In 1997, the Congress enacted legislation that was considered the most extensive and complicated legislation the Internal Revenue Service (IRS) faced since the Tax Reform Act of 1986. For example, the Taxpayer Relief Act of 1997 contained nearly 300 new provisions. Close to half of these provisions were effective for Tax Year 1998. The IRS also embraced strategies, such as those suggested by Vice President Gore in the task force report entitled, Reinventing Service at the IRS, to improve the treatment of taxpayers and customer service availability and accuracy.

We initiated an audit strategy to evaluate the IRS’ efforts to ensure that taxpayers would have the information necessary to properly file tax returns and to ensure the IRS would be able to properly process those returns. This audit focused on the IRS’ efforts to implement key legislative changes affecting the processing of tax returns for the 1999 filing season, including ensuring that taxpayers had information necessary to properly file returns, and that the IRS would be able to properly process returns. The IRS refers to the first half of any calendar year, when most individual taxpayers file tax returns and the IRS processes those returns, as "the filing season."

Plans to implement legislative changes for the 1999 filing season included hundreds of actions, including: revising existing forms and instructions; developing new forms and instructions; changing computer processing programs; training IRS employees; revising Internal Revenue Manuals; revising or preparing new publications; and issuing revenue procedures and regulations. Submission Processing reported preparing 191 Requests for Information Services (RIS) to request computer programming changes for the 1999 filing season, 80 of which were to implement legislative requirements.

The IRS’ process of developing tax forms, instructions, and computer programs to implement new tax legislation was effective, but could be improved to provide IRS management greater assurance that significant actions are taken timely and effectively. In addition, the IRS can increase customer service and decrease taxpayer burden while implementing new tax provisions.

Most of the findings presented in this report were reported to IRS management through Audit memoranda as they were identified. In most instances, the responsible IRS managers initiated immediate corrective action on the findings presented in our memoranda. As a result:

• Over 1.1 million taxpayers avoided delays in the processing of their tax returns.
• Computer generated estimated tax penalties of $237 million were assessed for taxpayers whose estimated tax base minus withholding was $1,000 or more.
• The government avoided losing at least $1.8 million of revenue as taxpayers deducted more student loan interest than was allowable by law.
• Over 1.1 million taxpayers will receive annual reminder notices for the amount of their conversion from a traditional Individual Retirement Account (IRA) to a Roth IRA. Taxpayers need to include the conversion amount in subsequent year tax returns.

The IRS prepared RISs documenting necessary computer programming changes for most of the legislative provisions requiring such programming changes. However, necessary RISs for four significant legislative provisions had not been prepared. These included programming changes to implement provisions for the Roth Individual Retirement Accounts (IRA), the increased Adjusted Gross Income limits on IRAs, the Alternative Minimum Tax for Children, and Farmers Income Averaging. Failure to implement any of these four tax provisions properly could result in improper processing of tax returns.

There were 11 legislative provisions which we considered to be significant based on the number of taxpayers affected, the anticipated revenue effect, and other complexities. RISs prepared by Submission Processing to implement six of these legislative provisions, and one additional RIS related to another legislative provision, contained inaccurate programming instructions and/or were missing some programming instructions.

The IRS had no documentation indicating that RISs went through a review process to ensure that each aspect of a legislative provision was completely and accurately addressed in the RIS.

The IRS had a number of opportunities to assist taxpayers when implementing the 1997 legislation. The IRS could have notified certain affected taxpayers of the Child Tax Credit early in 1998 and reminded them of their option to start recognizing its benefits by adjusting their withholding allowances. Also, the IRS could have planned to send reminder notices to taxpayers who converted traditional IRAs to Roth IRAs and elected to spread the taxable income over four years. There were also instances where the IRS could have used additional colors of print and shading on tax returns to highlight important tax changes. However, the IRS did not take full advantage of these opportunities.

To ensure that increased emphasis is placed on significant legislative changes, the implementation process should contain procedures to ensure that IRS executives are made aware of critical actions that are overdue. This important control element could be accomplished by having the Chief Operations Officer assign each key legislative provision to an IRS executive. Also, a quality review should be performed on RISs developed to implement tax legislation.

The IRS could improve its customer service by notifying taxpayers who may qualify for the Child Tax Credit, but did not claim it, of their eligibility. The IRS should also consider the judicious use of colored text and shading on tax forms to emphasize significant items or changes.

Management’s Response: IRS management agreed that increased emphasis should be placed on highly significant legislative provisions. As part of its charter to transition the IRS’ National Office into the modernized structure, the Communications and Liaison Modernization Team developed a process for implementing new legislation in the new structure. The team leader was very familiar with the implementation process used for the IRS Restructuring and Reform Act of 1998 and took this process into account in developing a new process.

IRS’ Submission Processing function will issue new procedures and initiate a review process to ensure that all aspects of legislative provisions are fully and accurately designed and implemented.

IRS management did not implement our recommendation to notify taxpayers who appeared to be eligible for the Child Tax Credit on their 1998 income tax return but did not claim it. They expressed concern that taxpayers receiving such a notice would lower their withholding in response to the notice but find when they completed their subsequent tax returns that they were not eligible for the credit. Instead, they plan to continue to communicate with taxpayers regarding this credit through outreach programs. IRS management also did not implement our recommendation to judiciously use red text to emphasize significant items or changes on tax forms and instructions. They cited negative publicity associated with the IRS’ use of additional colors to enhance artwork on the 1995 tax package. However, the IRS will reevaluate the effective use of a second color and will explore more effective use of shading, tints, and other graphic treatments.

Office of Audit Comment: Based on an analysis of the IRS’ Individual Masterfile, we estimate there could be as many as 1.7 million taxpayers who qualified for the Child Tax Credit in Tax Year 1998 but did not claim or receive the credit. In our opinion, the IRS should notify these taxpayers that they may be eligible for the credit and advise them of the steps they need to take to amend their 1998 tax returns if necessary.

In our opinion, the judicious use of red text for a sound business purpose would not be perceived as wasteful and warrants testing.