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The Internal Revenue Service's (IRS) budget request shows how IRS intends to balance spending for enforcement and taxpayer service, including spending for new initiatives and the Business Systems Modernization (BSM) program. A combination of enforcement and taxpayer service promotes compliance with the tax laws. GAO was asked to (1) compare IRS's proposed FY 2008 budget to prior years' and assess how the new spending initiatives are justified, and (2) describe IRS's enforcement, filing season, and BSM performance. GAO analyses are based on IRS's 2008 budget submission, supplementary IRS data, interviews with IRS officials, and prior GAO reports. Some of GAO's analyses have been reported earlier this year and updated here. IRS's budget proposes to increase spending by almost 5 percent to $11.6 billion. The budget proposes shifting a greater proportion of spending to enforcement, continuing a trend since 2004. IRS projects that revenue from the new initiatives will have a relatively small impact on the tax gap--less than one percent of the gap last estimated at $290 billion in 2001. The tax gap is the difference between what taxpayers owe and voluntarily pay. Justifications for the new initiatives varied with some lacking descriptive, cost, and expected performance information. For example, an initiative for improving compliance estimates provided no information on how the budget and staff needed or work to be done were determined. Without such information, decision makers do not have an informed basis for approving and funding the new initiatives. IRS has made noticeable progress in its enforcement efforts including increasing the amount of enforcement revenue collected and enforcement staffing. For example, between FY 2004 and 2006 enforcement revenue increased 13 percent to $48.7 billion. Nevertheless, enforcement remains on GAO's high-risk list. The tax gap has been a persistent problem in spite of efforts to reduce it, as the rate of taxpayers' voluntarily compliance with the tax laws has changed little over the past three decades. To better target enforcement resources, IRS has requested funding to do additional compliance research which GAO has long supported. Finally, GAO has reported on IRS's lack of a data-based plan to improve compliance. Filing season performance in 2007 improved in some areas compared to prior years', but there have been challenges. As of April 20, IRS processed about 104.6 million individual income tax returns and issued 88.2 million refunds. Electronic filing grew, telephone access is somewhat better, and Web site use continues to grow. However, fewer than 4 percent of eligible taxpayers used the Free File program. The latest release of Customer Account Data Engine (CADE), the new tax processing system, was delayed. As a result, millions of taxpayers did not benefit from CADE's faster processing of refunds. IRS recently issued its plan, the Taxpayer Assistance Blueprint, to improve taxpayer service.... [ABSTRACT FROM AUTHOR]

The Internal Revenue Service (IRS) most recently estimated that the gross tax gap--the difference between what taxpayers pay in taxes voluntarily and on time and what they should pay under the law--reached $345 billion for tax year 2001. The tax gap arises when taxpayers fail to comply with their individual income, corporate income, employment, estate, or excise tax obligations through (1) underreporting of tax liabilities on tax returns; (2) underpayment of taxes due from filed returns; or (3) nonfiling, which refers to the failure to file a required tax return altogether or on time. IRS's tax gap estimates are based on a variety of data sources. Recently, IRS studied individual taxpayer compliance through the National Research Program (NRP), and used the resulting compliance data to estimate the tax gap for individual income tax underreporting and the portion of employment tax underreporting attributed to self-employment taxes for tax year 2001. NRP, which involved reviewing around 46,000 individual tax returns, has yielded very important new information on taxpayer compliance for the first time since IRS's previous compliance measurement study was undertaken for tax year 1988. Compliance measurement studies such as NRP have the potential to identify ways to improve taxpayer compliance, which could in turn reduce the tax gap and improve the nation's fiscal stability. For example, each 1 percent reduction in the net tax gap would likely yield around $3 billion annually. Given its potential to improve individual taxpayer compliance, you asked us to review the results of the 2001 NRP study. In response, we agreed to identify (1) specific areas of individual taxpayer noncompliance that are promising targets for additional research to improve reporting compliance, and (2) opportunities, if any, found through the course of our work to improve future NRP studies. Areas of individual taxpayer noncompliance that are promising targets for additional research to improve reporting compliance include: income/losses from partnerships and S corporations, income/losses from rental real estate, sole proprietor income/losses, income/losses from farming, other income--net operating losses, gambling income/losses, capital gains for assets other than securities, other gains/losses, Earned Income Tax Credit, Additional Child Tax Credit, deduction for charitable contributions, deduction for medical and dental expenses, deduction for job expenses and most other deductions, and exemptions. IRS could benefit from electronically capturing complete NRP examination case files. Although IRS creates an electronic record for each tax return reviewed for NRP, these records do not contain all of the information contained in the corresponding hard copy examination case files. For example, information taxpayers provide to IRS during examinations is only included in the paper case file and not in the electronic records. Furthermore, some paper case files are not... [ABSTRACT FROM AUTHOR]

The Internal Revenue Service's (IRS) tax filing season performance is a key indicator of how well IRS serves taxpayers. This year's filing season was expected to be risky because of tax system changes, including the telephone excise tax refund (TETR) which can be requested by all individuals and entities that paid the excise tax. GAO was asked to describe IRS's service to taxpayers so far this filing season (including the impact of this year's tax systems changes). GAO was also asked to provide updates of previous assessments of the performance of paid tax preparers, IRS's efforts to modernize its information systems, and what IRS is doing to better measure taxpayer compliance. GAO compared IRS's filing season performance to prior years' and goals and based analyses of paid preparers, information systems, and compliance research efforts on recent reports. IRS's interim filing season performance is improved in some areas. The number of individual income tax returns processed to date is comparable to last year, and the number filed electronically is almost 6 percent greater. Taxpayers' ability to reach an IRS telephone assistor was somewhat less than last year, but the accuracy of answers to taxpayers' questions was about the same. Use of IRS's Web site increased, important because it is available 24 hours a day and is less costly than some other types of assistance. However, there have been challenges. Taxpayers' use of the Free File program, which provides free tax preparation and electronic filing through IRS's Web site--is 5.2 percent below last year at this time. Also, the Customer Account Data Engine (CADE), a modern tax return processing system, became operational 2 months behind schedule. IRS still expects to post 17 -19 million taxpayer accounts to CADE, which is about two and a half times more than last year. Tax systems changes have not had a significant effect on filing season performance. For example, IRS has received a fraction of the TETR-related telephone calls it expected to date. Because paid preparers prepared over 62 percent of all individual income tax returns last year, they are a critical quality control for tax administration by helping to prevent noncompliance. Last year, GAO reported to this Committee about errors made by paid preparers. Some of the most serious errors involved not reporting business income and failing to itemize deductions. GAO's limited work last year did not permit observations about the quality of the work of paid tax preparers in general and undoubtedly, many preparers do their best to prepare tax returns that are compliant with tax laws. In response to GAO's report, IRS has scheduled compliance reviews of some preparers. In addition, recent Justice Department suits to stop fraudulent return preparation at more than 125 outlets of one preparation chain for allegedly taking part in tax preparation scams highlight the importance and obligations of paid preparers. Despite progress made... [ABSTRACT FROM AUTHOR]

Congress created the Taxpayer Advocate Service (TAS) to assist taxpayers in resolving problems with the Internal Revenue Service (IRS) and to propose changes to IRS's practices to mitigate problems affecting taxpayers in general. TAS uses case advocacy and systemic advocacy, respectively, to address these two goals. GAO was asked to address (1) why TAS's caseload has increased since 2004, (2) how well TAS conducted its case advocacy activities in terms of measures such as customer satisfaction and quality, and (3) how well TAS measures and reports its systemic advocacy efforts. GAO interviewed TAS and IRS managers and other staff, reviewed TAS and IRS documents, and analyzed TAS and IRS data. The number of individual taxpayer cases opened by TAS increased substantially in fiscal years 2005 and 2006 and our analysis of TAS and IRS data shows that these increases correlated with increases in IRS enforcement activities both overall and in some specific IRS enforcement programs. For example, changes in the number of tax refunds frozen by IRS coincided with changes in the number of frozen refund cases at TAS. While TAS made changes after fiscal year 2004 to its guidance for accepting new taxpayer cases, this did not notably influence TAS's caseload increase in fiscal years 2005 and 2006. For example, TAS created two additional case acceptance criteria in fiscal year 2006 that resulted in a little more than 500 of the approximately 244,000 cases received that year. TAS measures customer satisfaction and found that the taxpayers TAS serves remained satisfied from fiscal years 2002 to 2006. TAS also measures the quality of its case advocacy and found that this improved from 2002 to 2004 and stayed about the same in 2005 and 2006. While these case advocacy measures are sound, there is important missing information in that TAS does not have meaningful measures of case advocacy efficiency or cost. A meaningful measure of efficiency would consider the ratio of cases closed to the time spent on them and take into account case complexity and the quality of the work, and unit cost information is needed to fully understand this information. TAS is developing the means to capture time per case, the key component of unit cost, and case complexity. TAS currently does not measure the effectiveness of its systemic advocacy efforts. TAS is piloting a program to study systemic advocacy effectiveness in a few areas, but not broadly. Also, it is difficult to determine what actions were taken to address systemic issues raised in the annual report to Congress, TAS's primary method for providing information to Congress and the public about its systemic advocacy efforts. For example, the report describes serious problems faced by the taxpayers but does not include the status of addressing those issues. [ABSTRACT FROM AUTHOR]

The International Telecommunications Satellite Organization (INTELSAT)--an intergovernmental organization launched in 1964 to design, develop, and operate a commercial telecommunications satellite system--enjoyed certain privileges that domestic companies do not, including some related to taxation. Each member nation designated a Signatory to participate as an investor. The U.S. Signatory was COMSAT, a private corporation. Intelsat privatized in 2001, and its tax situation changed. In response to congressional requests for information on whether Intelsat could continue to enjoy any preferential tax treatment as a foreign corporation, GAO did this study to describe how INTELSAT and COMSAT were treated for U.S. tax purposes prior to INTELSAT'S privatization and to describe how current U.S. tax treatment for a domestically incorporated satellite company in the United States compares to current U.S. tax treatment for a foreign corporation with operations, services, and revenue in the United States. As an international organization, INTELSAT was exempt from all U.S. federal income taxes, communications taxes with respect to activities under INTELSAT agreements, and customs duties on imports of communications satellite equipment. INTELSAT and its property, income, operations, and other transactions were also exempt from all taxes in the District of Columbia, except for those not used for, or related to, the purposes of INTELSAT. In contrast, COMSAT was subject to all applicable U.S. taxes. Currently, U.S. income tax treatment of satellite corporations, like other corporations, depends, in part, on whether the corporation is incorporated domestically or is a foreign corporation. The United States taxes the worldwide income of U.S. domestic corporations, regardless of where the income is earned. However, when the tax is due depends on several factors, including whether the income is from a U.S. or foreign source and, if it is from a foreign source, whether it is earned through direct operations or through a subsidiary. Tax on income from a subsidiary may be deferred. The United States generally taxes foreign corporations on any U.S.-source income they earn, but taxes them only on certain types of foreign-source income (and generally only if the latter income is attributable to an office or fixed place of business in the United States). In order to avoid double taxation of income earned in a foreign country, the United States allows corporations to claim a credit for foreign taxes they paid on foreign-source income. Specific income-sourcing rules exist for determining the U.S. taxation of income that domestic and foreign corporations earn from space, ocean, or international communications activities. The rules differ depending on the type of activity and whether the corporation is domestic or foreign. [ABSTRACT FROM AUTHOR]

The Department of Defense's (DOD) total military compensation package for active duty members consists of both cash and noncash benefits. Since the late 1990s, Congress and the DOD have increased military cash compensation by increasing basic pay and allowances for housing, among other things. Military members also receive tax breaks, which are a part of their cash compensation. Moreover, active duty personnel are offered substantial noncash benefits, such as retirement, health care, commissaries, and childcare. In some cases, these noncash benefits exceed those available to private-sector personnel. DOD relies heavily on noncash benefits because it views benefits as critical to morale, retention, and the quality of life for service members and their families. To better understand the military compensation system, Congress asked us to provide the Chairman and Ranking Minority Member of the Senate Committee on Finance with information on active duty military compensation and its tax treatment. In January 2004, we briefed Congressional staff on our preliminary observations. Because our work identified that the combat zone tax exclusion could impact some service members, Congress asked us to focus our work on military cash compensation and to do additional work to estimate the effect of the combat zone tax exclusion on service members' compensation. We provided Congress subsequent briefings that estimated the effect of the combat zone exclusion. As requested, we have updated and combined the briefings for this report to (1) summarize active duty cash compensation and describe how military compensation varies at different career points for officers and enlisted members; (2) explain how military pay is taxed and any special tax treatment of military compensation; (3) estimate the effects of interactions between the combat zone exclusion and certain tax credits on military members' compensation; and (4) describe the benefits DOD provides active duty members as well as specific programs available to members that encourage wealth building. The foundation of military cash compensation is what the DOD calls regular military compensation--the sum of basic pay, nontaxable allowances for housing and subsistence, and the associated federal tax savings. Some members also receive additional cash compensation in the form of special pays, incentives, and other allowances. In general, regular military compensation progresses steadily with pay grade and years of service. Military service brings with it significant tax advantages. Basic pay and most other pays are generally subject to federal income tax; however, certain allowances are not taxed, such as the basic allowances for housing and subsistence. DOD considers the federal tax advantage as the additional income military members would have to earn in order to receive their current take-home pay if their allowances for housing and subsistence were taxable. In fact, DOD views the federal tax advantage as part of service members' cash compensation when it compares military pay with civilian pay. In addition, pay earned--including basic pay, bonuses, special pays, and allowances--while members are serving in one of the 15 designated combat zones is excluded from taxes. The complex interactions between the combat zone exclusion and certain tax credits (principally the Earned Income Tax Credit and the Additional Child Tax Credit) appear to be creating unintended consequences. Specifically, some low-income- earning service members who serve in a combat zone are worse off for tax purposes, while some higher-income-earning members are better off because they become eligible for a tax credit that is normally targeted to low-income workers. Benefits are a substantial portion of noncash military compensation. DOD offers a wide range of benefits to active duty members, including health care, retirement, education assistance, and installation-based benefits--that is, services found on military installations, such as commissaries and child care. Some of the benefits DOD provides encourage wealth building over a service member's career. Military retirement--a lifetime annuity generally provided to members who serve 20 years or more--is one of the primary wealth-building programs available to military members. However, DOD estimates that less than half of officers and only about 15 percent of enlisted members will become eligible for retirement. In addition, other savings programs are offered, such as the Thrift Savings Plan and the Savings Deposit Program. [ABSTRACT FROM AUTHOR]

When taxpayers claim more withholding allowances than they are entitled to or improperly claim exemption from withholding, either no tax or too little tax is withheld from their wages. As a result, some taxpayers end up owing the Internal Revenue Service (IRS) additional taxes, and if the taxes are not paid on time, they become delinquent. This report responds to a Congressional request for information on these taxpayers. Specifically, we provided information on (1) how many taxpayers claimed more than 10 allowances for federal income tax withholding purposes and (2) how many taxpayers claimed exemption from federal income tax withholding and, of those taxpayers, what proportion did not file federal income tax returns and had invalid Social Security numbers. We have two concerns about the information that IRS maintains on taxpayers who claimed more than 10 withholding allowances or exemption from federal tax withholding that preclude us from using it to answer Congressional questions. First, we are concerned about the completeness of the information because a significant number of employers may not send IRS the required forms. Second, some of the information may not be current--it may not reflect the current withholding status of some taxpayers. While acknowledging the limits of the information, IRS officials told us that the information is useful for tax compliance purposes. Also, the officials said that IRS has efforts under way intended to influence employers to comply with the reporting requirement. [ABSTRACT FROM AUTHOR]

About $1 trillion in income was distributed in 2001 by flow-through entities such as partnerships and trusts. These entities do not pay taxes on flow-through income. They report it to the Internal Revenue Service (IRS) on a Schedule K-1 and their partners or beneficiaries pay any tax. Concerned about underreporting, IRS began matching the flow-through income reported on Schedule K-1s with that reported on individuals' returns. In 2002, IRS began sending notices to taxpayers about suspected noncompliance. After complaints that many notices were going to compliant taxpayers, IRS stopped sending notices. Concerned about the burden, Congress asked GAO to, among other things, (1) describe the burden caused by the notices and IRS's rationale for stopping them, (2) assess IRS's management of the program, and (3) describe the steps IRS will take to address any problems. IRS stopped issuing Schedule K-1 notices after complaints about the burden the program imposed on compliant taxpayers. Originally, IRS intended to focus the program on two categories of income--interest and dividends--wherein matching was straightforward, and therefore the number of notices sent to compliant taxpayers could be minimized. However IRS changed the matching program to cover additional categories of flow-through income without clearly informing taxpayers and tax preparers. Matching these additional categories of income was less straightforward. As a result, IRS sent notices about suspected noncompliance to more compliant taxpayers than it intended. In fact, about two-thirds of the notices were sent to taxpayers later determined to be compliant. After taxpayers complained, and after sending out about 70 percent of the planned notices, IRS responded by stopping the notices. IRS has assessed about $41.4 million in additional tax from the notices that were sent and approximately $26.9 million was directly attributable to Schedule K-1 underreporting. IRS did not timely implement two parts of the plans for managing the Schedule K-1 matching program. First, IRS did not test the feasibility of focusing the program on interest and dividend income until after recommending such a focus and communicating the recommendation to taxpayers, preparers, and other stakeholders. Second, after changing the plan, IRS did not clearly communicate the changes. IRS is taking steps to improve communications and reduce the burden on compliant taxpayers. However, neither IRS nor GAO knows whether these changes will improve communications and reduce burden while maintaining the effectiveness of the Schedule K-1 matching program as a compliance tool. [ABSTRACT FROM AUTHOR]

In light of the fourth anniversary of the Internal Revenue Service (IRS) Restructuring and Reform Act of 1998, which established Congress' expectation that IRS modernize to better meet taxpayer needs, GAO gave an overview of IRS's current performance and resources and then assessed the progress that IRS has made modernizing and the risks to continued progress. Overall, IRS has seen increased workload, decreased staffing, and significant changes in the allocation of resources between taxpayer assistance programs and its compliance and collection programs. Between 1995 and 2001, IRS's workload, measured by returns filed, increased by 10 percent while aggregate staffing declined by 14 percent. Over the same time, there was a significant internal reallocation of resources with a disproportionate decline in compliance and collection program staffing to accommodate more emphasis on taxpayer service, such as telephone assistance, and to information systems operation and investment. Electronic filing of returns increased but not enough to reduce paper returns sufficiently to free significant processing resources for use elsewhere. The reallocation of resources shows signs of beginning to produce more accurate service for taxpayers, but the compliance and collection programs have seen large and pervasive declines in performance indicators such as audit rates, collection cases closed, enforcement actions such as liens and levies, and raw productivity. [ABSTRACT FROM AUTHOR]

When computing their federal taxes, taxpayers either claim a standard or itemized deduction. In recent years, about 70 percent of taxpayers have claimed the standard deduction. GAO found that on 948,000 tax returns for tax year 1998, taxpayers did not itemize their deductions yet had payments for mortgage interest and points and for state and local income tax that exceeded the standard deductions for their filing status. GAO estimated that these taxpayers are likely to have overpaid their taxes by about $473 million. When charitable contributions, real estate and personal property tax payments are included, the total overpayment could reach $945 million. [ABSTRACT FROM AUTHOR]

The Earned Income Tax Credit (EIC), which is expected to provide more than $20 billion in refundable tax credits in fiscal year 2002, is intended to offset the burden of the Social Security payroll tax on low-income workers and encourage low-income individuals to work. About 75 percent of the 17.2 million eligible households have claimed the credit. GAO found that the participation rate varied by the number of qualifying children in the household. Participation rates for households with one or two qualifying children were 96 percent and 93 percent respectively. In contrast, the participation rate for households with three or more qualifying children was 62.5 percent. The participation rate for households with no qualifying children was 44.7 percent. Although qualifying households were eligible to claim $22.3 billion in EICs in 1999, the Internal Revenue Service estimates that participating households actually claimed $20.9 billion. [ABSTRACT FROM AUTHOR]

When computing their federal taxes, taxpayers either claim a standard deduction or itemize deductions. This report estimates (1) the number of taxpayers who may have overpaid their taxes by claiming the standard deduction instead of itemizing their deductions, and (2) the amount of taxes they may have overpaid. On about 510,000 individual tax returns in tax year 1998, GAO found that taxpayers did not itemize their deductions yet had mortgage interest payments that exceeded the standard deduction amount for their tax filing status. These taxpayers may have overpaid their taxes by about $311 million. The average overpayment amount was $610, and about 35 percent of the taxpayers had overpaid their taxes by more than $500. [ABSTRACT FROM AUTHOR]

In November 1997, the Internal Revenue Service (IRS) held the first in a series of problem-solving days in its 33 districts. Between November 1997 and July 1998, these events attracted more than 22,000 taxpayers, who met with IRS staff in an attempt to resolve their tax problems. IRS advertised its problem-solving days in national and local newspapers as well as in television and radio spots. Taxpayers and practitioners were urged to call in advance to schedule appointments to discuss their tax problems. Some taxpayers who called in advanced were able to resolve their problems over the phone. For taxpayers who scheduled an appointment, IRS was generally able to provide information about the taxpayers' case at the time of the appointment. Taxpayers who walked in without an appointment generally were able to meet with IRS staff to discuss their situation. Surveys found that taxpayers were generally satisfied with the initiative, even though not all taxpayers who participated in the problem-solving days were able to fully resolve their problems. IRS has reviewed the types of problems that taxpayers have sought to resolve on problem-solving days and identified four main problem areas: penalties, audit reconsiderations, installment agreements, and offers in compromise. IRS now has task groups reviewing each of these areas to identify administrative or legislative actions needed to reduce such problems in the future. [ABSTRACT FROM AUTHOR]

Pursuant to a congressional request, GAO estimated the amount of federal income taxes that individuals and corporations in Puerto Rico would pay if the: (1) termination of the Puerto Rican economic activity credit and the change in political status occurred today; and (2) amount and distribution of individual and corporate incomes in Puerto Rico remain similar to what they have been in recent years. GAO noted that: (1) given the uncertainty over income growth in Puerto Rico after both the phaseout of the economic activity credit and the potential change to statehood, it is difficult to project the impact statehood would have on future combined federal individual and corporate income tax revenues; (2) it roughly estimated the impact that statehood would have on individual income tax revenue if personal incomes remain similar to what they have been in recent years; (3) there is more uncertainty over the impact of statehood on corporate tax revenue because, even if corporate incomes remain close to their current levels, the revenue impact would be sensitive to decisions that corporations made regarding their organizational form and repatriation of profits; and (4) while GAO is able to roughly illustrate the extent to which the corporate tax revenue impact could vary, depending on the decisions corporations make, GAO has no basis for predicting what the actual corporate decisions would be. [ABSTRACT FROM AUTHOR]

This report provides information on the income ranges of taxpayers who may have overpaid federal taxes by not itemizing. GAO found that of the returns filed for tax year 1998, 53 percent of taxpayers who may have overpaid federal taxes by not itemizing, had adjusted gross incomes of $50,000 or less. Eleven percent showed adjusted gross incomes of more than $75,000. The median adjusted gross income for these returns was about $47,000. The median adjusted gross income for all returns filed in tax year 1998 was about $27,000. [ABSTRACT FROM AUTHOR]