Tax Abatements: Better IRS Data Could Benefit Small Businesses	 
and IRS (31-JAN-02, GAO-02-336).				 
                                                                 
The Internal Revenue Service (IRS) abates hundreds of thousands  
of small business tax assessments annually because either the	 
business or IRS made an error in calculating the taxes. 	 
Preventing these errors would eliminate the need for abatements  
and save IRS time and money. IRS officials said that abatement	 
data could help them provide services to small business. The	 
officials said that such data might help them find ways to	 
prevent errors that result in abated tax assessments. IRS has	 
some data on tax abatements for small business. IRS' master files
contain information on taxpayers' accounts, including abatements.
IRS also has paper documents on each abatement transaction. In	 
1999, IRS developed a data file on all abatements that it	 
extracts and updates from the master files quarterly. However,	 
GAO found many problems with IRS' electronic abatement data. GAO 
identified several steps that IRS could take to improve existing 
data on such tax abatements and to obtain additional data on the 
volume, nature, and burden of tax abatements for small		 
businesses. However, IRS needs to weigh the potential costs and  
benefits. If IRS begins obtaining data step-by-step, insights	 
into the potential benefits of improving and/or collecting	 
additional data can be gained and informed judgements can be	 
reached about how much data to gather and how to minimize the	 
costs to obtain it.						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-336 					        
    ACCNO:   A02720						        
  TITLE:     Tax Abatements: Better IRS Data Could Benefit Small      
Businesses and IRS						 
     DATE:   01/31/2002 
  SUBJECT:   Small business					 
	     Taxpayers						 
	     Cost control					 
	     Data collection					 
	     Cost effectiveness analysis			 
	     Data integrity					 
	     Tax administration 				 

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GAO-02-336
     
United States General Accounting Office

GAO Report to the Ranking Minority Member, Committee on Small Business &
Entrepreneurship, U.S. Senate

January 2002

TAX ABATEMENTS

Better IRS Data Could Benefit Small Businesses and IRS

GAO-02-336

Contents

      Letter                                                                           1

                                                Results                                2
                                  Recommendations for Executive Action                 3

                                            Agency Comments                            3

    Appendix I    Briefing to the Staff of the Senate Committee
                                 on Small Business and Entrepreneurship

   Appendix II    Comments From the Internal Revenue Service

Abbreviations

IRS Internal Revenue Service
SB/SE Small Business and Self-Employed

United States General Accounting Office Washington, DC 20548

January 31, 2002

The Honorable Christopher S. Bond
Ranking Minority Member
Committee on Small Business and Entrepreneurship
United States Senate

Dear Senator Bond:

The Internal Revenue Service (IRS) abates hundreds of thousands of small
business tax assessments annually because either the business or IRS
made an error in calculating the taxes.1 As we stated in our March 2001
report, making and then abating tax assessments imposes costs on
taxpayers and IRS.2 Preventing the errors that lead to the assessments
would stop the need for such abatements and reduce costs in time and
money for taxpayers and IRS.

Because of your interest in reducing these costs to taxpayers and IRS, you
asked us to determine (1) what IRS' views are on the benefits and costs of
collecting data on the errors related to small business tax assessments that
have to be abated; (2) what data IRS has on the volume, nature (what tax
issue was in error, who made the error, how did the error occur, and why
did the error occur) and burden of various tax abatements for small
businesses; and (3) what improvements, if any, IRS can make to its data on
tax abatements for small businesses and what the related costs are in
making them.

To answer these questions, we analyzed IRS' data on tax abatements for
small businesses, extracted from IRS master files over a 2-ï¿½ -year period
ending July 28, 2001. We also discussed with IRS officials any studies or

1A tax abatement is a reduction of a tax assessment on a taxpayer's account.
Not all abatements arise from errors with tax assessments. For example, a
taxpayer can carry back a net operating loss to an earlier tax year to abate
a correct tax assessment. Because we focused on abatements of assessments
associated with an error in determining the amount of tax assessed, we
excluded tax abatements due to net operating loss carrybacks, substitute
returns that IRS prepares using income information from third parties, and
debt discharges, such as for bankruptcy, that are used to offset correct
assessments.

2Tax Administration: IRS Can Help Taxpayers Reduce the Need for Tax
Abatements (GAO-01-328, Mar. 30, 2001).

Results

research IRS had on tax abatements relating to small businesses and the
benefits and costs of various steps to use and improve data on tax
assessments and the abatement process. We conducted our work from May
through December 2001 in accordance with generally accepted government
auditing standards.

On December 19, 2001, we provided a detailed briefing to your office on the
results of this work. This report includes published briefing slides and
transmits our recommendations to the Commissioner of Internal Revenue.3

IRS' Small Business and Self-Employed Division (SB/SE) officials said that
to the extent that the volume of tax abatements was significant, having
abatement data could be beneficial in providing services to small
businesses. The officials said such data might help them find ways to
prevent errors that result in abated tax assessments. However, the officials
were not sure how much data they needed because they must first weigh the
benefits against the costs of collecting, maintaining, and using the data.
These benefits and costs depend on such variables as whether data are
collected electronically or manually and to what extent the data will be
useful in preventing errors.

IRS has some data on tax abatements for small businesses. IRS' master files
contain information on taxpayers' accounts, including abatements. In
addition, IRS has paper documents on each abatement transaction. In 1999,
IRS developed a data file on all abatements that it extracts and updates
from the master files quarterly.4

We found various problems with IRS' electronic abatement data:

* Volume of Tax Abatements for Small Businesses-IRS cannot readily identify
small business taxpayers from all other taxpayers because the abatement data
file includes all types of taxpayers that fall under SB/SE. These include
individual taxpayers who have no wage income, but have rent, royalty,
partnership, or pension income. (See app. I, pp. 16 and 17.)

3See app. I for the briefing handout.

4IRS  developed the  data file for  our report entitled  Tax Administration:
IRS' Abatement of Assessments in Fiscal Years 1995-1998 (GAO/GGD-99-77, June
4, 1999).

* Nature of Errors Related to Tax Abatements-IRS master files have limited
electronic data on what tax issue was associated with the error but no
electronic data on who caused the error or how the error occurred. However,
these data can usually be identified by manually reviewing paper documents
for each tax assessment. Data on why the error occurred are harder to find
or not documented. (See app. I, p. 18.)

* Data on Taxpayer Burden and IRS Costs-IRS does not capture data on
taxpayer burden or on IRS costs associated with assessing and then abating
taxes on small business. The abatement process can be time-consuming and
burdensome to the taxpayer and costly to IRS. (See app. I,

p. 19.)

* Use of Available Data on Tax Abatements-SB/SE officials did not know that
the abatement data file existed. Although IRS Information Services analysts
updated the abatement data file quarterly, the file was not distributed to
anyone. (See app. I, p. 20.)

We identified several steps that IRS could take to improve existing data on
tax abatements for small businesses and to obtain additional data on the
volume, nature, and burden of tax abatements for small businesses. However,
each step imposes some level of costs that IRS needs to weigh against the
potential benefits. (See app. I, p. 23.) If IRS begins obtaining data
step-by-step, insights into the potential benefits of improving and/or
collecting additional data can be gained so more informed judgments can be
reached concerning how much data to gather and how to minimize the costs of
obtaining it. Even with improved electronic data, IRS may still need to
manually review paper abatement documents to determine potential ways to
prevent errors.

Recommendations for To improve IRS' ability to understand and address tax
abatements for small businesses, we recommend that the Commissioner of
Internal Executive Action Revenue:

* Evaluate the benefits and costs of various steps for improving existing
data or collecting additional data on the volume, nature, and burden of
small business tax abatements, and

* Use any improved or additional data to study cost-effective ways to reduce
or eliminate the errors in tax assessments that have to be abated.

Agency Comments In a letter dated January 29, 2002, from the IRS
Commissioner, he stated that our audit provided valuable insights into steps
IRS can take to assist

small businesses. The Commissioner agreed with our first recommendation to
evaluate the benefits and costs of various steps for improving existing data
or collecting additional data on the volume, nature, and burden of small
business tax abatements. The Commissioner said that the implementation of
our second recommendation to use any improved or additional data to study
cost-effective ways to reduce or eliminate the errors in tax assessments
that have to be abated was dependent upon the outcome of IRS' findings based
on our first recommendation. The Commissioner's view is consistent with our
second recommendation. In addition, the Commissioner said that IRS has
already taken some action to implement our recommendations. (See app. II.)

As arranged with your office, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days after
its issuance. We will then send copies of this report to the Chairman of the
Senate Committee on Small Business and Entrepreneurship and the Chairman and
ranking Minority Member of the House Committee on Small Business. We will
also send copies to the Secretary of the Treasury; the Commissioner of
Internal Revenue Service; the Director, Office of Management and Budget; and
other interested parties. We will make copies available to others on
request. The report is also available on GAO's home page at
http://www.gao.gov.

This report was prepared under the direction of Tom Short. Other major
contributors were Thomas Bloom, Larry Dandridge, Marshall Hamlett, and
Thomas Venezia. If you have any questions about this report, please contact
Tom Short or me on (202) 512-9110.

Sincerely yours,

Michael Brostek Director, Tax Issues

Appendix II: Comments From the Internal Revenue Service

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