IRS's Use of Information on Taxpayers Claiming Many Allowances or
Exemption From Federal Income Tax Withholding (06-NOV-03,	 
GAO-04-79R).							 
                                                                 
In September 2003, we responded to a request from Representative 
Elton Gallegly to provide information on the number of taxpayers 
who claimed more than 10 withholding allowances and taxpayers who
claimed exemption from federal income tax withholding. The	 
Internal Revenue Service (IRS) calls such claims questionable	 
Form W-4s. However, in the course of performing our work, we	 
became concerned about the reliability of the information that	 
IRS maintains on these taxpayers and decided that we could not	 
use it to answer Representative Gallegly's questions. The	 
objectives of this letter are to summarize our findings about the
reliability of the information IRS maintains on taxpayers who	 
claimed more than 10 withholding allowances or exemption from	 
federal tax withholding and to bring to your attention some	 
resulting questions about the value of IRS continuing to collect 
the information.						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-79R 					        
    ACCNO:   A08830						        
  TITLE:     IRS's Use of Information on Taxpayers Claiming Many      
Allowances or Exemption From Federal Income Tax Withholding	 
     DATE:   11/06/2003 
  SUBJECT:   Data collection					 
	     Data integrity					 
	     Federal taxes					 
	     Income taxes					 
	     Tax administration 				 
	     Tax exempt status					 
	     Taxpayers						 
	     IRS Questionable Form W-4 Program			 

******************************************************************
** This file contains an ASCII representation of the text of a  **
** GAO Product.                                                 **
**                                                              **
** No attempt has been made to display graphic images, although **
** figure captions are reproduced.  Tables are included, but    **
** may not resemble those in the printed version.               **
**                                                              **
** Please see the PDF (Portable Document Format) file, when     **
** available, for a complete electronic file of the printed     **
** document's contents.                                         **
**                                                              **
******************************************************************
GAO-04-79R

United States General Accounting Office Washington, DC 20548

November 6, 2003

The Honorable Mark W. Everson Commissioner of Internal Revenue

Subject: 	IRS's Use of Information on Taxpayers Claiming Many Allowances
or Exemption From Federal Income Tax Withholding

Dear Mr. Everson:

In September 2003, we responded to a request from Representative Elton
Gallegly to provide information on the number of taxpayers who claimed
more than 10 withholding allowances and taxpayers who claimed exemption
from federal income tax withholding. The Internal Revenue Service (IRS)
calls such claims questionable Form W-4s. However, in the course of
performing our work, we became concerned about the reliability of the
information that IRS maintains on these taxpayers and decided that we
could not use it to answer Representative Gallegly's questions. For
background, see our letter to Representative Gallegly in enclosure 1.

The objectives of this letter are to summarize our findings about the
reliability of the information IRS maintains on taxpayers who claimed more
than 10 withholding allowances or exemption from federal tax withholding
and to bring to your attention some resulting questions about the value of
IRS continuing to collect the information.

                                    Results

We have two concerns about the information that IRS maintains on taxpayers
who claimed more than 10 withholding allowances or exemption from federal
tax withholding that precluded us from using it to respond to
Representative Gallegly's questions. First, we are concerned about the
completeness of the information because a significant number of employers
may not send IRS the required forms. According to IRS's information, about
75 percent of the large employers with 1,000 or more employees in its
Large and Medium-Size Business (LMSB) and Small Business/Self-Employed
(SB/SE) divisions that filed employment tax returns in tax year 2001 did
not send IRS any forms. Although the number of questionable Form W-4s IRS
might receive from individual employers can vary, it seems unlikely that
75 percent of employers with 1,000 or more employees could have no
employees who submitted questionable Form W-4s. Second, some of the
information may not be current-it may not reflect the current withholding
status of some taxpayers. If an employee who previously claimed more than
10 allowances or claimed exemption

from federal income tax withholding submitted a new Form W-4 claiming 10
or fewer allowances or not claiming exemption from withholding, the
database would continue to show the earlier information. There is no
requirement for employers to submit Form W-4s other than those claiming 10
or more allowances or exemption. We could not quantify the significance of
our concerns about the reliability of IRS's data; however, the uncertainty
about how complete and current the data were precluded us from using them
to respond to Representative Gallegly's questions.

While acknowledging the limitations of the information in the Questionable
Form W-4 database, IRS's Wage and Investment (W&I) Division officials
stated that the information in the database was useful to them for tax
compliance purposes. The officials said that they use the database to
identify useful leads in determining possible underwithholding issues that
can lead to noncompliance. For example, tax examiners at IRS's Fresno
Computing Center routinely review the withholding information of certain
taxpayers to substantiate their claims. If the taxpayers cannot
substantiate their claims, the examiners would require that the taxpayers'
withholdings be adjusted to appropriate levels. According to the Treasury
Inspector General for Tax Administration, about 70 percent of the cases
closed by the examiners in fiscal year 2001 resulted in no changes to the
taxpayers' withholding claims.1

However, considering what we learned about the reliability of the data,
questions may be raised about the value and fairness of IRS's enforcement
efforts that rely on the database. One question is whether it is worth
devoting IRS's resources to maintaining a database of questionable
reliability. According to information IRS provided us in July 2003, 32
full time equivalent staff was dedicated to the Questionable Form W-4
program. A related question is whether it is worth the burden borne by
those taxpayers who send IRS forms. Another question is about the
evenhandedness of IRS's use of the database as a compliance tool.
Taxpayers whose employers are not submitting questionable Form W-4s are
less likely to face compliance checks under the program than taxpayers
whose employers do submit the forms.

IRS has reengineering efforts underway to improve the Questionable Form
W-4 database, which we discuss in our report to Representative Gallegly.
Based on information from program officials, these efforts were being
implemented when we were preparing this report. Although we did not assess
IRS's reengineering plans, it was not clear to us that the plans would
address the data reliability concerns we discussed in this report and in
our report to Representative Gallegly. The reengineering efforts address
database improvements to enhance compliance checks.

In addition to summarizing our concerns, our letter to Representative
Gallegly contains details of the scope and methodology of the work that we
performed from October 2002 through June 2003 in accordance with generally
accepted government auditing standards.

1Treasury Inspector General for Tax Administration, Improvements to the
Questionable Form W-4 Program Are Needed to Determine Program Impact on
Taxpayer Compliance, Reference Number: 2003-40-006 (Washington, D.C.:
October 2002).

Conclusions and Recommendation

We have questions about the value and fairness of using the Questionable
Form W-4 program database for compliance purposes because of uncertainties
about the extent that the data are complete and current.

Because of these questions we recommend that you assess the value of IRS's
Questionable Form W-4 program and determine whether the program should
continue in its current form.

                       Agency Comments and Our Evaluation

On October 28, 2003, we received comments from the Commissioner of
Internal Revenue on a draft of this report. The Commissioner agreed with
our recommendation, stating that he will undertake a comprehensive review
of the Questionable Form W-4 Program to determine its effectiveness and
relevancy in the current environment. Further, he said that the
Commissioner of the W&I Division is to lead the effort. The Commissioner's
comments are reprinted in enclosure 2.

-----This report contains a recommendation to you. The head of a federal
agency is required by 31 U.S.C. 720 to submit a written statement on
actions taken on this recommendation. You should send your statement to
the Senate Committee on Governmental Affairs and the House Committee on
Government Reform within 60 days after the date of this report. A written
statement also must be sent to the House and Senate Committees on
Appropriations with the agency's first request for appropriations made
over 60 days after the date of this report.

We are sending copies of this report to the Secretary of Treasury and to
interested
congressional committees. This report will also be available at no charge
on GAO's
Web Site at http:www.gao.gov.

If you have any questions about this report, please contact me at (202)
512-9110 or by
E-mail at [email protected]. Key contributors to this assignment were Charlie
Daniel
and Arthur L. Davis.

Sincerely yours,

James R. White
Director, Strategic Issues

Enclosures

Enclosure 1: Report to Representative Elton Gallegly

Enclosure 2: Comments from the Internal Revenue Service

(450248)

The General Accounting Office, the audit, evaluation and investigative arm
of

GAO's Mission 	Congress, exists to support Congress in meeting its
constitutional responsibilities and to help improve the performance and
accountability of the federal government for the American people. GAO
examines the use of public funds; evaluates federal programs and policies;
and provides analyses, recommendations, and other assistance to help
Congress make informed oversight, policy, and funding decisions. GAO's
commitment to good government is reflected in its core values of
accountability, integrity, and reliability.

The fastest and easiest way to obtain copies of GAO documents at no cost
is through the Internet. GAO's Web site (www.gao.gov) contains abstracts
and full-

Obtaining Copies of GAO Reports and Testimony

text files of current reports and testimony and an expanding archive of
older products. The Web site features a search engine to help you locate
documents using key words and phrases. You can print these documents in
their entirety, including charts and other graphics.

Each day, GAO issues a list of newly released reports, testimony, and
correspondence. GAO posts this list, known as "Today's Reports," on its
Web site daily. The list contains links to the full-text document files.
To have GAO e-mail this list to you every afternoon, go to www.gao.gov and
select "Subscribe to e-mail alerts" under the "Order GAO Products"
heading.

Order by Mail or Phone 	The first copy of each printed report is free.
Additional copies are $2 each. A check or money order should be made out
to the Superintendent of Documents. GAO also accepts VISA and Mastercard.
Orders for 100 or more copies mailed to a single address are discounted 25
percent. Orders should be sent to:

U.S. General Accounting Office 441 G Street NW, Room LM Washington, D.C.
20548

To order by Phone: 	Voice: (202) 512-6000 TDD: (202) 512-2537 Fax: (202)
512-6061

To Report Fraud,	Contact: Web site: www.gao.gov/fraudnet/fraudnet.htm

                  Waste, and Abuse in E-mail: [email protected]

Federal Programs Automated answering system: (800) 424-5454 or (202)
512-7470

Public Affairs 	Jeff Nelligan, Managing Director, [email protected] (202)
512-4800 U.S. General Accounting Office, 441 G Street NW, Room 7149
Washington, D.C. 20548

This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed in
its entirety without further permission from GAO. However, because this
work may contain copyrighted images or other material, permission from the
copyright holder may be necessary if you wish to reproduce this material
separately.
*** End of document. ***