The Internal Revenue Service (IRS) received more than 130 million individual income tax returns during the 2010 filing season. The percentage of returns filed electronically has increased from 52 percent in 2005 to 71 percent in 2010. However, in 2010, IRS still processed 40 million tax returns filed on papersome of which must be filed on paper due to their complexity or required supplemental documentation. Electronic filing benefits taxpayers by reducing processing errors and expediting their refunds. It also benefits IRS because no transcription of tax data is necessary, unlike for returns filed on paper.
Increasing electronic filing would reduce IRS's return processing costs and increase revenue by facilitating enforcement. As noted in GAO's December 2010 report, IRS estimated savings of $3.10 per return for returns filed electronically versus paper in fiscal year 2009. Millions of dollars in processing costs could therefore be avoided by encouraging electronic filing. Based on GAO's prior reports from 2007 to 2010, IRS has three opportunities to increase electronic filing of individual income tax returns:
Require tax software identification numbers:As noted in GAO's February 2009 report, having a more complete software identification number would allow IRS to better target its research of ways to promote electronic filing. IRS now requires software identification numbers for returns prepared using software and then printed and submitted on paper, but does not have plans to transcribe this information. More comprehensive information about tax software versions used to prepare both electronically-filed and paper returns would help inform research into how the pricing and attributes of different software products affect taxpayers' willingness to use software and file electronically.
Prevent rejects of electronically filed returns:As noted in GAO's September 2009 report, IRS could also increase electronic filing by working with taxpayers and their representatives to reduce the number of rejected returns. As tax returns are received electronically, IRS begins a series of automated checks to verify basic information (such as Social Security numbers) and then rejects returns containing errors. If a return is rejected, IRS sends an electronic notice with one or more error codes explaining why the return was rejected, and how the error can be corrected and the return resubmitted. However, some codes are very general and cover multiple issues, while others are so narrow that they are rarely used. Frustrated taxpayers may simply print and mail their returns to IRS without making corrections leaving IRS to identify and correct the errors and process the paper returns, thereby losing the benefits of electronic filing.
Require bar coding:As noted in GAO's November 2007 report, IRS could require that tax software vendors encode relevant information in a bar code that would be embedded on all paper returns printed from tax software and mailed, as several states already do. IRS could then scan the bar code to obtain electronic information such as a taxpayer's Social Security number and address from the return. While not as beneficial as electronic filing, bar coding would still provide efficiencies over data transcription and enable more information to be available electronically. In December 2010, IRS reported that it is reviewing options to enhance current systems with bar code capabilities and developing detailed requirements and timetables.
In keeping with efforts to increase the availability of electronic tax data for enforcement purposes, IRS could also increase the amount of tax data available electronically by increasing the amount of data from paper tax returns it transcribes into its computer databases. Currently, to control data-entry costs, IRS does not transcribe all data from paper tax returns into its computer databases, thus limiting information available electronically for enforcement purposes. As noted in GAO's November 2007 report, transcribing more or all return information, thus having it available electronically, could help IRS target audits on noncompliant taxpayers, avoid burdening compliant taxpayers with unnecessary audits, and make more productive use of IRS's audit resources. For example, in 2007 officials from one of IRS's enforcement programs (Automated Underreporter) estimated that having all tax return information available electronically would increase tax revenue annually by $175 million.
IRS generally agreed with GAO's prior recommendation to require a more complete software identification number, and said that it would do so by the 2010 filing season. IRS has taken some actions such as requiring a software identification number on printed returns but does not plan to transcribe this information. GAO continues to believe that if IRS were to collect more information via expanded software identification numbers on tax returns, such information could support research into how software affects electronic filing. GAO recognizes that there would be some offsetting costs. However, increasing electronic filing could lower total tax return processing costs by switching costly paper filing to more economical electronic filing.
IRS agreed with GAO's prior recommendations to develop a reject prevention strategy, include external stakeholders in its reject working group, develop an action plan for that group, and provide clearer descriptions of why returns are being rejected. IRS has taken significant action to address these recommendations in conjunction with its ongoing research into advancing electronic filing.
IRS agreed with GAO's prior recommendations that it should determine actions needed to require software vendors to include bar codes on printed individual income tax returns and the cost of those actions. While bar coded paper returns are still more expensive to process than electronically filed returns, states that require bar coding of returns report that greater electronic access to return data has allowed them to more easily verify information and improve enforcement. GAO continues to believe that bar coding of printed returns has the potential to reduce processing costs, facilitate access to taxpayer information, and improve compliance. IRS has conducted further research on the burden to IRS and software providers of requiring bar codes on printed returns as part of its ongoing studies to promote electronic filing.
Finally, IRS agreed with GAO's prior recommendation that more comprehensive and easily accessible electronic return information would facilitate enforcement efforts and thus increase revenue collected from noncompliant taxpayers, and IRS is taking steps to study the issue. For example, IRS recently identified options to increase electronic filing, but has yet to define an overall strategy for doing so. As noted above, having more tax return information available electronically could increase revenues by at least hundreds of millions of dollars.
GAO expects to continue assessing IRS's progress in addressing these issues.
The information contained in this analysis is based on the related GAO products listed under the "Related GAO Products" tab and GAO's work following up on the recommendations from those products.
For additional information about this area, contact James White at (202) 512-9110 or firstname.lastname@example.org.
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