Tax Administration: Information on Selected IRS Tax Enforcement  
and Collection Efforts (05-APR-01, GAO-01-589T).		 
								 
This testimony discusses (1) the relationship between Internal	 
Revenue Service (IRS) audits of taxpayers and other programs IRS 
uses to ensure that taxpayers' returns are accurate and (2) how  
IRS is managing the increased workload in two of its		 
programs--offers-in-compromise and innocent spouse claims. IRS	 
audited over 600,000 taxpayers in fiscal year 2000, either	 
face-to-face or through the mail. IRS has several programs that  
use computerized screening procedures to review all tax returns  
to detect certain types of errors. These programs result in	 
millions of contacts with taxpayers to inform them of adjustments
IRS made to their liabilities, seek explanations for errors IRS  
believes were made, or ask taxpayers to check whether they erred 
on their returns. The programs vary in their similarity to	 
audits; some of the programs are most similar to audits that IRS 
conducts through the mail. The programs IRS uses to detect errors
on tax returns are completely reliant on information that	 
taxpayers report on the tax returns and that IRS receives from	 
third parties. Therefore, audits remain an important tax	 
enforcement tool. Several factors suggest that the IRS may be	 
gaining better management control over the innocent spouse	 
workload. Unlike the offer-in-compromise program, the workload	 
for the innocent spouse program appears to have leveled off after
increases following enactment of the IRS Restructuring and Reform
Act. With this leveling off and enhancements in its case	 
processing capacity, IRS plans this fiscal year to move many	 
cases back into its centralized case processing facility,	 
potentially freeing up hundreds of field staff to return to other
examination-related duties.  In the past two years, the 	 
offer-in-compromise program has experienced a greater rise in its
workload and is not as far along as the innocent spouse program  
in implementing processes that IRS believes will help gain better
control over the workload.					 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-01-589T					        
    ACCNO:   A00747						        
    TITLE:   Tax Administration: Information on Selected IRS Tax      
             Enforcement and Collection Efforts                               
     DATE:   04/05/2001 
  SUBJECT:   Debt collection					 
	     Reporting requirements				 
	     Tax law						 
	     Tax return audits					 
	     Taxpayers						 
	     Voluntary compliance				 
	     Tax administration 				 
	     IRS Innocent Spouse Program			 
	     IRS Offer in Compromise Program			 

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GAO-01-589T

TAX ADMINISTRATION Information on Selected IRS Tax Enforcement and
Collection Efforts Statement of Michael Brostek. Director, Tax Issues

United States General Accounting Office

GAO Testimony Before the Committee on Finance, U. S. Senate For Release on
Delivery

10: 00 a. m. EDT on Thursday, April 5, 2001

GAO/ GAO- 01- 589T

1 Chairman Grassley, Ranking Member Baucus, and Members of the

Committee: I am pleased to join you today as you address a number of issues
related to the role of the Internal Revenue Service (IRS) in enforcing the
nation's tax laws. As you requested, I will discuss two topics: (1) the
relationship between IRS audits of taxpayers and other programs IRS uses to
ensure that taxpayers' returns are accurate, and (2) how IRS is managing the
increased workload in two of its programs- offers- in- compromise and
innocent spouse claims. My testimony primarily is based on our past work and
reviews we are doing of the offer- in- compromise and innocent spouse
programs. I will summarize my main points before providing more detail on
these topics.

IRS audited over 600,000 taxpayers in fiscal year 2000, either face- to-
face or through the mail. However, audits do not fully reflect IRS' efforts
to ensure that taxpayers accurately report their tax liabilities. IRS has
several programs that use computerized screening procedures to review all
tax returns to detect certain types of errors, such as underreporting of
interest or other types of income. These programs result in millions of
contacts with taxpayers to inform them of adjustments IRS made to their tax
liabilities, seek explanations for errors IRS believes were made, or ask
taxpayers to check whether they erred on their returns. The programs vary in
their similarity to audits; some of the programs are most similar to audits
that IRS conducts through the mail. However, audits have statutory
limitations- IRS is generally limited to one examination of a taxpayer's
books and records for each taxable year. This limitation does not apply to
the other programs IRS uses to ensure that tax returns are accurate.
Further, the programs IRS uses to detect errors on tax returns are
completely reliant on information that taxpayers report on the tax returns
and that IRS receives from third parties. Therefore, audits remain an
important tax enforcement tool. This is especially true for taxpayers whose
income and other tax characteristics are not subject to routine third- party
reporting to IRS. IRS' computerized checks on the accuracy of tax returns
could help to free up staff to audit these taxpayers.

2 Recently, much attention has been focused on declines in IRS' audit rates
for individual

taxpayers, which in fiscal year 2000 fell 40 percent below the lowest
previously reported audit rate. These declines are of concern because
taxpayers may take low audit rates as a signal that underreporting or
underpaying of taxes is unlikely to be detected, which might lead to
declines in voluntary compliance. However, noncompliance can also be
unintentional, for instance if a taxpayer errs due to misunderstanding a tax
rule. If declining audit rates do affect voluntary compliance, the effect
might be offset in part by use of IRS' other programs to detect inaccurate
tax returns or by IRS' efforts to better inform taxpayers of their tax
responsibilities and to answer their tax- related questions. However, the
net effect of these factors on voluntary compliance is not known,
principally because IRS has not measured voluntary compliance in reporting
tax liabilities since 1988.

The offer- in- compromise program was established to provide a means for
taxpayers to settle tax debts that cannot be paid in full while providing
for payment of some portion of the taxes owed. Under the innocent spouse
program, IRS can relieve a spouse of tax debts based on equity
considerations, such as not knowing that their spouses failed to pay taxes
due. In 1998, Congress encouraged greater use of both of these programs.
Since that time, the workload in both programs has increased substantially,
leading to rising inventories of cases and concerns about the time taken to
process cases. IRS' ending inventory of unresolved workable offers has
almost tripled from fiscal year 1997 to fiscal year 2000. IRS' innocent
spouse program, which received about 3,000 new cases in the 4 months prior
to the IRS Restructuring and Reform Act (Restructuring Act), now receives on
average about 5,000 new cases each month. IRS has taken a number of steps in
both programs, including reassigning staff from other duties, to handle the
increased workload. In the past two years, the offer- in- compromise program
has experienced a greater rise in its workload and is not as far along as
the innocent spouse program in implementing processes that IRS believes will
help gain better control over the workload. Given how recently changes have
been made in both programs, it is not yet clear whether the steps IRS has
taken and plans to take will enable it to significantly reduce case
inventories.

3

Audits and Other Programs for Ensuring the Accuracy of Tax Returns

IRS uses several programs to ensure that tax returns include all of the
information necessary for properly determining taxable income and the tax
due on that income. Although audits are a key program for ensuring that tax
returns are accurate, they represent a small portion of the activities IRS
undertakes for this purpose. Briefly, the key programs include the
following:

Audits: Section 7602 of the Internal Revenue Code gives IRS the authority to
examine a taxpayer's books and records as well as to take testimony to
ensure the accuracy of tax returns. Section 7605( b) restricts IRS' exercise
of this authority by allowing not more than one examination of a taxpayer's
books of account for each taxable year, unless the taxpayer requests
otherwise or unless authorized by the Treasury Secretary. Section 6501
generally requires that examinations of a taxpayer's books and records must
occur within 3 years of the taxpayer's due date for filing the tax return
unless the taxpayer agrees to an extension of this period. IRS conducts
face- to- face audits from its field offices (referred to hereafter as field
audits) and correspondence audits out of its 10 service centers.
Correspondence audits are conducted through the mail. They cover less
complex issues than field audits and generally address only one or two
issues on the tax return.

Information returns: Under various sections of the Code, third parties are
required to file information returns with IRS and taxpayers to report tax-
related information such as wages, interest, dividends, or other income paid
to taxpayers. In its information returns program, IRS uses computers to
compare that information to the information that taxpayers provide on their
tax returns, checking whether (1) taxpayers included income on their tax
returns that information returns indicated had been paid to them
(underreporter program), and (2) taxpayers filed a tax return when
information returns indicated that they had received income (nonfiler
program).

4

Math errors: When a tax return is received and before it is accepted, IRS
uses computers to identify and correct clerical and mathematical errors and
to check the accuracy of Social Security numbers shown on the return. These
clerical and mathematical error checks rely solely on information provided
by the taxpayer on the return, while the Social Security number checks
compare Social Security numbers on the return to data on Social Security
numbers provided to IRS by the Social Security Administration. Section 6213
of the Internal Revenue Code identifies the specific items on the return
that can be checked under IRS' math error authority. Table 1 provides some
information about the workload in fiscal year 2000 for each of these
programs.

Table 1: Fiscal Year 2000 Workload for IRS' Key Programs to Ensure
Compliance by 125 Million Taxpayers

Key programs to ensure taxpayers have filed accurate returns Audits
Information returns Fiscal year 2000 activities Field a Correspondence
Underreporter Nonfiler

Math error

Percent of filed returns screened by computer 100% 100% 100% N/ A 100%
Number of taxpayers contacted 237,561 380,204 1,353,545 1,251,375 5,751,000
Percent of taxpayers with filed returns contacted 0.19% 0.30% 1.08% N/ A
4.50% b a For this figure, “field audit” refers to all face- to-
face audits done by IRS.

b The rate for audit and underreporter cases was calculated using the 125
million taxpayers who filed in 1999 because it was from these taxpayers that
IRS selected returns to audit and identified taxpayers to receive
underreporter contacts in 2000. We used 127.7 million tax returns filed in
2000 to calculate the coverage for math error because it was these returns
that were reviewed for math errors.

Source: IRS data. As table I shows, in fiscal year 2000, all individual tax
returns were screened for accuracy by IRS computers. For example, all tax
returns are analyzed and scored by IRS' computers to determine which returns
are most likely to be subject to a change if audited. Although the various
programs screen all returns, not all items on the returns

5 are reviewed, with the elements screened depending on the type of program.
Also, the

number of taxpayers who were contacted under each program varied. The
largest numbers of taxpayers contacted in fiscal year 2000 were contacted
under the math error program-- about 5.75 million taxpayers, or 4.5 percent
of all taxpayers. IRS did about 617,000 audits, of which over 60 percent
were correspondence audits, and sent about 1.4 million underreporter notices
and 1.3 million nonfiler notices.

In addition to these programs, IRS also has certain special programs that
focus on the accuracy of specific tax reporting issues. For instance, IRS
checks to determine whether the dependent Social Security numbers on a
return also appear on returns filed by other taxpayers- a duplicate Social
Security number check. IRS also checks whether an individual who has self-
employment income has paid self- employment tax. These and other checks can
generate what IRS calls “soft notices.” The soft notices ask
taxpayers to review their return for certain types of errors, but do not
assess or propose assessing additional tax or otherwise change the tax
returns. For the duplicate Social Security number and self- employment
checks, IRS essentially screens all tax returns through its computers for
these potential problems. In calendar year 1998, IRS sent about 1.9 million
soft notices to taxpayers in connection with duplicate Social Security
number and self- employment checks according to the most recent data we have
from IRS.

How Audits Compare to Other Programs for Checking Tax Returns and How Audits
Have Evolved Over Time

IRS' field audits clearly differ from IRS' math error, information return,
and soft notice efforts since these audits are done face- to- face rather
than through the mail. However, over 60 percent of the audits--
correspondence audits-- are less obviously different from the other programs
for checking tax returns' accuracy because these audits are done through the
mail. Correspondence audits are most like, but not identical to, some of the
contacts IRS has with taxpayers in the information returns program and are
least like the contacts in the math error program.

6 Information returns program and correspondence audit contacts with
taxpayers can

appear to be similar because, among other things, they both occur through
mail originated in an IRS service center; usually involve an error that IRS
believes it has detected in the accuracy of some item on a tax return;
result in IRS' contacting a taxpayer after his or her return has been
processed and, in most cases, the taxes have been paid or refund made; ask
taxpayers to respond by agreeing or disagreeing that the error exists, and
by providing at least some explanation of their position if they disagree;
use an IRS employee known as a tax examiner who is to review any responses
and is to accept taxpayer responses that appear to reasonably support their
positions; and can result in IRS' assessing an additional tax liability if
taxpayers do not respond.

However, differences also exist along many of these dimensions. Unlike the
information return program, correspondence audits trigger the section 7605(
b) restriction that limits IRS to one inspection of a taxpayer's books of
account for each taxable year, unless authorized by the taxpayer or the
Secretary of the Treasury. Correspondence audit notices generally ask
taxpayers to provide information from their books and from records such as
birth certificates and school records. Information returns program notices
do not specifically ask taxpayers to provide copies of information from
their books and records. Rather, taxpayers are asked only to explain the
discrepancy between their returns and what IRS had reported to it on
information returns. According to IRS officials, most taxpayers do so in a
letter without sending copies of books and records.

The potential taxpayer errors covered by the information returns program
deal with types of income reported on information returns--- such as wages,
interest, and

7 dividends. 1 Correspondence audits can deal with income as well as
deductions,

exemptions, and credit items that can be audited through the mail. Over 80
percent of correspondence audits that closed during fiscal year 2000 dealt
with earned income tax credits.

The tax examiners in the information returns program are not trained to do
audits. Therefore, if the taxpayer sends in books and records that need more
review, these tax examiners are to send the case to the correspondence audit
unit.

These differences, particularly the section 7605( b) limitation, are
significant. However, if taxpayers have had little experience in dealing
with IRS, they may not understand the differences between correspondence
audits and information returns program contacts. From these taxpayers'
perspective, IRS has sent them a letter in either case that questions the
accuracy of an item on their tax return and requires that they respond if
they believe IRS is incorrect. If taxpayers do not respond, IRS ultimately
can assess the additional taxes on the basis of the evidence it has in its
files.

Math error contacts are more limited in their similarity to correspondence
audit contacts. For example, both types of contacts can change the tax
liability that taxpayers reported on the filed tax return, and both contacts
are handled through the mail. Otherwise, math error contacts differ from
audit contacts. For example, the math error program screens returns for
errors before being accepted by IRS as valid returns. If an error is found,
taxpayers are sent a notice within a few weeks after submitting their
return. The math error notices do not ask taxpayers for information about
the return, as would correspondence audit notices. Rather, math error
notices inform taxpayers that they have made an error, and that IRS has made
changes that increase or decrease their tax liabilities. If taxpayers
disagree with the change, they can follow procedures to request that IRS
abate, that is, reduce or rescind, the change in their taxes.

1 IRS also receives information returns for the mortgage interest tax
deduction and may contact taxpayers about discrepancies related to it.

8 Although audits have the distinguishing characteristic of requiring
taxpayers to submit

books and records for IRS review, what is counted as an audit can change
over time. For instance, in 1994, IRS concluded that certain service center
contacts were no different than other types of contacts counted as
correspondence audits. Subsequently, IRS has counted these contacts as
audits. This change shifted a couple hundred thousand contacts to the
correspondence audit program during that time period.

A movement in the opposite direction occurred in 1996. In 1996, Congress
amended the statutory definition of a mathematical or clerical error to
include missing or invalid Social Security numbers in claims for dependency
exemptions and the earned income credit. 2 This change resulted in about
700,000 cases moving out of the correspondence audit program and into the
math error program during fiscal year 1997.

In a broader perspective, the evolution of technology and the law has
enabled IRS to make greater use of computers to perform what had required
reviews of books and records by IRS auditors. The information returns
program is such a case. Before Congress enacted laws requiring various
institutions to file “information returns” on income paid, IRS
had little choice but to ask for taxpayers' books and records to determine
whether they had underreported their income. IRS could only do this for a
small portion of all taxpayers. With passage of the various information
reporting laws and expansion of their use beginning in the 1970s, IRS began
to receive copies of materials that were part of books and records without
having to ask taxpayers directly for the information. As IRS' computing
capacity grew in the 1970s and 1980s, it was able to match virtually all of
the information returns it received with individual tax returns. IRS'
enhanced computer capacity allows it to substantially verify all the income
reported on tax returns by many individual taxpayers. In 1996, we reported
that 45 percent of the taxpayers claimed the standard deduction and that all
the income they reported on their tax returns was subject to information
reporting. 3 Because IRS does not have to directly

2 P. L. 104- 188 and P. L. 104- 193. 3 Tax Administration: Alternative
Filing Systems, (GAO/ GGD- 97- 6, Oct. 16, 1996).

9 ask taxpayers for information from books and records, none of these
specific income

verifications count under the definition of audits. However, computerized
checks on the accuracy of tax returns are limited in that they depend on
information provided by taxpayers and third parties. Because a significant
portion of income received by some individuals is not subject to third party
information reporting, and because other items affecting tax liability such
as most itemized deductions, also are not subject to information reporting,
audits remain an essential program for ensuring that taxpayers file accurate
tax returns. To the extent that the computerized checks that are now
available to IRS help free up audit staff, IRS may be able to redirect the
staff to audit taxpayers whose income and deductions are not wellcovered by
the information matching programs.

Measuring Voluntary Reporting Compliance Is Key to Understanding the Effect
of IRS' Audits and Other Actions to Promote Compliance

The falling audit rates since fiscal year 1995 have generated concerns about
increases in noncompliance because taxpayers may feel they can underreport
income or otherwise underpay taxes with little fear of being caught. In
fiscal year 2000, IRS audited 0.49 percent of the income tax returns filed
by individual taxpayers. This rate was about 45 percent lower than the audit
rate in 1999, over 70 percent lower than the rate in 1995, and about 40
percent lower than the lowest previous audit rate of 0.8 percent, which
occurred in 1990.

An increase in the use of other programs, such as the math error and the
information returns program, may help offset any tendency towards lowered
compliance. However, the number of contacts in these programs has also been
falling since fiscal year 1995. For example, the number of information
returns program contacts for unreported income has fallen about 50 percent
since 1995.

Other factors may also help to encourage overall voluntary compliance
levels. IRS initiatives to help taxpayers better understand the tax law and
their tax responsibilities

10 may offset unintentional noncompliance resulting from such things as
misunderstanding

tax requirements. If these programs are reducing unintentional
noncompliance, the overall voluntary compliance rate could hold steady, or
even increase, even if some taxpayers intentionally underpay their taxes due
to the signal that falling audit rates may send.

Neither IRS nor external observers know the net effects that the decline in
audit rates and changes in other IRS programs have on voluntary reporting
compliance. One reason is that IRS does not have current, reliable
information on the levels of voluntary reporting compliance. IRS last
measured overall income tax compliance for tax year 1988. IRS and others are
concerned that the compliance information is out of date because the tax
laws have changed, and because IRS has completely reorganized itself and
refocused its philosophy to become more taxpayer service- oriented.

Because each of the programs IRS uses is best suited to identifying and
correcting a specific type of noncompliance, it is important for IRS to know
specifically where taxpayers are not reporting accurately. For example, the
information returns program is best suited to identifying taxpayers who
underreport income such as wages, interest, and dividends. Similarly, the
math error program can best identify taxpayers who use an incorrect Social
Security number for dependents or make a calculation error. However, at this
time, only an audit enables IRS to identify noncompliance in reporting items
that affect business net profit or loss, personal income not covered on
information returns, and most personal deductions.

Having more information about the specific types and level of errors made by
taxpayers in reporting items on tax returns has potential benefits beyond
better targeting IRS' enforcement efforts. With this information, IRS also
can analyze ways to improve voluntary compliance through nonenforcement
efforts- such as better education, service, and forms-- as well as to
improve resource allocation and the training of all types of IRS staff.

11 IRS is currently developing plans to again measure voluntary compliance.
A draft

business plan has been developed, and IRS is in the process of contacting
various stakeholders to obtain their input. The project, called the National
Customer Research Study, will measure all three areas of compliance--
obtaining information on the proportion of returns that were filed properly,
that reported the tax liabilities accurately, and that fully paid these tax
liabilities. Because a voluntary compliance measure is key to understanding
the effects of IRS' efforts to properly administer the tax laws, we are
currently reviewing IRS' National Customer Research Study.

IRS' Offer- in- Compromise Program

An offer- in- compromise is a contract between IRS and an individual or
business taxpayer to settle a tax debt for less than the amount of the debt.
Taxpayers can submit an offer for all types of taxes, as well as interest
and penalties, arising under the Internal Revenue Code. Generally, offer
agreements require the taxpayer to file returns and pay taxes for 5 years
from the date IRS accepts the offer. Failure to do so permits IRS to begin
immediate collection actions for the original amount of the liability. The
offer- incompromise program is currently administered by IRS' Small
Business/ Self- Employed (SB/ SE) Division.

Offers were not widely used to resolve tax debts until 1992, when IRS
adopted a new offer policy that placed more emphasis on the use of offers as
a means to enhance overall compliance and to help manage the inventory of
delinquent tax accounts. The goal of the new offer policy was to achieve
collection of what was potentially collectible at the earliest possible time
and at the least cost to government.

More recently, the Restructuring Act called for certain changes in the offer
program directed at providing greater consideration to the taxpayer in
resolving collection issues through compromise. Among other things, the
Restructuring Act required that IRS (1) consider the facts and circumstances
of each case when evaluating offers, (2) not reject offers from low- income
taxpayers solely on the basis of the amount offered, and (3) independently
review all proposed offer rejections before notifying taxpayers and allow

12 taxpayers to appeal any such rejection. These changes were effective upon
enactment of

the act on July 22, 1998. Trends in Offer Workload IRS data show that its
workload for the offer- in- compromise program has significantly increased
in recent years. The number of workable offers-- that is, offer applications
that meet IRS' criteria to process them-- has increased by 83 percent, from
about 51,700 offers in fiscal year 1997 to about 94,500 offers in fiscal
year 2000. Because IRS was unable to keep up with this increase in offers
received, IRS' ending inventory of unresolved workable offers almost
tripled, from about 32,300 in fiscal year 1997 to about 87,500 in fiscal
year 2000. Figure 1 shows these trends in workable offers and ending
inventory.

Figure 1: Trends in Workable Offers and Ending Inventory

Offers 0 10,000

20,000 30,000

40,000 50,000

60,000 70,000

80,000 90,000

100,000

Workable Offers Ending Inventory

Fiscal Year 1997 1998 1999 2000

Source: IRS data.

13 According to IRS, several factors contributed to the growth in the number
of workable

offers. First, the publicity resulting from the outreach and marketing
efforts of IRS and tax practitioners brought the revised program to the
attention of taxpayers and their practitioners. Second, prior to fiscal year
1999, IRS would not accept an offer- incompromise application for processing
if it was incomplete in providing such things as financial information or if
the offer was missing the taxpayer's signature. In 1999, IRS began accepting
all offer applications for processing except those from taxpayers in
bankruptcy proceedings or taxpayers who had not filed all required federal
tax returns. Instead of returning an incomplete offer, IRS now accepts the
offer for processing and works with the taxpayer to obtain the information
needed. Finally, IRS previously had installment agreements with many
taxpayers that extended for up to 15 years and longer. In 1999, IRS decided
to halt the practice of agreeing to such long- term installments and decided
instead to work with the taxpayers on an offer- in- compromise with a
deferred payment schedule. This shifted some of the workload from the
installment agreement program into the offer- in- compromise workload.

IRS measures its timeliness in working offers- in- compromise by the percent
of offers it completes within 6 months of the date the offer is accepted for
investigation. As shown in the figure below, the percentage of offers IRS
completed within 6 months has declined from 64 percent in fiscal year 1997
to 38 percent in fiscal year 2000. For fiscal year 1999, IRS established a
goal to close 59.3 percent of offers within 6 months of the date the offer
is accepted for investigation. It set a goal of closing 51.4 percent of
offers within 6 months for fiscal year 2000. IRS did not meet either of
these goals: it closed 51.4 percent of its workable offers within 6 months
in fiscal year 1999 and 37.9 percent in fiscal year 2000. In addition, the
percentage of cases in the ending inventory over 6 months old increased from
19 percent to 43 percent between fiscal years 1997 and 2000. Figure 2 shows
the trend in offers closed within 6 months for fiscal years 1997 through
2000 and IRS' goals for fiscal years 1999 and 2000.

14 Figure 2: Percentage of Offers Closed Within 6 Months in Fiscal Years
1997- 2000 and IRS'

Goals for Fiscal Years 1999 and 2000

Percent closed within 6 months Goal

1999 Percent

0 10

20 30

40 50

60 70

80 90

100 Fiscal Year

1997 1998 1999 2000

Source: IRS data. According to IRS officials involved in the offer program,
several program changes have contributed to IRS' inability to meet its 6-
month goal for processing offers. These include:

Relaxing the criteria for accepting offer applications for processing. The
change in criteria for accepting applications, discussed previously,
resulted in the time taken to obtain required information for a complete
offer application being counted in IRS' processing time.

15 Expanding the basis for accepting offers to include factors such as
hardship and

equity. 4 IRS officials said that this was done because they believed, in
considering and passing the Restructuring Act, Congress expressed its intent
that IRS should be more flexible in working with taxpayers who want to
settle tax debts. IRS officials said that they first consider the offer
under their normal criteria for evaluating offers, and then the taxpayer
must demonstrate that an exceptional circumstance exists that would make
payment of the tax a hardship, unfair, or inequitable. Whenever these
factors are considered, the process takes longer.

Implementing the Restructuring Act requirement that IRS perform an
independent administrative review of all proposed offer rejections. IRS has
also included as part of this review all proposed decisions to return an
offer because of a taxpayer's failure to provide information IRS requested.
According to IRS officials, these reviews have increased processing time by
almost a month for those offers that were reviewed.

The relationship between the number of workable offers and the capacity of
staff to process them affected inventory levels. In an attempt to manage the
growing numbers of workable offers and cases that have been in inventory
more than 6 months, IRS shifted staff to the offer program from other field
collection activities, such as tax delinquent account investigations. The
total direct time charged to the offer program increased by 77 percent, from
an equivalent of about 350 full- time equivalent positions (FTE) 5 in fiscal
year 1997 to about 619 FTEs in fiscal year 2000. However, with the
reassignment of more staff into the program, IRS officials said its most
productive offer staff were taken off of casework in order to provide newly
assigned staff on- the- job training and coaching, which decreased
productivity. During the same period, the time directly charged to
collection activities by all collection field staff decreased by 33 percent
from an

4 Under IRS regulations prior to this change, IRS generally accepted offers
based on doubt as to collectibility (taxpayers owe tax but cannot pay the
entire debt) and doubt as to liability (taxpayers claim they do not owe all
or part of the tax in question). Most offers were accepted based on doubt as
to collectibility. 5 An FTE generally consists of one or more employed
individuals who collectively complete 2,080 work

hours in a given year. Therefore, either one full- time employee or two
half- time employees equal one FTE.

16 equivalent of 6,098 FTEs to 4,114 FTEs. Table 2 shows the trends in FTE
utilization in

the offer- in- compromise program for fiscal years 1997 through 2000. Table
2: Direct Field Collection FTE Utilization for Fiscal Years 1997 to 2000

FY 1997 FTEs

FY 1998 FTEs

FY 1999 FTEs

FY 2000 FTEs

Percent Change FYs 1997- 2000

Offer- in- compromise program

350 356 414 619 77 % Total for all collection activities

6,098 5,487 4,532 4,114 (33 %) Source: IRS data. With the decline in staff
assigned to all collection activities and an increase in collection staff
working offers, the share of total direct collection FTEs devoted to the
offer- in compromise program has grown from about 6 percent of all
collection activities to 15 percent between fiscal years 1997 and 2000.

Key Actions Taken by IRS to Address Offer Workload Concerns In recent years,
IRS has taken various actions to address its offer workload concerns. The
key actions IRS has taken, designed in part to reduce inventory backlog and
processing times, include

assigning more staff to the offer program, as discussed previously;
streamlining the offer process for certain cases; for example, IRS changed
its investigation and processing procedures in 1999 by requiring less
documentation for low risk offers and raised the maximum liability for
streamlined offers from $25,000 to $50,000;

17 creating an offer specialist position for revenue officers assigned to
work offers;

developing training programs for offer specialists, independent
administrative reviewers, and walk- in and call- site employees so that they
can better answer taxpayer questions about the offer program; developing an
Internet- based self- help interactive offer application; this tool provides
background information on the offer process, instructions, and electronic
offer forms to assist taxpayers to prepare quality offers and thereby reduce
up- front processing time-- this effort was part of SB/ SE's most recent
strategic plan and was implemented at the end of fiscal year 2000; revising
offer forms and instructions to make them more user- friendly; simplifying
the deferred payment option by eliminating the collection of interest on the
accepted amount; and contracting to study how to reengineer the offer
process to reduce processing time.

Key Actions Planned by IRS to Address Offer Workload Concerns SB/ SE's
fiscal year 2001 strategic plan sets forth two actions that IRS is to
undertake to improve the efficiency of its offer- in- compromise program.
They are to

centralize the processing of new offers- in- compromise at two sites by
August 2001 to improve offer quality, timeliness, and efficiency (The two
sites are to assemble the initial case files used in processing all offers
and fully process offers with liabilities under $50,000 that meet certain
criteria. Offers with liabilities over $50,000 are to be sent to IRS field
offices for evaluation and final processing. To carry out this action, SB/
SE's plan states that 650 lower- graded offer staff would be needed at the
centralized locations. These staff reportedly would free up over 600 higher-
graded revenue officer FTEs for other work by fiscal year 2004. IRS expects
that centralization will enable its field staff to completely work its
inventory backlog by fiscal year 2004 if the number of new offers received
remains constant.); and consolidate onto one platform the key databases used
by collection personnel to perform the administrative legal requirements for
processing liens, bankruptcies, and

18 offers- in- compromise. (This action is intended to allow more efficient
access to

information in these databases. The plan states that the database
integration is to occur after fiscal year 2002.)

In addition, IRS is planning to revise the offer application package to
better explain to taxpayers the requirements for submitting financial
information with the offer application.

Summary and Observations Through fiscal year 2000, the workable offers and
the inventory of existing offer cases increased rapidly, and IRS'
performance in meeting its goals for processing cases within 6 months
deteriorated. In response, IRS reassigned staff who would have been
performing other collection activities into handling offers. Faced with
potential continuing high workloads, IRS has adopted a more long- term
strategy of centralizing the processing of offers and hiring lower- graded
staff to specialize in this function to free up collection staff for other
activities. The centralization is planned to begin later this fiscal year.
Among other things, it will require reassigning hundreds of employees and
providing them facilities, equipment, and training. Although centralization
and IRS' other initiatives may enable it to gain control over its growing
inventory, success will require careful management of the centralization
process and a leveling off in the growth of workable offers received by IRS.
Consequently, it remains to be seen how much progress IRS will make and how
quickly.

IRS' Innocent Spouse Program

Under tax law, married couples who file joint tax returns are treated as a
single unit, which means that each spouse becomes individually responsible
for paying the entire amount of the tax associated with that return.
Accordingly, an “innocent spouse” can be held liable for tax
deficiencies assessed after a joint return was filed, even if those
liabilities were solely attributable to the actions of the other spouse.

19 However, if certain conditions are met, the innocent spouse may be able
to obtain relief

from the tax liability. The Restructuring Act revised the conditions for
obtaining relief to make it easier for taxpayers to qualify for innocent
spouse relief. The act liberalized the former conditions and added new
conditions. Simply stated, the three basic provisions related to innocent
spouse relief are as follows: 6

When the innocent spouse had no knowledge that there was an understatement
of tax attributable to erroneous items of the other individual filing the
joint return, and considering all facts and circumstances, it would be
inequitable to hold the innocent spouse liable for the tax. When the
innocent spouse otherwise qualifies, he or she may request to have the tax
deficiency from a jointly filed return recalculated to include only items
allocable to him or herself. When the tax shown on a joint return was not
paid with the return, the innocent spouse may obtain “equitable
relief” if he or she did not have knowledge that the funds intended to
pay the tax were not used for that purpose. Equitable relief is also
available for understatements of tax for which relief under the above two
conditions was not available.

Each condition above has different eligibility requirements and provides
different types of relief. Relief is generally available to taxpayers for
liabilities arising after July 22, 1998, the date the act was enacted, and
for liabilities that arose before that date but remained unpaid as of that
date.

Currently, IRS' Wage and Investment (W& I) Division has overall
responsibility for managing the innocent spouse program. W& I has an
agreement with SB/ SE whereby SB/ SE field staff work innocent spouse cases
requiring face- to- face contact with taxpayers. Prior to IRS'
reorganization, the former Examination Division handled innocent spouse
relief requests.

6 IRC sect. 6015, and IRC sect. 66( c).

20 Workload Concerns Developed After the Restructuring Act's Changes

Limited data exist to determine the trend in innocent spouse workload.
However, existing data suggest that workload increased substantially after
the Restructuring Act's changes. Prior to the Restructuring Act, IRS
administered innocent spouse relief as part of its process of examining tax
returns and did not keep statistics on the number of cases in which innocent
spouse relief was requested or on the disposition of those requests.
According to a statement by the IRS Commissioner, in the approximately 4
months before enactment of the Restructuring Act, IRS received about 3,000
innocent spouse cases. In the first 7 months after IRS established a system
for more reliably tracking innocent spouse cases, it received over 43,000
innocent spouse cases.

Although innocent spouse submissions increased after the enactment of the
Restructuring Act, data are not available to document the increase because
IRS did not systematically track innocent spouse cases until March 1999. 7
Since cases have been tracked, it appears that the annualized innocent
spouse workload has been relatively stable even though the submissions have
not spread evenly over the fiscal year. The limited trend information
currently available show that submissions tend to be lower in the early
months of the fiscal year- October through January-- then climb
substantially during and after the tax filing season, before falling off
again. Taking this pattern into account, the 43,255 cases received in the
seven months after IRS instituted its case tracking system were within 12
percent of the volume received in the same 7 month period of fiscal year
2000- 38,695. Further, the 16,422 cases received through March 6 of this
fiscal year is slightly less than the 18,643 received during the comparable
period the prior year.

When an innocent spouse case is received, IRS screens the case to determine
whether it meets basic eligibility requirements before thoroughly
investigating it. IRS data shows that the percentage of cases received that
IRS determined met the eligibility

7 IRS began limited tracking of innocent spouse cases on March 6, 1999 when
it implemented the innocent spouse tracking system. If a taxpayer files a
claim for innocent spouse relief covering more than one tax

21 requirements for consideration has declined substantially after fiscal
year 1999. For the 7

months of fiscal year 1999 that IRS tracked the cases, about 90 percent of
them were judged by IRS to be eligible for further review to determine if
innocent spouse relief should be granted or denied. In fiscal year 2000, 54
percent of cases were judged to be eligible for further review. IRS data for
fiscal year 2001- October 1, 2000 through March 6, 2001- shows that about 59
percent of cases received warranted further investigation to assess their
merits for relief consideration.

On the whole, however, because IRS was unable to process this influx of new
cases as rapidly as they were arriving, the inventory of cases being worked
at the end of fiscal years 1999 and 2000 reached 33,232 and 39,552 cases,
respectively. As of March 6, 2001, the inventory of cases in inventory
remained similar in size to that at the end of the prior fiscal year. Table
3 shows basic workload statistics for the innocent spouse program since IRS
began tracking the cases on March 6, 1999 through March 6, 2001.

year or tax period, IRS evaluates the merits of the claim for each tax year
individually to determine whether relief should be granted. Therefore, the
claim for each tax year is counted as a case.

22 Table 3: Statistics on the Innocent Spouse Workload 8

Dates received Cases Received

Cases eligible for review

End- ofperiod inventory

Completed cases a

Between March 6, 1999, and September 30, 1999 b

43,255 38,992 33,232 NA Between October 1, 1999, and September 30, 2000

60,987 32,762 39,552 32,202 Between October 1, 2000, and March 6, 2001

16,422 9,681 39,111 10,122 a We have included closed cases as well as cases
for which IRS has reached its determination and sent a letter to the
taxpayer, but for which the taxpayer's period to appeal the determination is
still open. b Figures up to September 30, 1999, are approximate. Data on the
number of cases completed up to September 30, 1999, are not available.

Source: IRS Innocent Spouse Tracking System data. According to IRS, the
increase in the number of innocent spouse cases received pursuant to the
liberalized relief provisions led to its substantial inventory of open cases
for several reasons:

The Restructuring Act provisions were effective upon enactment of the law,
giving IRS limited time to estimate likely increases in workload and
determine appropriate staffing levels and make staffing assignments. The
volume of cases received exceeded IRS' expectations, leading IRS to assign
additional staff to the effort. The expanded innocent spouse relief
provisions were especially complex. IRS had to develop guidance for the new
and revised relief provisions and provide training for existing and newly
assigned staff.

8 IRS had about 7,000 cases in inventory that were closed before the
tracking system was implemented that are not included in these numbers.

23 In response to the increased inventory of innocent spouse cases, in
fiscal year 2000 IRS

increased program staff more than anticipated: it had planned to devote 717
FTEs; it actually used 887 as shown in the following table. 9

Table 4: FTEs for Processing IRS' Innocent Spouse Claims in Fiscal Year 2000

Projected Actual Total Fiscal year W& I SB/ SE W& I SB/ SE Projected Actual

2000 115 602 119 768 717 887 Source: IRS. For fiscal year 2001, IRS
projected that W& I and SB/ SE would use 169 and 409 FTEs, respectively. IRS
attributes the decrease in projected FTE usage by SB/ SE primarily to
expected efficiencies in case processing pursuant to a plan to move workload
back to the W& I's centralized case processing facility.

Key Actions Taken by IRS to Address Innocent Spouse Workload Concerns IRS
has taken a number of actions to better manage its inventory of innocent
spouse cases and help ensure that the claims are being processed in a
timely, accurate, and consistent manner. Some of the actions were based on
recommendations by the Treasury Inspector General for Tax Administration
(TIGTA), and others were done on IRS' own initiative.

In April 1998, as the Restructuring Act was being considered, IRS designated
the Cincinnati Service Center as a central processing site for innocent
spouse cases. The service center was to screen new cases. Those cases over a
certain dollar threshold or that required face- to- face contact with
taxpayers were to be sent to field offices to resolve, while the less
complex and low dollar cases were to be handled by service

9 IRS does not have good data on FTE usage for the program prior to fiscal
year 2000.

24 center staff. IRS officials believed that this centralization would
facilitate more rapid

and consistent processing of cases because staff in the service center would
specialize in the innocent spouse cases and follow consistent procedures and
processes in resolving cases. In March 1999, IRS established an innocent
spouse tracking system to more accurately assess the status of cases in
inventory and resource needs. In May 1999, IRS added a national project
manager, and in November 1999 three issue specialists were selected to help
manage and oversee the nationwide operations of the program. In June 1999,
IRS announced the establishment of a centralized innocent spouse review
process for closed cases in order help ensure that case decisions were made
as accurately and consistently as possible among the IRS offices involved in
the program. Initially, 100 percent of the field office cases and a 10-
percent sample from the Cincinnati Service Center were to be sent to the
centralized review office. A sampling procedure is now being used to
determine how many cases from the field should be forwarded to the
centralized review office. 10 IRS set a goal for fiscal year 2000 that the
centralized review process would concur with the decisions made by the
submitting offices in 85 percent of the cases reviewed. The concurrence rate
achieved for fiscal year 2000 was 82.3 percent. The goal is 90 percent for
fiscal year 2001. In April 2000, IRS made an internal web page available to
examiners and other IRS staff as a central reference for information about
the innocent spouse program. In January 2001, the first phase of an innocent
spouse integrated case processing (ICP) system was implemented at the
Cincinnati Service Center. The ICP uses algorithms that direct examiners
through a series of questions leading to a decision about what, if any,
relief is due to the taxpayer. The ICP also automatically prompts the
examiner to create a documented case file. The ICP is intended to increase
the accuracy and consistency of determinations since it is designed to help
ensure that examiners consider all pertinent aspects of a taxpayer's case in
accordance with the

10 The sampling methodology was set up by IRS' Atlanta District Office of
Research and Analysis and is a projectible representative sample for each
field office.

25 law. IRS is planning future enhancements to the ICP that would make it
easier for

examiners to access and update taxpayer data. IRS projects that the system
will save about 50 FTEs in its first year and 60 in its second year of use.

Although IRS has undertaken many initiatives to better deal with the
innocent spouse workload, it has experienced a number of problems in coping
with the increasing workload and in implementing some of its initiatives.
For example:

The volume of cases received was considerably above IRS' expectations. To
deal with the unanticipated increases in workload, IRS added temporary
employees to the service center staff. However, according to a report by
TIGTA on IRS' innocent spouse program, those employees spent a majority of
their 90- day details being trained by permanent staff on how to work these
complex cases. 11 This depressed the productivity of experienced staff
without realizing much benefit from the additional temporary employees. When
the service center could not keep up with the volume of cases, IRS
distributed cases to the field offices that it had hoped to be able to
process centrally. Between the July 22, 1998, passage of the Restructuring
Act and December 7, 1998, IRS was developing interim regulations to
implement the equitable relief provisions of the new law. Therefore, cases
for which equitable relief could apply had to be held in the service center
until the regulations were promulgated at which point their processing could
be resumed and completed. Although W& I is responsible for the innocent
spouse program, when contacts with taxpayers are needed to resolve cases,
the SB/ SE division staff make those contacts. In our work, we found that
several SB/ SE field offices had completed only a small number of innocent
spouse cases. The national innocent spouse program manager in W& I lacked
authority to direct SB/ SE managers to adjust staffing levels for innocent
spouse cases to ensure more uniform processing of taxpayers' claims. In
December of 2000 and January of 2001, a memorandum of understanding was
signed by the

11 Increased Attention Is Needed to Ensure Timely, Accurate Determinations
on Innocent Spouse Claims for Relief, May 2000.

26 Commissioners of W& I and SB/ SE, respectively, on the use of field staff
to work

innocent spouse cases. Key Actions Planned by IRS to Address Innocent Spouse
Workload Concerns IRS has identified operational priorities and improvement
projects to help address workload case quality concerns.

The W& I division plans to develop an additional training course related to
marital abuse and the equitable relief provision, improve the innocent
spouse tracking system so that program performance data are more quickly
available to program officials, and improve outreach to taxpayers and tax
practitioners.

The SB/ SE plans to begin moving innocent spouse cases back to the
centralized case processing facility in Cincinnati to improve case
processing, reduce cycle time, and reduce existing inventories. SB/ SE would
continue to work cases generated in the field offices, 12 but IRS estimates
that new case starts in SB/ SE field locations will decrease in fiscal year
2001.

Summary and Observations Several factors suggest that IRS may be gaining
better management control over the innocent spouse workload. Unlike the
offer- in- compromise program, the workload for the innocent spouse program
appears to have leveled off after increases following enactment of the
Restructuring Act. With this leveling off and enhancements in its case
processing capacity such as the new integrated case processing system, IRS
plans this

12 IRS field staff are to investigate any potential innocent spouse issue
that comes up during contacts with taxpayers. Some of these contacts end up
as innocent spouse cases and would be handled by the SB/ SE field staff.

27 fiscal year to move many cases back into its centralized case processing
facility,

potentially freeing up hundreds of field staff to return to other
examination- related duties. IRS also established a review process for
innocent spouse cases to better ensure that the law is applied accurately
and uniformly. IRS did not achieve its goal of an 85- percent concurrence
rate between the determinations made in the review process and those that
had been made in the field or the centralized processing facility, but did
achieve an 82.3 percent concurrence rate. The automated integrated case
processing system that has been implemented at the central case processing
facility holds promise in helping IRS further improve accuracy and
uniformity in applying the innocent spouse provisions because it
standardizes the questioning process for determining eligibility and better
ensures that all appropriate documentation is considered. Although these
factors suggest growing managerial control over the innocent spouse
inventories, considerable uncertainty remains. For example, we know little
about why the portion of cases found eligible for detailed review has
decreased or whether innocent spouse workloads will be remain roughly
stable.

- - - - We look forward to continuing to work with this Committee and
Congress in considering the issues I have discussed today as well as other
issues related to our tax system. This concludes my prepared statement. I
will be happy to answer any questions you or other Members of the Committee
may have.

GAO Contacts and Staff Acknowledgements

For more information regarding this testimony, please contact Michael
Brostek, Director, Tax Issues, and Assistant Directors Charlie W. Daniel and
Thomas Short on (202) 5129110. Sharon Caporale, John Gates, Susan Malone,
Louis G. Roberts, and Michael Tropauer also made key contributions to this
statement.

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