Internal Revenue Service
Procedural Changes Could Enhance Tax Collections Gao ID: GAO-07-26 November 15, 2006GAO previously testified that federal contractors abused the tax system with little consequence. While performing those audits, GAO noted that the Internal Revenue Service (IRS) records sometimes contained inaccurate or outdated tax information that prevented IRS from taking appropriate collection actions against those contractors, including submitting their tax debt to the Federal Payment Levy Program (FPLP) for collection. As a result, GAO was asked to review IRS's coding of tax debt excluded from the FPLP to determine whether (1) IRS tax records contain inaccurate status or transaction codes that exclude tax debt from the FPLP, (2) IRS's monitoring could be strengthened to ensure the accuracy of its status and transaction codes, and (3) other opportunities exist to increase the amount of tax debt included in the FPLP.
IRS tax records had inaccurate information that resulted in it erroneously excluding cases from the FPLP and other tax collection actions. The FPLP is a cost-effective automated system used to collect unpaid taxes from certain federal payments. GAO estimates that as of September 30, 2005, over 500,000 tax records' equating to about $2.4 billion in tax debt--contained inaccurate codes that IRS systems used to exclude tax debts from the FPLP. Inaccuracies included tax debts coded as having active installment agreements even though the tax debtor had stopped making payments. IRS's monitoring of cases was insufficient to identify and correct the coding errors GAO identified. Additionally, IRS's monitoring of financial hardship cases is not sufficient to ensure their ongoing accuracy. IRS grants tax debtors experiencing financial difficulty a hardship designation that excludes them from the FPLP and other tax collection activities until their income increases. To measure this, IRS solely uses the income reported on the tax debtor's annual tax returns. However, IRS does not monitor those tax debtors to ensure they are filing and paying current taxes. For 31 financial hardship cases GAO examined, 24 had ceased to file tax returns. Although IRS has increased the amount of tax debt it submits to the FPLP, additional policy changes could further improve the program's effectiveness. Since 1992, IRS has almost tripled the maximum income it allows tax debtors in financial hardship to earn; raising it to $84,000 in 2004--almost double the national median income. As a result, whereas in 1992 no one earning above the median income was considered to be in financial hardship (and therefore excluded from the FPLP), in 2005 almost two-thirds of the tax debt in financial hardship was owed by individuals earning over the median income. Although a financial hardship designation may be appropriate in many situations, allowing relatively high-income tax debtors to avoid tax collection action, including the FPLP, calls into question the fair application of the tax system and may contribute to noncompliance. IRS policy also limits the amount of tax debt in the FPLP by excluding $5 billion in tax debt from the program while IRS is pursuing levies from other assets or income sources. Additionally, during notification IRS excludes individuals' tax debt from the FPLP about twice as long as legally necessary.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Team: Phone:GAO-07-26, Internal Revenue Service: Procedural Changes Could Enhance Tax Collections
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GAO:
Report to the Permanent Subcommittee on Investigations, Committee on
Homeland Security and Governmental Affairs, U.S. Senate:
November 2006:
Internal Revenue Service:
Procedural Changes Could Enhance Tax Collections:
Enhancing IRS Collection Procedures internal Revenue Service:
GAO-07-26:
GAO Highlights:
Highlights of GAO-07-26, a report to the Permanent Subcommittee on
Investigations, Committee on Homeland Security and Governmental
Affairs, U.S. Senate
Why GAO Did This Study:
GAO previously testified that federal contractors abused the tax system
with little consequence. While performing those audits, GAO noted that
the Internal Revenue Service (IRS) records sometimes contained
inaccurate or outdated tax information that prevented IRS from taking
appropriate collection actions against those contractors, including
submitting their tax debt to the Federal Payment Levy Program (FPLP)
for collection.
As a result, GAO was asked to review IRS‘s coding of tax debt excluded
from the FPLP to determine whether (1) IRS tax records contain
inaccurate status or transaction codes that exclude tax debt from the
FPLP, (2) IRS‘s monitoring could be strengthened to ensure the accuracy
of its status and transaction codes, and (3) other opportunities exist
to increase the amount of tax debt included in the FPLP.
What GAO Found:
IRS tax records had inaccurate information that resulted in it
erroneously excluding cases from the FPLP and other tax collection
actions. The FPLP is a cost-effective automated system used to collect
unpaid taxes from certain federal payments. GAO estimates that as of
September 30, 2005, over 500,000 tax records”equating to about $2.4
billion in tax debt”contained inaccurate codes that IRS systems used to
exclude tax debts from the FPLP. Inaccuracies included tax debts coded
as having active installment agreements even though the tax debtor had
stopped making payments.
IRS‘s monitoring of cases was insufficient to identify and correct the
coding errors GAO identified. Additionally, IRS‘s monitoring of
financial hardship cases is not sufficient to ensure their ongoing
accuracy. IRS grants tax debtors experiencing financial difficulty a
hardship designation that excludes them from the FPLP and other tax
collection activities until their income increases. To measure this,
IRS solely uses the income reported on the tax debtor‘s annual tax
returns. However, IRS does not monitor those tax debtors to ensure they
are filing and paying current taxes. For 31 financial hardship cases
GAO examined, 24 had ceased to file tax returns.
Although IRS has increased the amount of tax debt it submits to the
FPLP, additional policy changes could further improve the program‘s
effectiveness. Since 1992, IRS has almost tripled the maximum income it
allows tax debtors in financial hardship to earn; raising it to $84,000
in 2004”almost double the national median income. As a result, whereas
in 1992 no one earning above the median income was considered to be in
financial hardship (and therefore excluded from the FPLP), in 2005
almost two-thirds of the tax debt in financial hardship was owed by
individuals earning over the median income. Although a financial
hardship designation may be appropriate in many situations, allowing
relatively high-income tax debtors to avoid tax collection action,
including the FPLP, calls into question the fair application of the tax
system and may contribute to noncompliance.
Figure: Tax Debt Associated With Debtors in Financial Hardship Who Can
Earn Over the 2004 National Median Income:
[See PDF for Image]
Source: GAO analysis of IRS data.
[End of Figure]
What GAO Recommends:
GAO makes four recommendations to IRS to increase the amount of tax
debt eligible for the FPLP and six recommendations to evaluate the
appropriateness and ongoing validity of IRS‘s hardship designations.
IRS agreed with five of our recommendations and partially agreed with
two others. IRS disagreed with three recommendations due to workload,
cost, or taxpayer rights considerations. GAO reiterated its support for
its recommendations.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-26].
To view the full product, including the scope and methodology, click on
the link above. For more information, please contact Steven J.
Sebastian at (202)512-3406 or sebastians@gao.gov.
[End of Section]
Contents:
Letter:
Results in Brief:
Background:
Coding Errors Excluded Tax Debt from the FPLP:
More Effective Monitoring Could Prevent Errors and Help Ensure Ongoing
Accuracy of Account Status:
Policy Changes Could Allow Billions of Dollars in Tax Debt to Enter the
FPLP:
Conclusions:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: Scope and Methodology:
Appendix II: Comments from the Internal Revenue Service:
Appendix III: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: Results of GAO's Statistical Sample of IRS Statutory FPLP
Exclusions:
Table 2: Results of GAO's Statistical Sample of IRS Policy FPLP
Exclusions:
Table 3: IRS's Financial Hardship Income Thresholds:
Table 4: IRS's Financial Hardship Income Thresholds Ceilings:
Table 5: Historical IRS Maximum Income Thresholds and Household Median
Incomes:
Figures:
Figure 1: Types of Taxes Owed, as of September 30, 2005:
Figure 2: IRS Tax Debt by FPLP Status, as of September 30, 2005:
Figure 3: Value of Levy Program Collections, Fiscal Years 2003 through
2006:
Figure 4: Percentage of Tax Records in Statutory Exclusion Population
Categories, as of September 30, 2005:
Figure 5: Percentage of Tax Records in Policy Exclusion Population
Categories, as of September 30, 2005:
Figure 6: Tax Debt Associated with Debtors in Financial Hardship Who
Can Earn Over the 2004 National Median Income, as of September 30,
2005:
Figure 7: Collections from IRS Notification Letters in Fiscal Year
2005:
Abbreviations:
ACS: Automated Collection System:
FMS: Financial Management Service:
FPLP: Federal Payment Levy Program:
IRS: Internal Revenue Service:
United States Government Accountability Office:
Washington, DC 20548:
November 15, 2006:
The Honorable Norm Coleman:
Chairman:
The Honorable Carl Levin:
Ranking Minority Member:
Permanent Subcommittee on Investigations:
Committee on Homeland Security and Governmental Affairs:
United States Senate:
As the nation's tax collector, the Internal Revenue Service (IRS)
collects approximately $2 trillion in taxes from businesses and
individuals annually. The vast majority of the tax revenues flow into
the federal government by voluntary payments from compliant taxpayers.
However, while most taxpayers comply with the tax laws and pay their
taxes as required, a significant number do not. At September 30, 2005,
IRS's records reflected about $250 billion of unpaid taxes. In
addition, IRS estimates that about $300 billion in additional taxes go
unassessed and therefore uncollected every year.
IRS's collection process is heavily dependent upon its automated
computer systems and the information that resides within these systems.
In particular, the status and transaction codes in each taxpayer's
account in IRS's master file taxpayer database[Footnote 1] are critical
to IRS in tracking the collection actions it has taken against a tax
debtor and in determining what, if any, additional actions should be
pursued. For example, IRS uses a specific transaction code to identify
tax debtors it has designated as being in financial hardship and who
are thus unable to pay their tax debt. IRS uses these status and
transaction codes to identify cases it should exclude from the Federal
Payment Levy Program (FPLP), which is an automated method of collecting
tax debt by offsetting federal payments made to individuals and
businesses, as well as from other collection actions.
In congressional hearings held in February 2004 and June 2005,[Footnote
2] we testified that Department of Defense and civilian agency federal
contractors abused the federal tax system with little consequence. In
those hearings, we noted that IRS excluded significant amounts of tax
debt from the FPLP for either statutory or policy reasons, thus
limiting opportunities to automatically collect from those who had not
paid their federal taxes. While performing those audits, we noted that
IRS records sometimes contained inaccurate or outdated tax information
that prevented it from taking certain collection actions against those
contractors, including using the FPLP to collect at least some of the
outstanding tax debt.
On the basis of those audits and your request, we initiated a review of
the status and transaction codes within IRS's master file database of
taxpayer accounts to assess the accuracy of these codes and the effect
inaccurate or outdated codes in the master file database could have on
the FPLP and IRS's other collection efforts. The specific objectives of
this report were to determine (1) whether and to what extent IRS tax
records contain inaccurate or out-of-date status or transaction codes
that exclude collection of tax debt through the FPLP; (2) whether IRS's
monitoring policies, procedures, and practices could be strengthened to
ensure the accuracy and timely updating of its status and transaction
codes; and (3) whether opportunities exist to increase the amount of
tax debt subject to collection through the FPLP.
Tax debts may be excluded from the FPLP for either policy or statutory
reasons.[Footnote 3] To meet our objectives, we selected statistical
samples of IRS's outstanding tax-due accounts that were excluded from
the FPLP as of September 30, 2005. We examined the underlying records
to determine whether or not IRS had documentation supporting the
accuracy of the status and transaction codes both when they were
originally entered in IRS's systems and at the point in time of our
review. We supplemented our review of IRS records with information
gathered through data mining. For those sample items for which we
determined the codes were inaccurate or out of date, we reviewed IRS's
policies and procedures related to the FPLP to determine whether and
how IRS policies, procedures, or practices could be strengthened to
improve the ongoing accuracy of those codes and thus increase the
volume of tax debt that would be included in the FPLP. Finally, we
reviewed IRS's exclusion categories to identify opportunities for IRS
to modify its exclusion criteria so that more tax debt is subject to
collection through the FPLP. See appendix I for more detailed
information on the scope and methodology of our work.
Our work was performed from November 2005 through September 2006 in
accordance with generally accepted government auditing standards.
Results in Brief:
IRS's tax records contain inaccurate or out-of-date information that
resulted in IRS erroneously excluding tax debt from the Federal Payment
Levy Program (FPLP) and possibly other collection actions. Although our
review of tax debt excluded from the FPLP did not identify a high
percentage of FPLP-related coding errors, the errors did prevent IRS
from taking collection against tax debtors owing billions of dollars in
tax debt. Based on a review of two statistical samples of cases
excluded from the FPLP, we estimate that 6 percent of tax debts
excluded from the FPLP for statutory reasons and 1 percent excluded for
policy reasons were in error. On the basis of those error rates, we
estimate that over a half-million tax records with about $2.4 billion
in tax debt were erroneously excluded from the FPLP, as of September
30, 2005.
IRS did not identify and correct the coding errors we found because it
did not sufficiently monitor the timely updating of the status and
transaction codes or the effect of computer programming changes. In our
sample transactions, we found that IRS did not identify six computer-
programming-related coding errors because it did not fully assess the
effect of certain computer-programming changes on taxpayer account
status codes. Similarly, IRS did not identify a bankruptcy-related
coding error because it did not monitor the timely updating of the
bankruptcy-related transaction codes. In addition, although we found no
coding errors in the coding of cases designated as financial hardship
cases, our analysis revealed that IRS's policies for monitoring the
status of such cases are not sufficient to ensure the ongoing accuracy
of hardship designations. To illustrate, when IRS determines that a tax
debtor is in financial hardship and, as such, is deemed unable to pay,
IRS excludes the debt from the FPLP, as well as other collection
actions. IRS then limits its monitoring of the cases to an automated
review of the tax debtor's income as reported on the debtor's
subsequent years' income tax returns. However, for 24 of the 31 sample
cases coded by IRS as being in financial hardship, the tax debtor had
ceased to file tax returns. As a result of its policy to limit its
monitoring of financial hardship cases for tax debtors who ceased to
file tax returns, IRS had no way to determine whether the tax debtors'
financial condition had improved such that the tax debt should be
included in the FPLP and other collection actions.
IRS has increased the amount of tax debt subject to collection through
the FPLP by over $28 billion over the past 2 years. Nonetheless,
opportunities exist for IRS to amend its policies to allow billions of
dollars in additional tax debt to be included in the FPLP. For example,
of the $247 billion in unpaid taxes owed as of September 30, 2005, $23
billion, or almost 10 percent, is owed by tax debtors IRS has
designated as being in financial hardship; therefore, IRS does not
attempt to collect their outstanding tax debt. IRS allows tax debtors
earning up to $84,000--almost twice the median income for all
households in the United States--to be designated as being in financial
hardship. In total, IRS has placed tax debtors collectively owing over
$6 billion in tax debt in its top financial hardship income threshold
of between $76,000 and $84,000. Because they have been designated by
IRS as being in financial hardship, although they are earning
relatively high incomes, these tax debtors are excluded from the FPLP
and do not face other tax collection action from IRS. From 1992 to
2004, IRS almost tripled the maximum amount it allows tax debtors to
earn before being subject to collection action, far above the rate of
inflation. IRS could not provide us any data analysis that supported
those increases. As a result of those large increases, almost two-
thirds of all tax debt IRS has designated as being in financial
hardship is owed by tax debtors IRS allows to earn more than the
national median household income before their unpaid tax debt again
becomes subject to IRS collection action. In contrast, in 1992, no tax
debtor with a financial hardship designation was allowed to earn more
than the median household income without becoming subject to collection
action.
IRS policies also continue to exclude from the FPLP about $5 billion of
tax debt that has been assigned to its Automated Collection System
(ACS). In ACS, IRS enforcement personnel attempt to make telephone
contact with tax debtors to collect the unpaid tax debt. By excluding
tax debts in the ACS from the FPLP, IRS may be limiting its ability to
utilize a viable collection mechanism. We also found that IRS's
policies exclude all tax debt from the FPLP until IRS completes its
notification process. During this process, IRS sends a series of up to
four separate notices to tax debtors demanding payment of their taxes-
-a process that by IRS policy can take up to 6 months for individuals
with income tax debt. IRS is statutorily required to send two notices
before initiating the levy process, but IRS's current policies prevent
cases from timely entering the FPLP while it sends out multiple notice
letters, a process that can take almost twice as long as statutorily
required. Although each notice letter generates some collections of tax
debt, IRS receives over 70 percent of all notice collections from its
first notification letter. Once IRS fulfills the two-notice statutory
requirement, IRS could submit the tax debt to the FPLP while continuing
to send the tax debtor additional notifications. Doing so could
facilitate the timely movement of tax debt into the program and could
thus expedite and increase tax collections.
We are making ten recommendations to the Commissioner of Internal
Revenue for executive action, including four recommendations designed
to improve IRS's monitoring of tax debt, to increase the amount of tax
debt in the FPLP, or to accelerate how quickly tax debt enters the
program, and six recommendations to help ensure IRS's financial
hardship designations are appropriate.
IRS agreed with five of our recommendations, partially agreed with two
other recommendations, and disagreed with the remaining three
recommendations. IRS agreed to (1) evaluate steps necessary to ensure
the timely termination of defaulted installment agreements, (2)
evaluate the appropriateness of its current financial hardship income
thresholds, (3) implement policy changes to govern how financial
hardship thresholds are changed in the future, (4) evaluate whether to
include noncompliance with filing requirements as a factor in
reactivating cases in financial hardship, and (5) evaluate the
feasibility of referring tax debtors with financial hardship
designations to IRS's withholding compliance program for special
attention if they do not pay their current tax obligations.
IRS partially agreed with our recommendation to add language about
IRS's ability to levy income and assets to its early notification
letters, stating it would consider adding such language to some of the
later notices, but not the first notice. Based on IRS's comments, we
have modified our recommendation to add such language beginning with
the second notice. IRS also partially agreed with our recommendation to
review tax debtors' financial conditions to verify the continued
validity of its financial hardship designation, stating that it did not
agree with conducting such a review every 3 years, but that it would
study and consider including a time factor for such reviews. Based on
IRS's comments, we have modified our recommendation to conduct such
verification periodically.
IRS disagreed with our recommendation to put tax debt into the FPLP
early in the notice phase to accelerate the collection process, stating
that over two-thirds of tax debtors pay their tax debt in full after
IRS notifies them of the debt. IRS also did not agree with our
recommendation that it add additional tax debt to the FPLP when
collection officials were considering using other forms of levy. IRS
was concerned with the potential to inadvertently issue duplicate
levies and thereby cause tax debtors unanticipated hardship. In
addition, IRS did not agree with our recommendation that it change the
closing codes for tax debt cases designated as being in financial
hardship prior to the income threshold level changes that occurred in
2004. IRS stated that doing so may be difficult and may not be cost
effective.
We continue to believe that all ten current recommendations in this
report, if implemented, will assist IRS in its tax administration
duties. See the "Agency Comments and Our Evaluation" section of this
report for a more detailed discussion of the agency comments. We have
reprinted IRS's comments in appendix II of this report.
Background:
In its role as the nation's tax collector, IRS is responsible for
collecting taxes, processing tax returns, and enforcing the nation's
tax laws. Since 1990, we have designated IRS's enforcement of tax laws
as a governmentwide high-risk area.[Footnote 4] In attempting to ensure
that taxpayers fulfill their obligations, IRS is challenged on
virtually every front. While IRS's enforcement workload--measured by
the number of tax returns filed--has continually increased, only
recently have the resources IRS has been able to dedicate to enforcing
the tax laws begun to increase. IRS estimates that the annual gross tax
gap, that is, the difference between what taxpayers should pay on a
timely basis and what they actually pay, is about $345 billion. IRS has
reported that its enforcement activities, coupled with late payments,
recover about $55 billion of that amount, leaving an annual net tax gap
of almost $300 billion. IRS has a statutory limitation on the length of
time it can pursue unpaid taxes, generally 10 years from the date of
the assessment.[Footnote 5]
The amount of cumulative outstanding tax debt that IRS has identified
either through taxpayer reporting or through its various compliance
programs is also substantial. As of September 30, 2005, IRS's master
file database of taxpayer accounts reflected about $250 billion in
cumulative outstanding taxes owed by businesses and individuals. The
amount of unpaid taxes ranges from small amounts owed by individuals
for a single tax period to millions of dollars owed by businesses. The
taxes owed include individual income, corporate income, payroll, and
other types of taxes, as shown in figure 1.
Figure 1: Types of Taxes Owed, as of September 30, 2005:
[See PDF for image]
Source: GAO analysis of IRS data.
[End of figure]
As a part of its tax administration, IRS maintains over 24 million
separate tax debt account records in its master file database for
businesses and individuals. Within the master file database, IRS
records collection actions and the current status of tax debts through
a series of codes. The codes, referred to as status or transaction
codes, display a host of information, including the stage of the
collection process the tax debt is in; the capacity of a tax debtor to
pay, such as whether a tax debtor is considered to be experiencing
financial hardship; or other data such as whether the tax debtor is
under an arrangement with the IRS to pay the tax debt in installments.
IRS uses these codes to monitor and manage its inventory of outstanding
tax debt and its tax collection efforts.
Federal Payment Levy Program:
To improve the collection of unpaid taxes, the Congress, in the
Taxpayer Relief Act of 1997,[Footnote 6] authorized IRS to collect
delinquent tax debt by continuously levying (offsetting) up to 15
percent of certain federal payments made to tax debtors.[Footnote 7]
The payments include federal employee retirement payments, certain
Social Security payments, selected federal salaries, and contractor and
other vendor payments. Subsequent legislation increased the maximum
allowable levy amount to 100 percent for payments to federal
contractors and other vendors for goods or services sold or leased to
the federal government.[Footnote 8] The continuous levy program, now
referred to as the Federal Payment Levy Program (FPLP), was implemented
in 2000. Under the FPLP, each week IRS sends the Department of the
Treasury's Financial Management Service (FMS) an extract of its tax
debt files. These files are uploaded into the Treasury Offset
Program.[Footnote 9] FMS sends payment data to this offset program to
be matched against unpaid federal taxes. The program electronically
compares the names and taxpayer identification numbers on the payment
files to the control names (first four characters of the names) and
taxpayer identification numbers of the debtors listed in the offset
program. If there is a match and IRS has updated the weekly data sent
to the offset program to reflect that it has completed all statutory
notifications, the federal payment owed to the debtor is reduced
(levied) to help satisfy the unpaid federal taxes.
In creating the weekly extracts of tax debt to forward to FMS for
inclusion in the offset program, IRS uses the status and transaction
codes in the master file database to determine which tax debts are to
be included in or excluded from the FPLP. For example, IRS cannot levy
the assets of individuals and businesses to recover tax debts while the
tax debtor is involved in a bankruptcy proceeding. In such cases, IRS
uses the bankruptcy status code in the master file to block the tax
debt from being submitted to the FPLP. Under other circumstances, IRS
collection personnel can enter a transaction code into the tax debtor's
tax account to block the debt from being levied through the FPLP.
Consequently, the accuracy and appropriateness of status and
transaction codes is vital to the effective operation of the FPLP. We
reported in 2004 that incorrect or out-of-date IRS status and
transaction codes in IRS's records had inappropriately blocked
delinquent tax debt from being referred to the FPLP.[Footnote 10]
IRS currently excludes 62 percent of all tax debt from the FPLP because
of either statutory or policy reasons. As shown in figure 2, at
September 30, 2005, IRS excluded over $73 billion (29 percent) from the
FPLP for statutory reasons and about $82 billion (33 percent) for
policy reasons.
Figure 2: IRS Tax Debt by FPLP Status, as of September 30, 2005:
[See PDF for image]
Source: GAO analysis of IRS data.
[End of figure]
Cases excluded from the FPLP for statutory reasons include tax debt
that had not completed IRS's notification process, or tax debtors who
filed for bankruptcy protection or other litigation, who agreed to pay
their tax debt through monthly installment payments, or who requested
to pay less than the full amount owed through an offer in
compromise.[Footnote 11]
Cases excluded from the FPLP for policy reasons include those tax
debtors whom IRS has determined to be in financial hardship, those
filing an amended return, certain cases under criminal investigation,
and those cases in which IRS has determined that the specific
circumstances of the cases warrant excluding it from the FPLP.
Improvements in the Levy Program:
Since the inception of the FPLP, we have identified numerous issues
that have impeded the levy program from achieving its full potential.
In response to many of the issues we raised, IRS and other agencies
have made numerous improvements to the levy program that have
contributed to increased tax collections. IRS and FMS officials, along
with Department of Defense, General Services Administration, Office of
Management and Budget, and Department of Justice officials, created a
multiagency task force--referred to as the Federal Contractor Tax
Compliance Task Force--in 2004, primarily to address the issues raised
in our 2004 report related to defense contractors and the
FPLP.[Footnote 12] The multiagency nature of the task force reflected
that the involvement of several agencies was required for the FPLP to
reach its full potential. The task force, which has now become a
semipermanent body, has worked toward its stated goals and, along with
the efforts of the individual agencies, has been instrumental in making
significant improvements in the program. For example, the task force
has achieved its goal of adding most of the Department of Defense's
payment systems to the FPLP.
IRS, in conjunction with the task force, has made several policy
changes directed toward increasing the amount of unpaid tax debt that
it is submitting to the FPLP. For example, IRS altered its policies to
include the following tax debt in the levy program that had previously
been excluded:
* cases waiting in a "queue" to be actively worked by an IRS
collections official--formerly IRS blocked such cases from the FPLP for
a year each time a case entered the queue;
* nearly half of the cases assigned to its Automated Collection System
(ACS);[Footnote 13]
* most cases in the field that are being worked by an IRS revenue
officer; and:
* cases that have low dollar balances and cases for which the IRS has
been unable to locate or contact the tax debtor.
IRS has also worked with FMS to improve the process of matching tax
debtor names between FMS's payment files and IRS's tax debt files to
increase the number of payments and debts that are matched. This work
was important because the FPLP relies on matching both the tax
identification number and the control name in the payment to those in
the tax files to identify a federal payment for levy.
The FPLP has proved to be a cost-effective means of collecting
outstanding tax debt from tax debtors who receive payments from the
federal government, and the improvements IRS and other agencies have
made in the program have significantly increased tax collections since
2003, as shown in figure 3.
Figure 3: Value of Levy Program Collections, Fiscal Years 2003 through
2006:
[See PDF for image]
Source: GAO analysis of IRS data.
[End of figure]
Although the FPLP collected almost $300 billion dollars in previously
unpaid taxes during fiscal year 2006, the program has an even greater
effect on total tax collections. In previous reports, we have estimated
that IRS collects three times the amount of the direct levy collections
through voluntary revenues received as a result of taxpayers responding
to IRS's notice that their federal payments would be levied.[Footnote
14]
Coding Errors Excluded Tax Debt from the FPLP:
To maximize the effectiveness of the FPLP as a tool to collect
outstanding federal taxes, it is crucial that IRS record and maintain
accurate status codes for all tax debt within its systems. To test the
accuracy of the codes, we selected statistical samples of tax debt
excluded from the FPLP for both statutory and policy reasons to
determine if these status codes appropriately reflected the current
condition of the tax debt. Our testing of IRS's exclusion codes
consisted of samples of 100 tax debts excluded for statutory reasons,
and 100 tax debts excluded for policy reasons as of September 30, 2005.
While our review of the sample of tax debts excluded for policy reasons
did not identify a significant number of coding errors that would
affect the FPLP, our review of the sample of tax debts excluded for
statutory reasons did. On the basis of our samples, we estimate that
over a half-million tax records with over $2.4 billion in tax debt were
erroneously excluded from the FPLP.
Errors in Statutory Exclusion Codes:
At September 30, 2005, IRS had about $73 billion of outstanding tax
debt associated with about 9 million tax records that were excluded for
statutory reasons. As shown in figure 4, these tax records were almost
exclusively in four statutory exclusion categories: notice, bankruptcy,
offers in compromise, and installment agreements.
Figure 4: Percentage of Tax Records in Statutory Exclusion Population
Categories, as of September 30, 2005:
[See PDF for image]
Source: GAO analysis of IRS data.
[End of figure]
In reviewing the 100 tax records coded as statutorily excluded tax
debt, we identified six instances in which the records were incorrectly
coded. Table 1 presents the number of errors we found by exclusion
category.[Footnote 15]
Table 1: Results of GAO's Statistical Sample of IRS Statutory FPLP
Exclusions:
Statutory exclusions: Installment agreements;
Number of cases: 44;
Number of errors: 4.
Statutory exclusions: Notice phase;
Number of cases: 40;
Number of errors: 1.
Statutory exclusions: Bankruptcy/litigation;
Number of cases: 11;
Number of errors: 1.
Statutory exclusions: Offers in compromise;
Number of cases: 5;
Number of errors: 0.
Statutory exclusions: Total statutory exclusions;
Number of cases: 100;
Number of errors: 6.
Source: GAO analysis of IRS data.
[End of table]
As indicated in table 1, four of the errors we identified involved tax
debtors erroneously coded as paying on an installment agreement and
thus excluded from the FPLP.[Footnote 16] In each of the four cases,
IRS had not terminated the installment agreement within 5 months after
the tax debtor stopped making agreed-to payments. Although IRS's
guidance on the installment agreement termination process does not
contain a specific time frame, 5 months is the minimum amount of time
that would elapse if IRS's Internal Revenue Manual requirements on
terminating installment agreements were laid out in a timeline. In one
of the cases, IRS took 23 months to terminate the agreement after the
tax debtor had stopped making payments.
One error involved tax debt that had been erroneously kept in IRS's
notice phase. The notice phase is IRS's first phase in the tax debt
collection process and consists of a series of letters IRS sends to tax
debtors informing them of the tax debt and requesting payment. Each
letter is represented by a specific status code. The one error we
identified in this exclusion category resulted when an IRS computer
programming change in 2005 inadvertently blocked certain status codes
from being updated and thus prevented the related tax debt from exiting
the notice phase. IRS personnel took action to correct this systemic
error after we informed them of the issue.
We also found one bankruptcy-related case erroneously excluded from the
FPLP due to IRS failing to reverse a bankruptcy transaction code after
the bankruptcy had ended. According to IRS officials, IRS's time frame
for initiating action to reverse a bankruptcy code is 30 days after
bankruptcy actions have been completed. However, in this case, the
bankruptcy had ended almost a year before the time of our review, yet
IRS had not updated the status code in the tax debtor's account. IRS
reversed the bankruptcy code after we informed IRS personnel of the
issue. However, as a result of the error, the tax debt had been
erroneously excluded from the FPLP and all other collection action for
almost a year. We found no errors in the status codes for the five
offer in compromise cases we reviewed.[Footnote 17]
In total, the errors we found in the sample of tax records excluded for
statutory reasons equate to a 6 percent projected error rate. As a
result of these errors, we estimate that over a half-million tax
records containing about $2.4 billion in uncollected tax debt were
erroneously excluded from the FPLP[Footnote 18].
Errors in Policy Exclusion Codes:
At September 30, 2005, IRS had about $82 billion of outstanding tax
debt associated with about 7 million tax-period records that were
excluded for policy reasons. As shown in figure 5, tax records were
excluded primarily for three reasons: cases designated as financial
hardship, cases currently in or awaiting assignment to IRS's collection
function,[Footnote 19] and cases designated as currently not
collectible for reasons other than financial hardship, including low-
dollar cases.
Figure 5: Percentage of Tax Records in Policy Exclusion Population
Categories, as of September 30, 2005:
[See PDF for image]
Source: GAO analysis of IRS data.
[End of figure]
IRS is authorized to exclude tax debt from the FPLP based on a policy
determination of financial hardship.[Footnote 20] Tax debt in the other
two categories is excluded on a case-by-case basis. In other words, the
categories, themselves, are not explicitly excluded from the FPLP, but
individual cases in those categories may be excluded by IRS personnel
based on the circumstances of the particular case. For example, cases
that are in IRS's field collection status being worked by a revenue
officer are generally eligible for the FPLP; however, the revenue
officer can block the tax debt from inclusion in the FPLP when the
officer determines that pursuing other collection actions may be more
effective.
In reviewing the 100 tax records coded as excluded for policy reasons,
we identified one instance in which the records were incorrectly coded.
Table 2 presents the results of our review of the sampled cases.
Table 2: Results of GAO's Statistical Sample of IRS Policy FPLP
Exclusions:
Policy exclusions: Cases in, or awaiting assignment to, collection;
Number of cases: 36;
Number of errors: 1.
Policy exclusions: Cases IRS considers not currently collectible, other
than hardship, including low-dollar cases;
Number of cases: 33;
Number of errors: 0.
Policy exclusions: Financial hardships;
Number of cases: 31;
Number of errors: 0.
Policy exclusions: Total policy exclusions;
Number of cases: 100;
Number of errors: 1.
Source: GAO analysis of IRS data.
[End of table]
The one coding error we found involved a tax debtor who defaulted on an
offer in compromise, but IRS did not put the tax debt into the FPLP.
Although IRS correctly coded the tax debtor as having defaulted on the
agreed-to payment terms of the offer, IRS's system had not been
programmed to reverse the original "pending" code that IRS personnel
placed in the tax debt record while IRS was considering the tax
debtor's offer.[Footnote 21] Even though the tax debtor had defaulted
on the offer, the unreversed pending offer code continued to exclude
the case from the FPLP. On the basis of our finding, IRS implemented a
computer programming change to reverse existing pending codes for
defaulted offer in compromise cases.
We found no errors in the cases that IRS had designated as currently
not collectible for reasons other than financial hardship. Although IRS
is not going to actively seek collection from them, these cases are
generally included in the FPLP. However, IRS tax collections personnel
can exclude these cases from the FPLP on a case-by-case basis.
Our review of the limited data IRS retains related to financial
hardship cases and our own review of the tax debtor's financial
condition using available IRS information and outside data sources did
not identify any cases in which we believe IRS had erroneously coded a
tax debtor as being in financial hardship. However, as discussed later,
we do believe that IRS's existing processes increase the risk that
outdated status codes related to financial hardship cases could occur
and not be detected.
In total, the errors we found in the sample of tax records excluded for
policy reasons equate to a 1 percent projected error rate.[Footnote 22]
More Effective Monitoring Could Prevent Errors and Help Ensure Ongoing
Accuracy of Account Status:
IRS's current monitoring of the ongoing status of accounts did not
identify and correct the errors in our sample. In addition, although we
found no errors in the coding of financial hardship cases, our analysis
revealed that the design of IRS's policies for monitoring the status of
such cases is not sufficient to ensure the ongoing accuracy of hardship
designations.
Monitoring Did Not Identify Tax Debt That Should Have Been Eligible for
Levy:
The coding errors we identified in our samples of tax debts excluded
from the levy program for statutory and policy reasons could have been
avoided if IRS had more effectively monitored the ongoing status of
accounts to detect and prevent delays in putting tax debt into the
FPLP.
In the one case from our sample of statutory exclusions involving a
bankruptcy-related coding error, the transaction code blocking the case
from inclusion in the FPLP was not reversed within IRS's stated time
frame. IRS policy is that bankruptcy codes should be reversed within 30
days after a bankruptcy judge has dismissed the case.[Footnote 23] In
such cases, the tax debtor again becomes liable for repaying the tax
debt. IRS did not reverse the bankruptcy code in a timely manner
because the case was repeatedly transferred to different IRS personnel
without anyone taking action to reverse the code. As a result of
confusion caused by the repeated transfer of the case within IRS and no
one person having responsibility for monitoring the disposition of the
case, IRS did not recognize that the bankruptcy code had not been
reversed until we notified IRS officials during our review of the case.
In the four coding errors we identified involving installment agreement
cases, the errors were caused by a computer programming problem--
corrected in January 2006--that prevented the installment agreement
codes from automatically reversing within IRS's systems.[Footnote 24]
Generally, IRS's computer systems automatically begin the process to
reverse an active installment agreement code after a tax debtor fails
to make two scheduled monthly payments, but that did not happen in
these cases. IRS officials were unable to determine specifically why
this occurred, and stated that they do not monitor whether installment
agreement transaction codes are reversed within the 5-month time frame
indicated by IRS's Internal Revenue Manual for terminating installment
agreements.[Footnote 25] Until the installment agreement code is
reversed in the system, the tax debt remains excluded from the FPLP.
Had IRS been monitoring the timely termination of installment
agreements, these cases would have come to IRS's attention and afforded
it an opportunity to investigate the cause.
Two coding errors--one statutory exclusion case and the other a policy
exclusion case--were also caused by deficiencies in IRS's computer
programs. In the statutory exclusion case, the tax debt did not
automatically move through the notice process because IRS did not
include one of its several notice status codes in a computer
programming change. As a result, when the programming change was
implemented, the existing cases in that notice status were prevented
from automatically continuing their movement through the notice phase
and into collection. As a result, these cases remained excluded from
the FPLP and other collection actions. After we brought this case to
IRS's attention, it took corrective action to address this programming
deficiency. In the second case, involving a policy exclusion related to
a defaulted offer in compromise, IRS continued to exclude the tax debt
from the FPLP because, although IRS personnel properly entered a code
indicating a default on an offer in compromise, IRS's systems did not
reverse the code indicating the case had an initial pending offer. IRS
had recently implemented a programming change to the way it processes
offer in compromise-related transaction codes so that the code that
reverses an active offer in compromise transaction code also reverses
any pending offer in compromise codes related to the same tax case.
However, the programming change only affected offer in compromise cases
occurring subsequent to the date the change was implemented; it did not
affect pending offer codes that existed prior to the programming
change. After we notified IRS personnel of the error we identified,
they took corrective action to reverse the status code in this and
similar cases.
Monitoring of Financial Hardship Cases Does Not Consider Tax Debtors
Who Fail to File Tax Returns or Pay Current Taxes:
As discussed earlier, in our sample of tax debt cases excluded from the
FPLP for policy reasons, we found that all 31 cases that were excluded
due to the tax debtor being designated by IRS as being in financial
hardship were correctly coded based on IRS's existing policy and our
review of the limited documentation IRS maintained regarding the tax
debtor's income. However, we found deficiencies in IRS's procedures for
monitoring the ongoing status of financial hardship cases, which
hinders IRS's ability to ensure the ongoing accuracy of the financial
hardship designation. This, in turn, could result in additional tax
debt that should be eligible for levy not being forwarded to the FPLP.
To make the determination of whether a tax debtor is facing financial
hardship and thus does not have the means to pay the tax debt, IRS
analyzes the tax debtor's financial condition using guidelines for
allowable costs. On the basis of these guidelines, IRS officials place
individuals in one of nine income categories, or income thresholds.
These thresholds represent income level ceilings above which the tax
debtor again becomes subject to IRS's collection actions, including
forwarding of the tax debt to the FPLP. Once IRS designates a tax
debtor as being in financial hardship, it performs an automated
evaluation of the debtor's income based upon their annual tax return
filings. Specifically, IRS compares the income reported on the tax
debtor's tax return to the threshold level assigned to the tax debtor.
If the reported income exceeds the threshold, the financial hardship
designation is terminated and the tax debt becomes subject to
collection and can be put into the FPLP.
IRS policy discourages any other monitoring or follow-up of financial
hardship cases beyond the automated match. IRS does not routinely
update the tax debtor's allowable expenses or perform a periodic
review--such as once every 3 years--of the tax debtor's overall
financial condition. In fact, the Internal Revenue Manual directs IRS
personnel working financial hardship cases to not request future follow-
up reviews to check on compliance with future income tax filing
requirements or to update a tax debtor's financial condition.
Consequently, IRS relies only on the accuracy of the information
reported in the tax return filed by the tax debtor, with no review of
income information reported to IRS by third parties, such as Form W-2
and Form 1099 information reports,[Footnote 26] to assess the ongoing
accuracy of hardship designations. IRS's procedures do not require it
to remove a tax debtor from the financial hardship status if the tax
debtor fails to file a tax return, and failing to file does not flag
the case for IRS personnel to perform a review of the financial
hardship designation. Because of its monitoring policy, when a tax
debtor with a financial hardship designation does not subsequently file
an annual income tax return, IRS has no means of determining whether
the tax debtor's financial condition has improved and the hardship
designation should be terminated. Since individuals designated as being
in financial hardship are excluded from the FPLP--as well as all other
tax collection actions--not knowing whether the hardship designation
remains valid can result in IRS inappropriately excluding the tax debt
from the FPLP.
Generally, individuals with a financial hardship designation who do not
file a tax return are treated like other nonfilers: they can be
eventually subject to review by IRS's automated substitute-for-return
process. In that review, IRS examines other available data on the
taxpayer, assesses whether a tax return should have been filed, and
estimates the amount of tax due. However, that process generally does
not occur for more than a year after the failure to file, and only
individuals who meet certain criteria are reviewed. A financial
hardship designation is not one of the criteria and, therefore, these
cases do not have a high priority.
On the basis of our review of the sample cases, ceasing to file is not
an uncommon occurrence for tax debtors with hardship designations.
Twenty-four of the 31 tax debtors designated as financial hardship in
our sample cases had ceased filing tax returns after IRS had determined
the tax debtor was in financial hardship.
IRS's current practices also do not prevent tax debtors with a
financial hardship designation from accumulating additional tax debt by
not paying their current taxes. A financial hardship designation puts a
tax debtor's past debt in abeyance, but the hardship designation does
not automatically exempt the tax debtor from paying current taxes.
However, we found that IRS does little to prevent the further
accumulation of tax debt by these tax debtors. Of the 31 tax debtors
with financial hardship designations in our sample cases, we found that
4 filed but had not paid income taxes subsequent to being identified as
a financial hardship case. As with not filing a tax return,
accumulating new tax debt does not cause IRS to automatically terminate
the financial hardship designation, and IRS's procedures allow IRS
personnel to include the newly acquired tax debt into the hardship
designation, sometimes without any additional analysis of the tax
debtor's financial condition. Thus, a tax debtor's ever-increasing tax
debt can remain excluded from the FPLP as well as other collection
actions.
The effect of IRS's collection policy regarding financial hardship tax
debtors who accumulate new debt is essentially to both cease collection
of old debt and not require tax debtors to pay the current taxes they
owe. Allowing such tax debtors to continually not pay current taxes
without consequence appears to be giving tax debtors with financial
hardship designations an additional exemption from paying current taxes
as well as old tax debt and may contribute to the noncompliance of
other taxpayers.
In fiscal year 2006, IRS initiated a withholding compliance program
that has potential to help prevent wage-earning tax debtors from
accumulating more unpaid tax debt. The program is designed to identify
individuals who incur tax debt because they did not have their employer
withhold sufficient wages to cover their taxes due for the current
year. The program identifies those debtors and requires their employers
to increase the withholdings. However, due to resource constraints, IRS
actively pursues only a small portion of the tax debtors who
underwithhold. Additionally, while the program prioritizes cases for
review, a financial hardship designation is not a prioritization
criterion.
Policy Changes Could Allow Billions of Dollars in Tax Debt to Enter the
FPLP:
IRS has significantly improved the effectiveness of the FPLP by making
an additional $28 billion in unpaid tax debt eligible for the program
since 2004. However, certain changes in IRS's policies could result in
additional billions of dollars in tax debt entering the levy program
for potential collection or entering the program earlier. Under current
IRS policy, all tax debt for which the debtor is designated as being in
financial hardship, including those debts associated with tax debtors
earning relatively high income levels, are excluded from the levy
program. In addition, half of the cases in IRS's ACS are excluded from
the program, as are all cases throughout IRS's notification process.
IRS Excludes Many Cases from the FPLP with Incomes Exceeding the
National Median Income:
IRS has established policies that allow it to designate tax debtors
earning up to $84,000--nearly twice the national median income of about
$44,000[Footnote 27]--as being in financial hardship. IRS is authorized
to grant tax debtors a designation of financial hardship when
collection of the tax debt would cause the tax debtor to be unable to
pay his or her reasonable basic living expenses.[Footnote 28] IRS's
Internal Revenue Manual provides examples of financial hardship cases,
such as a disabled taxpayer who lives in a modest house that has been
equipped to accommodate the disability and whose fixed income is not
sufficient to both meet his or her living expenses and pay the tax
debt. IRS has the authority to determine allowable living expenses
according to the unique circumstances of individual tax debtors;
however, unique circumstances do not include the maintenance of an
affluent or luxurious standard of living.
Once designated as being in financial hardship, the tax debtors are
excluded from the FPLP and are also exempt from any other IRS
collection action until their self-reported income rises above one of
nine designated income thresholds. Since 1992, IRS has almost tripled
the income it allows tax debtors in financial hardship to earn without
pursuing collection, but IRS does not have documentation of any data
analysis that justified the large increases. Consequently, as of
September 30, 2005, about 65 percent of the tax debt in the financial
hardship category was owed by tax debtors who were allowed to earn more
than the national median income before being subject to collection
actions. Of the $247 billion total tax debt in IRS's records, IRS is
not pursuing collection of almost 10 percent of that amount--$22.6
billion--as a result of its financial hardship determinations.
As discussed previously, IRS makes a determination as to whether a tax
debtor qualifies as a financial hardship case based on an analysis of
the amount of income earned and the allowable expenses owed by the tax
debtor.[Footnote 29] If IRS determines that a tax debtor is unable to
pay the outstanding tax liability due to financial hardship, it places
a financial hardship transaction code in the tax debtor's account. The
transaction code is assigned one of nine subcodes (called closing
codes) indicating the income threshold level ceilings at which IRS has
determined that the tax debtor should be able to begin repaying the tax
debt. Tax debtors will not face any IRS collection action[Footnote 30]
until their total positive income--roughly equivalent to adjusted gross
income--exceeds the designated income threshold ceiling. IRS's
financial hardship income thresholds range in $8,000 increments from
$20,000 to $84,000, as depicted in table 3.
Table 3: IRS's Financial Hardship Income Thresholds:
1;
Income threshold ceilings effective: 2004-present: $20,000;
Number of tax records at September 30, 2005: 306,900;
Total tax debt at September 30, 2005 (dollars in billions): $2.1.
2;
Income threshold ceilings effective: 2004-present: 28,000;
Number of tax records at September 30, 2005: 173,600;
Total tax debt at September 30, 2005 (dollars in billions): 1.3.
3;
Income threshold ceilings effective: 2004-present: 36,000;
Number of tax records at September 30, 2005: 213,900;
Total tax debt at September 30, 2005 (dollars in billions): 2.0.
4;
Income threshold ceilings effective: 2004-present: 44,000;
Number of tax records at September 30, 2005: 223,000;
Total tax debt at September 30, 2005 (dollars in billions): 2.5.
5;
Income threshold ceilings effective: 2004-present: 52,000;
Number of tax records at September 30, 2005: 203,700;
Total tax debt at September 30, 2005 (dollars in billions): 2.5.
6;
Income threshold ceilings effective: 2004-present: 60,000;
Number of tax records at September 30, 2005: 169,000;
Total tax debt at September 30, 2005 (dollars in billions): 2.3.
7;
Income threshold ceilings effective: 2004-present: 68,000;
Number of tax records at September 30, 2005: 148,900;
Total tax debt at September 30, 2005 (dollars in billions): 2.3.
8;
Income threshold ceilings effective: 2004-present: 76,000;
Number of tax records at September 30, 2005: 91,300;
Total tax debt at September 30, 2005 (dollars in billions): 1.2.
9;
Income threshold ceilings effective: 2004-present: 84,000;
Number of tax records at September 30, 2005: 286,600;
Total tax debt at September 30, 2005 (dollars in billions): 6.4.
Total;
Income threshold ceilings effective: 2004-present: [Empty];
Number of tax records at September 30, 2005: 1,816,900;
Total tax debt at September 30, 2005 (dollars in billions): $22.6.
Source: GAO analysis of IRS data.
[End of table]
Five of the nine income thresholds included in IRS's financial hardship
designation have upper range ceilings above the 2004 national median
household income of $44,389. Of the approximately 1.8 million tax debt
records designated as financial hardship in IRS's unpaid assessments
database at September 30, 2005, approximately half--about 900,000--were
debts owed by tax debtors in one of the five income threshold
categories above the national median. Over 286,000 tax records--with
associated tax debt of about $6.4 billion--were for tax debtors in the
top income level threshold for financial hardship of up to $84,000.
The exclusion of tax debt from collection actions may be appropriate in
many circumstances to provide relief for those experiencing financial
difficulty. However, as shown in figure 6, $14.8 billion in tax debt
(65 percent of the tax debt) in financial hardship is owed by tax
debtors whom IRS will allow to earn more than the national median
household income before they have to begin repaying their tax
debt.[Footnote 31]
Figure 6: Tax Debt Associated with Debtors in Financial Hardship Who
Can Earn Over the 2004 National Median Income, as of September 30,
2005:
[See PDF for image]
Source: GAO analysis of IRS data.
[End of figure]
As shown in table 4, IRS's income thresholds used to determine whether
tax debtors are experiencing financial hardship and therefore cannot
currently pay their outstanding tax debt have not always been this
high. IRS significantly increased each of the nine income thresholds in
1997 and again in 2004. IRS had previously set rates in 1992. The 2004
increases averaged 77 percent but the individual threshold increases
ranged from 100 percent for the lowest threshold to 68 percent for the
highest.
Table 4: IRS's Financial Hardship Income Thresholds Ceilings:
1;
Income thresholds ceilings effective: 1992-1997: $6,000;
Income thresholds ceilings effective: 1997-2004: $10,000;
Income thresholds: ceilings effective: 2004-present: $20,000.
2;
Income thresholds ceilings effective: 1992-1997: 9,000;
Income thresholds ceilings effective: 1997-2004: 15,000;
Income thresholds: ceilings effective: 2004-present: 28,000.
3;
Income thresholds ceilings effective: 1992-1997: 12,000;
Income thresholds ceilings effective: 1997-2004: 20,000;
Income thresholds: ceilings effective: 2004-present: 36,000.
4;
Income thresholds ceilings effective: 1992-1997: 15,000;
Income thresholds ceilings effective: 1997-2004: 25,000;
Income thresholds: ceilings effective: 2004-present: 44,000.
5;
Income thresholds ceilings effective: 1992-1997: 18,000;
Income thresholds ceilings effective: 1997-2004: 30,000;
Income thresholds: ceilings effective: 2004-present: 52,000.
6;
Income thresholds ceilings effective: 1992-1997: 21,000;
Income thresholds ceilings effective: 1997-2004: 35,000;
Income thresholds: ceilings effective: 2004-present: 60,000.
7;
Income thresholds ceilings effective: 1992-1997: 24,000;
Income thresholds ceilings effective: 1997-2004: 40,000;
Income thresholds: ceilings effective: 2004-present: 68,000.
8;
Income thresholds ceilings effective: 1992-1997: 27,000;
Income thresholds ceilings effective: 1997-2004: 45,000;
Income thresholds: ceilings effective: 2004-present: 76,000.
9;
Income thresholds ceilings effective: 1992-1997: 30,000;
Income thresholds ceilings effective: 1997-2004: 50,000;
Income thresholds: ceilings effective: 2004-present: 84,000.
[End of table]
Source: IRS.
In justifying the large increases from previous threshold ceilings, IRS
stated that the new 2004 thresholds more accurately reflected current
economic conditions and that the new values were supported by Bureau of
Labor Statistics data and were consistent with the allowable expenses
in IRS guidance. IRS also stated that the revised income thresholds
were based on an analysis of allowable expense standards for high-cost
geographic areas considered in conjunction with current Bureau of Labor
Statistics poverty levels. Though it raised the top threshold to
$84,000, IRS had considered raising its top threshold for financial
hardship to $100,000.
Other than the above statements, IRS could not provide documentation of
any data analysis that supported its reasons for the large increases
since 1992. However, measures of median income raise questions about
the size of the increases to the income thresholds for financial
hardship determinations. As table 5 depicts, IRS's increases in the
financial hardship income thresholds has had the effect of raising the
maximum income threshold from about equivalent to the national median
income in 1992 to almost twice the median income in 2004. With respect
to high-cost areas, New Jersey's $61,359, the highest state median
income in 2004,[Footnote 32] was well below IRS's 2004 top three income
threshold levels. The lowest state median income in 2004 was $31,500.
Table 5: Historical IRS Maximum Income Thresholds and Household Median
Incomes:
Year: 1992;
IRS's maximum financial hardship income threshold: $30,000;
National median income for all households[A]: $30,636;
Percentage maximum level above/below median income: - 2.1%.
Year: 1997;
IRS's maximum financial hardship income threshold: 50,000;
National median income for all households[A]: 37,005;
Percentage maximum level above/below median income: + 35.1.
Year: 2004;
IRS's maximum financial hardship income threshold: 84,000;
National median income for all households[A]: 44,389;
Percentage maximum level above/below median income: + 89.2.
Source: IRS and U.S. Census Bureau.
[A] Median income is stated in 2004-equivalent dollars.
[End of table]
As a result of these large increases, almost two-thirds of all tax
debtors with IRS financial hardship designations are allowed to earn
more than the national median household income in 2004 before their
unpaid tax debt again becomes subject to IRS collection action. In
contrast, in 1992, no tax debtor with a financial hardship designation
was allowed to earn more than the median income without becoming
subject to collection action.
Measures of inflation also raise questions about the size of IRS's
increases. Bureau of Labor Statistics national inflation rate data
indicate that the effects of inflation would have justified lower
increases. For example, using inflation data from 1997 to 2004, the top
2004 threshold would have been about $60,000,[Footnote 33] far below
IRS's $84,000 level, and would have kept the top threshold at roughly
35 percent above the national median income as it was in 1997.
Exacerbating the effect of IRS's increases in its hardship thresholds
was the policy it used to implement the increases. IRS did not change
the subcodes indicating the income threshold ceilings or reexamine the
financial condition of tax debtors when it raised the income thresholds
ceilings. For example, the IRS subcodes indicating that tax debtors
were in the highest income threshold of $50,000 prior to the threshold
increases were not updated to reflect the new thresholds. Thus the tax
debtors remained in the highest income threshold and were allowed to
earn up to $84,000 before IRS would begin taking collection action.
Therefore, after the 2004 increases, the tax debtors in the top income
threshold category were allowed to earn $34,000 more annually before
IRS would remove the tax debtor from the financial hardship exclusion
category and begin pursuing collection of the outstanding tax debt. IRS
neither reassessed the financial condition of tax debtors with existing
financial hardship designations nor changed their existing designation
to one that closely matched their original income threshold amount.
Allowing relatively high income tax debtors, such as those earning
$84,000, to avoid tax collection action calls into question the fair
application of the tax system and may contribute to noncompliance by
other taxpayers. In addition, dramatically increasing the financial
hardship income threshold ceilings has effectively resulted in
increasing the number of tax debtors IRS classifies as being in
financial hardship. This, in turn, reduces the portion of IRS's
inventory of tax debt under active collection and reduces the portion
eligible for inclusion in the FPLP.
IRS Continues to Exclude Substantial Tax Debt in ACS from the FPLP:
Although IRS made policy changes in 2004 to allow about 40 percent of
the tax debt in ACS to enter the FPLP, IRS continues to exclude the
other 60 percent. The ACS is an automated call system designed to
schedule and follow up on IRS's outgoing calls to, and incoming calls
from, tax debtors. ACS personnel's primary activity is to contact tax
debtors by phone to attempt to collect outstanding tax debt. At
September 30, 2005, the ACS contained an inventory of about $8 billion
of unpaid tax debt. To manage the large inventory of tax debt in ACS,
IRS has divided the ACS inventory into 40 subcategories. In general,
those subcategories describe the status of IRS collection actions
within ACS, such as indicating that an installment agreement is pending
or specifying a collection action that is awaiting approval by a
supervisor.
Prior to 2005, all the tax debt in ACS was excluded from the FPLP. In
2005, in response to issues raised in our 2004 review of Department of
Defense contractors with outstanding tax debt,[Footnote 34] IRS changed
its policies to allow some of the tax debt assigned to ACS to enter the
FPLP. However, IRS has continued to exclude tax debt in 19 of the 40
ACS subcategories from the FPLP. Those 19 subcategories contain 60
percent, or about $5 billion, of the total tax debt in the ACS
inventory. Two of the excluded subcategories, which IRS calls R-5 and I-
6, contain approximately $3.9 billion of tax debt, and involve cases in
which IRS is placing a levy against a tax debtor's assets. These
"paper" levies, as IRS refers to them to distinguish them from
automated FPLP levies, are generally one-time levies placed against a
tax debtor's bank accounts or other financial assets, although they can
also be an ongoing garnishment of wages. FPLP levies, in contrast, are
continuous levies of all federal payments, including federal salaries,
pensions, social security, and contractor-related payments.
IRS has the authority to levy a tax debtor's assets to collect
outstanding tax debt. Therefore, simultaneously levying through both
the paper levy process and the FPLP would seem to be appropriate,
especially since many paper levies are one-time levies of a tax
debtor's assets. Additionally, the FPLP is a cost-effective means of
collecting from tax debtors. By excluding tax debt from the FPLP while
IRS personnel are working on a paper levy, IRS is relegating the FPLP
to a secondary role in the tax collection process. Because of its
potential, we have previously recommended that IRS use the FPLP as one
of the first steps in the IRS collection process and keep the debt in
the levy program until the taxes are fully paid.[Footnote 35]
IRS Excludes All Tax Debt from Levy during the Notification Process:
At September 30, 2005, IRS had excluded $25.1 billion from the FPLP
because it was in the process of notifying the tax debtor of the taxes
owed. The Internal Revenue Code prohibits IRS from levying a tax
debtor's assets, including doing so through the FPLP, until the tax
debtor has been given time to respond to a notice from IRS that a tax
debt exists. IRS's process of issuing a series of notice letters and
waiting for the tax debtor to respond can take 6 months for
individuals. IRS excludes tax debt from the FPLP during the entire
notice phase.
For individuals, the notification process consists of sending a series
of three or four computer-generated letters with increasingly urgent
language notifying the tax debtor of the debt and requesting payment.
Per the Internal Revenue Manual, IRS waits 5 weeks between letters and
up to 10 weeks after the last letter before moving the tax debt into
one of IRS's active collection statuses such as ACS. Consequently, the
notification process can take up to 6 months or longer to complete,
during which time IRS excludes the tax debt from other collection
activity, including the FPLP.
Although IRS excludes all tax debt from the FPLP during the entire
notice process, legally, tax debt could be included in the FPLP in
about 3 months--about half way through the general notice process for
individuals.[Footnote 36] IRS must allow the tax debtor 90 days after
notification of a potential tax debt liability to respond. If IRS does
not receive a response within that period, it can issue a notice of tax
deficiency and demand for payment. If the tax debt is not paid within
10 days after notice and demand for payment, IRS can initiate the
procedures for levy, including forwarding the tax debt to the FPLP.
Under this scenario, IRS could forward tax debt to the FPLP about 14 to
15 weeks after the first notice is sent to the tax debtor, and IRS
could fulfill its statutory requirement with only two notices before
initiating the levy process.[Footnote 37] For business tax debt, IRS
essentially follows this sequence. The notice process for business tax
debt consists of only two notices and is generally completed in about
15 weeks, at which time the tax debt can be included in the FPLP.
In addition to putting tax debt into the FPLP sooner in the overall tax
collection process, IRS could potentially enhance the tax collection
potential of notices by informing the tax debtor early in the process
of sending notice letters that unpaid tax debt can be subject to levy.
As shown in figure 7, about 70 percent of tax collections resulting
from notice letters are received as a result of IRS's first notice
letter. Very little is collected from subsequent notices until the last
notice letter, which includes specific language of IRS's authority to
levy or place a lien on the tax debtor's property.
Figure 7: Collections from IRS Notification Letters in Fiscal Year
2005:
[See PDF for image]
Source: GAO analysis of IRS data.
[End of figure]
The FPLP is a powerful tool for encouraging collection that goes beyond
the direct taxes collected through federal payment levies. We have
previously estimated that the threat of a levy brings in over three
times more collections than the levy itself.[Footnote 38] IRS could
take advantage of this potential during the notice phase if it were to
inform tax debtors early in the notice process that their tax debt
could be included in the FPLP.
Conclusions:
Although the collection of taxes is always important, it takes on added
prominence in times of severe budgetary uncertainty. As the nation's
tax collector, IRS must seek out and utilize the most cost-effective
means of collection at its disposal and apply those means to the
broadest application of tax debt. The FPLP is a cost-effective program
that has enabled IRS to greatly increase collection. The program's full
success is dependent on the accuracy of IRS's status and transaction
codes as well as the appropriateness of IRS's policies, procedures, and
practices regarding the exclusion of tax debt from the FPLP.
Improvements are needed in both arenas. The errors we identified in the
status and transaction codes of tax debt cases highlight potential
problem areas that have led to tax debt being inappropriately excluded
from levy action and therefore require IRS's attention. With regard to
its current policies, IRS continues to exclude over 60 percent of all
tax debt from the FPLP and does not appear to have fully adopted our
previous recommendation to use the FPLP as one of the first steps in
the tax collection process. Viewing the FPLP as a primary and efficient
collection tool could lead IRS to reevaluate its FPLP exclusion
policies and to reduce the extent and length of time tax debt is
excluded. Such changes hold the potential to subject billions of
dollars in additional tax debt to the FPLP, thus increasing the
government's chances of collecting some of this tax debt.
IRS faces tough challenges in balancing its tax collection activities
against its available resources. In times of tough budgetary
constraints, this can provide an incentive to close cases quickly or
otherwise reduce the active tax collection inventory, possibly at the
expense of maximizing tax collections. While reducing the number of
active cases does, in fact, reduce the resources required, it can also
have the effect of reducing collections, diminishing compliance, and
eroding the public's confidence in the fairness of the tax system. For
instance, in financial hardship cases, beyond those tax debtors granted
relief from paying tax debt due to unexpected financial difficulty,
each tax debtor who is allowed to avoid filing required tax returns or
paying current taxes, or who is perceived to live well while facing
little tax collection consequence, represents not only less money for
vital federal programs but one more advertisement for others to do the
same. Therefore, in setting financial hardship or other tax collection
policies, it is incumbent upon IRS to be particularly judicious in
setting income threshold levels and monitoring tax debt to ensure that
it is acting fairly toward all taxpayers.
Recommendations for Executive Action:
To increase the amount of tax debt eligible for, and to expedite the
entry of tax debt into, the FPLP, we recommend that the Commissioner of
Internal Revenue take the following actions:
* monitor the timely termination of defaulted installment agreements to
help ensure tax debt is made available to the FPLP as soon as possible;
* place tax debt in the notice phase into the FPLP as soon as legally
possible;
* consider adding language to IRS's second communication in the notice
process informing the tax debtor that IRS has the authority to collect
the debt by levying the tax debtor's income and assets if the tax debt
is not paid voluntarily; and:
* modify FPLP exclusion policy to allow tax debt in ACS subcategories R-
5 and I-6 that is being considered for a levy on financial assets
through paper levies to be concurrently included in the FPLP.
To help ensure that IRS's financial hardship FPLP exclusions are
appropriate, we recommend that the Commissioner of Internal Revenue
take the following actions:
* reevaluate whether the dollar ranges for existing financial hardship
income thresholds, especially those that exceed the national median
income, are appropriate and reasonable;
* consider changing the financial hardship closing codes for tax
debtors designated as being in financial hardship prior to the 2004
income threshold increases to a closing code that most closely
corresponds to the originally designated income threshold--for example,
tax debtors who were in a threshold of $50,000 prior to the change
would be given a different subcode (closing code) so that the tax
debtor's income ceiling stays as close to the original $50,000 ceiling
as possible under the new income thresholds;
* establish a policy so that in implementing future financial hardship
income threshold changes, tax debtors' financial hardship subcodes
(closing codes) are changed to ones that maintain the tax debtor's
income ceiling as close as possible to the ceiling prior to the change;
* establish a policy to review tax debtors' financial condition
periodically to verify the continued validity of the financial hardship
designation;
* evaluate the ongoing validity of the financial hardship designations
whenever tax debtors fail to file their annual tax returns by comparing
third-party income information to the tax debtors' designated financial
hardship income threshold ceilings; and:
* refer tax debtors with a financial hardship designation to IRS's
withholding compliance program for special attention if those tax
debtors do not pay their current income tax obligations.
Agency Comments and Our Evaluation:
In commenting on a draft of this report, IRS noted improvements made to
the FPLP and the extent to which such improvements have resulted in
increased collections while at the same time ensuring that taxpayer
rights have been protected. IRS also described several initiatives it
had undertaken to improve its program for taxpayer accounts classified
as currently not collectible, including a study to determine whether
changes to IRS's allowable living expense tables, used in the
determination of financial hardship status, would be appropriate given
the availability of additional economic data. We made 10
recommendations: IRS agreed with 5, partially agreed with 2, and
disagreed with 3. We modified the 2 recommendations with which IRS
partially agreed in order to address issues raised by IRS while
retaining the intent of our recommendations.
With respect to the four recommendations we made to either increase the
amount of tax debt eligible for the FPLP or expedite the entry of tax
debt into the FPLP, IRS agreed with one recommendation, partially
agreed with another, and disagreed with the remaining two
recommendations. IRS agreed with our recommendation that it monitor the
timely termination of defaulted installment agreements, and noted it
would identify those taxpayer accounts in installment agreement status
but which show no payment activity within the last 60 days and
determine if it needs to change the way it monitors installment
agreements. While IRS disagreed with our recommendation that it add
language about its legal authority to levy income and assets to its
first notice letter, it stated that it would consider adding stronger
language regarding possible enforcement activity in subsequent
collection notices. As an explanation for its reluctance to include
this course of action in the event of nonpayment, IRS noted that it had
received criticism in the past for early aggressiveness and not
affording taxpayers an opportunity to voluntarily satisfy their
liability. While IRS is not legally precluded from providing language
concerning its enforcement powers in the initial taxpayer notice, we
understand IRS's desire to attempt to provide sufficient opportunity
for taxpayers to voluntarily comply with their tax obligations without
threat of enforcement action. Accordingly, we have modified our
recommendation to add informative language about IRS's levy starting
with the second taxpayer notice rather than the first. The important
point to us is that IRS inform the tax debtor of its levy authority
earlier in the process.
IRS disagreed with our recommendation that it place tax debt in the
notice phase into the FPLP as soon as legally possible, stating that it
believed its current notification process was the most cost effective.
In stating its position, IRS noted that over three-fourths of tax
debtors pay their tax debt after receiving the first notice, and that
it believed the action recommended is not appropriate for individual
taxpayers who have a high payment rate during the notice process. We do
not believe that our recommendation would diminish the effectiveness of
IRS's notice process, especially the voluntary tax collections
resulting from the first notice. In fact, those tax debtors who would
typically pay their debt upon receipt of the initial notice would be
unaffected by the action we are recommending. Although implementing our
recommendation would allow IRS to begin levy procedures during the
notice phase, in practice, the tax debt generally would not be levied
before IRS completes the notice phase. As we discuss in our report, tax
debt could be included in the FPLP about three months after IRS
notifies the tax debtor of the tax liability, giving the tax debtor
sufficient time to respond to both the first and second notices before
the levy process would actually commence. Additionally, once the levy
process begins, IRS must still send the tax debtor a Collection Due
Process notice and wait about two and one-half months before levying a
payment through the FPLP. Consequently, tax debt would not generally be
levied before the notice phase is completed. However, by starting the
levy process during the notice phase, IRS would be able to begin
levying payments earlier than would otherwise be the case if the tax
debtor does not voluntarily fully pay or otherwise resolve the tax debt
during the notice phase because IRS would not have to continue to delay
levy action while it issues the Collection Due Process notice and waits
for the tax debtor to respond.
IRS also disagreed with our recommendation that it modify its FPLP
exclusion policy to allow tax debt in two subcategories of its ACS to
be eligible for the FPLP, citing concern that this could result in
duplicate levies and thereby create unanticipated hardships for
taxpayers. IRS also noted that it attempts to issue levies on cases
within these ACS subcategories that could generate more in collections
than would be collected through the FPLP due to the program's limit of
15 percent of each federal payment made to the tax debtor. We do not
believe these concerns have merit. We believe that IRS's current
process for manually blocking tax debt from the FPLP would provide a
sufficient safeguard against duplicate levies while at the same time
preserving adequate flexibility for other collection actions. As we
discuss in our report, IRS has the ability to block, and, on a case by
case basis, does block individual tax debt accounts from levy through
the FPLP. IRS could apply this same approach to these two ACS
subcategories. To manually block tax debt from the FPLP, IRS can place
a transaction code in the tax debtor's account that blocks the FPLP
from automatically levying the tax debt. The same transaction code can
be placed in the tax record if IRS wants to levy more than the 15
percent allowable under the FPLP. This process would allow IRS to
increase the effectiveness of the FPLP while preserving its ability to
use paper levies when appropriate and minimizing the risk of duplicate
levies.
With respect to the six recommendations we made to help ensure that
IRS's financial hardship FPLP exclusions are appropriate, IRS agreed
with four recommendations, partially agreed with one recommendation,
and disagreed with the remaining recommendation. Specifically, IRS
agreed with our recommendations to (1) reevaluate whether the dollar
ranges for existing financial hardship income thresholds are
appropriate and reasonable; (2) establish a policy that when future
financial hardship thresholds are changed, tax debtors' hardship
closing codes are changed to ones that maintain the tax debtor's
original income ceiling; (3) evaluate the ongoing validity of financial
hardship designations whenever tax debtors fail to file their annual
tax returns; and (4) refer tax debtors with a financial hardship
designation to IRS's withholding compliance program for special
attention if those tax debtors do not pay their current income tax
obligations. Although IRS agreed to reevaluate whether the dollar
ranges for existing financial hardship income thresholds are
appropriate and reasonable, it raised concerns that imposing a rigid
national median amount would disregard circumstances such as family
size, medical needs, and geographic variations in average income. It is
important to note that our recommendation does not advocate imposing
the national median amount as a rigid maximum threshold limit. We
recognize that IRS attempts to accommodate the needs of tax debtors
with varying family sizes, geographical locations, and various other
circumstances. However, as our report discusses, between 1992 and 2004,
IRS raised its top financial hardship income threshold ceiling from an
amount equal to the median national household income to an amount
almost twice the median income without any detailed analysis supporting
either the large increases or the deviation in the relationship of
these thresholds from the national median income.
While IRS disagreed with our recommendation that it establish a policy
to review tax debtors' financial condition every 3 years to verify the
continued validity of the financial hardship designation, IRS did agree
to consider including a time factor. Specifically, IRS noted that as
part of its initiatives to improve its program for taxpayer accounts
classified as currently not collectible, of which financial hardship is
a significant aspect, it will consider including a time factor.
Accordingly, we have modified our recommendation, replacing "every 3
years" with "periodically" to reflect IRS's willingness to consider
including a time factor for reviewing a tax debtor's financial
condition. However, in deciding upon the time factor to use, we believe
that IRS should take into account that tax debt is typically only
legally available for collection for 10 years. Thus, implementing a
time period of greater than 3 years could result in IRS affording
itself only one opportunity to reconsider the validity of the financial
hardship designation.
Finally, IRS stated that it could not agree with our recommendation
that it consider changing the financial hardship closing codes for tax
debtors designated as being in financial hardship prior to the 2004
increases it implemented in the income thresholds until it has
determined how many tax debt accounts would be affected by the
recommendation. IRS said that implementing the recommendation to change
existing closing codes would require significant computer programming
and system changes that it may not be able to implement, and which may
not be cost effective. Our recommendation is for IRS to consider
changing the hardship closing codes for the affected accounts; we are
not recommending that IRS must do so. Implicit in our use of the word
"consider" in our recommendation is a cost-benefit determination. In
considering whether to change the hardship closing codes, IRS should
take into account the work and cost involved in making this change as
well as the potential for increased collections in determining the cost
effectiveness of any modifications. However, we do believe that IRS
erred in not changing the financial hardship closing codes for existing
cases when it implemented the 2004 increases in the income thresholds.
As discussed in our report, by not changing the closing codes, IRS
allowed tax debtors who it previously believed could begin paying off
their tax debt at a certain income threshold to immediately begin
earning up to, on average, 77 percent more before IRS would hold them
liable for their tax obligations. This created the potential for
inequitable treatment between taxpayers in these same income brackets
who pay their taxes and tax debtors who do not, especially when some of
those tax debtors, on the day IRS changed the thresholds, were
thereafter allowed to earn up to $34,000 more income without IRS
considering whether they continued to warrant the hardship designation.
Consequently, in considering whether or not it is cost effective to
implement a change in the closing codes of the effected accounts, IRS
should also consider the issue of fairness with respect to the taxpayer
population as a whole.
We are sending copies of this report to the congressional committees
with jurisdiction over IRS and its activities, the Secretary of the
Treasury, the Commissioner of Internal Revenue, and interested
congressional committees and members. We will also make copies
available to others upon request. In addition, this report will be
available at no charge on the GAO Web site at [Hyperlink,
http://www.gao.gov].
If you have any questions about this report, please contact me at (202)
512-3406 or sebastians@gao.gov. Key contributors to this report are
listed in appendix III. Contact points for our Offices of Congressional
Relations and Public Affairs may be found on the last page of this
report.
Signed by:
Steven J. Sebastian:
Director:
Financial Management and Assurance:
[End of section]
Appendix I: Scope and Methodology:
To determine whether and to what extent Internal Revenue Service (IRS)
tax records contain inaccurate or out-of-date status or transaction
codes that exclude them from the Federal Payment Levy Program (FPLP),
we used IRS's unpaid assessments database as of September 30, 2005, to
select two statistical samples. We used IRS's criteria for the
statutory and policy exclusions from the FPLP to segment the tax
records in the unpaid assessments database into the two categories. The
population of statutory exclusions consisted of 9,068,508 tax records
that contained tax debt of $72,167,432,455. The population of policy
exclusions consisted of 7,183,880 tax records that contained tax debt
of $81,492,531,369. We selected a statistical sample of 100 tax debts
that were excluded from the levy program based on IRS's designation of
their tax record as being excluded because of a legal--statutory--
requirement of the Internal Revenue Code. We also selected a
statistical sample of 100 tax debts that were excluded from the levy
program based on IRS's policy determinations.
We randomly selected probability samples from the populations of tax
debt accounts excluded from the FPLP for statutory reasons and policy
reasons. With these probability samples, each tax account in each of
the populations had a nonzero probability of being included and that
probability could be computed for any account. Each sample tax account
selected was subsequently weighted in the analysis to account
statistically for all the tax accounts of its respective population.
The sample we selected from each population was only one of a large
number of samples that we might have drawn because for each sample we
followed a probability procedure based on random selections. Since each
sample could have provided different estimates, we express our
confidence in the precision of each sample's result as 95 percent
confidence intervals, which are intervals that would contain the actual
population value for 95 percent of the samples we could have drawn. As
a result, we are 95 percent confident that the confidence intervals
presented in this report will include the true values in the respective
study populations. For the statistical error rate projection, we used a
point estimate with a 95 percent confidence interval. The projected
point estimate combined with the confidence interval surrounding the
point estimate means that although we estimate the error rate to be at
the point, we are 95 percent confident that the true error rate is
somewhere between the interval's lower and upper limits.
For each sampled tax period, we obtained and reviewed IRS records on
the status and history of tax collection action with particular
emphasis on actions that affected the FPLP status of the tax debt. We
performed additional searches of criminal, financial, and public
records. We compared each sampled tax debt to IRS's FPLP exclusion and
inclusion criteria and determined the accuracy of the status or
transaction code that excluded the tax debt from the FPLP. We
categorized a sample tax debt as an error if the tax period did not
meet at least one exclusion criterion or had exceeded IRS's time frame
for ending an exclusion, such as the time frame for terminating an
installment agreement. In some cases, the time frame for terminating an
installment agreement was exceeded at the time IRS provided us records
to review rather than at the September 30, 2005, date of the unpaid
assessments database.
To determine whether IRS's policies, procedures, and practices could be
strengthened to ensure the accuracy and timeliness of its status and
transaction codes, we reviewed IRS's Internal Revenue Manual and
interviewed IRS officials to obtain criteria, guidance, and internal
controls on (1) coding cases for inclusion and exclusion from the FPLP
(2) processing cases in the notice phase; and (3) processing and
terminating cases in installment agreements, offers in compromise, and
financial hardship.
To determine whether opportunities exist to increase the amount of tax
debt included in the FPLP, we analyzed the effect of IRS's exclusion
criteria as well as the potential effect of changes in the exclusion
criteria on the amount of tax debt included in the FPLP. In assessing
the effect of potential changes in the statutory exclusions, we
compared the potential for modifying IRS's existing FPLP exclusion
criteria within the exclusion's legal framework, and we discussed the
potential changes with cognizant IRS officials.
Data Reliability Assessment:
For the IRS database we used, we relied on the work we perform during
our annual audit of IRS's financial statements. While our financial
statement audits have identified some data reliability problems
associated with the coding of some of the fields in IRS's tax records,
including errors and delays in recording taxpayer information and
payments, we determined that the data were sufficiently reliable to
address this report's objectives. Our financial audit procedures,
including the reconciliation of the value of unpaid taxes recorded in
IRS's master file to IRS's general ledger, identified no material
differences.
[End of section]
Appendix II: Comments from the Internal Revenue Service:
Note: Subsequent to providing the draft report to IRS, numbered GAO-06-
743, we renumbered the report to GAO-07-26.
Department Of The Treasury:
Internal Revenue Service:
Washington, D.C. 20224:
Commissioner:
September 29, 2006:
Mr. Steven J. Sebastian:
Director, Financial Management and Assurance:
U.S. Government Accountability Office:
441 G Street, N.W.
Washington, D.C. 20548:
Dear Mr. Sebastian:
I have reviewed your draft GAO report titled "Procedural Changes Could
Enhance Tax Collections" (GAO-06-743). We appreciate your recognition
of our success with the Federal Payment Levy Program (FPLP). In part
due to numerous improvements made to the program, this year the IRS
collected more money than ever before through FPLP while ensuring
taxpayer rights were protected. Through August 2006 we collected $260
million through FPLP, compared to $197 million collected through the
program for all of FY 2005.
Among the improvements to the FPLP, as of January 2006, 18 of the 20
Defense Finance and Accounting Service (DFAS) payment systems have been
added to the program. In addition, General Services Administration
salary payments were added in March of this year, and we are currently
working with the Financial Management Service (FMS) and DFAS to include
salary payments from military retirees, Department of Defense
civilians, and the Departments of Health and Human Services, Veterans
Affairs, and Energy.
Your report acknowledges the significant strides made by the Federal
Contractors Tax Compliance Task Force (FCTC) in identifying and
including contractors in the FPLP. The FCTC maximized the number of
delinquent tax debts the IRS makes available for matching, increased
the frequency of data exchanges between DFAS and FMS, improved the
timing of the Collection Due Process (CDP) notices that are required to
be issued to taxpayers before a levy can be made, and established a
process for validating Taxpayer Identification Numbers (TINs) of
federal contractors through the Central Contractor Registration (CCR).
The effectiveness of the FPLP depends on maximizing both the number of
debts provided by the IRS and the number of payments for which the
debts are successfully matched.
We have recently undertaken several initiatives to improve our
Currently Not Collectible (CNC) program, as we continually strive to
enhance program execution under our existing policies. These
initiatives include a joint SB/SE and W&I team charged with assessing
the overall effectiveness of the CNC reactivation process, and a study
to determine whether changes to our Allowable Living Expense tables
would be appropriate given the availability of additional economic
data.
We share your opinion that IRS should only place an account in CNC
status after rigorous financial analysis. We also agree that accounts
suspended for reasons of hardship should be subject to an accurate
reactivation system if the taxpayer's income rises. The CNC income
thresholds provide a wide range of reactivation points that, when
coupled with the use of the IRS' allowable living expenses, can
accurately determine the amount of income at which a taxpayer's
financial situation may have changed enough for the IRS to reevaluate
their ability to pay.
When standard allowance amounts are applied against an individual's
income, IRS employees can make a reasonable assessment of their ability
to pay. Each case is carefully considered to ensure requiring payments
would not cause a taxpayer to experience an undue financial hardship.
When an IRS employee determines collection of an account should be
suspended, an appropriate threshold that best matches the taxpayer's
current expenses is selected and notated systemically. Income on
subsequent returns in excess of the threshold triggers IRS to reassess
the taxpayer's financial situation.
Imposing a more rigid national median amount instead of an individually
determined threshold amount would disregard circumstances such as
family size, medical needs, and geographic variations in average
income. We place a high priority on avoiding undue burden on taxpayers
while helping them meet their tax responsibilities. Protecting taxpayer
rights and being sensitive to individual situations is an area we focus
on and work closely with the Taxpayer Advocate Service to achieve.
We believe a range of threshold amounts that IRS employees can select
from based on the knowledge they have attained about the taxpayers
situation is much fairer to taxpayers and provides a more accurate
determination. It also prevents premature reactivation of accounts
which is an unproductive use of IRS's limited resources.
Responses to your specific recommendations are enclosed. We will
continue to work on enhancing the FPLP and appreciate your
acknowledgement of IRS' accomplishments to date. If you have any
questions, please contact Floyd Williams, Director, Legislative
Affairs, at (202) 622-3720.
Sincerely,
Signed by:
Mark W. Everson:
Enclosure:
Recommendation for the Commissioner:
Monitor the timely termination of defaulted installment agreements to
help ensure tax debt is made available to the FPLP as soon as possible.
Response:
We agree with this recommendation and will identify how many accounts
are in an installment agreement without payments within the last 60
days and determine if a programming correction is warranted.
Recommendation for the Commissioner:
Place tax debt in the notice phase into the FPLP as soon as legally
possible.
Response:
We disagree with this recommendation. In the interest of cost-effective
tax administration, the IRS sends a series of notices to taxpayers
before resorting to levy as a means of collection. The vast majority of
taxpayers - 77.6 percent - full pay their accounts after the initial
first notice. While we have taken action to accelerate the CDP and levy
issuance on federal contractors that owe taxes, we do not believe this
is the appropriate action for individual taxpayers who have a high
payment rate during the notice process. We include cases in the FPLP
program following the notice stream to allow time for taxpayers to self
correct before levy is attempted. We continue to believe that this is
the most cost-effective way to resolve the greatest number of cases
early in the process, while still promoting voluntary compliance and
not causing undue hardship.
Recommendation for the Commissioner:
Consider adding language to IRS' first communication in the notice
process stating that the tax debtor's income and assets can be levied
to collect the unpaid tax debt, including federal payments to them
through the FPLP.
Response:
We disagree with the recommendation to change the first notice. As
noted above, a significant number of taxpayers satisfy their liability
after first notification of their balance due. Some balances due are a
result of tax adjustments or math errors identified during return
processing that are explained to taxpayers in the first notice. We have
received criticism in the past for early aggressiveness and not
affording taxpayers an opportunity to voluntarily satisfy their
liability. As a result these notices have been carefully created
jointly with the Taxpayer Advocate Service to ensure that we adhere to
taxpayer rights. We will consider stronger language regarding possible
enforcement activity in subsequent collection notices.
Recommendation for the Commissioner:
Modify FPLP exclusion policy to allow tax debt in Automated Collection
System (ACS) subcategories R-5 and I-6 that is being considered for a
levy on financial assets through paper levies to be concurrently
included in the FPLP.
Response:
We agree all appropriate debts should be included in the FPLP to
facilitate the collection process. However, we disagree with the
recommendation that ACS subcategories R-5 (Initial Levy Action) and I-
6 (Levy follow-up) should be included. These inventories are excluded
because ACS issues levies on these cases which could attach more than
the 15 percent that is subject to FPLP.
Of greater concern is that including these cases in FPLP may result in
duplicate levies which could create unanticipated hardships for
taxpayers. Therefore, we do not agree that these subcategories should
be included in the FPLP.
Recommendation for the Commissioner:
Reevaluate whether the dollar ranges for existing financial hardship
income thresholds, especially those that exceed the national median
income are appropriate or reasonable.
Response:
We agree that we should validate the effectiveness of our current CNC
reactivation thresholds in connection with our project to evaluate
whether changes to the Allowable Living Expense (ALE) tables are
warranted. However, imposing a rigid national median amount instead of
an individually determined threshold amount would disregard
circumstances such as family size, medical needs, and geographic
variations in average income. It would also cause the IRS to expend
resources handling prematurely reactivated, unproductive cases. The
range of reactivation thresholds must take into account a wide variety
of financial circumstances, and must work in concert with the ALE.
Recommendation for the Commissioner:
Consider changing the financial hardship closing codes for tax debtors
designated as being in financial hardship prior to the 2004 income
threshold increases to a closing code that most closely corresponds to
the originally designated income threshold - for example, tax debtors
who were in the threshold of $50,000 prior to the change would be given
a different subcode (closing code) so that the tax debtor's income
ceiling stays as close to the original $50,000 ceiling as possible
under the new income thresholds.
Response:
We cannot agree with this recommendation until we determine how many
Currently Not Collectible (CNC) accounts would be affected by it.
Execution of the recommendation would require significant programming
and system changes which we may not be able to implement. This fact,
coupled with a reduction in the number of accounts that would be
subject to this action over time, may reduce the cost effectiveness of
the recommended change.
Recommendation for the Commissioner:
Establish a policy so that in implementing future financial hardship
income threshold changes, tax debtors financial hardship subcodes
(closing codes) are changed to ones that maintain the tax debtor's
income ceiling as close as possible to the ceiling prior to the change.
Response:
We agree with this recommendation in concept, and will take it into
consideration while reviewing any future changes to the financial
hardship closing codes. However, we are concerned about the potential
programming costs of this recommendation, and will weigh the possible
benefits against these costs prior to deciding whether to implement it.
Recommendation for the Commissioner:
Establish a policy to review tax debtor's financial condition every 3
years to verify the continued validity of the financial hardship
designation.
Response:
We disagree with the recommendation to institute a mandatory financial
review process at a set time interval for every financial hardship CNC
case since this would involve a significant resource commitment with
limited, if any, increase in collection potential. Currently, when
declaring a case CNC under financial hardship, we have the opportunity
to choose a closing code that takes into consideration the taxpayer's
known future financial circumstances. Instituting a mandatory review
every 3 years would add approximately 180,000 to 200,000 taxpayer cases
into the collection work stream each year.[Footnote 39] In considering
this change, we would have to balance account reactivations against the
opportunity cost of the same resources being applied to working newer
accounts. Since we are currently evaluating our CNC reactivation
process and investigating opportunities for improvement, we will
consider including a time factor in our study as part of the cost
benefit analysis discussed in the corrective action above.
Recommendation for the Commissioner:
Evaluate the ongoing validity of the financial hardship designations
whenever tax debtors fail to file their annual tax returns by comparing
third-party income information to the tax debtors' designated financial
hardship income threshold ceilings.
Response:
We agree with this recommendation. During Fiscal Year (FY) 2006, Small
Business/Self-Employed and Wage and Investment formed a team, which is
now in the analysis phase, to look at the effectiveness of the
reactivation process for CNC. We currently review income sources
reported by third parties for all taxpayers who fail to file returns,
and place the account in the delinquent return notice process if a
taxable return filing requirement appears likely. If the taxpayer fails
to file the returns during this notice process, a Taxpayer Delinquency
Investigation (TDI) is generated. The TDI is placed in the inventory
stream for further investigation by contact employees based on current
inventory priorities. The team will continue to work in FY2007 to study
the impact of future non-filing compliance on the CNC financial
hardship reactivation.
Recommendation for the Commissioner:
Refer tax debtors with a financial hardship designation to IRS'
withholding compliance program for special attention if those tax
debtors do not pay their current income tax obligations.
Response:
We agree that this recommendation has merit. In FY2006, the IRS
initiated a withholding compliance program that identifies individuals
who incur tax debt due to under-withholding. The program, which is
still in its initial stages, requires the individual's employer to
increase the employee's federal tax withholdings. We are currently
assessing the effectiveness of the program and our ability to expand it
as our resources allow. We will continue research in this area to
determine the feasibility of implementing this type of process in
conjunction with the corrective action above.
[End of section]
Appendix III: GAO Contact and Staff Acknowledgments:
GAO Contact:
Steven J. Sebastian, (202) 512-3406 or sebastians@gao.gov:
Acknowledgements:
The following individuals made major contributions to this report:
William J. Cordrey, Amy Bowser, Ray Bush, Kenneth Hill, Inna Livits,
Dave Shoemaker, Sidney Schwartz, and Mark Yoder.
FOOTNOTES
[1] IRS's master files contain detailed records of taxpayer accounts.
[2] GAO, Financial Management: Some DOD Contractors Abuse the Federal
Tax System with Little Consequence, GAO-04-414T (Washington, D.C.: Feb.
12, 2004), and Financial Management: Thousands of Civilian Agency
Contractors Abuse the Federal Tax Systems with Little Consequence, GAO-
05-683T (Washington, D.C.: June 16, 2005).
[3] In the FPLP, IRS divides tax debt records into either included or
excluded categories based on the status and transaction codes in the
tax debt account. Further, IRS identifies excluded tax debt records as
those that are excluded because of a statutory requirement or because
of an IRS policy decision.
[4] Additionally, we designated IRS's financial management and systems
modernization as high-risk areas in 1995. GAO, High-Risk Series: An
Overview, GAO/HR-95-1 (Washington, D.C.: February 1995). In 2005, two
of IRS's high-risk areas--collection of unpaid taxes and earned income
credit noncompliance--were consolidated to make a single high-risk area
called enforcement of tax laws. Also in 2005, IRS's high-risk areas of
business systems modernization and financial management were merged
into a single high-risk area called business systems modernization.
GAO, High-Risk Series, An Update, GAO-05-207 (Washington, D.C.: January
2005).
[5] The 10-year period can be extended or suspended under a variety of
circumstances, such as agreements by the taxpayer to extend the
collection period in connection with an installment agreement,
bankruptcy litigation, and court appeals. Consequently, some tax
assessments can and do remain on IRS's records for decades.
[6] Pub. L. No. 105-34, 111 Stat. 788 (Aug. 5, 1997).
[7] 26 U.S.C. § 6331(h).
[8] 26 U.S.C. § 6331(h)(3).
[9] The Treasury Offset Program is an automated process administered by
the Department of the Treasury's FMS in which certain federal payments
are withheld or reduced (offset) to collect delinquent tax and nontax
debts owed to federal agencies, including IRS. For the FPLP, FMS
matches federal payments to the tax-debt records sent to it by IRS, and
when a match occurs, FMS offsets (levies) the federal payments and
transmits the amount levied to IRS to reduce the tax debtor's
outstanding debt and sends the residual to the debtor.
[10] GAO, Financial Management: Thousands of Civilian Agency
Contractors Abuse the Federal Tax System with Little Consequence, GAO-
05-637 (Washington, D.C.: June 16, 2005).
[11] An offer in compromise is an agreement between a tax debtor and
IRS that resolves the tax debtor's tax debt by accepting less than full
payment.
[12] Federal Contractor Tax Compliance Task Force, Report to Senate
Committee on Governmental Affairs Permanent Subcommittee on
Investigations (Washington, D.C.: Oct. 26, 2004).
[13] The ACS is an automated telephone-based system designed to
schedule and follow up on incoming calls from, and outgoing calls to,
tax debtors. ACS personnel make contact with tax debtors by phone to
attempt to collect outstanding tax debt.
[14] GAO, Tax Administration: Federal Payment Levy Program Measures,
Performance, and Equity Can Be Improved, GAO-03-356 (Washington, D.C.:
Mar. 6, 2003).
[15] We did not project an error rate for the individual statutory
exclusion subcategories because a statistical projection was valid only
for the statutory exclusion category as a whole.
[16] As noted in their titles, fig. 4 shows the percentage of tax
records in the population by category, whereas table 1 shows number of
tax records in our sample by category.
[17] When tax debtors believe that they cannot pay their delinquent tax
debt in full, they can make an offer to IRS to pay something less than
the full amount to satisfy their debt. IRS may accept offers that are
commensurate with the tax debtor's ability to pay, which IRS determines
through an analysis of the taxpayer's financial condition. IRS is
statutorily prohibited from levying the property of the tax debtor
while it considers the tax debtor's offer.
[18] The 95 percent confidence interval associated with the projected 6
percent error rate ranges from 2.2 percent to 12.6 percent. This range
means that we are 95 percent certain that the true error in the entire
population of statutorily excluded tax debt is between 2.2 percent and
12.6 percent. The range means that between 202,000 and 1,142,000 tax
records equating to between $56 million and $6.8 billion in tax debt
were erroneously excluded from the FPLP.
[19] When IRS has completed sending its initial series of notices to
the tax debtor, IRS assigns the tax debt to active collection whether
through the ACS system or to a revenue officer in the field, or it puts
the tax debt into a queue awaiting assignment to active collection.
[20] IRS is required to release the levy on all or part of the tax
debtors' property, including property subject to FPLP, if IRS
determines that levying the property is creating a financial hardship
on the tax debtor. 26 U.S.C. § 6343(a)(1).
[21] When a tax debtor submits an offer in compromise, IRS personnel
place a transaction code in the computer system indicating that they
are considering the merits of the offer. This "pending" transaction
code also stops all tax collection actions until IRS has decided
whether or not to accept the tax debtor's offer. Once accepted, IRS
places an additional code in the system indicating that there is an
"active" offer in compromise. Both the pending and the active offer
codes need to be reversed before a tax debt can be made eligible for
the FPLP.
[22] The estimated error is 1 percent and is associated with a 95
percent confidence interval of from 0.03 percent to 5.4 percent. We did
not project an error rate for the dollars associated with policy error
rate. We also did not project an error rate for the individual policy
exclusion subcategories because a statistical projection was valid only
for the overall policy exclusion category as a whole.
[23] When a judge dismisses a bankruptcy case, the debtor is denied any
debt relief.
[24] When IRS agrees to allow a tax debtor to repay tax debt through
installment payments, IRS personnel place a transaction code into IRS
computer systems. This transaction code stops all tax collection
actions except the installment agreement payments until the code is
reversed.
[25] The 5-month time frame is not specifically cited in the Internal
Revenue Manual. Rather, the manual lays out the process for terminating
an installment agreement as follows. IRS waits 1 month after the tax
debtor misses the first payment. If the tax debtor does not send in the
next payment, IRS's computer system generates a letter informing the
tax debtor that IRS intends to terminate the agreement. IRS gives the
tax debtor 90 days--3 months--to respond. IRS allows a total of about a
month for processing and mailing, bringing the total time to 5 months.
[26] IRS receives various information returns from third parties,
including forms W-2 and 1099, that are used to report an individual's
income. The W-2, the wage and tax statement, reports wages, salaries,
and tips paid to employees and the taxes withheld from them. The Form
1099 is used to report various types of income other than wages,
salaries, and tips.
[27] Department of Commerce, Economics and Statistics Administration,
U.S. Census Bureau, Income, Poverty, and Health Insurance Coverage in
the United States: 2004, issued August 2005. National median income is
based on 2004 data for all races and all households. Fifty percent of
households have incomes below and 50 percent have incomes above the
median.
[28] See 26 C.F.R. §301.6343-1(b)(4).
[29] IRS's Internal Revenue Manual describes allowable expenses as
those expenses that are necessary to provide for a tax debtor's
family's health and welfare and/or production of income. The allowable
expenses must be reasonable and are based in part on national and
regional standards.
[30] Although IRS does not engage in active collection actions against
a tax debtor with a financial hardship designation, IRS does retain any
future income tax refunds and uses them to reduce the tax debtor's
outstanding tax debt.
[31] Due to the rounding used in table 3, there is a 0.1 difference
between the sum in the table and the sum in the text and fig. 6 for
those tax debtors allowed to earn more than the national median
household income.
[32] Department of Commerce, Economics and Statistics Administration,
U.S. Census Bureau, Income, Earnings, and Poverty From the 2004
American Community Survey, (Washington, D.C.: August 2005).
[33] Department of Labor, Bureau of Labor Statistics, Consumer Price
Index - All Urban Consumers, http://www.bls.gov, downloaded August 16,
2006.
[34] GAO, Financial Management: Some DOD Contractors Abuse the Federal
Tax System with Little Consequence, GAO-04-95 (Washington, D.C.: Feb.
12, 2004).
[35] GAO-04-95.
[36] 26 U.S.C. §§ 6212(a), 6303(a), and 6331(a),(d). The time frames
described in the text assume the tax debtor does not contest the amount
of the tax assessment. If contested, the time frames are extended until
there is resolution as to the amount owed.
[37] Prior to initiating the levy process, IRS is required to assess
the tax due liability in accordance with 26 U.S.C. § 6201. Prior to
actually making the levy, IRS is required to send a notice of intent to
levy, 26 U.S.C. § 6331(a), and a prelevy Collection Due Process hearing
notice that informs the tax debtor of his or her right to a hearing, 26
U.S.C. § 6330(a). Both the intent to levy and the Collection Due
Process notice can be combined on one letter. IRS typically waits 10
weeks after issuing the Collection Due Process notice before actually
making the levy through the FPLP. IRS can inform the taxpayer of IRS's
levy authority within the first communication to the taxpayer,
including the deficiency notice, or in any other notice letters.
[38] GAO-03-356.
[39] CAR report 5000-149 (recap of CNC Accounts) for the cumulative
period ending September 30, 2003, September 30, 2004, and September 30,
2005. Line 2.14 total IMF CNC modules closed with cc 24-32 divided by
line 2.0 Total number of IMF TC 530 modules multiplied by line 1.0
total number of IMF CNC Taxpayers.
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