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Adjusting civil tax penalties for inflation potentially could increase revenues by tens of millions of dollars per year, not counting any revenues that may result from maintaining the penalties' deterrent effect

Why Area Is Important

 

The Internal Revenue Code has over 150 civil penalties that potentially deter taxpayer noncompliance. A number of civil tax penalties have fixed dollar amounts—either a specific dollar amount, or a minimum or maximum amount—that are not indexed for inflation. Over time, the lack of indexing can decrease the real value of Internal Revenue Service (IRS) assessments and collections significantly. Further, not adjusting the fixed penalties also means they are not maintained at the level Congress initially believed was appropriate to deter noncompliance. Finally, not adjusting these penalties for inflation may lead to inconsistent treatment of otherwise equal taxpayers over time because taxpayers who were penalized when the amounts were originally set could effectively pay a higher penalty than taxpayers who were penalized many years later.

What GAO Found

 

GAO has long recommended the periodic adjustment of civil tax penalties for inflation and previously identified that almost all of the increased revenues from inflation-adjusting penalties would have come from 4 of the 22 penalties it reviewed. In recent years Congress has adjusted some penalties, but has not inflation-adjusted the majority of penalties GAO studied and has rarely required IRS to inflation-adjust penalties going forward. In resetting penalties since GAO's report, Congress has generally fully restored their value but one fell well below a full adjustment. GAO continues to believe that adjusting civil penalties for inflation could increase collections, help deter noncompliance, and better ensure consistent treatment of taxpayers over time.

GAO found in August 2007 that adjusting civil tax penalty fixed-dollar amounts for inflation from 2000 to 2005 would have increased IRS collections by an estimated $38 million to $61 million per year based on a limited number of penalties GAO reviewed (see table below). Almost all of the estimated increase in collections would have been generated by four penalties:

  • failure to file tax returns,
  • failure to file correct information returns,
  • various penalties on returns by exempt organizations and by certain trusts, and
  • failure to file partnership returns.

Estimated Increase in IRS Collections from Inflation-Adjusting of Penalties Assessed, 2000-2005

Dollars in millions

Assessment year

Increased collections after
penalty adjustment

2000

$38.2

2001

42.1

2002

47.9

2003

53.2

2004

61.0

2005

60.3

Source: GAO analysis of IRS data.

 

These increases would have resulted because some of the penalties were set decades earlier and had decreased significantly in real value—in some cases by over one-half. For example, by 2007, the failure-to-file-tax-returns penalty decreased in real value by 53 percent since it had been set in 1982, and the failure-to-file-partnership-returns penalty decreased in real value by 64 percent since it had been set in 1979.

Since August 2007, Congress has increased the amount of five fixed penalties, three of which—failure to file correct information returns, failure to file partnership returns, and failure to file tax returns—were among the four penalties GAO had previously found would increase IRS collections the most if they were inflation-adjusted. The adjustment to one of the five—failure to file tax returns—was about two-thirds short of the level needed to fully adjust for inflation since the penalty was set in 1982. The 2008 adjustment to the failure-to-file-tax-returns penalty moved it from $100 to $135 whereas a full adjustment would have been to $225. Recently, in 2010, Congress did act to require IRS to periodically inflation-adjust two penalties—one of which—the failure to file correct information returns—Congress had increased since 2007 and one—intentional failure to file a certain information return form—it had not. Those more recent requirements for inflation-adjusting were consistent with the intent of GAO's previously stated position that Congress should consider requiring IRS to periodically adjust fixed-penalty amounts for inflation. However, many fixed penalties have not been adjusted at all and only the two will be periodically inflation-adjusted in the future.

According to GAO interviews with officials in the IRS offices that would be involved, the likely administrative burden associated with adjusting the fixed-dollar amounts of civil tax penalties for inflation on a regular basis would not be significant for IRS. Officials from the Office of Penalties, which has only a few staff, thought some additional staff might be needed to coordinate the necessary changes to forms, training materials, computer systems, and guidance, but not a significant increase. According to interviews with 28 tax practitioners associated with four professional organizations, periodic inflation adjustments to civil penalties likely would not place a significant burden on practitioners.

Actions Needed

 

In its August 2007 report, GAO said that Congress may want to consider requiring IRS to periodically adjust for inflation, and round appropriately, the fixed-dollar amounts of the civil penalties to account for the decrease in real value over time and so that penalties for the same infraction are consistent over time. Although Congress has increased the amount of some fixed penalties since GAO's report, only two penalties are to be adjusted for inflation on a periodic basis. Consequently, GAO continues to believe Congress should consider requiring IRS to periodically adjust all fixed penalties for inflation. Increased revenues potentially could be in the tens of millions of dollars per year, not counting any revenues that may result from maintaining the penalties' deterrent effect.

Framework for Analysis

 

The information contained in this analysis is based on the related GAO product listed under the "Related GAO Products" tab and additional GAO work from January 2008 through January 2011 to follow up on any actions taken pursuant to that report.

Area Contact

For additional information about this area, contact James R. White at (202) 512-9110 or whitej@gao.gov.