Tax Administration: Interim Report on Advance Tax Refunds	 
(13-DEC-01, GAO-02-257).					 
                                                                 
The Economic Growth and Tax Relief Reconciliation Act of 2001	 
directed the Treasury to issue advance 2001 tax refunds to	 
individual taxpayers who filed a tax year 2000 return. As a	 
result, the Internal Revenue Service (IRS) had to identify	 
eligible taxpayers so that checks could be sent to these	 
taxpayers by December 31, 2001. The Department of the Treasury's 
Financial Management Service was to issue the checks on behalf of
IRS, with the first checks to be received during the week of July
23, 2001. As of September 30, 2001, 84 million taxpayers were to 
have received $36 billion in advance tax funds. IRS offset about 
$2.1 billion from these advance tax refunds to recover delinquent
federal taxes. IRS spent $104 million to run the program through 
September 2001, which included IRS staffing costs as well as the 
costs associated with contracts, postage, and printing. The	 
Treasury Inspector General for Tax Administration identified two 
initial problems that affected either the accuracy or timeliness 
of the advance refund notices. One involved computer programming 
errors that resulted in 523,000 taxpayers receiving notices	 
indicating that they would receive larger advance tax refunds	 
than they were entitled to receive. The IG also determined that  
5.3 million taxpayers who had filled their tax returns by the	 
April 16 filing deadline would have delays of up to nine weeks in
receiving their advance refund notices. Two problems that	 
continued throughout the advance tax refund period involved (1)  
undeliverable refund notices and checks due to incorrect	 
addresses and (2) taxpayer difficulties in reaching IRS telephone
assistors. Another problem that was quickly identified and	 
corrected during the early stages of the advance tax refund	 
period involved duplicate checks sent to about 25 taxpayers.	 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-257 					        
    ACCNO:   A02527						        
  TITLE:     Tax Administration: Interim Report on Advance Tax Refunds
     DATE:   12/13/2001 
  SUBJECT:   Statistical data					 
	     Tax refunds					 
	     Taxpayers						 
	     IRS Advance Tax Refund Program			 
	     IRS TeleTax System 				 
	     USPS National Change of Address Program		 

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GAO-02-257
     
United States General Accounting Office

GAO Report to the Chairman and Ranking Minority Member, Committee on
Finance, U.S. Senate

December 2001

TAX ADMINISTRATION

Interim Report on Advance Tax Refunds

GAO-02-257

Contents

Letter

Results in Brief
Background
Billions of Dollars in Advance Tax Refunds Sent to Millions of

Taxpayers Various Problems Occurred During Implementation of the Advance
Refund Program Agency Comments

1

2 3

4

7 12

Appendix I Comments From the Internal Revenue Service

Appendix II Comments From the Financial Management Service

Tables

Table 1: Number of Taxpayers and Amount of Advance Tax Refunds Each Week
Through September 30, 2001 5 Table 2: Accessibility of IRS' Telephone
Assistance During Advance Tax Refund Period 10

Abbreviations

DFAS Defense Finance and Accounting Service
FMS Financial Management Service
IRS Internal Revenue Service
SSN Social Security number
TIGTA Treasury Inspector General for Tax Administration

United States General Accounting Office Washington, DC 20548

December 13, 2001

The Honorable Max Baucus
Chairman
Committee on Finance
United States Senate

The Honorable Charles E. Grassley
Ranking Minority Member
Committee on Finance
United States Senate

The Economic Growth and Tax Relief Reconciliation Act of 20011 directed
the Secretary of the Treasury to issue advance 2001 tax refunds to eligible
individual taxpayers who filed a tax year 2000 return. As a result, the
Internal Revenue Service (IRS) was tasked with identifying taxpayers who
were eligible for an advance tax refund so that checks could be sent to
these taxpayers by December 31, 2001. The Department of the Treasury's
Financial Management Service (FMS) was to issue the checks on behalf of
IRS, with the first checks to be received during the week of July 23, 2001.

In response to your request for information on IRS' efforts to implement
this provision of the Economic Growth and Tax Relief Reconciliation Act
of 2001, this interim report includes information on (1) the number and
dollar amount of advance tax refund checks issued through September 30,
2001, and related information, such as IRS' costs to administer this
program, and (2) various problems that were encountered during the
program's implementation. We plan to issue a final report on this program
around the end of March 2002.

To meet our objectives for this interim report, we discussed advance tax
refund procedures with IRS officials and obtained statistics on (1) the
number and dollar value of refunds issued, refunds that were offset due to
federal tax debts, and undeliverable refund notices and checks, and (2)
taxpayer contacts with IRS concerning these refunds. In addition, we
discussed advance tax refund procedures with FMS officials and obtained
statistics on the number of refund checks that were undeliverable and the
number and dollar value of refunds that were offset for debts other than

1P. L. No. 107-16, 115 Stat. 38.

Results in Brief

federal tax debts. We identified problems encountered during the program's
implementation through (1) analyses of statistical data and other
information and (2) discussions with IRS and FMS officials and staff of the
Treasury Inspector General for Tax Administration (TIGTA) who were reviewing
various aspects of the program. We did not independently verify the
statistical data provided by IRS and FMS.

We did our work between July and December 2001 in accordance with generally
accepted government auditing standards. We obtained written comments on a
draft of this report from the Commissioner of Internal Revenue and the
Commissioner of FMS. Their comments are discussed near the end of this
report and are reprinted in appendixes I and II, respectively.

As of September 30, 2001, about 84 million taxpayers were to have received
about $36 billion in advance tax refunds. IRS offset about $2.1 billion from
these advance tax refunds to recover delinquent federal taxes.2 FMS offset
another $469 million for delinquent child support payments, state taxes, and
federal debts other than delinquent taxes. It cost IRS about $104 million to
administer the advance tax refund program through September 30, 2001, which
included IRS staffing costs as well as the costs associated with contracts,
postage, and printing. FMS expects to incur about $34 million in costs to
issue the checks.

TIGTA identified two initial problems that affected either the accuracy or
timeliness of the advance refund notices that IRS sent to taxpayers.3 One
problem involved computer programming errors that resulted in 523,000
taxpayers receiving notices indicating that they would receive larger
advance tax refunds than they were entitled to receive. TIGTA brought the
problem to IRS' attention, and IRS corrected it before any advance tax
refunds were issued. TIGTA also determined that 5.3 million taxpayers who
had filed their tax returns by the April 16 filing deadline would have
delays from 1 to 9 weeks in receiving their advance refund notices because
of IRS' procedures for processing returns and the way programming was
developed to generate the notices.

2IRS indicated that this offset amount was an unofficial count.

3 While Most Taxpayers  Received Accurate  and Timely Notification  of Their
Advance Refunds, Millions Did Not (TIGTA, 2002-40-016, Oct. 24, 2001).

Two problems that continued throughout the advance tax refund period
involved (1) undeliverable refund notices and checks due to incorrect
addresses and (2) taxpayer difficulties in reaching IRS telephone assistors.
According to IRS, almost 2 million advance refund notices were undeliverable
as of September 30, 2001, and almost 300,000 advance refund checks valued at
about $95 million were undeliverable as of October 30, 2001. IRS has
procedures in place for updating addresses of taxpayers whose checks were
returned as undeliverable. Taxpayers attempting to reach an IRS telephone
assistor from July 1 through September 30, 2001, were successful 47 percent
of the time, which was well below the 61-percent level of service reported
during the 2001 filing season. Taxpayer demand for telephone service
increased significantly during the advance tax refund period, according to
IRS data, and IRS attributed the decline in service to that increased
demand. IRS had taken steps to prepare for the demand for telephone
assistance that it expected during the advance tax refund period. At the
time we prepared this report, we did not have sufficient information to
determine to what extent, if at all, the demand for telephone service
exceeded IRS' expectations or what other factors might have contributed to
the decline in service.

Another problem that was quickly identified and corrected during the early
stages of the advance tax refund period involved duplicate checks sent to
about 25 taxpayers. FMS had recovered either all or part of the duplicate
payments from 16 of the 25 taxpayers as of November 2001 and was in the
process of recovering the duplicate payments from the other 9 taxpayers.

For tax years beginning after 2000, the Economic Growth and Tax Relief
Reconciliation Act of 2001 applied a new 10-percent income tax rate to a
portion of an individual's income that was previously taxed at 15 percent.
To stimulate the economy more rapidly than would be achieved if taxpayers
had to wait until they filed their tax year 2001 tax returns to realize the
full impact of this rate reduction, the Act provided for eligible taxpayers
to receive an advance 2001 tax refund. To be eligible for an advance refund,
taxpayers (1) had to have a federal income tax liability on their tax year
2000 return, (2) could not be claimed as a dependent on someone else's tax
year 2000 return, and (3) could not be a nonresident alien.4 The amount of
advance tax refund that taxpayers could receive

4IRS identified about 34 million taxpayers who were ineligible for an
advance tax refund.

Background

depended on the filing status and amount of taxable income shown on the
taxpayer's tax year 2000 return. The maximum refund amount was $600 for a
married couple filing jointly or a qualified widow(er), $500 for a head of
household, and $300 for a single individual or married person filing
separately.

Before issuance of the advance tax refund checks, IRS was to send every
individual who filed a return for tax year 2000 a notice either informing
them of the refund amount they were to receive and the week in which they
were to receive it or telling them that they were ineligible for a refund
and why. FMS was to issue the advance tax refund checks for IRS with
assistance from the Defense Finance and Accounting Service (DFAS).5 Before
issuing any check, IRS and FMS were to reduce the amount of the check by the
amount of any delinquent federal tax or certain other debts, such as
delinquent child support payments, owed by the taxpayer.

Most advance refund checks were to be issued over a 10-week period from the
week of July 23, 2001, through the week of September 24, 2001, based, in
general, on the last two digits of a taxpayer's Social Security number
(SSN). For example, taxpayers with 00 through 09 as the last two digits of
their SSN were to receive their checks the week of July 23, 2001, while
taxpayers with 90 through 99 as the last two digits of their SSN were to
receive their checks the week of September 24, 2001. Taxpayers who filed
their tax year 2000 returns after April 16 were to receive their advance tax
refund checks later in the fall.6 All checks were to be issued by December
31, 2001.

IRS, through FMS, mailed out advance tax refunds according to a schedule
that called for taxpayers to begin receiving checks the week of July 23,
2001. As shown in table 1, from then through the end of September, about
84.1 million taxpayers were to have received about $35.5 billion in advance
tax refunds.

5Due to the large volume of advance tax refund checks expected to be issued
each week, FMS arranged for DFAS to assist in issuing these checks. DFAS
regularly issues payments on behalf of the Department of Defense for
military and civilian pay, military retirement, and contractor and vendor
payments.

6Because April 15, 2001, fell on a Sunday, the deadline for filing tax year
2000 individual income tax returns was extended to April 16, 2001.

Billions of Dollars in Advance Tax Refunds Sent to Millions of Taxpayers

Table 1:  Number of  Taxpayers and Amount  of Advance Tax Refunds  Each Week
Through September 30, 2001

Source: GAO's
analysis of IRS'
data.

According to IRS
officials, it
cost IRS about
$104 million to
administer the
advance tax
refund program
through the end
of fiscal year
2001. Included in
these costs were
$36 million for
contract costs, $33 million for postage, $30 million for labor, and $5
million for printing. IRS expected to incur an additional $12 million in
labor costs during fiscal year 2002 related to the advance tax refunds,
because refund payments were to be made through the end of December 2001.
FMS expected to incur about $34 million in total costs to issue the checks
on behalf of IRS, including the assistance provided by DFAS.

To administer the advance tax refund program, IRS, among other things, had
to

* develop the computer programming necessary to determine taxpayer
eligibility for the refund and the amount of each refund, including any
related federal tax offset;

* arrange for printing and mailing of notices that informed taxpayers
whether they would receive a refund;

* respond to telephone calls and correspondence from taxpayers concerning
the refund;

* resolve undelivered and returned advance refund checks; and

* prepare adjustment notices for refunds that were offset due to federal tax
debts.

According to an IRS official, it took about 3 months between March 2001 and
June 2001 to develop the necessary computer programming and to

arrange for printing and mailing of notices needed to implement the advance
tax refund program. IRS temporarily reassigned staff from other functions to
assist with taxpayer telephone calls and correspondence related to the
advance tax refunds. For example, IRS recalled furloughed staff at its forms
distribution centers to assist taxpayers who called IRS with questions about
the advance refund that were relatively easy to answer. In addition, IRS
used submission processing staff from its Philadelphia Service Center to
help respond to over 90,000 written inquiries from taxpayers concerning the
advance tax refunds.

Advance Tax Refunds Were Offset to Recover Federal Taxes and Other Debts

For any taxpayer whose account involves a federal tax debt, IRS is to offset
the advance tax refund due to the taxpayer, either in whole or in part, to
collect the debt. In addition, FMS is to offset the advance tax refunds to
collect other types of debt via the Treasury Offset Program.7 The notice IRS
sent to taxpayers who were eligible to receive an advance tax refund
included a statement that the amount of the refund could be reduced by any
outstanding debt owed, such as past due federal and state taxes or child
support.

According to data obtained from IRS and FMS, the two agencies had offset the
advance tax refunds by almost $2.7 billion because of taxpayer debt. As of
September 30, 2001, IRS had offset about $2.1 billion to recover delinquent
federal tax. As of October 31, 2001, FMS had offset about $469 million for
the following reasons:

* $263 million for delinquent child support.

* $191 million for federal debts other than delinquent taxes.

* $15 million for delinquent state taxes.

7The Treasury Offset Program involves a centralized database of delinquent
debts referred to FMS for offset against federal payments and includes
federal non-tax debts, state tax debts, and child support debts.

Various Problems Occurred During

*

Implementation of the Advance Refund * Program

The following problems were encountered in implementing the advance
tax refund program:

A computer programming problem resulted in about 523,000 taxpayers
receiving inaccurate refund notices.
About 5.3 million taxpayers received untimely refund notices because of
IRS' procedures for processing returns and the way programming was
developed to generate advance refund notices.

* About 2 million notices were returned to IRS due to incorrect addresses
and, as of October 30, 2001, IRS had about 300,000 undeliverable checks for
which it was seeking updated addresses.

* Taxpayers who called IRS during the advance tax refund period had greater
difficulty reaching IRS assistors than did taxpayers who called during the
same timeframe in 2000 or during the 2001 tax filing season.

* A small number of taxpayers received duplicate checks in the early stages
of the program.

Programming Problem Resulted in Some Inaccurate Advance Refund Notices

TIGTA identified an IRS computer programming problem that resulted in about
523,000 taxpayers receiving inaccurate advance refund notices.

As noted earlier, the maximum amount of a taxpayer's advance refund was to
be $600, $500, or $300 depending on the taxpayer's filing status. However,
the actual amount of the advance refund was limited to the lesser of (1) 5
percent of the taxable income on the taxpayer's tax year 2000 return and (2)
the net income tax from the tax year 2000 return after subtracting
nonrefundable credits, such as the credit for child and dependent care
expenses, child tax credit, credit for the elderly, and education credit.8
TIGTA found that IRS had erred in developing its computer program by not
limiting advance refund amounts to the net income tax after credits, thus
resulting in the inaccurate advance refund notices.

TIGTA informed IRS of this problem on July 3, 2001, and IRS was able to
correct the problem before any advance refunds were issued-thus avoiding
overpayments of about $118 million. IRS also sent corrected notices to the
affected taxpayers.

8Internal Revenue Code section 6428.

Many Taxpayers Received Untimely Notices

TIGTA also determined that 5.3 million taxpayers who filed their tax returns
by the April 16 filing deadline would have delays from 1 week to 9 weeks in
receiving their advance refund notices. TIGTA attributed the delays to the
following two reasons.

* IRS' normal procedure is to process income tax returns filed by taxpayers
who are due to receive a tax refund before processing income tax returns
filed by other taxpayers. Thus, many nonrefund returns filed by April 16 had
not been processed by the time IRS prepared the list of taxpayers who would
receive the first mailout of advance refund notices.

* When IRS developed the programming to generate the advance refund notices
for taxpayers affected by the above processing procedure, it decided to have
the notices mailed to the taxpayers just before they were to receive their
advance refund checks instead of having the notices mailed as soon as the
tax return was processed.

In response to a TIGTA recommendation, IRS issued a news release explaining
that some taxpayers might experience a delay in receiving their advance tax
refund notices.

Many Advance Refund Notices and Checks Were Undeliverable

One problem that IRS encountered throughout the implementation of the
advance tax refund program involved undeliverable refund notices and checks
due to incorrect addresses. Undeliverable advance refund notices were to be
returned to IRS' Philadelphia Service Center, and undeliverable advance
refund checks were to be returned to the FMS payment center from which they
were issued.

Through September 30, 2001, almost 2 million advance tax refund notices were
returned to IRS as undeliverable, including about 1.1 million notices sent
to taxpayers who were to receive a refund and about 900,000 notices sent to
taxpayers who were ineligible for a refund. According to an IRS official,
the undeliverable notices were sorted and counted by type of notice and then
destroyed. Because these notices were sent to taxpayers via first class
mail, the Postal Service was to forward notices for which taxpayers had
provided an address change. Therefore, IRS decided that it would not be cost
effective to follow up on the undeliverable notices. Even if a notice to a
taxpayer who was to receive an advance tax refund was returned as
undeliverable, a check would still have been sent to that taxpayer.

In a news release dated October 30, 2001, IRS indicated that there were
almost 300,000 undeliverable advance refund checks valued at about $95

million for which they urged taxpayers to contact IRS so that the checks
could be reissued to the correct address. According to an FMS official,
undeliverable tax refund checks are cancelled and information concerning the
cancelled checks is sent to IRS. IRS is to then research a taxpayer's
account to determine if there is an updated address to which another check
can be sent. IRS updates taxpayer addresses each week through a National
Change of Address Database maintained by the Postal Service. Taxpayers can
also update their addresses with IRS by submitting an IRS Form 8822 "Change
of Address." In addition, IRS authorized its customer service
representatives to accept change of address information over the telephone
from taxpayers who call about their advance tax refund. According to IRS
Philadelphia Service Center officials, much of the written correspondence
they received involved address changes from taxpayers who wanted to ensure
that they would receive their advance refunds. Although the number of
undeliverable advance refund checks was substantial, the percentage of
checks returned as undeliverable (less than 1 percent) was less than the
approximate 4 percent rate that an FMS official indicated was normal for
undeliverable tax refunds.

Taxpayers Calling IRS During the Advance Tax Refund Period Had Problems
Reaching an Assistor

At the time we prepared this report, we had data on the accessibility of
IRS' telephone assistance for the first 3 months of the advance tax refund
period. The data showed that taxpayers calling IRS during those 3 months had
problems reaching an assistor. Overall, when compared with the same 3-month
period in 2000 and with the 2001 tax filing season, the accessibility of
IRS' telephone assistance during the advance tax refund period generally
declined.

IRS had a two-pronged approach for responding to the increased demand for
telephone assistance that it expected during the advance tax refund period.
The first prong of IRS' strategy was to handle as many calls as possible
through automation, thereby freeing up assistors to handle calls that
required live assistance. To accomplish this, IRS publicized its TeleTax
phone number on notices sent to taxpayers and though an announcement played
on IRS' main telephone assistance line. The TeleTax line had recorded
information on the rebate program and an interactive service that told the
taxpayer the expected date the check would be mailed based on the last two
digits of the Social Security number entered by the taxpayer. The second
prong of IRS' strategy was to increase the staffing devoted to telephone
assistance. We are continuing to obtain information on the extent of IRS'
efforts in this regard. Among other things, however, IRS' forms distribution
centers recalled 450 employees

from furlough and trained them to handle simpler calls related to the
rebate.

Despite IRS' efforts to meet the increased demand for telephone assistance
during the advance tax refund period, taxpayers had greater difficulty in
accessing that assistance. IRS has four measures for judging its performance
in providing access to telephone assistance. As shown in table 2, IRS'
performance during the first 3 months of the advance tax refund period
declined for all four measures compared with the same time period in 2000
and declined for three of the four measures compared with the 2001 filing
season.9

Table  2:  Accessibility of  IRS'  Telephone Assistance  During Advance  Tax
Refund Period

Measure

7/1 through 9/30/01

7/1 through 9/30/00

2001 filing seasona

aThe 2001 filing
season data are
for January 1
through July 14,
2001.

bThis measure is
intended to show
IRS' effectiveness in providing callers with access to an assistor. It
includes callers who received automated service when the assistor service
queue was full.

cThis measure reflects the percentage of taxpayers who waited 30 seconds or
less to speak with an assistor.

dThis measure shows the percentage of taxpayers who hung up while waiting to
speak to an assistor.

eThis measure shows the average number of seconds taxpayers waited to speak
to an assistor.

Source: GAO's analysis of IRS' data.

We are inquiring into reasons for the decline in telephone accessibility
during the advance tax refund period and will include that information in
our final report. However, one possible explanation is that the demand for
telephone assistance exceeded IRS' expectations. Although we did not have
usable information on IRS' expectations when we wrote this report, we did
have IRS data on actual demand. IRS measures demand in two

9When we prepared this report, the most recent IRS data on accessibility was
for July 1 through September 30, 2001. Because of management information
system limitations, IRS does not regularly calculate these measures. IRS
officials said that they would provide data for October 1 through December
31, 2001, as soon as they are available.

ways-total call attempts and unique telephone number attempts.10 According
to IRS data for both of those measures, the demand for telephone assistance
was about twice as high during the first 3 months of the advance tax refund
period as it was during the same time period in 2000. In the first 3 months
of the advance tax refund period, IRS received about 23.8 million total call
attempts and about 13.3 million unique number attempts, compared to about
11.4 million and 7.1 million, respectively, during the same period in
2000.11

In commenting on a draft of this report, the Commissioner of Internal
Revenue said that although IRS made "extraordinary efforts to handle advance
refund calls," the high volume of telephone calls resulted in a reduced
level of service. The Commissioner's letter, which is in appendix I, cites
various statistics to document the increase in demand. Because those
statistics include calls to TeleTax, they differ from the statistics cited
in the preceding paragraph.

Some Taxpayers Received Duplicate Checks

Another problem related to the advance tax refunds was identified within the
first 2 weeks of the advance refund period and promptly corrected. The
problem involved duplicate checks sent to taxpayers by one of the three DFAS
centers that assisted FMS in issuing the advance tax refund checks. The
problem surfaced when two taxpayers who had received duplicate checks tried
to cash the second check and a third taxpayer notified IRS about receiving a
duplicate check. Once the problem was identified, FMS decided to suspend use
of the DFAS center from which the duplicate checks had emanated. According
to FMS, due to significantly lower check volumes than originally
anticipated, the DFAS center was subsequently retained as a contingency
site, rather than being returned to full check production.

10The number of total call attempts includes repeat calls and is the sum of
calls answered, calls abandoned by the caller before receiving assistance,
and calls that received a busy signal. The unique telephone number measure
is IRS' estimate of the number of taxpayers who called, rather than the
number of calls. It measures the number of calls from identifiable telephone
numbers and counts all call attempts from each telephone number as one call
until the caller reaches IRS and is served, or until a 1-week window
expires.

11The total call attempts data are for July 1 through September 29, and the
unique number attempts data are for July 1 through September 30. Both sets
of data are for IRS' three main toll-free telephone assistance lines and do
not include calls to the TeleTax line.

According to an FMS official, as of November 2001, about 25 instances of
duplicate checks had been identified. Of the 25 taxpayers who received
duplicate checks, 14 taxpayers had either fully repaid the extra payment or
had returned the duplicate check and 2 taxpayers had partially repaid the
extra payment. FMS was in the process of recovering the duplicate payments
from the other nine taxpayers.

                               Agency Comments

In commenting on a draft of this report, the Commissioner of Internal
Revenue and the Commissioner of FMS provided some clarifying information
that we used to revise the report where appropriate. In commenting on the
advance tax refund program in general, the Commissioner of Internal Revenue
said that IRS was able to accomplish what it did by "applying the maximum
resources possible and giving it top priority management attention." The
Commissioner of FMS said that the program was "extremely successful
particularly considering the time constraints placed upon us to plan and
execute this critically important and highly visible program."

As we agreed with your office, unless you publicly announce the contents of
this report earlier, we plan no further distribution of it until 30 days
from the date of this letter. We will then send copies to others who are
interested and make copies available to others who request them.

This report was prepared under the direction of David J. Attianese,
Assistant Director. If you have any questions about this report, please
contact me or Mr. Attianese at (202) 512-9110. Key contributors to this
assignment were Ronald W. Jones and Robert C. McKay.

James R. White Director, Tax Issues

Appendix II: Comments From the Financial Management Service

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