Tax Administration: IRS's Efforts to Improve Compliance With
Employment Tax Requirements Should Be Evaluated (15-JAN-02,
GAO-02-92).
Employers are required to withhold amounts from their employees'
salary to cover individual federal income tax, Social Security,
and Medicare taxes; match the amounts for Social Security and
Medicare taxes; and deposit these amounts with the U.S. Treasury.
In fiscal year 2000, the Internal Revenue Service (IRS) collected
$1.3 trillion in this manner. Most employers withhold and deposit
these taxes as required; however, the amount of unpaid employment
taxes, penalty, and interest has grown significantly. IRS data
show that in 1997, 1998, 1999, and 2000, delinquent employers
owed about $3.2, $3.5, $4.4, and $5 billion, respectively, in
unpaid employment taxes, penalties, and interest. The time IRS
takes to notify employers of delinquent payment of employment
taxes varies. On average, IRS takes about five weeks to initially
notify employers regarding employment tax delinquencies after the
Form 941 return is received. When employers fail to file Form 941
returns, IRS normally takes from 14 to 28 weeks to notify them of
this delinquency. Aside from its usual efforts to educate and
inform taxpayers of their responsibilities, IRS has four programs
to prevent or reduce employers' tax delinquencies. Two of these
programs were designed to achieve early contact with employers,
and two were designed to identify employers with existing,
multiple employment tax delinquencies and help them to return to
compliance. To evaluate the effectiveness of these programs and
to support informed judgments about whether to adopt new ones,
IRS planned to compare compliance rates of test and control
groups and to use customer surveys and focus groups. IRS' efforts
to evaluate these programs are being adversely affected by, among
other things, delays in obtaining reliable data. IRS officials
did not identify any specific programs to improve employment tax
intervention under IRS' ongoing effort to modernize its
organizational structure, management processes, and information
technology systems. However, certain aspects of its modernization
effort have some future potential to improve intervention.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-02-92
ACCNO: A02663
TITLE: Tax Administration: IRS's Efforts to Improve Compliance
With Employment Tax Requirements Should Be Evaluated
DATE: 01/15/2002
SUBJECT: Delinquent taxes
Collection procedures
Tax nonpayment
Tax violations
Government collections
Small business
Income taxes
Electronic Federal Tax Payment System
IRS Automated Collection System
IRS Business Master File
IRS Customer Account Data Engine Program
IRS Federal Tax Deposit Project
IRS Mentoring and Monitoring Program
FTD Soft Letter Program
ABC's of FTDs Program
FTD Alert Program
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GAO-02-92
United States General Accounting Office
GAO Report to the Ranking Minority Member, Committee on Small Business &
Entrepreneurship, U.S. Senate
January 2002
TAX ADMINISTRATION
IRS's Efforts to Improve Compliance With Employment Tax Requirements Should
Be Evaluated
GAO-02-92
Contents
Letter
Results in Brief
Background
Scope and Methodology
Time Taken to Initially Notify Employers Of Delinquencies Can
Vary Efforts to Evaluate IRS Programs to Prevent or Reduce Tax Delinquency
Have Experienced Problems IRS' Ongoing Modernization Could Improve
Intervention With
Employers Conclusions Recommendation for Executive Action Agency Comments
and Our Evaluation 1
2 4 5
8
13
18 20 21 21
Appendix I Comments From the Internal Revenue Service
Tables
Table 1: Form 941 Quarterly Return Data for Calendar Year 2000 11 Table 2:
Interest and Penalty Assessments for Depositors Missing the First and Last
Deposits of the 4th Quarter 2000 13
Figure
Figure 1: IRS Processing Steps and Time Frames for Form 941 Returns and
Related Notices for Fourth Quarter 2000
Abbreviations
ACS Automated Collection System
BMF Business Master File
EIN Employee Identification Numbers
FTD Federal Tax Deposit
IRS Internal Revenue Service
SB/SE Small Business and Self-Employed Division
TIGTA Treasury Inspector General for Tax Administration
United States General Accounting Office Washington, DC 20548
January 15, 2002
The Honorable Christopher S. Bond
Ranking Minority Member
Committee on Small Business & Entrepreneurship
U.S. Senate
Dear Senator Bond:
Employers are required to withhold amounts from their employees' salary
to cover individual federal income tax, Social Security, and Medicare
taxes; match the amounts for Social Security and Medicare taxes; and
deposit these amounts with the U.S. Treasury. In fiscal year 2000, the
Internal Revenue Service (IRS) collected $1.3 trillion in this manner.
Although the majority of employers withholds and deposits these taxes as
required, for those who fail to do so, the amount of unpaid employment
taxes, penalty and interest has grown significantly. As of September 30,
2001, IRS data show that in 1997, 1998, 1999, and 2000, delinquent
employers owed about $3.2, $3.5, $4.4, and $5.0 billion, respectively, in
unpaid employment taxes, penalties, and interest.
Although its data systems do not track what percentage of these unpaid
employment taxes are attributable to small businesses, IRS considers
employment tax compliance to be among the most challenging issues for
small businesses.1 Small businesses may be challenged because their
owners may not have sufficient capital or may lack experience or training
in business tax obligations, making it difficult for these businesses to
remain economically viable. According to Small Business Administration
data, about 50 percent of new businesses fail to remain open for at least 4
years following their creation. When confronted with a choice between
paying necessary operating expenses or depositing employment taxes,
struggling businesses may opt to pay business expenses instead of taxes.
Employers who do not deposit employment taxes may gain an unfair
advantage over those employers who comply voluntarily. Furthermore,
noncompliant employers can accumulate substantial unpaid taxes with
associated interest and penalties. Over time, these unpaid balances may
1 IRS defines small businesses as farmers, sole proprietorships,
partnerships, and corporations with assets of $5 million or less.
compound beyond the employers' ability to pay-ultimately placing their
businesses in greater financial jeopardy.
Because of your interest in IRS' timely intervention to help
employers-�particularly those with a small business--avoid the pyramiding of
taxes, interest, and penalties, you asked us to review various aspects of
IRS' efforts to notify and intervene with employers concerning delinquent
employment taxes. Accordingly, this report discusses (1) how long IRS takes
to notify employers of employment tax delinquencies; (2) what types of
intervention programs and initiatives IRS uses for employers with delinquent
employment taxes and how IRS evaluates the effectiveness of these efforts;
and (3) what new intervention programs or initiatives IRS is developing as
part of its modernization efforts.
As described further in this report, the employment tax deposit requirements
vary by the amount of employment taxes an employer owes. Employers with the
smallest employment tax liabilities pay on a quarterly basis; those with the
largest liabilities pay the next banking day; and those with
intermediate-sized liabilities pay on a monthly or more frequent basis.
Generally, small businesses would tend to be heavily concentrated in the
employment tax deposit categories calling for less frequent payments.
Although employment taxes for many employers must be paid throughout a
calendar quarter, IRS' ability to determine whether employers have paid as
frequently as required and in the amounts required is dependent on employers
filing the Employer's Quarterly Federal Tax Return (Form 941 return).
The time IRS takes to notify employers of delinquent payment of employment
taxes varies. On average, IRS takes about 5 weeks to initially notify
employers regarding employment tax delinquencies after the Form 941 return
is received. Filing the Form 941 return is crucial because IRS matches its
internal records of deposits employers made during the quarter to those
deposits employers subsequently listed on their returns. When employers fail
to file Form 941 returns, IRS normally takes from 14 to 28 weeks to notify
them of this delinquency. From the employers' standpoint, however, the date
of delinquent deposits is critical because interest and late penalties are
computed from the date the deposits were due, not from the date of
notification. Thus, the earlier deposits are missed in a quarterly period,
the greater the financial consequence for employers.
Aside from its usual efforts to educate and inform taxpayers of their
responsibilities, IRS has four programs to prevent or reduce employers'
Results in Brief
tax delinquencies. Two of these programs were designed to achieve early
contact with employers, and two were designed to identify employers with
existing, multiple employment tax delinquencies and help them to return to
compliance. Although all of the programs have an overall objective of
increasing employers' compliance rate, three were small efforts to assess
whether new approaches would be effective and should be adopted. IRS is
attempting to improve the fourth effort, IRS' Federal Tax Deposit (FTD)
Program, which has existed for many years. To evaluate the effectiveness of
these programs and to support informed judgments about whether to adopt the
new ones, IRS planned to compare compliance rates of test and control groups
and to use customer surveys and focus groups. IRS' efforts to evaluate these
programs are being adversely affected by, among other things, delays in
obtaining reliable data.
IRS officials did not identify any specific programs to improve employment
tax intervention under IRS' ongoing effort to modernize its organizational
structure, management processes, and information technology systems.
However, certain aspects of its modernization effort have some future
potential to improve intervention. For example, one of the four new
divisions IRS established in October 2000, the Small Business/Self Employed
Division, focuses specifically on the needs of small businesses and
self-employed persons. This focus is intended to enable IRS to better
understand the tax issues of this population so it can more effectively
serve their needs and promote their compliance. IRS also plans to place much
more emphasis on providing services to all taxpayers, including small
business employers, before they file their returns. This includes improved
instructions and other materials to aid in the understanding of tax
obligations, which is consistent with the early intervention efforts IRS has
already begun. IRS' plans to replace the many information systems it uses to
maintain taxpayer files with a single integrated system is central to its
modernization efforts. This system will allow for more rapid daily
processing of returns and related notices, including employment tax notices.
IRS does not expect, however, the replacement system to be operational for
Form 941 returns until at least 2005.
We are making a recommendation to the Commissioner of Internal Revenue to
ensure that evaluations are performed to measure the effectiveness of IRS'
early intervention programs. Evaluations are essential to the careful
expenditure of IRS' resources because they determine the overall benefits of
the programs, whether improvements are needed, or whether the programs
should be continued.
Background
We obtained IRS' written comments on a draft of this report in a January 3,
2002, letter from the Commissioner of Internal Revenue (see app. I). In
commenting on a draft of this report, the Commissioner agreed with our
recommendation and said that steps will be taken to evaluate the
intervention programs cited in our report.
All employers must file their Form 941 returns quarterly, although some are
to make employment tax deposit on differing schedules during a quarter. The
form contains information concerning the tax deposits made for a quarter and
is generally due by the end of the month after the close of the quarter.2
Until IRS receives and processes the Form 941 returns, it cannot match tax
deposits reported on the returns with its records of deposits received. Once
it matches this information, IRS notifies employers of any delinquencies
using a written notice. This is the employers' first statutory notice of the
delinquency. If the employer fails to respond to this first notice, IRS
sends follow-up notices and may later contact the employer by phone or,
eventually, make a personal visit. Although this entire process can take
years for those employers who do not respond, under IRS' processing
procedures, initial notices are sent within several weeks after IRS receives
the Form 941 return.
IRS provides a variety of outreach efforts to help employers understand how
to meet their tax obligations, many of which are designed to explain
requirements and to meet other needs of small business taxpayers. For
example, IRS makes tax forms with instructions and publications that explain
requirements available to taxpayers in a variety of formats including hard
copy, CD-ROM, and electronic form on the Internet. In addition to conducting
various workshops and seminars, many of which are tailored to the needs of
small businesses, IRS also recently established a Web site specifically
designed to address the needs of small business taxpayers. Beginning in
September 2001, IRS' Web site allows employers nationwide to use the
Internet to deposit employment taxes via the Electronic Federal Tax Payment
System On-Line.
Current IRS strategies and program plans call for providing more services to
taxpayers, including employers, to prevent noncompliance. To that end, IRS
has shifted its focus from addressing compliance issues after returns
2Employers who have deposited all employment taxes due during the quarter
are allowed an additional 10 days to file the Form 941 return.
*
Scope and Methodology
are filed to addressing them as early as possible, often through efforts to
better educate taxpayers about their tax responsibilities and to improve
forms, guidance, and other information available to taxpayers. This is
consistent with IRS' strategic objectives to reduce taxpayer burden,
uncertainty, and errors by clarifying tax law responsibilities and resolving
issues early in the process. IRS believes that its efforts to reduce
taxpayer burden will show significant progress over the next 2 years and
will be further enhanced by its plans for long-term business systems
modernization.
To determine how long IRS takes to contact employers after an employment tax
delinquency occurs, we analyzed the time between (1) the receipt of a
quarterly Form 941 return and IRS' mailing of an initial delinquency notice,
(2) when a Form 941 was due and IRS' mailing of a delinquency notice when
the employer fails to file a Form 941, and (3) when the employers should
have deposited employment taxes during a quarter and IRS' mailing of an
initial delinquency notice. For all three situations, we interviewed
cognizant officials from IRS' Small Business and Self-Employed Division
(SB/SE), IRS' National Office, and various field offices, and we obtained
related documentation.
* To determine the time between when a Form 941 return was due but not filed
and IRS' mailing of initial delinquency notices and the time between when an
employer fails to make a deposit during a quarter and IRS' mailing of a
notice, we relied on the flowchart of IRS' processes and associated
timeframes that we developed. We confirmed our summaries of IRS' processes
and related timeframes necessary to notify employers of delinquencies with
appropriate IRS officials at the National Office, Atlanta Service Center and
the Martinsburg Computer Center. IRS did not have data in its BMF One
Percent Sample File that we could use to estimate these timeframes.
* To determine the length of time between when IRS receives the Form 941
return and the issuance of the initial notice to the employer,
* we analyzed data extracted from IRS' Business Master File (BMF). The data
we used in this time analysis was extracted from an IRS data file
entitled the BMF One Percent Sample File.3 IRS uses this data file to
perform its own analysis of BMF information and to verify system performance
and output. IRS considers the results of analysis from the BMF One Percent
Sample data to be valid and uses the data file to perform comparable
analyses, however it does not use the data file to make estimates
projectable to the entire BMF. In addition, because we did not have access
to taxpayer data, we were not able to independently verify taxpayer
information contained in the data file. IRS officials did not have
programming resources available to extract a random sample of employment
tax-related delinquencies from the BMF, thus IRS' BMF One Percent Sample
File provided the best alternative for obtaining the data for the time
analysis. In providing delinquent employment tax information for the time
analysis, IRS extracted Form 941 return records and associated transaction
date information from the BMF One Percent Sample File. After removing the
employee identification numbers (EIN) from the file, IRS provided us with a
file containing transaction date information for the delinquent Form 941
returns selected. The data used in the time analysis reflects taxpayer
account information from the BMF as of September 2001. For tax years 1999
and 2000, over 66,000 account records were used in the analysis. About
25,000 records were eliminated from the time analysis because they were not
posted to the BMF as normal Form 941 quarterly returns. We also developed
flowcharts to describe IRS' processes and associated timeframes for
initially contacting delinquent employers to further validate the BMF sample
timeframe analysis; and verified the accuracy of the flowchart with IRS
officials.
* we reviewed and analyzed statistical information related to employment
taxes-including the number of Form 941 returns filed based on amounts paid
to determine the frequency of deposits. We also reviewed and analyzed IRS
employment tax-related collection policies and procedures, obtained relevant
publications and instructions, and reviewed relevant IRS web pages and
related reports.
* To identify IRS' current employment tax intervention programs and program
evaluation efforts, we
* interviewed appropriate IRS officials within SB/SE and other operational
groups who identified the following four intervention
3This data file contains approximately 1 percent of all the tax accounts in
the BMF, across all tax segments. The selection criteria for the file are
based on the last two digits of the 9-digit employer identification number
(EIN). Entities and tax modules whose last two digits contain zeros are
selected for inclusion in this data file.
programs: Mentoring and Monitoring, Federal Tax Deposit (FTD) Soft Letter,
ABC's of FTDs, and FTD Alert Program; and * obtained and discussed pertinent
program documentation including plans, progress reports, and schedules with
IRS officials.
* To determine IRS' plans under modernization as they related to employment
tax intervention and evaluation efforts, we * interviewed and discussed with
cognizant IRS officials IRS' business system modernization efforts; and
* obtained and reviewed relevant documentation including IRS' Strategic Plan
(Fiscal Year 2000-2005), and 2000 Progress Report-IRS Business Systems
Modernization Program .
You expressed interest in the level of resources IRS uses to contact
taxpayers with employment tax delinquencies. We researched this by
interviewing IRS officials and reviewing past reports by IRS and us. On the
basis of this work, we advised you that IRS' financial and data systems do
not collect or produce such specific information. Currently, IRS cannot
isolate the resources it uses to notify employers having employment tax
delinquencies for specific form types such as the Form 941 return. As a
result, you suggested that we not pursue the resource issue at this time.
You also expressed interest in whether there are intervention programs and
initiatives in use at other federal agencies or relevant nonfederal
organizations that could serve as best practice models for IRS. We are not
reporting on this topic because during our review of eight federal agencies
and five state tax authorities4 we did not find any intervention programs or
initiatives that could serve as best practice models. The primary reason for
this is that many of the organizations under review had significantly
different procedures than IRS for formally identifying a delinquency. For
example, these organizations often have shorter collection cycles than IRS
which enables them to notify delinquent parties in less time than IRS. IRS'
collection cannot begin until after it receives the quarterly Form 941
returns.
4These organizations were the Bureau of Alcohol, Tobacco and Firearms;
United States Customs Service; Department of Education; Farm Service Agency;
the Department of Housing and Urban Development; Pension Benefit Guaranty
Corporation; Rural Housing Service; Small Business Administration; the
Arizona Department of Revenue; the California Franchise Tax Board; Illinois
Department of Revenue; Texas Comptroller of Public Accounts; and Washington
State Department of Revenue. We selected them for their diversity of period
payment collections. We interviewed officials and obtained and reviewed
payment processing and collection procedures.
Time Taken to Initially Notify Employers Of Delinquencies Can Vary
*
*
This review primarily focuses on IRS' intervention efforts as they relate to
the initial notification of employment tax delinquencies. In addition, the
review covers IRS' efforts to intervene with taxpayers in order to educate
and inform them of their tax obligations and to expedite compliance. The
review did not cover IRS' subsequent enforcement and collection activities
such as contacting delinquent employers through IRS' Automated Collection
System (ACS)5 or contacts made by IRS' collection representatives in the
field.
We performed our work from June 2000 through December 2001 in accordance
with generally accepted government auditing standards.
The time IRS takes to notify employers of deposit or return delinquencies
and the amount of interest and penalty assessed is affected if employers
fail to meet two major employment tax responsibilities. Employers must make
periodic employment tax deposits during each quarter and file Form 941
returns by the last day of the month following the close of each calendar
quarter. The periodic deposits made throughout the quarter are subsequently
reported on the Form 941 returns. Filing these returns is crucial because
IRS determines compliance by matching its accounting records of deposits
made throughout the quarter with the deposit information reported on the
return. Consequently, failure to file Form 941 returns necessitates
additional IRS processing and can further delay employer notification of
delinquencies thus increasing employers' interest and penalty charges. Based
on IRS data and our discussions with IRS officials, we found the following:
Our analysis of IRS' data containing delinquent employment tax accounts
shows that IRS took an average of about 5 weeks from the date the Form 941
returns were filed to notify employers of a missed, late, or underpaid
deposit.
Based on our analysis of the steps IRS follows to detect and notify
employers of a failure to file a 941 return, which we confirmed with IRS
officials, we found that IRS normally takes from 14 to 28 weeks. During
5The Automated Collection System (ACS) is a computerized inventory system
that maintains balance due accounts and return delinquency investigations.
Most balance due accounts and return delinquency investigations are issued
to ACS after normal service center notices have been issued.
the first two quarters of the calendar year, individual return processing
demands affect the time IRS takes to process these notices.
Following a similar analysis confirmed by IRS, we found that when employers
have delinquent deposits, IRS notification reaches most employers from 3 to
23 weeks from the due date of the delinquent deposit the exact time is
primarily dependent upon when the deposit involved was due. From the
employers' standpoint, the date of any missed or underpaid deposit is
important because IRS computes interest and penalties from the date of the
delinquent deposit.
IRS Takes Several Weeks to Notify Employers of Employment Tax Delinquencies
Our analysis of IRS' delinquent employment tax data indicates that once IRS
receives Form 941 returns, it takes about 5 weeks to notify employers of
employment tax delinquencies. The time required to notify employers is
contingent on the date that employers file their Form 941 returns and the
ensuing IRS processing workload. Employers generally have until the end of
the month after the quarter closes to file their returns. During calendar
years 1999 and 2000, IRS received and processed about 5.7 million Form 941
returns per quarter. Using the 4th quarter of calendar year 2000 as an
example, IRS service centers began receiving and processing Form 941 returns
in mid-January 2001, although most were received in the surge of returns
arriving at IRS service centers following the due date of January
31. Figure 1 shows the multiple steps involved in IRS' weekly batch
processing of the Form 941 returns and the related time frames for each step
of processing 4th quarter returns.
Figure 1: IRS Processing Steps and Time Frames for Form 941 Returns and
Related Notices for Fourth Quarter 2000
4th Quarter 2000
January 2001 February 2001 March 2001
Source: IRS.
Not Filing a Form 941 Return Further Delays Notification
When employers fail to file Form 941 returns, IRS takes longer to notify
them because it first processes timely-filed returns before it begins to
identify missing returns. In that regard, we found that IRS normally takes
from 14 to 28 weeks after the due date to notify employers of their failure
to file a Form 941 return. IRS officials concurred with that timeframe for
IRS to notify employers of these delinquencies. IRS officials added that the
time variance is due to differences of tax quarter workloads with the
heaviest workload falling in the first two quarters of the calendar year. In
response to increased workloads, IRS prioritizes the processing of taxpayer
notices by notifying employers with the greatest liability and with repeated
return delinquencies first.
These notices do not assess penalties or interest against the employers but
rather advise them that IRS has not received the Form 941 returns and ask
the employers for explanations. For employers who also have failed to
deposit taxes due, interest and penalties continue to accrue until they
become compliant.
Time From Date of Delinquent Deposit Affects Interest and Penalties
Although the receipt date of the Form 941 returns is key to IRS' processing
and employer notification, interest and late penalties accrue from the date
of the employers' delinquent deposits. Accordingly, delinquent deposits from
early in a quarter will result in higher interest and penalties than
delinquent deposits from later in the quarter.
Employers owing smaller amounts of employment taxes are allowed to make less
frequent deposits. As shown in table 1, in calendar year 2000, about 71
percent of employers owed employment taxes of $50,000 or less annually and
could make deposits on a quarterly or monthly basis. Conversely, 29 percent
of employers owing more than $50,000 annually had to deposit employment
taxes more frequently.6 Employers who are in this deposit category made 95
percent of the total employment tax deposits.
Table 1: Form 941 Quarterly Return Data for Calendar Year 2000
Deposit frequency - First
category based on deposit
amount owed due Employers Revenue
Quarterly-for Due with the filing
of the 19% .2%
employers owing return-month after
less the
than $1,000 per
quarter quarter closes
Monthly-for employers owing between $1,000 to $50,000 annually
Depositor pays more frequently than monthly or quarterly-for employers owing
more than $50,000 annually
15th of the month 52% 4.3%
following the close of
each month in the
quarter
Varies, depending on 29% 95.5%
how often employees
are paid.
Source: Computations from IRS' FTD Payment and Penalty Report 200001-52.
Beginning January 1, 2001, more employers were allowed to pay employment
taxes quarterly as opposed to monthly or more frequently.
6For employers owing over $50,000 per year, deposits are made on either the
Wednesday or Friday following the payday; for employers whose deposits
accumulate to $100,000 or more, the deposit must be made the next banking
day.
From that date, employers owing less than $2,500 (rather than $1,000) could
pay when they file their returns, reducing employer burden and decreasing
the chance for delinquencies and other mistakes. Had this change been in
effect during calendar year 2000, the number of employers depositing
quarterly would have increased from about 19 percent to about 37 percent.
Because these employers pay when they file their Form 941 return, interest
and penalties have less time to accrue before they receive a notice
concerning delinquencies. Therefore, these depositors would be subject to
less interest and penalty than employers who fail to make deposits during
the quarter before the form 941 return is due.
A reduction in the frequency of required deposits can decrease the amount of
time that interest and penalties can accrue. However, for employers who are
required to deposit employment taxes more frequently than either monthly or
quarterly, missing or underpaying their first payment in the quarter allows
interest and penalties to accumulate for a longer period of time.
Table 2 shows the interest and penalty consequences for a hypothetical
monthly depositor and a depositor who pays more frequently during the
quarter, both of whom miss their first and last deposit due in the 4th
quarter. The table demonstrates the increased interest and penalty amounts
for missing deposits early in the quarter for both types of depositors. It
also shows that the impact is greater on depositors who pay more frequently,
as their deposits are due earlier in the quarter.
Table 2: Interest and Penalty Assessments for Depositors Missing the First
and Last Deposits of the 4th Quarter 2000
Deposit requirements
Deposits more frequently than monthly or quarterly Monthly deposits
Description of event
First deposit of quarter missed on Oct.18, 2000
Last deposit of quarter missed on Jan. 3, 2001
First deposit of quarter missed on Nov. 15, 2000 Last deposit of quarter
missed on Jan. 15, 2001
Amount of missed deposit $ 10,000.00 $ 10,000.00 $ 1,000.00 $ 1,000.00
Interest and penalty
Failure to deposit correct amount on time
(10 % if paid within 10 days of the notice) 1,000.00 1,000.00 100.00 100.00
Interest from date of missed deposita 373.67 176.59 30.25 14.90
Late pay penalty (one-half of 1% for each
month or part of a month late) 250.00 150.00 25.00 15.00
Total interest and penalty 1,623.67 1,326.59 155.25 129.90
Interest and penalty as a percent of
missed deposit 16.2% 13.2% 15.5% 13.0%
aIRS uses the interest rates determined each quarter by the Department of
Treasury. IRS personnel computed these interest charges based on the rates
in effect for the 4th quarter 2000.
Source: IRS
If employers fail to respond to the initial notice of a delinquency,
interest and penalty amounts can pyramid. For example, if employers fail to
deposit the correct amount within 10 days of receiving the notice, the
penalty increases from 10 to 15 percent of the delinquent deposit. Interest
continues to accrue until the deposit is paid. Generally, the late pay
penalty can accumulate up to 25 percent of the delinquent amount. Had these
employers also failed to file Form 941 returns, they would be subject to an
additional penalty of 4.5 percent per month, which could also compound to
22.5 percent.
Efforts to Evaluate IRS has developed several specific programs designed to
intervene with
employers to help prevent employment tax delinquencies and reduce the IRS
Programs to pyramiding of additional tax, interest, and penalty charges. IRS
officials Prevent or Reduce identified four programs that specifically seek
to intervene with employers
to prevent or reduce delinquent employment taxes: (1) Mentoring andTax
Delinquency Have Monitoring, (2) Federal Tax Deposit (FTD) Soft Letter, (3)
ABC's of FTDs, Experienced and (4) FTD Alert. While the first three programs
are in various stages of
completion, the fourth is an established program that is undergoing
Problems changes intended to improve it. To evaluate the effectiveness of
these programs, IRS planned to compare compliance rates of test and control
groups and to use customer surveys and focus groups. IRS has experienced
difficulties in completing performance evaluations for such
reasons as time delays in obtaining the data required to determine the
programs' effectiveness. The programs and IRS' evaluations of them are
discussed below.
Mentoring and Monitoring Program. This pilot program is IRS' largest recent
effort to prevent employment tax delinquencies among new employers. Under
the program new employers are given special educational materials at the
time they receive their employer identification number and some of these new
employers receive follow-up monitoring. IRS conducted this pilot program for
more than 13,000 new employers in four states (Kansas, New Mexico, Oklahoma,
and Texas). The 2-year program began in August 1999, and IRS expects to
complete its evaluation in early 2002.
IRS sent the special educational materials to two separate test groups of
new employers and offered additional services to the ones IRS considered at
higher risk of noncompliance.7 Every employer in the test groups received
educational materials that included a videotape, entitled "ABC's of FTDs;" a
workbook concerning FTD requirements; and other information to help new
employers. Nearly 7,000 employers in test groups considered higher risk were
offered additional monitoring services, which included assigning a Small
Business Representative to act as a mentor to to answer questions, provide
forms and publications, and remind employers of deposit and filing
requirements during monthly monitoring calls. Of the 1,716 employers that
initially accepted IRS' offer of these services, about 800 remained in this
part of the program at the time it was discontinued in July 2001.
IRS planned a two-pronged evaluation, using customer surveys for the test
group and a comprehensive evaluation of compliance data comparing the test
and control groups. In contrast to the special materials and services
provided the test groups, employers in the control groups received only the
letter IRS normally sends when new employers request an EIN.
IRS planned to mail customer surveys to test employers in fiscal year 2000,
directly after the educational materials were delivered and the monitoring
services were under way. These surveys were designed to obtain the views
7IRS identified higher risk employers as those who had paid employment taxes
before obtaining an EIN, who had previous delinquencies associated with
other businesses, and who were in industries with historically high
delinquency rates.
of test employers on the program materials and other services, but the
surveys were never conducted because of a lack of funding. As of October
2001, IRS had awarded a contract to have focus groups conducted in place of
the customer surveys; however, the focus groups were not expected to be
completed until mid-January 2002. The delays between the time that materials
and services were received and the time focus groups were to provide their
opinions could affect the usefulness of their responses.
IRS also plans to evaluate this program by comparing the compliance rate of
various risk categories of employees among the test group employers and with
corresponding categories within the control groups. Although it has been
delayed, IRS plans to begin evaluating the compliance data for the test and
control groups when they become available in late fall 2001. The data will
include such information as deposits made, returns filed, delinquencies and
resulting notices sent, and FTD penalties assessed. The analysis of these
data, along with a cost-benefit summary will be included in the business
analysis case that will be prepared to support recommendations about the
program's future.
In an August 2001 audit report8 on the results of its review of the
Mentoring and Monitoring pilot, the Treasury Inspector General for Tax
Administration (TIGTA) reported that the program should help new business
taxpayers with their federal employment tax responsibilities. TIGTA
expressed concerns, however, about the program's sampling methodology,
cost-effectiveness, and level of management oversight and raised certain
questions about expanding it nationwide at this time. Among other things,
TIGTA recommended that SB/SE Division management should provide oversight
for the remainder of the project, including the planned business case
analysis of the compliance results achieved under the pilot.
FTD Soft Letter. This pilot program seeks to improve employers' voluntary
compliance through intervening much earlier than IRS' long-standing FTD
Alert Program9 allows. The FTD Soft Letter was sent only to employers
required to make deposits more frequently than monthly and who appeared to
have underpaid tax deposits during the quarter. Before
8See TIGTA, A Prototype to Help New Small Business Employers Appears
Effective, But More Information Is Needed Before Expanding It Nationwide
(August 2, 2001). TIGTA was previously known as IRS' Office of Internal
Audit.
9See page 17 regarding the FTD program.
their quarterly Form 941 return was due, IRS sent these employers a letter
advising them of the potential discrepancy. IRS sent letters only to those
employers identified nationwide who had historically been compliant but were
assessed an FTD penalty in one of the past four quarters and paid it but
appeared to have made smaller than expected tax deposits in the current
quarter.
In October 2000, IRS sent a soft letter to 1,806 employers nationwide who
met the criteria. The letter included a phone number they could call to
request assistance, and a tear-off portion to notify IRS if they were no
longer in business or had no employees. In response, 339 of the 1,806
informed IRS that their businesses were defunct or no longer had employees.
IRS originally planned to evaluate the compliance of the test group against
a control group of similar employers that had not received a soft letter.
IRS was to begin the evaluation in January 2001, with the final report due
by July 2002. As of October 2001, IRS had not begun the evaluation, and no
decision had been made on whether or not to proceed with it.
According to IRS officials, evaluation plans were disrupted as the result of
IRS' ongoing reorganization. In that regard, responsibility for the soft
letter program was transferred from the now defunct Small Business Lab to
the SB/SE Division, established in October 2000. Although the program was
transferred in early 2001, IRS did not assign formal program responsibility
to the division until August 2001. In October 2001, newly assigned program
officials decided to evaluate the program to determine the program's
effectiveness and possible future use. Current plans call for a report based
on four quarters of compliance data to be completed by April 2002.
The ABC's of FTDs. This 2-hour class on FTD, including videotape entitled
"The ABC's of FTDs" and a course workbook, was designed to assist employers
who experienced difficulties in staying compliant with their federal tax
deposit obligations. Employers were invited to attend classes that were held
in September 1998, February 1999, and June 1999 in the Seattle metropolitan
area. If employers attended the class and remained compliant for two
subsequent quarters, IRS excused them from paying up to three tax quarters
of the FTD penalties they had previously incurred. However, only 28 of 315
employers invited to attend classes actually did so, according to IRS data.
To analyze the pilot program, IRS established both a test group consisting
of those employers who attended the educational classes and received the
materials and various control groups that did not. IRS had planned to track
payment compliance for these groups through June 2001, but instead concluded
the evaluation in June 2000, using compliance data from five quarters. IRS'
evaluation of the program revealed that employers made more FTD deposits and
filed fewer delinquent returns after attending the classes; however, IRS
could not attribute these improvements to class attendance. The evaluation
made several other points regarding the program:
* Low class attendance diminished the impact of the program.
* The test group tended to make more deposits than the control groups, even
before they were invited to attend.
* The employers who attended chose to come and, therefore, may have been
more motivated to be compliant.
The evaluation made several recommendations that have apparently not been
acted upon.10 The educational videotape and course workbook also were used,
however, as part of the Mentoring and Monitoring program materials in an
effort not only to educate employers but also to further evaluate the
materials' effectiveness. As previously discussed, however, the evaluation
of this program, expected to be completed in mid-January 2002, is to be
based on input from employer focus groups held more than a year after IRS'
originally planned customer surveys.
FTD Alert. IRS' FTD Alert program has existed since 1972 and is intended to
improve overall employment tax compliance. The current program's selection
criteria identifies only those depositors who owe more than $50,000 per
year, have delinquencies resulting in FTD penalties in recent quarters, and
appear to have underpaid the current quarter. If the employers have FTD
penalties in the four previous quarters, IRS Revenue Officers are required
to contact them to help them understand deposit requirements and the cost
and consequences of not depositing as required. Although the program
provides IRS with an opportunity to intervene with these employers
concerning their delinquencies, several aspects of the
10The recommendations included that IRS use focus groups or surveys to
determine why so many employers declined to participate in the program and
to obtain feedback about how the course should be improved. The evaluation
also recommended that IRS consider developing an alternative means of
educating taxpayers on FTD requirements, such as self-study courses or
offering on-line or CD-ROM versions in order to increase participation.
program have been criticized. IRS is in the early stages of addressing these
weaknesses, as discussed below.
Over the years, both our reports and IRS internal audit reports have been
critical of several aspects of the FTD Alert Program. For example, we stated
in a 1991 report that IRS lacked a tracking system to determine the result
of contacts made with delinquent employers, 11 and IRS echoed this same
criticism in TIGTA's 1998 internal report.12 Without such a system, IRS
cannot assess the effectiveness of the program. The IRS National Office FTD
analyst responsible for the program stated that a meeting is planned in
January 2002 to begin development of such a system.
As recommended by TIGTA in 1998, IRS' research organization has been
exploring ways to improve the FTD Alert Program that may result in current
selection criteria being replaced. According to IRS, earlier efforts have
demonstrated some success in identifying the most collectible delinquencies
and prioritizing the workload to target those delinquencies. IRS' effort to
improve employer selection criteria was to be completed in mid-2000, but its
information systems staff was unable to provide the required data when it
was originally requested owing to competing priorities. IRS requires the
data to develop algorithms based on the current selection criteria that
will, if successful, allow IRS to identify and prioritize employers
nationwide who are at risk of becoming delinquent. According to IRS
officials, the needed data were to be delivered by August 30, 2001. IRS
plans to test the algorithms during the winter, using test and control
groups, and evaluate them by spring 2002. By the end of June 2002, IRS plans
to prepare a final report detailing the methodology, findings, and
recommendations regarding the selection criteria.
IRS' ongoing modernization efforts do not currently include any programs
specifically designed to improve IRS' notification to employers with tax
delinquencies. However, sweeping organizational changes and information
system improvements may in the future reduce taxpayer burden and improve
compliance. These changes are not expected to be completed in the near term
but will be phased in over the next several years. Information system
improvements may help IRS to notify employers of tax
IRS' Ongoing Modernization Could Improve Intervention With Employers
11 See Tax Administration: Efforts to Prevent, Identify, and Collect
Employment Tax Delinquencies (GAO/GGD-91-94, August 28, 1991).
12See TIGTA, Service Procedures for Monitoring Federal Tax Deposits (Aug.
14, 1998).
delinquencies more quickly and effectively, but implementation is not
expected to begin for business returns, such as the Form 941 returns, until
at least 2005.
Organizational Changes Could Begin to Help Employers
IRS is making major organizational changes designed to reduce taxpayer
burden and improve services. For example, it has created four new operating
divisions tailored to more effectively meet the needs of specific groups of
taxpayers. Similarly, IRS is also designating that only certain service
centers will receive and process business tax returns and related tax
information, and officials believe this specialization could eventually
expedite processing. As part of its strategic plan, IRS will emphasize
providing assistance to taxpayers before tax returns are filed and providing
earlier intervention with taxpayers when problems arise.
One of IRS' four new operating divisions is dedicated to serving the needs
of small business and self-employed taxpayers, while another serves large
and mid-sized businesses.13 According to IRS' plans, taxpayers in each of
these divisions should benefit from IRS' handling of all their respective
tax issues within a single organization. IRS management and staff are
expected to provide more tailored products and services to help their
respective taxpayer segments comply with applicable tax laws. Although the
new divisions officially began operations on October 1, 2000, they are still
developing processes and operating procedures. The SB/SE Division, in
particular, is not yet fully staffed.
In addition, IRS is shifting its workload to allow certain locations to
specialize in processing business returns. For example, instead of all 10
IRS service centers processing Form 941 returns, IRS plans to have only two
service centers doing this work. IRS does not expect this change to be
completed until at least 2002. Furthermore, according to an IRS
modernization official, the specialized services centers are not expected to
initially impact the current IRS processing time for Form 941 returns,
although the processing time could be reduced as IRS gains experience in
these two service centers.
13The SB/SE division is expected to serve about 45 million fully or
partially self-employed individuals and businesses that have assets under $5
million. In contrast, the Large/Mid-Sized Division is expected to serve
about 210,000 filers that include corporations with assets over $5 million.
Both types of filers tend to have more complex tax issues and more frequent
contact with IRS than do individual taxpayers.
Under the new structure, IRS also plans to place an increased emphasis on
prefiling activities, such as taxpayer education, outreach, and earlier
intervention with taxpayers. This new emphasis on preventing problems
instead of fixing them after the fact is one of modernization's key changes
intended to help employers avoid, or at least minimize, tax delinquencies.
Major Information System Improvements for Business Taxpayers Will Not Be
Available Until at Least 2005
Conclusions
Central to IRS' achieving its modernization vision is replacing the
multiple, antiquated information systems it currently uses to maintain
taxpayer accounts and to provide customer service with a single, integrated
system known as the Customer Account Data Engine (CADE). IRS expects CADE to
greatly improve its customer service capabilities by providing immediate
updates of taxpayer accounts and expediting its processing of returns and
payments. For example, CADE is to replace the current once-a-week processing
schedule that adds to the time IRS takes to notify employers of employment
tax delinquencies, with daily processing that could reduce the time for this
notification. These changes, however, are not expected to be available for
business processes for many years. IRS plans to incrementally phase CADE in,
beginning with the simplest individual tax accounts. Accordingly, IRS will
begin by processing the form 1040EZ using the CADE system and progress
eventually to using the system for more complex forms, such as business
returns. As a result, IRS' plans do not call for CADE to begin processing
Form 941 returns until at least 2005.
Early notification can help businesses that have failed to pay in a timely
manner their full employment tax liability or to timely file a Form 941
quarterly return by minimizing the penalty and interest charges associated
with delinquent deposits and tax returns. Until IRS improves its computer
systems, there does not appear to be much that can be done to further
decrease the time that IRS' processes require for routinely notifying all
businesses of their employment tax delinquencies.
In the interim, IRS has developed three new programs designed to prevent or
reduce employment tax delinquencies by speeding up or enhancing the
notification to certain groups of businesses. However, IRS has not
successfully followed through on its plans to evaluate these programs. It
has also experienced delays in evaluating its efforts to improve its
long-standing FTD Alert program. We believe IRS needs to properly evaluate
whether the benefits to be derived from expansion of the pilot programs and
retention of the FTD Alert program justify the program costs.
Recommendation for Executive Action
Agency Comments and Our Evaluation
We recommend that the IRS Commissioner require the SB/SE Commissioner to
develop and execute a plan for evaluating the effectiveness of the
employment tax early intervention programs. The plan should address the
resources needed to evaluate the interventions, ensure the clear and timely
assignment of responsibility for the evaluations, and include milestones for
completing the efforts.
On January 3, 2002, we received written comments on a draft of this report
from the Commissioner of Internal Revenue (see app.I). The Commissioner said
that IRS has researched measurement practices used by public and private
sector institutions in conjunction with SB/SE's efforts to develop plans for
outreach measurement. The Commissioner also said that the intervention
programs we identified have already provided valuable insight into the needs
of small business taxpayers. He agreed with our recommendation and said that
the Commissioner, SB/SE, will review each of the programs in our report and
determine the extent of evaluation required. Further, when the review is
completed, each SB/SE office responsible for a program will evaluate the
specific intervention effort and make recommendations for implementation.
As agreed with your office, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days from
the date of this letter. At that time, we will send copies to the
Commissioner of Internal Revenue and other interested parties. We will also
make copies available to others upon request.
If you have any questions regarding this report, please contact me or Joseph
E. Jozefczyk at (202) 512-9110. The major contributors to this report were
Marvin McGill, Linda Standau, Tom Bloom, and Grace Coleman.
Sincerely yours,
Michael Brostek Director, Tax Issues
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