We conducted this review at the request of the Assistant commissioner (Forms and Submission Processing) to assist Internal Revenue Service (IRS) management in determining whether the threshold requirements for individual taxpayers to make estimated (ES) tax payments should be further increased to reduce taxpayer burden and lower the IRS’ processing costs. Our review showed that raising the threshold level would reduce burden for a significant number of taxpayers and lower costs. However, raising the threshold level would also delay the collection of taxes and result in significant additional government borrowing costs. In addition, removing the legal requirement and discipline for making quarterly payments could have a detrimental impact on taxpayer compliance.

In 1943, the congress established statutory requirements for withholding on salaries and wages and for making ES tax payments on certain other sources of income, such as self-employment, interest, dividends, and rent. The ES tax system "levels the playing field" between wage earners and other taxpayers and supports the "pay as you go" concept by requiring quarterly deposits.

For Tax Years (TY) 1985 through 1997, individual taxpayers were required to make ES tax payments if they expected to owe at least $500 in tax after subtracting their withholding and other credits. This threshold level was increased to $1,000 for TY 1998.

Raising the ES tax payment threshold level would reduce burden on a significant number of taxpayers. At every $500 increment up to $3,500, most of the taxpayers, who would no longer be required to make ES tax payments if the threshold was increased, are in the "age 65 or over" group.

For example, we estimate that raising the ES tax payment threshold from $1,000 to $2,000 would:

• Require 1.6 million fewer taxpayers to make ES tax payments. These would include approximately 942,000 taxpayers (58 percent) who are age 65 or older.

• Save taxpayers from 4.5 to 5.1 million hours that are spent in preparing and submitting the necessary forms to comply with the law.
• Save taxpayers $2.1 million in postage costs.
• Avoid the assessment of ES tax penalties against 194,000 taxpayers.

Raising the ES tax payment threshold requirements would also reduce IRS operating costs. For example, we estimate that raising the threshold from $1,000 to $2,000 would result in more than $5.9 million in printing, mailing, and processing cost savings for the IRS.

However, one potential issue with raising the ES tax payment threshold level is that currently compliant taxpayers may become accounts receivable problems for the IRS once the legal requirements and the discipline for making quarterly ES tax payments are removed. For TY 1996, we estimate that approximately $2.6 billion was received through ES tax payments made by taxpayers with ES tax liabilities ranging from $1,000 to $1,999. Although our analysis indicates that these taxpayers were generally compliant (i.e., approximately 94 percent were fully paid by the regular return due date), we cannot conclusively predict their future behavior under a different set of circumstances.

A second issue with raising the ES tax payment threshold is the additional government borrowing costs that would be incurred as a result of the delayed cash flow into the Treasury. For example, we estimate that raising the threshold from $1,000 to $2,000 would delay the IRS’ receipt of approximately $2.6 billion in taxes and cause the government to incur more than $66 million in additional annual borrowing costs.

Raising the current ES tax payment threshold level would result in a cost to the government that would exceed the process cost savings that could be realized. Therefore, any decision by the Assistant commissioner (Forms and Submission Processing) to recommend changes to the payment requirements must be made on a basis that weighs other factors more heavily than a cost/benefit analysis.

As a result, we make no specific recommendation as to whether the ES tax payment threshold level should be further increased. We believe that the Assistant commissioner (Forms and Submission Processing) needs to carefully balance the benefits (e.g., taxpayer burden reduction and processing cost savings) that could be realized with a higher threshold against the downsides (e.g., a potentially undesirable impact on taxpayer compliance and additional government borrowing costs) before recommending to the congress that the Internal Revenue code be amended to raise the threshold.

One method which the Assistant commissioner (Forms and Submission Processing) could effectively use to evaluate the inherent compliance risk associated with any future increases to the ES tax payment threshold level would be to study the impact that the increase from $500 to $1,000 had on taxpayer behavior in TY 1998. This information would be available at the conclusion of the 1999 filing season.

Management’s Response: The chief Operations Officer expressed his appreciation for the analysis that we provided at the request of the Assistant commissioner (Forms and Submission Processing). He stated that the report contains valuable information that will be taken into consideration when making any future policy decisions regarding ES tax payments.