This report presents the combined results of a series of reviews and analyses dealing with business taxpayers. The overall objective of this collective effort was to identify opportunities for the Internal Revenue Service (IRS) to:

• Better serve business taxpayers by reducing taxpayer burden and improving customer service.
• Increase IRS efficiency and effectiveness.

For these reviews, we defined business taxpayers as corporations, small business corporations, partnerships, fiduciaries, employers, or individuals with their primary source of income from a sole proprietorship or farm. These taxpayers represent approximately 14 percent of total taxpayers and 85 percent of total dollars collected by the IRS. In Fiscal Year (FY) 1996, there were approximately 18 million business taxpayers who filed about 47 million tax returns and paid an estimated $1.3 trillion in taxes.

We conducted reviews of five processes in which business taxpayers frequently deal with the IRS: providing upfront education, establishing a new business entity, processing Federal Tax Deposits (FTD), monitoring FTD compliance, and processing tax returns. We conducted audit work to varying degrees within each process and recommended opportunities for improvement. In addition to summarizing those reviews in this report, we are making additional recommendations to improve service provided to business taxpayers. (Appendix IV provides an overview of the individual reviews and recommendations and actions taken by IRS management to address the recommendations.)

The current IRS systems and procedures for business taxpayers were designed to primarily facilitate IRS operations rather than address all the various individual needs of taxpayers. As a result, they are often complex, confusing, and burdensome. We determined that the processes for dealing with business taxpayers could be improved and updated.

The IRS recognized that across-the-board changes were needed and, in January 1998, announced its plans to modernize and change the way it does business. The goals of the new, modernized organization are to enable taxpayers to better understand and comply with the tax laws and ensure fairness in compliance programs. In addition, the IRS implemented changes during our review. For example, the IRS increased the threshold requirement for making FTDs so that taxpayers would not have to make FTDs until their employment taxes reached $1,000 per quarter, up from $500 per quarter. This should eliminate monthly FTDs and reduce taxpayer burden for approximately 500,000 small business taxpayers.

To complement the modernization efforts, we made recommendations in the series of individual audits that addressed opportunities for the IRS to reduce burden and improve service to business taxpayers. The following highlights the actions taken or planned by the IRS in response to some of our recommendations made in the series of individual audits, as well as the potential benefits to both business taxpayers and the IRS.

• The IRS submitted a request for programming changes in computer instructions to prevent notices to new businesses who have not filed an employment tax return because they have not yet hired employees.

• The IRS will conduct a risk assessment to explore the possibility of having taxpayers satisfy their Form 941 filing requirements via a telephone call if they have $0 liability.

• The IRS will develop new criteria for identifying taxpayers who may need an early contact to fully pay their delinquent employment tax liabilities.

• The IRS will revise customer surveys for small business workshops and classes to obtain evaluative feedback, and use the feedback to identify taxpayers’ needs.

• The IRS will increase publicity about its educational workshops for businesses by using the Internet and business periodicals, and expand joint efforts with tax professional organizations to recruit volunteers to be instructors at tax workshops.

In addition to these actions already taken or planned, the IRS can further improve its processes by considering the following areas for improvement.

The existing avenues for providing education to small businesses are not readily available to all taxpayers. Although the IRS is seeking to expand the types of education offered, it will not be able to reach all taxpayers. Many taxpayers: live outside the geographical location where workshops, classes or walk-in sites are offered; may be reluctant to attend an IRS-sponsored event; and/or may not have Internet or CD-ROM access.

The current program to identify taxpayers who do not make their FTD payments does not consider both organizational goals of increased revenue and increased compliance and may not result in more timely full payment. The IRS concentrates on only a small number of taxpayers when making early contacts about missed FTD payments, which does not sufficiently address the goal of increased compliance among all taxpayers. We also question the effectiveness of the current program because taxpayers fully paid their tax liabilities at about the same rate (88 percent within a year for employers with more than or equal to $50,000 annual Form 941 liability versus 82 percent for employers with less than $50,000 annual liability), regardless of whether they were included in the delinquent FTD program.

Business returns processing would be more effective and efficient if centralized in a few locations. In FY 1997, about 92 percent of the estimated 42.5 million business returns (excluding individual returns for sole proprietors or farms) processed were paper returns. Paper return processing is much more costly and involves a higher error rate than electronic return processing (10 percent versus 0.2 percent). If business returns were processed at service centers that process only business returns (rather than a mixture of individual and business returns), the estimated 42.5 million returns could be processed at three locations. With increased electronic filing, the IRS could process the returns in one location, with another location as back-up. Centralized processing would provide increased effectiveness, efficiency, and executive accountability for the IRS. Taxpayers could benefit because the IRS could provide greater consistency and expertise in processing and resolving returns.

In addition to these three areas for improvement, we also evaluated the opportunity of annual filing of Form 941 returns for some segments of the small business employer population. Form 941, which is filed quarterly, is used by employers to report and pay their portion of employment taxes, as well as the taxes withheld from their employees. With annual Form 941 filing, small business employers could eliminate filing quarterly returns and just file an annual return. Similarly, the IRS would not have to process these quarterly returns, which would save on processing costs. We did not make any recommendations to the IRS regarding annual filing, but we did issue a memorandum to provide information for future consideration by IRS management.

We identified three additional opportunities for the IRS to reduce burden and improve service to business taxpayers, and increase its efficiency and effectiveness. These involve expanding the avenues for providing education to small businesses, re-evaluating the current program for monitoring and following up on delinquent FTD payments, and moving towards centralized processing of business tax returns in two locations.

IRS management responded that they had joined efforts with the Small Business Administration (SBA) and developed partnerships with several entities of the SBA to provide information, IRS materials, and small business workshops on tax related topics. The IRS Collection Division will re-evaluate the cost effectiveness of the FTD monitoring program and also determine how it can be tailored more toward the IRS' goals of increased revenue and increased compliance. In addition, the IRS Executive Officer for Service Center Operations is responsible for developing a transition plan to consolidate business return processing into the determined number of locations.

Management’s complete response to the draft report is included as Appendix VI.