Federal Tax Deposit Penalties Have Been Significantly Reduced, but Additional Steps Could Further Reduce Avoidable Penalty Assessments

 

September 2005

 

Reference Number:  2005-30-136

 

 

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.

 

September 2, 2005

 

 

MEMORANDUM FOR DEPUTY COMMISSIONER FOR SERVICES AND ENFORCEMENT

 

FROM:     Pamela J. Gardiner /s/ Pamela J. Gardiner

                 Deputy Inspector General for Audit

 

SUBJECT:     Final Audit Report - Federal Tax Deposit Penalties Have Been Significantly Reduced, but Additional Steps Could Further Reduce Avoidable Penalty Assessments (Audit # 200430016)

 

This report presents the results of our review of Federal Tax Deposit (FTD) penalties assessed and abated by the Internal Revenue Service (IRS).  The overall objectives of this review were to determine whether current studies and workgroups were effectively addressing FTD compliance and issues raised by the IRS Taxpayer Advocate Service (TAS), whether recent changes were effective in improving FTD compliance, and whether other changes to the FTD penalty program could further improve compliance or reduce taxpayer burden.

In summary, there are specific rules regarding the timing and methods for making FTD payments.  If payments are not made timely or correctly, the IRS imposes FTD penalties.  These rules are considered by many to be complex and confusing.  The IRS TAS has repeatedly cited concerns regarding this area of tax administration.  We performed computer analyses of taxpayer accounts with FTD penalties assessed for Tax Year (TY) 2003 on the IRS Business Master File.  Our preliminary analysis identified over 1.4 million returns with FTD penalties assessed totaling $3.4 billion.

The number of FTD penalties assessed and subsequently abated has declined significantly.  The IRS has taken steps to reduce both the number and dollar amounts of assessed and abated FTD penalties.  It has developed notices to inform taxpayers of changes in deposit requirements as withholding and employment tax liabilities increase, and has implemented a one-time penalty abatement program for taxpayers that voluntarily use the Electronic Federal Tax Payment System for 1 full year.

The TAS reports cited the complexity of the FTD rules as a contributing factor to the high rates of FTD penalty assessments and abatements.  We agree that these rules are complex and hard to understand and most likely contribute to the number of penalties assessed.  However, our review of a judgmental sample of 194 penalties assessed on the TY 2003 Employer’s Quarterly Federal Tax Returns (Form 941) indicated complexity was not the primary reason for many FTD penalty assessments.  Of the 194 taxpayers with penalties, 183 had either a history of paying correctly or other indicators that they knew the deposit requirements.  Most of these taxpayers just paid late or paid the tax with their returns instead of making timely and required FTD deposits. 

The IRS currently has a program in place that helps avoid assessment of unnecessary FTD penalties on certain returns that do not have valid liability information included with them.  Penalties on these returns would normally be computed by averaging the taxpayers’ liabilities over the quarter.  Instead of making the averaged penalty assessment, the IRS, in certain cases meeting its criteria, issues a Computer Paragraph (CP) 207 Notice to the taxpayers asking for additional information to help avoid the penalty assessment.  However, the criteria for this program are limited and do not necessarily identify all the larger-dollar cases.

The IRS Office of Penalties and Interest has developed and forwarded two Requests for Information Services to the IRS Chief Information Officer to expand this program to include significantly more of the averaged penalties.  These steps should significantly reduce the large penalty assessments and abatements.  However, we believe the IRS should take additional steps to further reduce the assessment/abatement problems. 

We reviewed the 2,000 largest penalties assessed on Forms 941 in TY 2003.  The penalties totaled almost $1.12 billion.  Approximately $1.05 billion (94 percent) of that amount was abated as of April 26, 2005.  Since approximately 26 percent of the 2,000 largest-dollar penalties we reviewed did not meet the criteria for the CP 207 Notice, but instead involved penalties computed based on apparently valid information filed with the returns, the IRS should consider developing a notice similar to the CP 207 Notice that will apply to these cases.  Criteria for this notice would have to be based on research of the characteristics of these cases, including the amount of the penalties.  In discussions with us, the TAS agreed with this concept but believes the IRS needs to make some improvements to the CP 207 Notice before expanding the program.

The IRS should also determine why certain taxpayers repeatedly incur and pay FTD penalties and take steps to change this trend.  We identified more than 87,000 taxpayers that had FTD penalties assessed in 9 or more of the 12 quarters during TYs 2001 through 2003, including 20,893 taxpayers with penalties assessed in all 12 quarters.  We reviewed a statistical sample of accounts for 102 of these 20,893 taxpayers and found that 60 percent paid these penalties each quarter.  The penalties assessed averaged $1,805 per quarter or $21,659 over the 3-year period. 

We recommended the Director, Office of Penalties and Interest, Small Business/Self-Employed (SB/SE) Division, work with appropriate staff from the offices of the Commissioners, Large and Mid-Size Business Division, SB/SE Division, and Wage and Investment Division to (1) address the TAS’ concerns with the CP 207 Notice, (2) ensure the steps proposed by the IRS Office of Penalties and Interest to expand the CP 207 Notice reviews are implemented, and (3) commission a research project with the objective of identifying other large FTD penalties that are likely to be reversed and developing procedures similar to those used with the CP 207 Notice.  We also recommended these officials commission a research project to identify taxpayers that incur and timely pay FTD penalties on a recurring basis with the objective of determining the cause and developing a strategy to reduce assessment of repeat penalties for this taxpaying segment. 

Management’s Response:  IRS management agreed with our recommendations.  They have enhanced the programming for the CP 207 Notice generation process and developed a new CP 207L Notice for proposed penalties of $100,000 or more.  Management’s response addresses cases meeting the criteria for the CP 207 Notice (no valid liability information included on the return) but does not address cases based on apparently valid information filed with the returns, as recommended.  On August 12, 2005, the Office of Penalties and Interest requested a copy of the data reviewed in our audit and will study those data for characteristics of other cases that may benefit from a notice similar to the CP 207 Notice.  In addition, the Office of Penalties and Interest and the TAS plan to review the effectiveness of the revised CP 207 Notice and new CP 207L Notice in mid-2007 when they will have 4 quarters of posted information available.  Therefore, we concur with the corrective action proposed by the IRS.

The Director, Office of Penalties and Interest, will also commission a research project to identify taxpayers that incur and timely pay FTD penalties on a recurring basis, determine the cause(s) of this behavior, and develop a strategy to reduce repeat penalty assessments for this taxpaying segment.  Management’s complete response to the draft report is included as Appendix VII.

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 Curtis Hagan, Assistant Inspector General for Audit (Small Business and Corporate Programs), at (202) 622-3837.

 

Table of Contents

Background

The Number and Dollar Amounts of Federal Tax Deposit Penalties Assessed and Subsequently Abated Have Declined Significantly

The Internal Revenue Service Has Implemented Programs to Help Reduce Deposit Penalties for Taxpayers Having Changes in Their Deposit Requirements

The Internal Revenue Service Is Implementing a One-Time Penalty Abatement for Taxpayers Who Voluntarily Use the Electronic Federal Tax Payment System for 1 Year

Taxpayers Responsible for Making Timely Payments Failed to Do So

The Internal Revenue Service Should Review Potential Large-Dollar Federal Tax Deposit Penalties Before Making Actual Assessments

Recommendations 1 through 3:

The Internal Revenue Service Should Determine Why Certain Taxpayers Repeatedly Incur Federal Tax Deposit Penalties and Take Steps to Change This Trend

Recommendation 4:

Appendix I – Detailed Objectives, Scope, and Methodology

Appendix II – Major Contributors to This Report

Appendix III – Report Distribution List

Appendix IV – Outcome Measures

Appendix V – Federal Tax Deposit Penalty Rules and Percentages

Appendix VI – Federal Tax Deposit Rules – Publication 15 (Circular E), Employer’s Tax Guide

Appendix VII – Management’s Response to the Draft Report

 

Background

Business taxpayers generally pay their Federal payroll taxes by periodically depositing payment amounts in a bank or other financial institution that is authorized to accept these payments.  This type of payment is called a Federal Tax Deposit (FTD).  FTDs account for most of the revenue received by the Internal Revenue Service (IRS).  Taxes that are paid through the FTD process include:

  • Income taxes withheld from employees.
  • Social Security and Medicare taxes withheld from employees plus the employer’s matching portion.
  • Federal unemployment taxes.
  • Certain excise taxes.

There are specific rules regarding the timing and methods for making FTD payments.  For example, a business with a history of significant tax liabilities may be required to deposit using the IRS Electronic Federal Tax Payment System (EFTPS).  Also, the timing of the required deposit is generally based on the business’ past and present tax liabilities. 

If payments are not made timely or correctly, the IRS imposes FTD penalties.  Penalties for untimely payments are assessed on a sliding scale based on the amount of time the payments are late.  Penalties for payments made incorrectly, such as including a payment with a tax return when deposits are required or not making required electronic deposits, are also imposed.

These rules are considered by many to be complex and confusing.  The IRS Taxpayer Advocate Service (TAS) stated in its 2003 Annual Report:

There is a significant problem in the administration of the FTD penalty.  A substantial number of penalties assessed under IRC [Internal Revenue Code] section 6656 are abated.  Current IRS practices result in both the IRS and taxpayers expending valuable time and resources in negotiating requests for abatement of the FTD penalty.  Further, taxpayer confusion about Federal tax reporting can lead to penalties.

This Report also noted that, the higher a penalty amount, the more likely it was to be abated.  The Report indicated that, of $4.9 billion in FTD penalties assessed in 2003, nearly $3 billion was abated.  The TAS 2002 Annual Report also cited concerns about difficulties taxpayers have with rules relating to when deposits must be made.

We initiated this review to determine whether actions undertaken by the IRS were effectively addressing issues raised by the TAS, as well as addressing other FTD compliance issues.  We performed computer analyses of taxpayer accounts with FTD penalties assessed in Tax Year (TY) 2003 on the IRS Business Master File (BMF).  Our preliminary analysis identified over 1.4 million returns with FTD penalties assessed totaling $3.4 billion, with the Employer’s Quarterly Federal Tax Return (Form 941) accounting for 97 percent of all returns with penalties and 92 percent of the penalty dollars assessed.  Because of this, we limited our detailed review to Forms 941.

This review was performed from September 2004 through June 2005 at the Ogden, Utah, and Fresno, California, Campuses using tax return information filed nationwide.  The audit was conducted in accordance with Government Auditing Standards.  Detailed information on our audit objectives, scope, and methodology is presented in Appendix I.  Major contributors to the report are listed in Appendix II.

The Number and Dollar Amounts of Federal Tax Deposit Penalties Assessed and Subsequently Abated Have Declined Significantly

The number of FTD penalties assessed and penalties abated has declined significantly.  IRS Statistics of Income (SOI) Division data show that, between Fiscal Years (FY) 2000 and 2004, the number of employment tax-related FTD penalties decreased each year, from 4.2 million to 2.3 million.  The number of penalties abated stayed about the same as a percentage of the total, approximately 22 percent. 

Figure 1:  Total Number of FTD Penalties Assessed and Abated

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.

The dollar amounts of these assessed penalties also decreased significantly, from $5.7 billion to $3.7 billion.  The dollars abated over that time averaged approximately 60 percent. 

Figure 2:  Total FTD Penalty Dollars Assessed and Abated

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.

We conducted a computer analysis of IRS tax return records and found that, of the 23.6 million TY 2003 Forms 941 filed, 1.43 million (6.1 percent) were assessed FTD penalties.  Our numbers are lower than those in the SOI Division statistics because we included only Forms 941 and because we looked at each quarterly tax return in total and not as individual assessment and abatement transactions.  For example, one return can have multiple assessments and abatements caused by changes to returns or by misapplied payments being located.  

Although FTD penalties assessed and abated have declined significantly, approximately 1 in 16 Forms 941 filed is still assessed an FTD penalty.  We found the majority of penalties assessed and then abated were caused by taxpayer errors or omissions.  This represents a challenge for both the IRS and business taxpayers.

The Internal Revenue Service Has Implemented Programs to Help Reduce Deposit Penalties for Taxpayers Having Changes in Their Deposit Requirements

In general, a business that has payroll taxes of $2,500 or more in a quarter is required to make monthly FTD payments (or deposits), due the 15th of each succeeding month.  As a business grows and its employment tax liability increases, it may be required to start making what are referred to as semi-weekly deposits.  Depending on the day of the week the tax liability is incurred, semi-weekly deposits are made on the subsequent Wednesday or Friday.  The rules for these deposit requirements can be confusing.  To help taxpayers make the change in deposit requirements, the IRS has implemented several steps to inform and educate them.

Before the start of a new tax year, taxpayers that have to change from monthly to semi-weekly deposits receive a Computer Paragraph (CP) 136 Notice informing them of their deposit requirement changes.  This Notice includes details regarding how the determination was made and provides instructions on how to make timely deposits. 

The IRS Office of Penalties and Interest recently introduced a second notice that is sent to taxpayers as soon as it becomes apparent they may still be making monthly deposits instead of required semi-weekly deposits.  The notice is sent after the first month of the new period is reviewed and is referred to as the early intervention notice (CP 236 Notice).  The IRS has also implemented an automatic waiver of the penalty (communicated by a CP 235 Notice) for the first quarter of the deposit requirement change if taxpayers do not meet the new deposit requirements.  With each notice, the IRS includes the rules and instructions regarding the taxpayer’s new deposit requirements. 

The IRS Office of Penalties and Interest believed the additional notice (CP 236 Notice) would reduce the first and second quarter penalties from TY 2003 to TY 2004.  Our computer analysis of these tax periods showed penalties assessed were, in fact, down approximately 16 percent and dollars assessed were down almost 25 percent.  There were about 1.5 percent fewer returns filed in the 2004 period, but the numbers are still adequate to show the intended effect was achieved.

The Internal Revenue Service Is Implementing a One-Time Penalty Abatement for Taxpayers Who Voluntarily Use the Electronic Federal Tax Payment System for 1 Year

The IRS implemented the EFTPS to improve the accuracy of deposit information and to make it easier for taxpayers to make deposits.  Electronic collections increased from $1.15 trillion in 1998 to $1.6 trillion in 2004.  Currently, almost 96 percent of employment taxes are paid by electronic funds transfers.  Electronic deposits help to significantly reduce deposit errors and errors in filling out and processing paper FTD coupons.

The IRS, through its Taxpayer Education and Communication Office, is marketing the EFTPS through a new incentive program.  Beginning with TY 2005, the IRS will provide a one-time FTD penalty abatement for taxpayers that voluntarily enlist in the EFTPS program and use it successfully for 1 full year. 

Taxpayers Responsible for Making Timely Payments Failed to Do So

The TAS Annual Reports cited the high rates of FTD penalty assessments and abatements as an issue involving the complexity of the FTD rules.  We agree that these rules are complex and, during initial reading, can be hard to understand (see Appendix VI).  This complexity most likely contributes to the number of penalties assessed; however, our review of a judgmental sample of 194 penalties assessed on TY 2003 Forms 941 indicated the reasons for assessment of FTD penalties were not just instruction or complexity issues.  We determined 183 of those taxpayers had either a history of paying correctly or other indicators that they knew the deposit requirements, such as prior waivers and reasonable cause abatements of the penalty.  Most of these taxpayers just paid late or paid with the returns instead of making timely and required FTD deposits. 

From our sample of 194 penalties, 10 cases did involve changes in deposit requirements.  However, the early notification program mentioned above had fully informed these taxpayers of their deposit requirements.  Taxpayers in all 10 cases had received the automatic first quarter waiver of the FTD penalty, and 6 of those had received an additional reasonable cause abatement of penalty for the second quarter.

The Internal Revenue Service Should Review Potential Large-Dollar Federal Tax Deposit Penalties Before Making Actual Assessments

The IRS has committed to reduce taxpayer burden and improve compliance related to FTD penalties and has implemented several steps mentioned previously.  We identified additional steps the IRS could take to further accomplish this objective.  The first step, discussed here, involves large-dollar FTD penalty assessments.  (A second step is discussed on page 10.)

We stratified the FTD penalties assessed on Forms 941 during TY 2003 and reviewed the characteristics of the 2,000 largest penalty transactions.  These penalties totaled almost $1.12 billion and ranged from nearly $102,000 to over $32 million.  Approximately $1.05 billion (94 percent) of that amount had been abated as of April 26, 2005.  This 94 percent reversal rate supports the TAS 2003 Annual Report contention that large-dollar penalties are much more likely to be reversed.

The IRS currently has a program in place that helps avoid assessment of unnecessary FTD penalties on certain returns that do not have valid liability information included with them.  Penalties on these returns would normally be computed by averaging the taxpayers’ liabilities over the quarter.  Instead of making the averaged penalty assessment, the IRS, for cases meeting its criteria, issues a CP 207 Notice to the taxpayers asking for additional information to help avoid the penalty assessment.  However, the IRS limited the criteria for this program and did not address all the larger-dollar cases. 

The IRS Office of Penalties and Interest has developed and forwarded two Requests for Information Services to the IRS Chief Information Officer to expand this program to include significantly more of the averaged penalties.  These steps should significantly reduce the large penalty assessments and abatements.  We believe an additional step could further reduce large-dollar assessments and abatements.

Since approximately 26 percent of the 2,000 largest-dollar penalty cases we reviewed did not meet the criteria for the CP 207 Notice program, but instead involved penalties computed based on apparently valid information filed with the returns, the IRS should consider developing a notice similar to the CP 207 Notice that will apply to these cases.  The intent would be to delay actual assessment on these cases and make contact with the taxpayers on large-dollar penalties that are not based on the averaging method to which the CP 207 Notice applies.

Criteria for this notice would have to be based on research of the characteristics of these cases including the dollar amount of the penalties and the probability that the penalties would be reversed.  For example, criteria for issuing the notice could include dollar amounts representing a 75 percent probability of being reversed. 

Our review was limited to penalties of nearly $102,000 and higher, which represented the top 2,000.  Again, 94 percent of the total dollars assessed on our 2,000 penalty transactions were subsequently abated.  Depending on resource availability, the IRS could set its criteria for issuing this notice significantly lower than the $102,000, which was the lowest penalty dollar amount in our strata.

By not assessing penalties over a certain dollar amount (which the IRS would set) before contacting the taxpayers directly to determine whether the proposed penalties are correct, the IRS could provide a more proactive and customer-oriented method to resolve these penalties.  Such a program could also start the process to correct the probable problem earlier.  We looked at the time it took to resolve 100 of the 2,000 cases and found the average time from the penalty assessment date to the abatement date was 13 weeks.

In discussions with us, the TAS agreed with the concept of expanding the use of the CP 207 Notice and developing a similar notice to address other large-dollar FTD penalties but expressed the opinion that the IRS needs to make some improvements to the CP 207 Notice and related IRS processing procedures before expanding the program.

Recommendations

The Director, Office of Penalties and Interest, Small Business/Self-Employed (SB/SE) Division, should coordinate with appropriate staff from the offices of the Commissioners, Large and Mid-Size Business (LMSB) Division, SB/SE Division, and Wage and Investment (W&I) Division, to:

1.      Address the TAS’ concerns with the CP 207 Notice and related processing issues.

Management’s Response:  The IRS has enhanced the programming for the CP 207 Notice generation process and developed a new CP 207L Notice for proposed penalties of $100,000 or more.  The Director, Office of Penalties and Interest, SB/SE Division, and the TAS plan to review the effectiveness of the revised CP 207 Notice and new CP 207L Notice in mid-2007 when they will have 4 quarters of posted information available.

2.      Ensure the steps proposed by the IRS Office of Penalties and Interest to expand the CP 207 Notice reviews are implemented.

Management’s Response:  The Director, Exam Policy, SB/SE Division, has obtained approval of Requests for Information Services that are on schedule to implement the expanded CP 207 Notices for generation on first quarter 2006 Forms 941.

3.      Commission a research project with the objective of identifying other large FTD penalties that are likely to be reversed and developing a notice similar to the CP 207 Notice and implement procedures to contact the taxpayers and resolve the proposed penalties prior to assessment.  Criteria for this notice should be evaluated based on availability of resources and the probability that the penalty would ultimately be reversed.

Management’s Response:  The Large Corporation Units in Ogden, Utah, and Cincinnati, Ohio, will review CP 207L Notices and make taxpayer contacts prior to mailing.  The Director, Exam Policy, SB/SE Division, will assess the benefit of reducing the notice dollar threshold based on the success of this CP 207L Notice process and the resources used to work this Notice.

Office of Audit Comment:  Management’s response addresses cases meeting the criteria for the CP 207 Notice (no valid liability information included on the return) but does not address cases based on apparently valid information filed with the returns, as recommended.  On August 12, 2005, the Office of Penalties and Interest requested a copy of the data reviewed in our audit and will study those data for characteristics of other cases that may benefit from a notice similar to the CP 207 Notice.  In addition, as mentioned earlier, the Office of Penalties and Interest and the TAS plan to review the effectiveness of the revised CP 207 Notice and new CP 207L Notice in mid-2007 when they will have 4 quarters of posted information available.  Therefore, we concur with the corrective action proposed by the IRS.

The Internal Revenue Service Should Determine Why Certain Taxpayers Repeatedly Incur Federal Tax Deposit Penalties and Take Steps to Change This Trend

Many of the taxpayers included in our sample of 194 penalty cases (discussed previously) had multiple FTD penalties.  For these cases, we reviewed the 6 quarters between January 1, 2003, and June 30, 2004, and found that 128 (66 percent) had penalties assessed in 3 or more of these 6 quarters.  Because of the high rate of recurrence, we performed another computer analysis of the BMF to determine how many taxpayers had multiple FTD penalties assessed on TYs 2001, 2002, and 2003 quarterly returns.  We found that, in the 12 quarters of those years, 908,000 taxpayers had more than 1 FTD penalty assessed.  More than 87,000 taxpayers had penalties assessed in 9 or more quarters (913,915 separate penalty assessments).

We performed an analysis of the accounts of 20,893 taxpayers that had penalties assessed in all 12 quarters and found a large percentage of these taxpayers appeared to treat the penalty as a cost of doing business and/or did not fully understand the cause and impact of the penalty.  We reviewed tax account information for a statistically valid sample of 102 of these 20,893 taxpayers and found that approximately 60 percent paid these penalties each quarter.  The penalties assessed to these taxpayers averaged $1,805 per quarter or $21,659 during the 3-year period. 

Part of the IRS’ mission is to help taxpayers understand their tax responsibilities.  The IRS currently does not help taxpayers that continue to be assessed and pay FTD penalties determine why they continually incur these penalties and what the taxpayers could do to avoid them. 

The IRS could use our computer-identified list of taxpayers or develop different criteria to identify taxpayers that pay the FTD penalty repeatedly.  The IRS should consider either a direct contact program or a mailed survey to identify education or compliance areas that could be stressed to reduce this recidivism rate.  By developing a strategy to reduce or eliminate the assessment of repeat penalties for this taxpaying segment, the IRS could save these taxpayers more than $270 million over a 3-year period.

Recommendation

4.      The Director, Office of Penalties and Interest, SB/SE Division, should coordinate with appropriate staff from the offices of the Commissioners, LMSB Division, SB/SE Division, W&I Division, and the TAS to commission a research project to identify taxpayers that incur and timely pay FTD penalties on a recurring basis with the objective of determining the cause and developing a strategy to reduce assessment of repeat penalties for this taxpaying segment.  Consideration should be given to contacting these taxpayers directly or through a notice or questionnaire.

Management’s Response:  The Director, Office of Penalties and Interest, SB/SE Division, has requested the data reviewed in this audit and, in September 2005, will commission a research project to identify taxpayers that incur and timely pay FTD penalties on a recurring basis, determine the cause(s) of this behavior, and develop a strategy to reduce repeat penalty assessments for this taxpaying segment. 

 

Appendix I

 

Detailed Objectives, Scope, and Methodology

 

The overall objectives of this review were to determine whether current studies and workgroups were effectively addressing Federal Tax Deposit (FTD) compliance and issues raised by the Internal Revenue Service (IRS) Taxpayer Advocate Service (TAS), whether recent changes were effective in improving FTD compliance, and whether other changes to the FTD penalty program could further improve compliance or reduce taxpayer burden.  To accomplish these objectives, we:

I.                   Determined whether current studies and workgroups were effectively addressing FTD compliance.

A.    Reviewed portions of the TAS 2002 and 2003 Annual Reports related to FTD penalty issues and the IRS Office of Penalties and Interest response to those reports to evaluate the extent of the reviews and complexity of raised issues.

B.     Reviewed research projects and employment tax literature compilations to identify studies being conducted and issues raised and/or resolved by those studies.  This included the IRS Office of Penalties and Interest Final Report dated October 16, 1998.

C.     Reviewed the Office of Penalties and Interest Post Notice Review Compliance Initiatives and looked at work being conducted by the Taxpayer Advocacy Panel on an annual Employment Tax Return initiative.

II.                Determined whether there were areas of the FTD penalty program that could be enhanced to improve compliance or reduce taxpayer burden.

A.    Obtained a computer database of Business Master File accounts that had FTD penalty assessments (and any related abatements) made between January 1, 2001, and June 30, 2004.

B.     Selected and reviewed, from 1.4 million taxpayer accounts having FTD penalties assessed during 2003, a judgmental sample of 194 (we selected 202 penalty transaction codes at random and eliminated 8 that were related to the Computer Paragraph (CP) 207 Notice and were for $0.00) to determine the reasons for assessments and any subsequent abatements, to identify sample characteristics and trends, and to determine any possible actions that could reduce burden or prevent unnecessary assessments.

C.     Performed various data analyses to verify or refute assumptions regarding taxpayer categories and related FTD penalty trends.  Special analyses included a review of taxpayers with multiple penalties and a review of the 2,000 largest-dollar assessments and subsequent abatements related to those large-dollar assessments.  As part of this analysis, we selected a judgmental sample of 100 transactions and evaluated the average length of time taken to abate the penalty. 

D.    Performed a data analysis of taxpayers with penalties in multiple quarters.  As part of this analysis, we selected a statistically valid sample of 102 of the 20,893 taxpayers (95 percent confidence, +/- 10 percent precision range, expected occurrence rate of 60 percent) with penalties assessed in all 12 quarters during Calendar Years 2001, 2002, and 2003.

III.             Determined whether recent changes were effective in improving FTD compliance.

A.    Performed a computer analysis to compare the numbers and dollar amounts of FTD penalties assessed in the first and second quarters of 2003 with the numbers and dollar amounts of penalties assessed in the first and second quarters of 2004 to determine whether the new CP 236 Notice (intervention notice, reminder to deposit semi-weekly) had reduced total penalties as the IRS predicted.

B.     Reviewed the new program that allows a one-time waiver of the FTD penalty for taxpayers that move from paying with coupons to the Electronic Federal Tax Payment System (EFTPS) that starts in Tax Year 2005.  We reviewed IRS publicity for this program as well as the Request for Information Services (RIS) developed to ensure proper programming and comments related to this RIS.  As part of this analysis, we reviewed payroll tax payment trends for both the EFTPS and coupon payments for recent years.

IV.             Determined whether issues raised by the TAS regarding clarity of notices, forms, and instructions were still of concern and whether changes could be made to improve the FTD process.

A.    Reviewed all employment and excise tax forms and associated instructions that relate to FTD penalty provisions to determine clarity of instructions and possible areas for improvement.

B.     Reviewed general notices, such as math error and balance due notices related to employment and excise tax returns, to identify high-volume issues and any relevant trends.  We also reviewed notices specific to FTD penalties that are the responsibility of the IRS Office of Penalties and Interest.  This included a detailed review of the Annual Notification of FTD Deposit Requirements (CP 136 Notice), the Reminder to Deposit Semi-weekly (CP 236 Notice), and the Notice of Penalty Waiver Due to the Change in the Deposit Requirement (CP 235 Notice).

 

Appendix II

 

Major Contributors to This Report

 

Curtis Hagan, Assistant Inspector General for Audit (Small Business and Corporate Programs)

Richard J. Dagliolo, Director

Kyle R. Andersen, Audit Manager

Greg Schmidt, Lead Auditor

Annette Bates, Senior Auditor

Debra D. Morgan, Auditor

Layne Powell, Information Technology Specialist

Dorothy Richter, Information Technology Specialist

 

Appendix III

 

Report Distribution List

 

Commissioner  C

Office of the Commissioner – Attn:  Chief of Staff  C

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

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

Commissioner, Tax Exempt and Government Entities Division  SE:T

Commissioner, Wage and Investment Division  SE:W

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

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

Deputy Commissioner, Tax Exempt and Government Entities Division  SE:T

Deputy Commissioner, Wage and Investment Division  SE:W

Director, Research, Small Business/Self-Employed Division  SE:S:SRM:R

Director, Taxpayer Education and Communication, Small Business/Self-Employed Division  SE:S:CGL&D:T

Director, Office of Penalties and Interest, Small Business/Self-Employed Division  SE:S:C:CP:PC:P

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: 

            Deputy Commissioner for Services and Enforcement  SE

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

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

Commissioner, Tax Exempt and Government Entities Division  SE:T:CL

Commissioner, Wage and Investment Division  SE:W:S:W

 

Appendix IV

 

Outcome Measures

 

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

Type and Value of Outcome Measure:

·         Taxpayer Rights and Entitlements – Potential; $270,607,546 applicable to 12,494 taxpayer accounts (see page 10).

Methodology Used to Measure the Reported Benefit:

We obtained Internal Revenue Service (IRS) Business Master File records of 20,893 Employer’s Quarterly Federal Tax Returns (Form 941) filed for tax periods in Calendar Years 2001 - 2003 that had Federal Tax Deposit penalties assessed on all 12 quarterly returns.  We selected a statistically valid sample of 102 of these taxpayers at a 95 percent confidence level, an expected error rate of 60 percent, and a precision of +/- 10 percent.  We found that 59.8 percent of the taxpayers in our sample consistently paid these penalties.  Based on the results of our sample, we estimate that 12,494 of the taxpayers in our population paid the penalties in each of the 12 quarters.  On average, the penalties incurred by these taxpayers over the 3-year period totaled $21,659.  By developing a strategy to reduce or eliminate assessment of repeat penalties for this taxpaying segment, the IRS could save these taxpayers $270,607,546 (12,494 taxpayers X $21,659).

 

Appendix V

 

Federal Tax Deposit Penalty Rules and Percentages

 

Failure to make timely deposit of employment taxes can result in the Federal Tax Deposit (FTD) penalty being assessed.  The penalty is based on a graduated four-tier system.  The penalty amount varies with the length of time within which the taxpayer corrects the failure to make the required deposit.  It is determined as follows:

  • Two percent – Payment is no more than 5 days late.
  • Five percent – Payment is more than 5 days late but no more than 15 days late.
  • Ten percent – Payment is more than 15 days late.
  • Fifteen percent – If the payment is not made on or before the day that is 10 days after the date of the first delinquency notice to the taxpayer.

In addition,

·         Ten percent – Amounts subject to electronic deposit requirements but not deposited using the Electronic Federal Tax Payment System.

·         Ten percent – Deposits made at an unauthorized financial institution, paid directly to the Internal Revenue Service, or paid with the tax return (when FTD deposits are required).

 

Appendix VI

 

Federal Tax Deposit Rules – Publication 15 (Circular E), Employer's Tax Guide

 

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.

 

Appendix VII

 

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.