The Internal Revenue Service (IRS) has estimated that the gross tax gap—the difference between taxes owed and taxes paid on time—was $450 billion for tax year 2006 (the most recent year for which data were available). IRS estimated that it would eventually recover about $65 billion of this amount through late payments and enforcement actions, leaving a net tax gap of $385 billion. Because the net tax gap is so large and the effectiveness of various new IRS enforcement initiatives largely remains to be determined, tax law enforcement is on GAO’s high-risk list. The nation’s long-term fiscal challenges heighten the importance of reducing the tax gap.
In a series of reports in 2013, GAO identified several areas where IRS can further improve its programs and collect additional tax revenue, reduce its costs, and facilitate voluntary compliance. These improvements include the following.
As of February 2014, IRS’s four offshore voluntary disclosure programs, which offered incentives for taxpayers to disclose their offshore accounts and pay delinquent taxes, interest, and penalties, have resulted in more than 43,000 disclosures by taxpayers and over $6 billion in revenue collected. However, based on reviews of IRS data, in March 2013, GAO reported that IRS may be missing attempts by taxpayers to circumvent the programs. GAO identified more than 200,000 instances where it appeared that taxpayers with unreported foreign accounts may have chosen not to participate in one of IRS’s offshore programs.
One technique identified, called a quiet disclosure, involved taxpayers filing amended tax returns for some or all of the tax years covered by an offshore program, and reporting the income from the previously unreported accounts. These taxpayers would generally pay taxes and interest on the previously unreported income and possibly accuracy-related or delinquency penalties, but would avoid the higher offshore penalty. Another technique involved declaring existing offshore accounts, which could have been open for years, as new when filing a current-year tax return. Unlike a quiet disclosure, these taxpayers would only pay tax on the current-year offshore income. If additional research by IRS confirms that taxpayers are circumventing its offshore programs using either of these techniques, pursuing those taxpayers could result in significant additional revenue.
In addition, GAO found that IRS missed opportunities to better target taxpayers with offshore accounts. Examples include the following: (1) the 2009 offshore voluntary disclosure program application did not ask taxpayers how they learned of the program, and (2) IRS has not targeted outreach efforts about offshore account reporting requirements to recent immigrants. Using such information could promote voluntary compliance, help IRS better target noncompliant taxpayers bolster overall fairness of the program, and increase taxes collected.
In August 2013, GAO reported on the potential major benefits to taxpayers and IRS of the Compliance Assurance Process (CAP) whereby IRS examiners and participating large corporations work to reach agreement on how to report tax issues before their tax returns are filed. IRS initiated CAP as a pilot program in 2005 with the goals of saving IRS time and resources while ensuring compliance, reducing taxpayer burden, and increasing certainty on tax amounts owed. IRS officials decided to make the program permanent in 2011 and to start expanding the program in 2013 based on a desire to meet these goals, such as generating IRS resource savings, and on positive feedback from taxpayers and IRS staff. However, although CAP started 8 years ago, IRS has not evaluated CAP’s effectiveness, tracked its progress against goals, or assessed whether CAP should be expanded and if so, to what extent.
Also, because IRS does not have a system to track resource savings, it does not know the amount of resources saved through CAP nor does it have a plan for reallocating saved resources. CAP is an ambitious effort to improve tax audits of large corporations and holds the promise of significant benefits to participating corporations and IRS. However, without a CAP-wide assessment to validate such benefits, support for CAP, both inside and outside IRS, could wane.
IRS conducts examinations for two purposes: research and operations. In May 2013,GAO reported significant differences in the procedures for examinations (i.e., audits) IRS conducted for research purposes compared to regular, operational examinations.
The first step in either type of examination is classification, where IRS classifiers screen tax returns to select issues that merit an examination. One difference between research and operational examinations is that IRS classifiers see the entire tax return when classifying returns for research examinations. By contrast, operational classifiers only see portions of a return. Examiners told GAO that transcribing more lines from paper returns and having access to all the lines of electronic returns would improve classification decisions and reduce the risk of compliant taxpayers being needlessly audited. Another difference is that research examiners have more specific guidance on how to save case files electronically than operational examiners. Clarifying the key files to be saved electronically by updating operational training and guidance regarding electronic case files could minimize costs and make file sharing more efficient by reducing storage costs and processing time. For example, IRS said electronic case files could save time in processing more than 100,000 audit reconsiderations that IRS works on each year by making it easier for examiners to search the old files and identify what previous examiners concluded. IRS officials also have said that savings on handling costs is one of the benefits of added electronic documentation. IRS must place hundreds of thousands of field examination case files into storage at a federal records center each year. IRS said that it spends about $5 to $9 for each document it recalls from federal record centers. The money IRS spends on recalling documents may be saved through greater use of electronic files. In addition, having electronic case files facilitates the ability for examiners to share their work with colleagues and reduces the chances that files will get lost.
In December 2013, GAO found that some IRS staff had developed extensive sets of prewritten, standardized case notes that allowed them to quickly update a taxpayer’s account regarding their installment agreements (which allow taxpayers to pay their tax debt in scheduled payments). GAO also found that IRS staff were handwriting case notes on paper copies of the agreements and then typing those same notes into IRS’s computers. More automation and less redundant data entry could reduce resource needs. In fiscal year 2012, IRS used 1,800 full time equivalent staff to approve 3.2 million new installment agreements and collected almost $10 billion from them. With the large volume of installment agreements, efficiency gains matter to handle increased service demands with limited resources.
The programs are the 2003 Offshore Voluntary Compliance Initiative, 2009 Offshore Voluntary Disclosure Program, 2011 Offshore Voluntary Disclosure Initiative, and 2012 Offshore Voluntary Disclosure Program. The 2012 program remains open. Generally, the offshore programs offer participating taxpayers a lower penalty than they could have been subject to if IRS had discovered their offshore account outside of the program, and no risk of criminal prosecution, if eligible taxpayers fully disclosed their previously unreported offshore accounts, and paid taxes due plus interest and penalties.
For the 2009 program, the standard offshore penalty was 20 percent of the highest aggregate account balance during the calendar years that correspond to the tax years covered by the program. The penalty increased in future programs.
IRS limits what operational classifiers see to those lines that are transcribed if a tax return is filed on paper. These limits apply even for electronic returns.
An audit reconsideration is the administrative process IRS uses to reevaluate prior audits where IRS assessed additional tax and it remains unpaid, or a tax credit was reversed. If the taxpayer disagrees with the original determination, the taxpayer must provide information not previously considered during the original examination. It is also the process IRS uses when the taxpayer contests a Substitute for Return (i.e., a return that IRS generates when a taxpayer does not file) determination by filing an original delinquent return.
GAO made multiple recommendations to reduce the tax gap and improve taxpayer service in four reports issued in March, May, August, and December of 2013. Specifically, GAO recommended that the Commissioner of the IRS take the following eight actions:
IRS could generate cost savings by applying more rigorous analyses, expanding use of electronic filing, and achieving program efficiencies. These actions could generate cost savings. Furthermore, IRS could increase revenue collections through better enforcement of tax laws and services designed to facilitate voluntary compliance, such as through identifying continued offshore tax evasion. GAO was not able to estimate the amount of savings or collections from these actions in part because IRS does not collect data needed to do so.
The information contained in this analysis is based on findings from the products in the related GAO products section. GAO analyzed agency documents and interviewed officials from the Department of the Treasury, IRS, and other parties. GAO analyzed budget data from IRS and related budget documents. GAO also analyzed relevant federal laws, regulations, and procedures.
In commenting on the four reports issued in March, May, August, and December of 2013 on which these analyses are based, IRS agreed with six of the eight recommendations presented, but did not state whether it agreed or disagreed with two. For those six it agreed with, IRS said it is taking action to address them. For example, in its response to GAO’s recommendation to explore options for employing a methodology for identifying and pursuing potential quiet disclosures, IRS responded that they are taking steps to implement our recommendation and address any identified noncompliance, as warranted.
IRS did not agree or disagree with two of GAO’s recommendations, but acknowledged related actions it is taking to address them. First, in response to GAO’s recommendation that IRS find ways to transcribe and use additional data from paper-filed tax forms and clarify examiner guidance on saving case files, the agency agreed to study the possibility of increasing data transcription, and clarify its policy on when case files should be saved electronically, among other actions. Second, in response to GAO’s recommendation that IRS adopt a set of standardized account entries and eliminate redundancy when entering installment agreement account data, IRS acknowledged that standardized account entries can sometimes lead to increased efficiencies and lower costs, and taxpayers and IRS can benefit by the elimination of redundancy in its processes. IRS stated that it will explore whether the introduction of standardized account entries into the installment agreement process will yield increased efficiencies and lower costs, and will evaluate whether there are unnecessary redundancies in its current processes that can be eliminated without adversely affecting tax administration.
GAO provided a draft of this report section to IRS for review and comment. IRS provided comments in response to GAO’s recommendations regarding offshore tax evasion and the evaluation of the agency’s corporate audit process. In regards to the actions needed to identify continued offshore tax evasion, IRS said it will continue to take corrective actions in response to the agreed-upon recommendations GAO’s March 2013 report. In regards to the actions needed to evaluate IRS’s streamlined corporate audit process, IRS said it is continuing to pursue corrective actions and plans to provide a response to each action by June 30, 2014. IRS did not provide comments on GAO’s other recommendations presented in this report section.