TREASURY INSPECTOR GENERAL FOR TAX ADMINISTRATION

 

 

 

Repeated Efforts to Modernize Paper Tax Return Processing Have Been Unsuccessful; However, Actions Can Be Taken to Increase Electronic Filing and Reduce Processing Costs

 

 

 

September 10, 2009

 

Reference Number:  2009-40-130

 

 

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.

 

Phone Number   |  202-622-6500

Email Address   |  inquiries@tigta.treas.gov

Web Site           |  http://www.tigta.gov

 

September 10, 2009

 

 

MEMORANDUM FOR COMMISSIONER, WAGE AND INVESTMENT DIVISION

 

FROM:                            Michael R. Phillips /s/ Michael R. Phillips

                                         Deputy Inspector General for Audit

 

SUBJECT:                    Final Audit Report – Repeated Efforts to Modernize Paper Tax Return Processing Have Been Unsuccessful; However, Actions Can Be Taken to Increase Electronic Filing and Reduce Processing Costs (Audit # 200940010)

 

This report presents the results of our review to assess the Internal Revenue Service’s (IRS) strategy to convert paper-filed individual income tax returns into an electronic format.  This audit was included as part of our Fiscal Year 2009 Annual Audit Plan under the major management challenge of Modernization of the IRS.

Impact on the Taxpayer

In Calendar Year 2008, the IRS received 156.3 million individual income tax returns, of which 66.4 million (42.5 percent) were paper-filed.  The IRS has devoted significant resources to identify ways it could modernize its method for processing paper tax returns but has had no success.  Actions can be taken including mandating electronic filing (e-filing) for paid preparers and developing processes to convert paper returns into an electronic format which would significantly reduce paper filings, processing costs, and error rates, with the added benefit of faster tax refunds and more accurate tax returns for taxpayers.

Synopsis

The IRS continues to receive large numbers of paper-filed individual income tax returns despite a continued growth in e-filing.  Processing of paper-filed tax returns costs the IRS approximately $190.6 million.  Error rates are considerably higher for paper-filed tax returns.  Many errors are due to IRS employee keypunch errors when inputting information from the paper tax returns into IRS computers.  In contrast, e-filed tax returns are sent through a number of validations before the IRS accepts them.  Unlike a paper tax return, an e-filed tax return is not accepted until the validity check confirms the tax return is free of errors.  Once notified of an error, the taxpayer or preparer has to correct the tax return and resubmit it through e-filing or by paper.  In some instances, rejected returns are not resubmitted.

Because the IRS has not been able to implement a modernized submission processing system to convert paper tax returns into an electronic format, it has to continue to use a labor intensive, costly, and error-prone system.

Repeated efforts have been initiated to modernize paper tax return processing with no success.  Significant resources have been expended on developing modernization concepts.  Since at least as far back as 1988, the IRS has attempted to develop a system to replace its current paper tax return processing.  However, these efforts have resulted in little more than conceptual visions.

While the IRS has not been able to move beyond the conceptual stage for modernizing paper processing, there are actions that would reduce paper filings and/or convert paper tax returns into an electronic format.  These options could result in a significant increase in e-filing as well as significant processing cost savings to the IRS.  The options are:

  • Mandate e-filing for paid preparers (this option would require a change in the law).  The majority of paid preparers are already familiar with operating in an electronic environment.  Most paid preparers who filed paper tax returns[1] actually used an electronic tax software preparation package and 70 percent also e-filed at least 1 tax return, which indicates a familiarity with the electronic preparation and e-filing process.
  • Convert residual paper returns into an electronic format.  Updating the Modernized Submission Processing concept to include pursuing successful processes followed by States that use scanning technology could provide the IRS with an option to convert paper-filed tax returns into an electronic format, thereby reducing processing costs associated with paper-filed tax returns.

Implementation of these 2 options could result in a 26.9 percent increase in e-filing, with cost savings of $66.6 million annually ($333 million over 5 years), and provide the ability to convert 13.2 million paper tax returns into an electronic format.

Recommendations

We recommended that the Commissioner, Wage and Investment Division, pursue implementing successful processes followed by States that use scanning technology (Optical Character Recognition and Two-Dimensional Bar Codes) to convert paper-filed tax returns prepared by individuals using a tax preparation software package into an electronic format.

Legislative Recommendation

Consider mandating e-filing for all paid preparers.

Response

IRS management agreed with the two recommendations.  The Wage and Investment Division will pursue the implementation of processes that use scanning technology (Optical Character Recognition and Two-Dimensional Bar Codes).  Two-Dimensional Bar Codes will be a project proposal for the 2012 Modernization Vision and Strategy planning cycle.  In the meantime, a new proposal will be submitted to enhance legacy systems with Two-Dimensional Bar Code capabilities.  The legislative recommendation is currently under consideration by the Department of the Treasury and included in the President’s Fiscal Year 2010 budget request.  Management’s complete response to the draft report is included as Appendix V.

Copies of this report are also being sent to the IRS managers affected by the report recommendations.  Please contact me at (202) 622-6510 if you have questions or Michael E. McKenney, Assistant Inspector General for Audit (Returns Processing and Account Services), at (202) 622-5916.

  

Table of Contents

 

Background

Results of Review

Repeated Efforts Have Been Initiated to Modernize Paper Submission Processing With No Success

Actions Are Needed to Reduce Paper-Filed Tax Returns and/or Convert Paper Tax Returns to an Electronic Format

Recommendation 1:

Recommendation 2:

Appendices

Appendix I – Detailed Objective, Scope, and Methodology

Appendix II – Major Contributors to This Report

Appendix III – Report Distribution List

Appendix IV – Outcome Measure

Appendix V – Management’s Response to the Draft Report

  

Abbreviations

 

  e-file(d); e-filing

Electronically file(d); electronic filing

ETAAC

Electronic Tax Administration Advisory Committee

FY

Fiscal Year

  IRS

Internal Revenue Service

  2-D Barcode

Two-Dimensional Bar Code

  

Background

 

Paper-filed individual tax returns accounted for 42.5 percent of tax returns received in Calendar Year 2008.  Processing of these returns cost the IRS approximately $190.6 million.

The Internal Revenue Service (IRS) continues to receive large numbers of paper-filed individual income tax returns despite a continued growth in electronic filing (e-file).  In Calendar Year 2008, the IRS received 156.3 million individual income tax returns of which 66.4 million (42.5 percent) were paper-filed.  As of May 1, 2009, the IRS had received 40.6 million paper-filed tax returns, representing 30.9 percent of the 131.6 million individual income tax returns received.  The IRS recognizes that even though it is getting closer to meeting its 80 percent e-file goal,[2] paper‑filed tax returns will continue to present a challenge in the foreseeable future.  Figure 1 provides IRS projections on the volume of individual paper-filed tax returns for Calendar Years 2010 through 2015.

Figure 1:  Projected Filing Volumes of Individual Tax Returns
(as of October 2008)

Year

Total Returns

Number of
E-File
Returns

E-File Percentage

Number of
Paper-Filed Returns

Paper-Filed Percentage

2010

140,903,300

98,310,400

70%

42,592,900

30%

2011

141,565,500

103,357,600

73%

38,207,900

27%

2012

143,096,300

106,771,700

75%

36,324,600

25%

2013

144,218,200

109,552,500

76%

34,665,700

24%

2014

144,921,000

112,223,300

77%

32,697,700

23%

2015

145,599,200

114,486,800

79%

31,112,400

21%

Source:  IRS’ 2008 Calendar Year Return Projections for the United States and IRS Campuses[3] (Document 6186).

E-filing provides processing and error resolution savings

E-filed tax returns provide the IRS with significant processing cost savings and low error rates:

·        IRS processing costs:  $0.35 for an e-filed tax return versus $2.87 for a paper-filed tax return.[4]

·        Error rates:[5]  historically, less than 2.5 percent for e-filed tax returns versus more than 25 percent for paper-filed returns.[6] 

Error rates are considerably higher for paper-filed tax returns largely because of IRS employee keypunch errors when inputting information from the paper tax returns into IRS computers.  In contrast, e-filed tax returns are sent through a number of validations which check for more than 600 possible errors before the IRS accepts the tax return.  E-filed tax returns that do not pass the validation checks are rejected and sent back to the taxpayer or preparer for correction.  For example, validity checks are performed on the taxpayer name, address, Social Security Number, and year of birth.  Errors include incorrect Social Security Numbers of dependents, incorrect birthdates, numbers in an alphabetic field, and invalid zip codes.  Unlike a paper tax return, an e-filed return is not accepted as filed until the validity checks confirm the tax return is free of these types of errors.  Once notified of an error, the customer has to correct the tax return and resubmit it through e-file or by paper tax return.  In some instances, rejected returns are not resubmitted.

Taxpayers benefit when e-filing

Taxpayer e-file benefits include:

  • Faster refunds.  With e-file, taxpayers receive refunds in one-half the time it takes to file a paper tax return and receive a refund check.  Taxpayers who choose Direct Deposit can receive their refund in as few as 10 days.
  • More accurate returns.  In addition to the error checks built into return preparation software, additional checks are performed during acceptance processing of e-file returns.  These additional checks reduce the chance of receiving an error letter from the IRS.
  • Electronic confirmations.  Taxpayers are notified electronically that their returns have been received.
  • File now, pay later payment options.  Taxpayers can file early and pay later by scheduling an electronic funds withdrawal to be debited on or before April 15th.  Taxpayers can also pay by credit or debit card when they e-file their returns.[7]
  • Convenient Federal/State e-filing.  Taxpayers in 37 states and the District of Columbia can e-file their Federal and State tax returns in 1 transmission to the IRS.  The IRS forwards the State data to the appropriate State tax agency.

Taxpayers can also receive no-cost e-filing by using the IRS’ Free File program.  The Free File program is a free Federal online tax preparation and e-filing program for eligible taxpayers developed through a partnership between the IRS and the Free File Alliance, LLC, a group of private-sector tax preparation companies.  The program enables eligible taxpayers to use commercial tax software for free.  Taxpayers with adjusted gross incomes up to $56,000 can use the standard Free File options in Calendar Year 2009—that is approximately 98 million United States taxpayers.

In addition, there is an option that opens up the Free File program to nearly everyone, even those with incomes exceeding $56,000.  This option is Free File Fillable Forms.  These Fillable Forms allow taxpayers to fill out their tax forms and e-file them with the IRS at no cost.  These forms are only available through the Free File program link on IRS.gov (the public IRS Internet web site).  This option does not include the step-by-step question and probe process, but it does allow taxpayers to enter their tax data, perform basic math calculations, sign their tax returns electronically, print their returns for recordkeeping, and e-file their returns.  This option may be right for those who are familiar with the tax law, know what forms they want to use, and do not need assistance.

The IRS initiated an Advancing E-File Study in an effort to meet the e-file goal set by Congress

The goal of the IRS’ Advancing E-file Study is to help the IRS validate and launch future studies, research, and other activities to meet the goal of an 80 percent e-file rate set by Congress.  Specifically, the IRS initiated a major effort to collect, synthesize, and analyze all substantial data on the IRS e-file program in one document called the Advancing E-file Study Phase 1 Report, dated August 14, 2008.  The report includes the program’s history, stakeholders, taxpayer and preparer behaviors, related programs and efforts, and options for expansion.  The Phase 1 report does not include recommendations on selecting or implementing specific options for advancing e-file, but lays the foundation for doing so in future phases.

Phase 2 of the Advancing E-file Study is underway and was planned for completion in spring/summer 2009; however, it has been pushed back until the fall of 2009.  Phase 2 will include a cost/benefit analysis of the options to increase e-file based on original research of taxpayer and preparer motivators and analysis of the business and engineering/costing studies of those options.

This review was performed at the Wage and Investment Division Submission Processing function offices in Lanham, Maryland, and the Austin Submission Processing Site in Austin, Texas, during the period December 2008 through May 2009.  We conducted this performance audit in accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objective.  We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objective.  Detailed information on our audit objective, scope, and methodology is presented in Appendix I.  Major contributors to the report are listed in Appendix II.

  

Results of Review

 Repeated Efforts Have Been Initiated to Modernize Paper Submission Processing With No Success

The IRS process to receive and input paper-filed tax returns is extremely labor intensive, costly, and prone to errors.

The IRS has devoted significant resources to initiate studies to identify ways the IRS could modernize its method for processing paper tax returns.  In order to process paper tax returns, information on the tax return must be entered by hand into a computer by an IRS employee.  This manual process of inputting information into a computer system converts the information into an electronic format, which then can be processed electronically.  The IRS has studied different ways to automate this labor-intensive and costly process.

However, none of these studies have moved beyond the concept stage, which leaves the IRS expending significant resources ($190.6 million annually) to process paper-filed tax returns.  Current processing methods require the IRS to employ more than 5,000 data transcribers during peak processing.  For decades, the IRS has used an elaborate manual system to process its U. S. Individual Income Tax Return (Form 1040) series of paper tax returns.  Paper returns are:

  • Received and opened in a mailroom, then sorted and batched by return type.
  • Coded and edited to prepare the returns for transcription by ensuring all tax forms are attached, completed, and signed.  Special codes are also applied as needed to perform specific computations of tax liabilities, and then a Document Locator Number is added.
  • Transcribed into IRS computers.
  • Corrected for taxpayer and IRS errors.
  • Filed for storage. 

Without a modernized paper submission processing system that converts paper tax returns into an electronic format, the IRS will continue to have to use its labor-intensive, error-prone, and costly system to process paper-filed tax returns.  In addition, the manual transcription of information from paper-filed tax returns into IRS computers has historically high error rates, which causes costly rework in order to ensure returns are correctly processed and cause no harm to taxpayers.

Significant resources have been expended developing modernization concepts

Since at least as far back as 1988, the IRS has attempted to develop a system to replace its current paper tax return processing.  However, none of these efforts have resulted in more than conceptual visions.  Figure 2 provides the progression of efforts conducted to modernize paper submission processing.

Figure 2:  Efforts Initiated to Modernize Paper Submission Processing

1988

Document Processing System – Developed to replace the IRS’ labor-intensive, paper-based tax return processing system using imaging technology and Optical Character Recognition.

Cancelled due to cost overruns.

2003

Submission Processing Visioning Taskforce – Established to develop a 2–6 year overarching vision for the future submission processing organization, processes, and systems.

Concept was approved to pursue funding and then the concept was rolled into the next proposal.

2004

Modernized Paper Pipeline Processing Proposal – Proposal for a system capable of processing all IRS form types using the latest Optical Character Recognition, Intelligent Character Recognition, and Two-Dimensional Bar Code (2-D Barcode) recognition technology to capture information from the different submissions and convert that information into an electronic format.

Funding was pursued but not approved.

2007

Modernized Submission Processing Proposal – Current conceptual approach for an investment proposal to modernize paper submission processing.

Funding request was delayed.

Source:  Treasury Inspector General for Tax Administration research and interviews with IRS officials.

Modernized Submission Processing is the IRS’ latest concept

The IRS has completed work on the Modernized Submission Processing concept, its latest effort for modernizing paper tax return processing.  This concept provides for a system that will automate the extraction of paper tax return information.  The IRS projects that the system would cost an estimated $66.2 million in development costs.  After the system is fully implemented, the recurring operation and maintenance costs are estimated to be $10.7 million per year.  The IRS had planned to request funding for the concept in Fiscal Year (FY) 2010; however, no funding was ultimately requested.

The concept provides for a paper processing system that will use optical scanning, automated data extraction through Optical Character Recognition and 2-D Barcodes, modernized and legacy data export, and return-of-record image archive for the Form 1040 series of returns.  The initial deployment was proposed for August 2011 at one of the three campuses that process paper-filed individual income tax returns with deployment to the remaining campuses in August 2012.[8]  The IRS anticipated that numerous benefits would be realized once fully implemented and estimated that $67 million per year would be saved.

  • $30 million from eliminating the Full-Time Equivalents[9] required to process paper returns.  This estimate is based on the labor and overhead costs for the function used to input a paper tax return.
  • $16 million from eliminating the expense of maintaining the Service Center Recognition Image Processing System.  The cost savings for this system is the annual maintenance costs.  The Service Center Recognition Image Processing System will be retired once the new system is fully implemented.
  • $21 million from eliminating the expenses for the filing and storage of paper tax returns.  Files and storage savings were based on savings from the contract with the National Archives and Records Administration and the cost of IRS files operations.

The Modernized Submission Processing Solution Concept[10] has been completed and was previously ranked by IRS senior executives as one of the top new modernization priorities for the FY 2010 investment portfolio.  However, no funding was ultimately requested for FY 2010, and it is no longer on the IRS’ Enterprise Prioritization list for funding in FY 2010 or FY 2011.

Actions Are Needed to Reduce Paper-Filed Tax Returns and/or Convert Paper Tax Returns to an Electronic Format

While the IRS has not been able to move beyond the conceptual stage for modernizing paper submission processing, there are actions that would reduce paper filings and/or convert paper tax returns into an electronic format.  These options can result in a significant increase in e-filing as well as significant processing cost savings to the IRS.  The options are:

  • Mandate e-filing for paid preparers[11] (this would require a change in current law).
  • Convert residual paper returns into an electronic format.

Implementation of these options could result in a 26.9 percent increase in e-filing with processing cost savings of $66.6 million annually as well as the ability to convert 13.2 million tax returns[12] into an electronic format.

Mandating e-file for paid preparers

A Federal mandate for paid preparers to e-file individual income tax returns would result in an increase of 26.9 percent[13] in e-filed tax returns and reduce IRS paper tax return processing costs by $66.6 million annually.[14]  The majority of paid preparers are already familiar with operating in an electronic environment.  Most paid preparers who filed paper tax returns actually used an electronic tax software preparation package and 70 percent also e-filed at least 1 tax return, which indicates a familiarity with the electronic preparation and e-filing process.  However, while paid preparers are willing to e-file returns, some taxpayers are reluctant to do so, according to IRS management.  Analysis of IRS return processing data for Processing Year 2008 showed that:

  • 26.4 million (40.8 percent) of the 64.8 million paper-filed Forms 1040 were filed by 538,782 paid preparers; 21.6 million (81.5 percent)[15] of these were prepared using an electronic tax software preparation package and then mailed to the IRS.
  • 378,056 (70 percent) of the 538,782 paid preparers also e-filed at least 1 tax return and, of the remaining preparers who did not e-file at least 1 tax return, 141,967 prepared a tax return using computer preparation software, which indicates they are familiar with the electronic preparation and e-filing process.

Figure 3 illustrates the methods used by paid preparers for paper return submissions.

Figure 3:  Methods Used by Paid Preparers to Prepare Paper Returns
(Processing Year 2008)

Method Used by Paid Preparers to Prepare Paper Returns

Returns

Percent

Handwritten

4,882,074

18.5%

Computer

21,565,688

81.5%

Total

26,447,762

100.0%

Source:  Treasury Inspector General for Tax Administration analysis of the IRS’ Individual Return
Transaction File
[16] for Processing Year 2008.

Federal law currently prohibits the IRS from mandating e-filing

Federal law currently prohibits the IRS from requiring e-filing of individual income tax returns.  In order for a Federal mandate of individual e-filing to be implemented, the law would have to be changed.  Advisory Groups and the Government Accountability Office have reported to Congress the benefits that could be achieved by mandating e-filing:

·        The Electronic Tax Administration Advisory Committee (ETAAC) has advocated a Federal e-file mandate for several years.  In its June 19, 2008, Annual Report to Congress,[17] the ETAAC reported, “At this time, [the] ETAAC believes that all reasonable voluntary means have been exhausted with respect to encouraging preparers to e-file Individual Tax Returns, and it is time to take a stance by announcing an e-file mandate for tax return preparers.”

·        The IRS Oversight Board agreed with the ETAAC’s recommendation in its Electronic Filing 2008 Annual Report to Congress.[18]  The Board supports the concept that Congress should lift the statutory prohibition on e-filing mandates for individual returns and give the IRS the discretion to implement such e-file mandates in the future as might be appropriate.  

·        The Government Accountability Office has also suggested an e-file mandate.  Its 2006 Filing Season report[19] suggested that Congress should mandate e-filing by paid tax preparers meeting criteria such as filing a certain number of tax returns.  The Government Accountability Office stated, “With the slowing growth rate in electronic filing, [the] IRS is missing an opportunity to generate additional savings.  Federal and [S]tate mandates for electronic filing have demonstrated success in increasing electronic filing; however, [the] IRS currently lacks the authority to mandate electronic filing for certain income tax returns such as individual returns filed by paid tax preparers.  Using IRS estimates, savings from such a mandate could be on the order of $60 million per year.”

It should also be noted that the President’s FY 2010 budget request for the IRS contains a legislative proposal to expand e-filing requirements for paid preparers.  This proposal would allow regulations to require that tax return preparers who file more than 100 returns (or any other person who files more than 250 returns) e-file tax returns for individuals, estates, and trusts.

Many States are already mandating e-filing for paid preparers

In recent years, a number of States have adopted requirements mandating that certain paid preparers must e-file all tax returns they prepare.  As of November 2008, 20 (47 percent) of the 43 States that have a personal State income tax [20] have adopted some type of mandate that paid preparers e-file State individual income tax returns.  Some of these States have included volumes of tax returns prepared when determining which specific preparers have to e-file.  For example, in 2004, the State of California mandated that tax preparers who prepared more than 100 California individual income tax returns during the previous year had to e-file all of their clients’ current year returns.  Also, in 2008, the State of Kansas passed legislation that required paid preparers who prepare 50 or more returns per year to e-file not less than 90 percent of returns eligible for e-filing.  Figure 4 shows the States that currently have an e-file mandate for paid preparers.

Figure 4:  Map of States With E-file Mandates for Paid Preparers

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

 Significant processing cost savings could be achieved as a result of a paid preparer mandate

A Federal mandate requiring paid preparers to e-file would provide significant processing cost savings to the IRS and would accelerate the time it will take for the IRS to meet its 80 percent e-filing goal.  In addition, this would significantly reduce the volume of tax returns with keypunch errors that would require correction.  Figure 5 shows the expected e-filing increase of an e-file mandate.

Figure 5:  Projected E-Filing Increase From an E-file Mandate

Projected Return Filings

Current Projection 2010

Percentage

With Mandate 2010

Percentage

Total Individual Returns Forms 1040/A/EZ

140,903,300

 

140,903,300

 

Total Paper Individual Returns

42,592,900

30%

16,145,138

11%

Total Electronic Individual Returns

98,310,400

70%

124,758,162

89%

Source:  IRS’ 2008 Calendar Year Return Projections for the United States and IRS Campuses
(Document 6186) and Treasury Inspector General for Tax Administration analysis of the IRS’ Individual Return Transaction File for Processing Year 2008.

Mandating e-filing for paid preparers[21] for individual income tax returns would result in a 26.9 percent increase[22] in the number of e-filed tax returns and would reduce IRS paper tax return processing costs by $66.6 million annually.  Over 5 years, potential processing cost savings could total approximately $333 million.

Legislative Recommendation

Recommendation 1:  Consider mandating e-filing for all paid preparers.

Management’s Response:  The IRS agreed with this recommendation, which is currently under consideration by the Department of the Treasury and included in the President’s FY 2010 budget request.  The initiative will require e-filing by tax preparers who file more than 100 tax returns in a calendar year.  The proposal would be effective for tax returns required to be filed after December 31, 2010.  Since the Department of the Treasury and the Administration have already considered the subject, the IRS does not plan to take further action with regard to this recommendation.

Converting residual paper returns into an electronic format

Electronic tax preparation software companies currently provide tax software packages that enable State tax agencies to optically convert paper-filed tax returns into an electronic format using Optical Character Recognition and 2-D Barcodes.  While mandating e-filing for paid preparers will significantly reduce the number of paper returns received by the IRS, it will not eliminate them.  In Calendar Year 2008, taxpayers submitted 36.5 million paper returns of which 13.2 million, or 36.2 percent, were prepared using an electronic tax preparation software package.  Yet these returns were mailed to the IRS as a paper tax return.  The IRS will still need to develop a process to convert these residual paper returns into an electronic format.

Updating the Modernized Submission Processing concept to include pursuing successful processes followed by States that use scanning technology, including the use of Optical Character Recognition and 2-D Barcodes, could provide the IRS with an option to convert paper-filed tax returns into an electronic format, thereby reducing processing costs associated with paper-filed tax returns. 

Representatives from the State of California told us that they partnered with tax software developers to provide a Scannable section called a “Scanband” on State personal income tax returns.  Currently, 24 states are using scanning technology including scanbands and bar codes to improve the efficiency of tax return processing and in most of the States the bar code technology captures all data on a State individual income tax return.  Figure 6 shows the States that currently use scanning technology.

Figure 6:  Map of States Using Scanband and/or 2-D Barcodes

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

The State of California Franchise Tax Board uses Optical Character Recognition to capture data and convert paper State personal income tax returns into an electronic format.  The Franchise Tax Board uses high-speed scanners to take images of personal income tax returns and either captures data from scannable forms or uses the return image to hand input the data.  The Franchise Tax Board’s imaging system cost approximately $12.8 million for nonrecurring development costs and a total of $2.5 million in annual maintenance and operating costs.  Last year, the Franchise Tax Board processed approximately 7 million paper personal income tax returns, of which 3.9 million (55.7 percent) used data captured from scannable forms.  California State tax return preparers use tax preparation software that creates a scannable section on the face of the return called a “Scanband.”  The Scanband includes all the tax return information that is needed to process the return, such as name, address, income, and refund amount.  The remaining pages of the return contain the same data that were included in the Scanband.  Figure 7 shows the scannable version of a California Resident Income Tax Return.

Figure 7:  California Resident Income Tax Return (Form 540) With Scanband

Figure 7 was removed due to its size.  To see Figure 7, please go to the Adobe PDF version of the report on the TIGTA Public Web Page.

 

In another example, the New York State Department of Taxation and Finance captures tax return data using 2-D Barcodes.  This is a preferred option based on conversations we had with one large e-file provider because it is less confusing to the taxpayer since it looks like a regular tax return with a single cover sheet.  A 2-D Barcode is a machine readable representation of information encoded in a pattern of two dimensions.  Returns that are prepared on a computer and filed on paper have the data captured and printed in a 2-D Barcode capable of being read by either hand-held or high-speed scanners.  As of June 2009, the State of New York processed 39 percent of its paper Tax Year 2008 returns using 2-D Barcodes.  Figure 8 shows the cover sheet with 2-D Barcodes for the New York Resident Income Tax Return.

Figure 8:  New York State Cover Sheet for Form IT-201 Resident Income Tax Return

Figure 8 was removed due to its size.  To see Figure 8, please go to the Adobe PDF version of the report on the TIGTA Public Web Page.

 

These scanning technologies could be used in a rescaled version of the Modernized Submission Processing concept to provide the IRS with options to further reduce processing costs associated with residual paper-filed tax returns subsequent to an e-file mandate.  In addition, to further reduce implementation and equipment costs, the IRS should consider directing these taxpayers to submit returns to a single return processing site.  Implementing a process to convert paper-filed tax returns that were prepared using a tax software package into an electronic format could result in further reductions in paper-filed tax return processing costs.

Recommendation

The Commissioner, Wage and Investment Division, should:

Recommendation 2:  Pursue the implementation of successful processes followed by States that use scanning technology (Optical Character Recognition and 2-D Barcodes) to convert paper-filed tax returns prepared by individuals using a tax preparation software package into an electronic format. 

Management’s Response:  The IRS agreed with this recommendation.  The Wage and Investment Division will pursue the implementation of processes that use scanning technology (Optical Character Recognition and 2-D Barcodes).  2-D Barcodes will be a project proposal for the 2012 Modernization Vision and Strategy planning cycle.  In the meantime, a new proposal will be submitted to enhance legacy systems with 2-D Barcode capabilities.  Detailed requirements and timetables for that proposal are being developed, with a targeted implementation date of January 2011.  It should be noted that there are budget and information systems prioritization constraints that may impact the IRS’ ability to implement this recommendation.

 

Appendix I

 

Detailed Objective, Scope, and Methodology

 

The overall objective of our review was to assess the IRS’ strategy to convert paper-filed individual income tax returns into an electronic format.  To accomplish our objective, we:

I.                    Identified the process used to develop the strategy to convert paper-filed individual income tax returns into an electronic format.

II.                 Identified the options the IRS considered and determined adequacy of testing of the various options, the accuracy of cost information included, and the method used to determine the potential benefits to be realized.

III.               Identified potential obstacles that could impact on the timely implementation of the strategy as well as IRS efforts to address the potential obstacles.

IV.              Identified processes used by State tax agencies to process paper-filed tax returns that could be used as a Best Practice.

V.                 Determined the effect of an e-file mandate for paid preparers by analyzing 90,472,107 individual income tax return records[23] for Processing Year 2008 on the Individual Return Transaction File[24] and identified 26,447,762 paper individual income tax returns prepared by paid preparers.

 

Appendix II

 

Major Contributors to This Report

 

Michael E. McKenney, Assistant Inspector General for Audit (Returns Processing and Account Services)

Russell Martin, Director

Tina Parmer, Audit Manager

Steven Vandigriff, Lead Auditor

Karen Fulte, Senior Auditor

 

Appendix III

 

Report Distribution List

 

Commissioner  C

Office of the Commissioner – Attn:  Chief of Staff  C

Deputy Commissioner for Services and Enforcement  SE

Chief Technology Officer  OS:CTO

Deputy Commissioner, Wage and Investment Division  SE:W

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

Director, Electronic Tax Administration and Refundable Credits, Wage and Investment Division  SE:W:ETARC

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

Director, Submission Processing, Wage and Investment Division  SE:W:CAS:SP

Chief, Program Evaluation and Improvement, Wage and Investment Division  SE:W:S:PRA:PEI

Senior Operations Advisor, Wage and Investment Division  SE:W:S

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 Internal Control  OS:CFO:CPIC:IC

Audit Liaison:  Chief, Program Evaluation and Improvement, Wage and Investment Division  SE:W:S:PRA:PEI

 

Appendix IV

 

Outcome Measure

 

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

Type and Value of Outcome Measure:

·        Inefficient Use of Resources – Potential; return processing costs of $66.6 million on 26,447,762 individual tax returns; $333 million in return processing costs over 5 years (see page 7).  It should be noted that realization of this outcome measure is contingent upon enactment of legislation.

Methodology Used to Measure the Reported Benefit:

We used computer analysis to identify from the IRS Individual Return Transaction File[25] a universe of 26,447,762 paper individual income tax returns filed by paid preparers in Processing Year 2008.  Paid preparer returns were identified as those that included a preparer Social Security Number, Preparer Tax Identification Number, or Employer Identification Number.  It excluded returns prepared by volunteer preparers, and we further limited paid preparers to those that prepared six or more returns.  IRS return processing costs $0.35 for an e-filed tax return versus $2.87 for a paper-filed tax return.  If the tax law is changed to mandate e-file for paid preparers, processing cost savings of $333 million over 5 years could be put to better use.

 

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.


[1] For the purpose of this report, we defined paid preparers as those that included a preparer Social Security Number, Preparer Tax Identification Number, or Employer Identification Number and prepared six or more tax returns.  It excluded returns prepared by volunteer preparers.

[2] The IRS Restructuring and Reform Act of 1998 required that paperless filing should be the preferred and most convenient means of filing Federal tax and information returns.  It should be the goal of the IRS to have at least 80 percent of all returns filed electronically.

[3] The data processing arm of the IRS.  The campuses process paper and electronic submissions, correct errors, and forward data to the Computing Centers for analysis and posting to taxpayer accounts.

[4] Advancing E-file Study Phase 1 Report, dated August 14, 2008.

[5] The error rate is the percentage of returns that are identified by the Error Resolution System with a transcription, math, or other error.

[6] IRS’ Miscellaneous Monitoring Reports.

[7] For credit and debit card transactions, there is a fee charged by the service providers.  Fees are based on the amount of the payment and may vary by service provider.

[8] Processing of certain business returns was proposed for July 2013.

[9] A measure of labor hours in which 1 Full-Time Equivalent is equal to 8 hours multiplied by the number of compensable days in a particular fiscal year.  For FY 2008, 1 Full-Time Equivalent is equal to 2,096 staff hours.  For FY 2009, 1 Full-Time Equivalent is equal to 2,088 staff hours. 

[10] A Solution Concept is the first step toward the development of a modernization investment proposal and documents the project scope, assumptions, timeline, risks, and the technical solution envisioned.

[11] For the purpose of this report, we defined a paid preparer as those who included a preparer Social Security Number, Preparer Tax Identification Number, or Employer Identification Number and prepared six or more tax returns.  We excluded returns prepared by volunteer preparers.

[12] Prepared by taxpayers using tax preparation software then printed and mailed.

[13] Based on current IRS projections for Processing Year 2010.

[14] Processing cost savings are based on a 26.4 million increase in e-filing by paid preparers and the $2.52 difference in the cost of processing a paper return and an e-filed return.

[15] Totals may not compute to those presented due to rounding.

[16] The Return Transaction File contains all edited, transcribed, and error-corrected data from the Form 1040 series and related forms for the current processing year and 2 prior years.

[17] Electronic Tax Administration Advisory Committee:  Annual Report to Congress, dated June 19, 2008.

[18] IRS Oversight Board:  Electronic Filing 2008 Annual Report to Congress, dated January 2009.

[19] Tax Administration:  Most Filing Season Services Continue to Improve, but Opportunities Exist for Additional Savings (GAO-07-27, dated November 2006).

[20] Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming do not have a personal State income tax.

[21] The IRS requires paid preparers to sign the tax returns they prepare and to identify themselves using either their Social Security Numbers or Preparer Tax Identification Numbers.  If the preparer is self-employed or a member of a firm, they are also to provide their Employer Identification Numbers.  Our analysis identified returns that included a preparer Social Security Number, Preparer Tax Identification Number, or Employer Identification Number and excluded returns prepared by volunteer preparers.  The analysis further limited paid preparers to those that prepared six or more returns.  This criterion was based on preparer identification issues reported in our report entitled Inadequate Data on Paid Preparers Impedes Effective Oversight (Reference Number 2009-40-098, dated July 14, 2009).

[22] Based on current IRS projections for Processing Year 2010.

[23] To assess the reliability of computer-processed data, programmers in the Treasury Inspector General for Tax Administration Office of Information Technology validated the extracted data, and we verified the appropriate documentation.  In addition, run-to run balancing was performed and the data in the selected fields were analyzed to verify the validity of the data.

[24] The Return Transaction File contains all edited, transcribed, and error-corrected data from the U.S. Individual Income Tax Returns (Form 1040 series) and related forms for the current processing year and 2 prior years.

[25] The Return Transaction File contains all edited, transcribed, and error-corrected data from the U.S. Individual Income Tax Returns (Form 1040 series) and related forms for the current processing year and 2 prior years.