would increase both the complexity of Underpayment of Estimated Tax by Individuals, Estates, and Trusts (Form 2210) and the difficulty of computing estimated tax penalties for noncompliant taxpayers.

Office of Audit Comment:  Given the significant increase in nonwage income and the extensive noncompliance with making estimated tax payments, we continue to believe taxpayers could benefit from a system of regularly scheduled monthly payment dates.  The fact that nearly one-third of the taxpayers that make estimated tax payments incur penalties strongly suggests the current quarterly payment system, in place since 1943, is not working effectively.  Monthly payment intervals are an established and common business practice in the private sector.  Most Americans are already used to making monthly payments on their home mortgages, rent, car loans, credit cards, and utilities.  Many utility companies establish fixed monthly billing dates whereby their customers pay the same amount on the same date of each month through an even billing process.  In addition, many homeowners have mortgage escrow accounts set up to have money held to pay property taxes and insurance premiums so they do not have to worry about coming up with several large lump sum payments, each with different due dates, throughout the year.  Also, taxpayers that cannot pay the full amount with their individual income tax returns can make arrangements with the IRS to make monthly installment payments.

We believe the Commissioner’s concern with the taxpayer burden associated with a monthly payment system would be alleviated with the successful promotion of electronic payments. In addition, the IRS instructions for Form 2210 state that taxpayers do not need to file the Form in most cases if an estimated tax penalty is due and that, because the Form is complicated, the IRS strongly encourages the taxpayer to let the IRS figure the penalty. Finally, substantial taxpayer burden would be reduced if the monthly payment system helped taxpayers avoid estimated tax penalties.  Under a monthly system, 12 smaller payments would be spread out over a year. Therefore, the estimated tax penalty for one skipped or late monthly payment would be less than that for a skipped or late quarterly payment under the existing system, which requires larger payment amounts and longer intervals between payments.

3.      Develop a legislative proposal, for submission to the Department of the Treasury, to change the manner in which the estimated tax penalty rate is determined to ensure it serves as a more effective deterrent to noncompliance with estimated tax payment requirements.

Management’s Response:  The Commissioner, SB/SE Division, disagreed with this recommendation, stating that, in July 2001, the IRS had developed a legislative proposal recommending the Congress raise the minimum underpayment amount on which penalties are assessed for failure to make estimated tax payments and change the rate at which the estimated penalty is determined.  The proposed changes would apply to tax years beginning after December 31, 2003. The Commissioner stated the proposal has been incorporated into Section 201 of Senate Bill (S.) 882, Tax Administration Good Government Act, and, therefore, the IRS does not believe developing an additional legislative proposal is required.

Office of Audit Comment:  We continue to believe our recommendation has merit.  The legislative proposal cited by the Commissioner, SB/SE Division, was referred to the Senate Committee on Finance on April 10, 2003, and had not been acted on as of January 15, 2004.  While applying the underpayment rate on a daily basis would increase the amount of the estimated tax penalty, the increase would not, in our opinion, be sufficient to effectively deter taxpayers from avoiding estimated tax payments.  By our calculations, for example, a taxpayer who missed making a $5,000 estimated tax payment for the October - December 2003 quarter would face an increased penalty of only 66 cents under the proposed tax law change.

To assist in promoting the IRS’ goals to provide prefiling taxpayer assistance, potentially reduce the significant number of taxpayers that are incurring estimated tax penalties and/or filing balance due returns, and potentially reduce the IRS’ eventual collection costs, the Directors, Compliance, SB/SE and W&I Divisions, and the Director, Customer Assistance, Relationships, and Education, W&I Division, should coordinate to:

4.      Develop and send educational midyear reminder notices to those taxpayers that were assessed estimated tax penalties in the prior tax year and had made no estimated tax payments during the first 6 months of the current tax year or had made substantially smaller payments or untimely payments during the first 6 months.  This notice would remind taxpayers of the estimated tax requirements and potentially help them avoid significant penalties before they fall too far behind in their estimated tax payment obligations.

Management’s Response:  The Commissioner, SB/SE Division, disagreed with this recommendation, stating that, in early 2000, the IRS had initiated a “soft letter” project to determine whether a “soft letter” would significantly increase FTD payment compliance.  The Commissioner advised that, based on the results of that study, a reminder notice would have little or no impact on payment compliance.

The Commissioner also disagreed with our estimate that penalty and interest could be reduced by $2.1 billion over 5 years by assuming the midyear reminder notice could result in a 25 percent increase in payment compliance, stating that the percentage was not based on any empirical data.  The Commissioner also did not agree that sending reminder notices to taxpayers assessed estimated tax penalties would reduce collection costs by $12.9 million over 5 years, stating that, based on the results of the FTD “soft letter” study, there would be no collection cost savings and that our estimate did not reflect the administrative cost of adding a midyear reminder notice.

Office of Audit Comment:  We believe the concept of a midyear reminder notice to taxpayers that have stopped making estimated tax payments should, at a minimum, be tested.  The Commissioner, SB/SE Division, cited the results of an FTD “soft letter” project as evidence that a reminder notice would have little or no impact on estimated tax payment compliance.  However, the IRS’ own final report, dated March 2003, on the results of that project recommended “further study about the effectiveness of the ‘soft letter’ as an early intervention tool to improve filing and payment compliance may be warranted.”  Further, the report on the FTD “soft letter” project stated sending a “soft letter” to the taxpayer helped to “winnow out” earlier in the collection pipeline some cases that did not need further contact.  Finally, the FTD “soft letter” was directed to businesses responsible for paying employment taxes.  This customer segment significantly differs from individual taxpayers that are responsible for making estimated tax payments on their nonwage income.

While the Commissioner, SB/SE Division, is correct that there are no empirical data to support our assumption that a midyear reminder notice would improve payment compliance by 25 percent, our estimate that penalties and interest could be reduced by $412.7 million per year, or $2.1 billion over 5 years, was based on 285,400 taxpayers becoming payment compliant.  These 285,400 taxpayers represented only about 5 percent of the 5.7 million noncompliant taxpayers that incurred estimated tax penalties in TY 1998. Similarly, our estimate of the cost savings that could be realized through a 25 percent improvement in payment compliance was based on avoiding collection action on approximately 204,000 taxpayers.  Our estimate of the collection cost savings was reduced by the estimated cost to mail the reminder notices. Our methodology in arriving at these estimates is presented in detail in Appendix IV.

To improve compliance by promoting electronic payment options for making estimated tax payments, the Director, Taxpayer Education and Communication, SB/SE Division, should:

5.      Consider including Tax Form 9783 in the estimated tax packages mailed to taxpayers, expanding the brief explanation of the EFTPS in Publication 505, and amending those IRS instructions and publications applicable to estimated tax payments that do not sufficiently emphasize the EFTPS is offered to taxpayers as a free service by the Department of the Treasury.

Management’s Response:  The Commissioner, SB/SE Division, agreed with this recommendation, stating an E-Submissions Messaging Team was created in August 2003 to ensure information concerning IRS payment options is available and consistent in IRS tax products.  The group is currently reviewing small business publications, notices, and IRS tax packages to ensure electronic payment options are displayed prominently and EFTPS benefits and uses are specifically detailed.  The proper messages emphasize the EFTPS as the preferred payment option and highlight it as a “free” service offered by the Department of the Treasury.

This group will continue to review new ways to enhance Form 1040-ES taxpayer compliance.  Proposals under consideration include 1) adding a coded Form 9783 in the U.S. Individual Income Tax Return (Form 1040) tax package to track the number of enrollments submitted through the paper enrollment process, and 2) providing an information insert describing the benefits and use of the EFTPS and directing taxpayers to the applicable web site for electronic enrollment.

 

Appendix I

 

Detailed Objective, Scope, and Methodology

 

Our objective was to determine if the Internal Revenue Service (IRS) has effective processes for achieving timely intervention when an underpayment or nonpayment of income taxes, Federal Tax Deposits (FTD), and/or estimated taxes is identified.

To meet this objective, we:

I.                    Evaluated the use of outbound calls and timely intervention activities performed by the Automated Collection System (ACS) function.

A.                 Evaluated the types of cases worked at the ACS call sites and determined whether management believes the early intervention method may not be productive.

B.                 Analyzed the types of cases for which the ACS function makes outbound calls and determined whether the outbound calls are successful in collecting funds and closing cases.

C.                 Obtained and analyzed the entire population of 1,136 cases from an “ACS Over $25,000 Case Analysis Study” completed by the Wage and Investment Division to compare the cases closed by the ACS function with outbound calls and the cases closed without outbound calls.

D.                 Determined the status of the Small Business/Self-Employed Division’s Collection Process Improvement study that addresses the use of the predictive dialer as a method for working more ACS function cases.

E.                  Evaluated the feasibility of the predictive dialer process to perform additional outbound calls for the ACS function.

F.                  Analyzed the status of the Business Systems Modernization project for Filing and Payment Compliance that includes a model to shorten the payment compliance life cycle.

II.                 Evaluated the effectiveness of the FTD Alert Program that is designed to prevent delinquencies for small business taxpayers.

A.                 Identified the objectives and goals of the FTD Alert Program and determined whether there is a system to measure Program results.

B.                 Evaluated the status of IRS management’s corrective actions for five audit recommendations on FTD Alerts contained in an audit report issued by the former IRS Inspection function (Service Procedures for Monitoring Federal Tax Deposits (Reference Number 085105, dated August 14, 1998)).

C.                 Evaluated the status of IRS management’s corrective actions for a recommendation on FTD Alerts contained in an audit report issued by the Treasury Inspector General for Tax Administration (Consolidated Report on Opportunities for the Internal Revenue Service to Improve Service to Business Taxpayers (Reference Number 2000-30-015, dated December 1999)).

D.                 Evaluated the current FTD Alert process and the status of IRS Research Projects on the development and testing of a new FTD Alert model.

E.                  Considered methods to improve the FTD Alert Program, e.g., moving the alerts from the Collection Field function to a predictive dialer for outbound calls.

III.               Evaluated the need for a delinquency prevention program for individual taxpayers required to make estimated tax payments.

A.                 Identified the objectives and goals of the estimated tax program.

B.                 Analyzed an IRS Individual Master File (IMF) extract of all Tax Year 1998 individual income tax accounts for which the taxpayers had (1) filed a return after its Calendar Year (CY) 1999 due date or (2) filed a timely return in CY 1999 but had not paid all taxes due by the regular April 15 return due date.  The extract identified 2,025,189 taxpayers that were assessed the estimated tax penalty.

C.                 Considered methods to improve the estimated tax process, such as sending reminder notices to previous estimated tax filers if they do not make any estimated tax payments in the first two payment periods and/or making outbound calls to these taxpayers.

IV.              Evaluated early intervention programs employed by state tax agencies.

A.                 Sent questionnaires to nine state governments to inquire about their collection techniques and early intervention practices.

B.                 Evaluated the six questionnaire responses received and determined whether there are best practices that would benefit the IRS operations.

 

Appendix II

 

Major Contributors to This Report

 

Richard J. Dagliolo, Acting Assistant Inspector General for Audit (Small Business and Corporate Programs)

Philip Shropshire, Director

William E. Stewart, Audit Manager

Theodore J. Lierl, Senior Auditor

Robert A. Nicely, Senior Auditor

Marcus D. Sloan, Auditor

Marjorie A. Stephenson, Auditor

Robert J. Carpenter, Computer Specialist

Layne D. Powell, Computer Specialist

 

Appendix III

 

Report Distribution List

 

Commissioner  C

Office of the Commissioner – Attn:  Chief of Staff  C

Deputy Commissioner for Services and Enforcement  SE

Commissioner, Large and Mid-Size Business Division  SE:LM

Deputy Commissioner, Large and Mid-Size Business Division  SE:LM

Acting Deputy Commissioner, Small Business/Self-Employed Division  SE:S

Deputy Commissioner, Wage and Investment Division SE:W

Director, Compliance, Small Business/Self-Employed Division  SE:S:C

Director, Compliance, Wage and Investment Division  SE:W:CP

Director, Customer Account Services, Small Business/Self-Employed Division SE:S:CAS

Director, Customer Account Services, Wage and Investment Division  SE:W:CAS

Director, Customer Assistance, Relationships, and Education, Wage and Investment Division

SE:W:CAR

Director, Field Specialists, Large and Mid-Size Business Division  SE:LM:FS

Director, Strategy and Finance, Wage and Investment Division  SE:W:S

Director, Taxpayer Education and Communication, Small Business/Self-Employed Division 

SE:S:T

Director, Business Marketing Services, Small Business/Self-Employed Division  SE:S:T

Director, Communications and Liaison, Small Business/Self-Employed Division  SE:S:MS:CL

Director, Filing and Payment Compliance, Wage and Investment Division  SE:W:CP:FPC

Deputy Director, Compliance Policy, Small Business/Self-Employed Division SE:S:C:CP

Director, Payment Compliance, Small Business/Self-Employed Division  SE:S:C:CP:PC

Chief Counsel  CC

National Taxpayer Advocate  TA

Director, Office of Legislative Affairs  CL:LA

Director, Office of Program Evaluation and Risk Analysis RAS:O

Office of Management Controls  OS:CFO:AR:M

Audit Liaisons: 

            Commissioner, Large and Mid-Size Business Division SE:LM

Commissioner, Small Business/Self-Employed Division SE:S

Commissioner, Wage and Investment Division  SE:W

 

Appendix IV

 

Outcome Measures

 

This appendix presents detailed information on the measurable impact that our recommended corrective actions will have on tax administration.  These benefits will be incorporated into our Semiannual Report to the Congress.

Type and Value of Outcome Measure:

·        Taxpayer Rights and Entitlements – Potential; $412.7 million; over 5 years, $2.1 billion in reduced penalty and interest assessments against taxpayers currently being assessed estimated tax penalties (see page 9).

Methodology Used to Measure the Reported Benefit:

We analyzed an IRS Individual Master File (IMF) extract that included all Tax Year (TY) 1998 individual income tax accounts for which the taxpayers had (1) filed a return after its Calendar Year (CY) 1999 due date or (2) filed a timely return in CY 1999 but had not paid all taxes due by the regular April 15 return due date.  This extract identified 2,025,189 taxpayers that were assessed the estimated tax penalty.  The following methodologies were used to estimate the reported benefits:

Taxpayer Rights and Entitlements:  We analyzed all 2,025,189 taxpayer accounts extracted from the universe of 5.7 million taxpayers assessed estimated tax penalties.  Our analysis showed 1,141,599 of the 2,025,189 taxpayers could have benefited from midyear reminder notices from the IRS as a potential means for improving payment compliance and reducing collection costs. We assumed a 25 percent improvement in payment compliance from the reminder notice and determined these taxpayers could avoid $412.7 million in penalties and interest.

As shown in Table 1, these 1,141,599 taxpayers were assessed nearly $1.7 billion in penalties and interest for TY 1998:

Table 1:  Total Penalty and Interest Assessments on Selected Taxpayers

Assessment

Amount

Failure to Pay Penalty

$    299,290,163

Estimated Tax Penalty

      412,302,451

Accrued Penalty

      207,345,154

Interest

      446,318,951

Accrued Interest

      285,584,279

Total

$1,650,840,998

Source:  The Treasury Inspector General for Tax Administration (TIGTA) analysis of IRS Master File data.

Assuming that sending midyear estimated tax payment reminder notices potentially would result in a 25 percent improvement in taxpayer payment compliance, the reduced penalty and interest would be $412,710,250 ($1,650,840,998 X .25) per year, or nearly $2.1 billion over 5 years for 285,400 taxpayers (1,141,599 X .25). The estimated outcomes are based on achieving payment compliance by only 5 percent (285,400/5.7 million) of the taxpayers assessed estimated tax penalties.

Inefficient Use of Resources:  We analyzed 2,025,189 taxpayer accounts from the universe of 5.7 million taxpayers assessed estimated tax penalties.  Our analysis indicated 1,141,599 of the 2,025,189 taxpayers could have benefited from midyear reminder notices from the IRS as a potential means to prevent or minimize future estimated tax penalties, future balance due returns, and future accounts receivable.  These included:

·        603,533 taxpayers that were assessed estimated tax penalties for TY 1997 but made no estimated tax payments for TY 1998.

·        111,913 taxpayers that made estimated tax payments for TY 1997 but made none for TY 1998.

Our analysis showed 324,928 of the 1,141,599 taxpayers fully paid their taxes when they filed their returns, and the IRS subsequently sent 1 or more collection notices for delinquent taxes and/or penalties and interest to the remaining 816,671 taxpayers.  In addition, the accounts of 143,497 taxpayers eventually reached the Taxpayer Delinquent Account (TDA) status in the Automated Collection System (ACS) function inventory, and 26,580 of these were ultimately referred to the Collection Field function (CFf) for resolution.

Table 2 shows our estimate of the IRS collection costs on these 816,671 taxpayer accounts:

Table 2: Estimated Collection Costs

Category

Number

Unit Cost

Total Estimated Cost

Collection Notices

646,594

$    2.02

$  1,306,120

ACS TDAs

143,497

    14.44

    2,072,097

CFf TDAs

  26,580

   291.10

    7,737,438

Total

816,671

 

$11,115,655

Source:  TIGTA analysis of IRS Master File data and IRS cost data.

Assuming that sending a midyear estimated tax payment reminder notice potentially would result in a 25 percent improvement in taxpayer compliance, the reduced annual IRS collection costs would be $2,778,914 ($11,115,655 X .25) for 204,168 taxpayers (816,671 X .25).  We estimate the IRS’ mailing costs to send midyear estimated tax payment reminder notices to 1,141,599 taxpayers would be $194,072 (1,141,599 notices @ $.17 each).

The reduced IRS collection costs of $2,778,914 would be offset by increased mailing costs of $194,072. Thus, the potential net saving would be $2,584,842 per year, or $12.9 million over 5 years.

 

Appendix V

 

Management’s Response to the Draft Report

 

The response was removed due to its size.  To see the response, please go to the Adobe PDF version of the report on the TIGTA Public Web Page.