-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-499T		

TITLE:     Internal Revenue Service: Assessment of the Interim 
Results of the 2006 Filing Season and Fiscal Year 2007 Budget Request

DATE:   04/27/2006 
				                                                                         
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GAO-06-499T

     

     * IRS's Filing Season Performance to Date Has Improved in Impo
          * Return Processing Has Been Smooth and Electronic Filing Cont
          * Telephone Access and Accuracy Improved, in Part Due to Lower
          * IRS's Web Site Is Being Used More, Is Performing Well, and H
          * Taxpayers Continue Their Recent Pattern of Using IRS's Walk-
          * Taxpayers Using Chain Paid Tax Preparers May Receive Incorre
     * IRS's Budget Proposes Decreases in Staffing and Identifies S
          * IRS's Budget Proposes Decreases in Funding After Adjusting f
               * IRS's Budget Request Proposes to Maintain or Improve Taxpaye
               * IRS's Budget Request Reduces Enforcement Staffing Slightly,
               * Budget Request for IS Funding is Up Slightly, and IRS Has Ta
               * IRS's Proposed BSM Budget Reduction Could Impede Future Prog
          * IRS's Budget Request Identified Some Savings, but Opportunit
               * Accurate Cost Information Would Help IRS Make Resource Alloc
     * IRS Sets Long-Term Goals, but Lacks a Data-Based Plan for Ac
          * IRS's Budget Proposes Long-Term Goals, but Lacks a Data-Base
          * Addressing the Tax Gap Requires Solutions Beyond Funding and
     * Contacts and Acknowledgments
     * Filing Season Performance:
     * IRS's Budget Requests:
     * Tax Gap and Compliance:
     * Financial Statement Audits:
     * Business Systems Modernization:
     * Other:
     * GAO's Mission
     * Obtaining Copies of GAO Reports and Testimony
          * Order by Mail or Phone
     * To Report Fraud, Waste, and Abuse in Federal Programs
     * Congressional Relations
     * Public Affairs

Statement for the Record

Before the Subcommittee on Transportation, Treasury, the Judiciary, and
Housing and Urban Development, and Related Agencies, Committee on
Appropriations, U.S. Senate

United States Government Accountability Office

GAO

For Release on Delivery Expected at 9:30 a.m. EDT

Thursday, April 27, 2006

INTERNAL REVENUE SERVICE

Assessment of the Interim Results of the 2006 Filing Season and Fiscal
Year 2007 Budget Request

Statement of James R. White Director

Strategic Issues

Statement of David A. Powner Director

Information Technology Management Issues

Internal Revenue Service Internal Revenue Service Internal Revenue Service
Internal Revenue Service Internal Revenue Service

GAO-06-499T

Mr. Chairman and Members of the Subcommittee:

Since the passage of the Internal Revenue Service (IRS) Restructuring and
Reform Act of 1998 (RRA 98)1, IRS has made noticeable improvements to
taxpayer services such as telephone assistance and delivered some
modernized information systems that, among other benefits, speed up
refunds to taxpayers. Increased funding financed some of the improvements,
but a significant portion has been financed internally through
efficiencies from increased electronic filing of tax returns and other
operational improvements.

IRS has also increased revenue collected through its enforcement programs;
however, tax law enforcement continues to be included on our list of
high-risk federal programs.2 This is due, in part, to the persistence of a
large tax gap. 3 IRS estimated the gross tax gap to be $345 billion for
tax year 2001. After late payments by taxpayers and revenue brought in by
IRS's enforcement efforts, the resulting net tax gap is estimated to be
$290 billion.4 Even modest progress in reducing the tax gap would yield
significant revenue; each 1 percent reduction would likely yield nearly $3
billion annually.

If its 2007 budget request is a harbinger of longer term funding, IRS
faces an era of tight budgets. Consequently, continued performance
improvements will depend on the extent to which IRS can make more
efficient use of limited resources to provide internal funding for the
improvements. By indicating how resources are allocated to specific
programs and activities within the agency, the budget request is a key
planning tool showing where the agency intends to achieve additional
efficiencies.

1Pub. L. No. 105-206 (1998).

2GAO, High Risk Series: An Update, GAO-05-207 (Washington, D.C.: January
2005).

3The tax gap is an estimate of the difference between the taxes that
should have been timely and accurately paid and what was actually paid.
Throughout this statement, references to the tax gap refer to the gross
tax gap unless otherwise noted.

4GAO, Tax Gap: Making Significant Progress in Improving Tax Compliance
Rests on Enhancing Current IRS Techniques and Adopting New Legislative
Actions, GAO-06-453T (Washington, D.C.: Feb. 15, 2006).

The 2007 budget request is also an indication of how IRS intends to
achieve longer term goals. For the first time, IRS lists two agencywide
long-term goals: to increase the compliance rate and reduce the proportion
of taxpayers who think it is acceptable to cheat on their taxes.5 This
budget can be viewed as a first step in a series of annual steps that will
determine whether IRS achieves these long-term goals.

Our statement discusses IRS's 2006 filing season performance to date and
fiscal year 2007 budget request. To address your request, we assessed (1)
the interim results of IRS's 2006 filing season performance compared to
prior years; (2) IRS's budget request compared to prior years; and (3) how
the budget helps IRS achieve its long-term goals aimed at reducing the tax
gap.

Our assessment of the interim results of IRS's filing season is based on
comparing IRS's performance this year to prior filing seasons, monitoring
various production meetings and production statistics, reviewing other IRS
documents and reports, interviewing IRS and Treasury Inspector General for
Tax Administration (TIGTA) officials and paid tax preparers and other
external stakeholders, reviewing TIGTA and other external reports, and
reviewing IRS's Web site. Our assessment of the budget request is based on
a comparative analysis of IRS's fiscal year 2002 (in most cases) through
2007 budget requests, funding, expenditures, and other documentation and
interviews with IRS officials. We used historical budget and performance
data from reports and budget requests used by the IRS, Department of the
Treasury, and Office of Management and Budget. In past work, we assessed
IRS's budget and performance data. Since the data sources and procedures
for producing this year's budget and performance data have not
significantly changed from prior years, we determined that the data were
sufficiently reliable for the purposes of this statement. We did not
verify IRS's estimates for enforcement revenue and the tax gap. IRS
presents tax gap information as supplemental information in its financial
statements; that information is not required to be audited. However, we
have been involved in tax gap methodology briefings, and the TIGTA has an
ongoing review of the accuracy of IRS's tax gap estimates. Additionally,
our analysis of IRS's Business Systems Modernization (BSM) program was
based primarily upon the results of our detailed review of IRS's fiscal
year 2006 BSM expenditure plan that we recently reported to you.6 We
performed our work in Washington, D.C., and Atlanta, Georgia, from January
2006 through April 2006, in accordance with generally accepted government
auditing standards.

5 The Congress set one long-term goal for the IRS in RRA 98 for IRS to
have 80 percent of individual returns, business returns, and information
returns filed electronically by 2007. We and IRS have previously reported
that IRS likely will not meet this goal for having 80 percent of all
individual returns tax returns filed electronically by 2007. Also, IRS's
budget describes plans to establish other agencywide goals, targets for
which have not yet been established and therefore are not listed in the
budget request.

Our statement makes these key points:

           o  IRS has improved its 2006 filing season performance to date in
           important areas compared to last year, continuing a recent trend.
           IRS's returns processing has gone smoothly and over 64 percent of
           refunds are now directly deposited to taxpayers' bank accounts,
           which is faster, more convenient and less costly than issuing
           paper checks. Electronic filing continues to grow, but at a slower
           rate. So far this filing season, electronic filing rate has
           increased 2.1 percentage points compared to an average percentage
           point increase of 5.1 annually for the previous two years.
           According to IRS officials, the slower rate of growth is due, in
           part, to new income limits in the Free File program, which reduced
           the number of taxpayers eligible to file electronically for free
           via IRS's Web site, and the termination of the TeleFile program,
           which eliminated electronic filing by phone. Telephone assistance
           has improved this year, in part, due to lower call volume. The
           percentage of taxpayers attempting to reach an IRS telephone
           assistor and who actually received service increased 1.6
           percentage points to 83.3 percent this filing season and the
           length of time taxpayers waited to get their calls answered
           decreased from 256 seconds to 205 seconds. The accuracy of IRS's
           responses to tax law and account questions improved-both are now
           at 90 percent or more. IRS's Web site is being used more, is
           performing well based on third-party evaluations, and has been
           reconfigured with the goal of improving taxpayer service.
           Taxpayers continued the recent pattern of using IRS's walk-in
           sites less, and using sites run by community-based organizations
           and staffed by volunteers more. In addition to service from IRS,
           millions of taxpayers-particularly those with complicated
           returns-receive service from paid preparers.7 However, we recently
           reported8 that chain paid tax preparers may not be providing
           accurate and complete assistance, putting taxpayers at risk of
           owing back taxes, interest, and penalties.

           o  IRS's fiscal year 2007 proposed budget is $11 billion, which is
           a small decrease compared to the 2006 enacted level after
           adjusting for expected inflation. 9 For service, the budget
           proposes to cut staffing by 4 percent. For enforcing tax laws, the
           budget proposes to cut staffing by 2 percent. However, for service
           and enforcement, the budget sets performance goals for 2007 that
           are higher than or equal to those for 2006. For maintaining and
           operating IRS's existing information systems (IS), the 2007 budget
           request shows an increase in resources when compared to the 2006
           enacted budget. However, when compared to the level currently
           assumed for 2006, the 2007 budget request leaves Full-time
           Equivalents (FTE)10 for IS virtually constant. For the BSM
           program, which is the ongoing effort to replace the agency's aging
           information systems, the budget proposes to reduce spending by
           about 15 percent. This reduction could delay delivery of improved
           services for taxpayers. As it has in prior years, IRS's budget
           request identifies savings-the 2007 budget proposes to save over
           $121 million and 1,424 FTEs. However, additional opportunities
           exist for savings. One would be to increase electronic filing by
           additional use of mandates. IRS currently mandates electronic
           filing by large corporations and 12 states currently mandate
           electronic filing of individual income tax returns by certain tax
           preparers. Another opportunity would be to consolidate IRS's 25
           telephone call sites. IRS officials told us that the call sites
           have space that is not used for 850 staff. Call sites could be
           consolidated without affecting service to taxpayers. Finally, IRS
           has long been hampered by a lack of current and accurate cost
           information for making resource allocation decisions. IRS recently
           implemented components of a cost accounting system, but needs to
           continue gathering the cost data needed to make it an effective
           planning tool.

           o  IRS's budget request sets two long-term goals: increasing the
           rate of voluntary compliance from 83 percent to 85 percent by 2009
           and reducing the percentage of taxpayers who think it is
           acceptable to cheat on their taxes from 10 percent to 9 percent in
           2008. These goals will be challenging to meet because the tax gap
           has persisted at a relatively stable level of 81 to 84 percent for
           many years. However, because the effect of taxpayer service and
           enforcement on compliance has never been quantified, IRS does not
           have a data-based plan demonstrating how it will use its programs
           to achieve its goals and reduce the tax gap. Nor does IRS have a
           plan for measuring compliance by 2009. Reducing the tax gap will
           likely require new and innovative solutions such as simplifying
           the tax code, increasing income subject to withholding, and
           increasing information reporting about income. Despite these
           limitations, IRS's budget request includes several proposals for
           increasing compliance that would not require additional resources
           for IRS. For example, the Department of the Treasury plans to
           study, and we have long supported, clarifying the definition of
           independent contractors and requiring additional information
           reporting on their income, steps that could increase tax revenue
           by billions of dollars.

6GAO, Business Systems Modernization: Internal Revenue Service's Fiscal
Year 2006 Expenditure Plan, GAO-06-360 (Washington, D.C.: Feb. 21, 2006).

7 As noted in our report, complicated returns are defined as those using
the Form 1040 as opposed to the Form 1040EZ, those claiming itemized
deductions and not the standard deduction, and those claiming the Earned
Income Tax Credit.

8GAO, Paid Tax Return Preparers: In a Limited Study, Chain Preparers Made
Serious Errors, GAO-06-563T (Washington, D.C.: April 4, 2006).

9The Congressional Budget Office is estimating inflation to be 1.8 percent
in 2007. Congressional Budget Office, The Budget and Economic Outlook:
Fiscal Years 2007 to 2016. (Washington, D.C.: January 2006).

10 According to IRS, a FTE is the equivalent of one person working
full-time for one year with no overtime. A staff year includes overtime.
Therefore, the cost of 1 staff year is equal to the cost of 1 FTE plus
overtime.

    IRS's Filing Season Performance to Date Has Improved in Important Areas,
                           Continuing a Recent Trend

IRS improved its 2006 filing season performance in important areas that
affect large numbers of taxpayers. This continues a trend of improvement
since at least 2002. Returns processing has gone smoothly and electronic
filing continues to grow, although at a slower rate than in previous
years. Taxpayer assistance has improved in the two most commonly used
services-toll-free telephones and the Internet Web site. Fewer taxpayers
visited IRS's walk-in sites, and more sought assistance at
volunteer-staffed sites.

Return Processing Has Been Smooth and Electronic Filing Continues to Grow,
Although At a Slower Rate Than Previous Years

From January 1 through April 14, 2006, IRS processed 91.8 million
individual income tax returns. Of those returns, 63.4 million returns were
filed electronically (up 2.3 percent) and 28.3 million returns were filed
on paper (down 7.1 percent).

According to IRS data and officials, returns processing has gone smoothly
so far this filing season. IRS issued 78 million refunds, 50 million, or
64 percent of which were directly deposited, up 5.4 percent over the same
period as last year. Direct deposit is faster, more convenient for
taxpayers, and less expensive for IRS than mailing paper checks.

Because of the volume of tax returns, it is normal for IRS to experience
some processing disruptions, although this year, disruptions have not been
significant. For example, 13 different tax forms were unavailable for
electronic filing until February 1 due to the late hurricane relief
legislation, which caused a minor processing delay for some returns.

Furthermore, IRS officials said that the new Customer Account Data Engine
(CADE), which is intended eventually to replace IRS's antiquated Master
File system containing taxpayer records, processed over 6 million returns
and dispersed 5.3 million refunds as of April 14, 2006 without
disruptions. IRS is reporting that direct deposit refunds and paper check
refunds are being issued within 4 and 6 business days, respectively, after
tax returns are posted to CADE, which is faster than for returns processed
by the Master File system. CADE's growth in future years will directly
benefit taxpayers. Not only can it speed up refunds, but it also updates
taxpayer account information quicker than the Master File system.

Representatives of the taxpayer industry corroborated IRS's view that the
filing season is going smoothly. Groups and organizations that we talked
to included the National Association of Enrolled Agents, the American
Institute of Certified Public Accountants, and others. In addition, the
TIGTA recently testified that thus far it has seen no significant problems
during the filing season.11

The growth of electronic filing is important, because it generates savings
by reducing staff years needed for labor intensive paper processing.
Between fiscal years 1999 and 2006, IRS reduced the number of staff years
devoted to paper and electronic processing by 1,586, or 34 percent as
shown in figure 1.

11 Written statement of Treasury Inspector General for Tax Administration,
J. Russell George, before the Committee on Appropriations, Subcommittee on
Transportation, Treasury and Housing and Urban Development, the Judiciary,
District of Columbia, and Independent Agencies, U.S. House of
Representatives, Hearing on the Internal Revenue Service's Fiscal Year
2007 Budget, Washington, D.C., Mar. 29, 2006.

Figure 1: Number of Individual Returns and IRS Staff Years for Individual
Paper and Electronic Processing, Fiscal Years 1999-2007

aFiscal years 2006 and 2007 are IRS projections.

Note: Staff years and FTE are units of measurement that are often used
interchangeably. As noted in the figure, staff years for paper filing are
for selected major activities only.

Electronic filing continues to grow but at a slower rate than previous
years. This year's 2.1 percent rate of growth is less than the average
annual rate of growth of 5.1 percent for each of the preceding 2 years.
According to IRS officials, the slower growth in electronic filing this
year is due, in part, to changes in the Free File program, which reduced
the number of taxpayers eligible to file electronically for free this year
and reduced publicity and advertising by companies involved in that
program, and the termination of the TeleFile program, which eliminated the
way for taxpayers to file their returns electronically via telephone.

The Free File program enables taxpayers to file their returns
electronically via IRS's Web site. Through IRS's Web site, taxpayers can
access the Web sites of 20 companies comprising the Free File Alliance.
The alliance is a consortium of tax preparation companies that agreed to
offer free return preparation and electronic filing for taxpayers that
meet certain criteria (see app. 1 for further detail). In an amended
agreement with IRS that took effect this year, the Free File Alliance set
a $50,000 income limitation on taxpayer participation. This limit was
absent last year and reduced the number of taxpayers eligible to
participate in the program. As of April 13, 2006, IRS processed about 3.5
million free file returns, which is a decrease of 24 percent from the same
period last year. This decline is inconsistent with IRS's projection that
it would receive 6 million tax returns filed through the Free File
program, almost a million more compared to last year.

For 2006, IRS terminated the TeleFile program. IRS expected that
eliminating TeleFile would reduce electronic filing, but justified the
decision because of declining usage and relatively high costs. The number
of taxpayers using the program had been decreasing-from approximately 5.7
million in 1999 to 3.8 million in 2004. IRS estimated the cost per tax
return submitted through TeleFile, typically Form 1040EZ, to have been
$2.63 versus $1.51 for a return filed on paper, largely due to contractor,
telecommunications, and other costs. Given the limitations of IRS's cost
accounting system, the validity of these figures is unknown. IRS officials
stated that the reason for this year's increase in the number of 1040EZ
returns filed on paper is due, in part, to the elimination of TeleFile.
Through April 14, 2006, the number of 1040EZ returns filed on paper has
increased 20 percent from last year.

Options for increasing electronic filing, in particular mandated
electronic filing, will be discussed in the budget section of this
statement.

Telephone Access and Accuracy Improved, in Part Due to Lower Call Volume

Taxpayers' ability to access IRS's telephone assistors and the accuracy of
answers provided improved compared to previous years. From January 1
through April 15, 2006, IRS answered approximately 31 million phone calls,
which is about a 7 percent decline from the same period last year.12 The
call volume has been less than projected by IRS and less than was assumed
when IRS set staffing levels for telephone assistors for the filing
season. IRS officials offered several explanations for the unexpected
decline in call volume. One explanation is that more taxpayers are using
improved tax preparation software, which reduces their need to call IRS.
Another explanation is that more taxpayers are getting through to a
telephone assistor the first time they call, thus reducing the need for
taxpayers to call again.

As shown in table 1, the percentage of taxpayers who attempted to reach an
assistor and actually got through and received service-referred to as the
level of service-is 83.3 percent so far this filing season compared to
81.7 percent over the same period last year-and greater than its 2006
fiscal year goal of 82 percent. According to IRS officials, one possible
explanation for the improvement in access is the decline in overall call
volume. When call volume decreases, taxpayers are likely to wait less time
to speak with an IRS telephone assistor. As a result, fewer taxpayers
would likely hang up, increasing the percentage of taxpayers who get
through to an assistor.

IRS also reported that, so far this filing season, the average speed of
answer (length of time taxpayers wait to get their calls answered) is down
51 seconds from the same time last year to 205 seconds, a decrease of
about 20 percent, and significantly better than IRS's 2006 fiscal year
goal of 300 seconds. IRS also reported that the rate at which taxpayers
abandoned their calls13 to IRS decreased from 12 percent to 9.7 percent
compared to the same period last year.

12Despite less demand overall, call volume increased from affected
taxpayers in federally-declared disaster areas. IRS maintains a special
services hotline (1-866-562-5227) to provide assistance on questions
related to hurricane relief and combat zone participation. Between January
1 and April 15, 2006, the hotline answered 63,203 calls, an increase of
195 percent over the same period in 2005. According to IRS officials, the
hotline received primarily combat zone calls in 2005 because there were so
few federally-declared disaster areas. Therefore, IRS officials attribute
the 2006 increase to the three major hurricanes in 2005.

Table 1: IRS Telephone Assistance Performance in the First Weeks of the
Filing Seasons, 2002 through 2006

Source: IRS.

a Total calls (i.e., calls answered by assistors and automation) and CSR
level of service are based on actual counts from January 1 to April 20,
2002; April 19, 2003; April 17, 2004; April 16, 2005; and April 15, 2006.

b From January 1 to April 20, 2002; April 19, 2003; April 17, 2004; April
16, 2005; and April 15, 2006.

cBased on a representative sample estimated at the 90 percent confidence
interval from January through March 2002, 2003, 2004, 2005, and 2006.

Using a statistical sampling process, IRS estimates that the accuracy of
telephone assistors' responses to taxpayers' tax law and account questions
improved compared to last year. IRS estimates its tax law accuracy rate to
be 90 percent, an increase of 1.9 percentage points over the same time
period last year, continuing an improvement since 2004.14 Additionally,
IRS estimates that the accuracy rate to taxpayers' inquiries about their
accounts, to be 92.9 percent this year compared to 91.6 percent over the
same period last year, continuing an improvement since 2003. IRS officials
attribute these improvements in performance to several factors, including
better and more timely performance feedback for telephone assistors,
increased assistor experience, better training, and increased use of the
Probe and Response Guide, a script used by telephone assistors to
understand and respond to tax law questions.

13IRS divides abandoned calls into two subsets, primary abandons and
secondary abandons. Primary abandons occur when callers hang up before
being put into queue to wait for an available assistor. Secondary abandons
are the number of callers who hang up after being put into the queue to
wait for an assistor. In November 2004, IRS established a program to help
determine where primary abandons occur within the IRS scripts. According
to IRS officials, looking at the number and percentage of where callers
hang up highlights opportunities where IRS can improve its menu prompt
phrasings in a way that would be more beneficial for callers.

14IRS's customer account and tax law accuracy rates are estimated from
representative samples. Based on these estimates, accuracy rates for 2006
were statistically better than those of 2005.

IRS's Web Site Is Being Used More, Is Performing Well, and Has Been Reconfigured
with the Goal of Improving Taxpayer Service

Use of IRS's Web site has increased so far this filing season compared to
prior years based on the number of visits and downloads. From January 1
through March 31, IRS's Web site was visited 95 million times by visitors
who downloaded 90 million forms and publications. The number of visits
reflects a 7.5 percent increase over the same period last year while the
number of forms and publications downloaded has increased by 34 percent.

Further, IRS's Web site is performing well. For example,

           o  we found IRS's Web site to be readily accessible, easy to
           navigate, and easy to search,

           o  an independent weekly study by Keynote, a company that
           evaluates Web sites, reported that IRS's Web site has repeatedly
           ranked second out of 40 government agencies evaluated in terms of
           average download time. The same study also reported that IRS has
           repeatedly ranked first out of the most commonly accessed
           government related Web sites for response time and success rate,
           and

           o  the American Consumer Satisfaction Index overall customer
           satisfaction with IRS's Web site increased from 68 to 72 percent
           after IRS reconfigured the site.

IRS reconfigured its Web site for the 2006 filing season. According to IRS
officials, the goal for reconfiguring the Web site was to improve overall
customer service through easier navigation and a more effective search
function. As a result, the number of Web site searches has decreased by 51
percent, from 108 million during the same period last year to 52.5 million
this year. Typically, search functions are used when users fail to find
information through links. According to IRS officials, the decrease in the
number of searches indicates that users are finding the information that
they need faster.

IRS also added the following new features to its Web site this year:

           o  Electronic IRS: The Electronic IRS brand reconfigured the IRS's
           Web site and made it easier to locate items, as evidenced by the
           decline in searches;

           o  Alternative Minimum Tax (AMT) Assistant: Helps taxpayers
           determine if they do not owe AMT; and

           o  Help for Hurricane Victims: A special link that provides
           victims of the recent hurricanes information on special tax
           relief, assistance and how to get help with tax matters.

IRS's Web site continues to include several important features in addition
to the Free File program:

           o  Where's My Refund, which allows taxpayers to check on the
           status of their refunds. As of April 15, 2006, 24 million
           taxpayers accessed the Where's My Refund feature to check on the
           status of their tax refunds. This was a 17 percent increase from
           the same period last year; and

           o  Electronic Tax Law Assistance, where taxpayers can ask IRS
           general tax law questions via its Web site. From January 1 through
           April 14, 2006, IRS received 10,160 emails requesting tax law
           assistance (down over 43 percent compared to last year). As of
           March 31, 2006, IRS estimated the accuracy rate of IRS's responses
           to tax law questions submitted via the Web site, to be 85 percent,
           similar to 2005. However, the average number of days that it took
           IRS to respond to tax law questions submitted via the Web site was
           2.2 days, compared to 1.2 days in 2005.

Taxpayers Continue Their Recent Pattern of Using IRS's Walk-In Sites Less and
Using Volunteer Sites More, And Information About the Quality of Service Remains
Limited

Fewer taxpayers have used IRS's 400 walk-in sites so far in the 2006
filing season compared to the same period in prior years. Staff at walk-in
sites provide taxpayers with information about their tax accounts and
answer taxpayers' questions within a limited scope of designated tax law
topics, such as those related to income, filing status, exemptions,
deductions, and related credits.15 Walk-in site staffs also provide
need-based tax return preparation assistance, limited to taxpayers meeting
certain requirements.16 As of April 1, 2006, the total number of contacts
at IRS's walk-in sites declined by approximately 12 percent compared to
last year. The decline thus far this year is consistent with the annual
trends in walk-in use shown in figure 2, including IRS's projection for
2006. The declines in the number of taxpayers using IRS's walk-in sites,
including for tax return preparation, are also consistent with IRS's
strategy to reduce its costly face-to-face assistance by providing
taxpayers with additional options, such as IRS's toll-free telephone
service, Web site, and numerous volunteer sites. It is unclear, however,
whether the declining volume is an indicator of how well IRS is meeting
taxpayers' demand for face-to-face assistance. For example, IRS does keep
track of the number of taxpayers entering a walk-in site, taking a number
to queue for service, but then leaving the site without receiving service.
If a taxpayer did not take a number, IRS would have no way of counting
those taxpayers.

IRS officials said the types of services offered at walk-in sites remained
constant for most sites from 2005 to 2006. For sites in areas with a high
number of natural disaster victims, IRS expanded the types of assistance
provided. For example, IRS adjusted the type of tax law questions that it
would answer at walk-in sites to include casualty loss and removed income
limitations for disaster victims seeking return preparation assistance at
walk-in sites.

15IRS considers some tax law questions to be out of scope related to
businesses and corporations, for example. If staff cannot answer
taxpayer's questions, they are required to refer taxpayers to IRS's
telephone service or Web site.

16Return preparation assistance is limited to taxpayers with income of
$38,000 or less. According to IRS, this limitation approximates the amount
set in the tax code for claiming the Earned Income Tax Credit. IRS has
required appointments for most taxpayers seeking this assistance since
2003.

Figure 2: Assistance Provided at IRS Walk-in Sites and Volunteer Sites,
2001 - 2006 Filing Seasons (contacts in millions)

Note: "Other walk-in contacts" includes assistance for account notices,
tax law inquiries, forms, and compliance work, but not return preparation.
For the walk-in sites, the time periods covered are December 31, 2000,
through April 28, 2001; December 30, 2001, through April 27, 2002;
December 29, 2002, through April 26, 2003; December 28, 2003, through
April 24, 2004; and December 26, 2004, through April 23, 2005. For
volunteer sites, the time period covered for 2001 is January 1, 2001,
through April 21, 2001; December 30, 2001, through April 27, 2002;
December 29, 2002, through April 26, 2003; December 28, 2003, through
April 24, 2004; and December 26, 2004, through April 23, 2005.

aFiscal years 2006 and 2007 are IRS projections. For walk-in sites,
projections cover the time periods of December 25, 2005 through April 22,
2006, and December 31, 2006 through April 28, 2007. For volunteer sites,
projections cover the time periods from January 1 through April 30, 2006
and 2007.

In contrast to IRS walk-in sites, the number of taxpayers seeking return
preparation assistance at approximately 14,000 volunteer sites has
increased this year by 8.7 percent, continuing the trend since 2001 (see
fig. 2). These sites, often run by community-based organizations and
staffed by volunteers who are trained and certified by IRS, do not offer
the range of services IRS provides at walk-in sites, but instead focus on
preparing tax returns primarily for low-income and elderly taxpayers and
operate chiefly during the filing season. As we have previously
reported,17 the shift of taxpayers from walk-in to volunteer sites is
important because it has allowed IRS to transfer time-consuming services,
such as return preparation, from IRS to other less costly alternatives
that can be more convenient for taxpayers.

IRS has used both walk-in and volunteer sites to provide relief efforts
for federally-designated disaster zones such as in hurricane-affected
areas. IRS developed a Disaster Referral Services Guide and new training
materials for employees to better equip them to address disaster-related
issues. In addition to the expanded services for disaster victims at IRS
walk-in sites noted above, volunteer sites performed outreach within their
network of partners by creating training material for tax preparers, and
agreeing with two organizations to accept referrals from IRS of disaster
victims needing tax return preparation assistance.

IRS continues to lack reliable data on the quality of the services
provided at walk-in and volunteer sites. As in previous years, TIGTA is
conducting an audit on the accuracy of some services provided at walk-in
sites, although the results will not be available until after the filing
season. However, TIGTA has noted problems with the quality of services
provided at IRS walk-in sites in prior reports.18 We have made
recommendations for IRS to improve its quality measurement at walk-in
sites.19 At volunteer sites, IRS is conducting different types of reviews
to monitor tax return preparation assistance.20 According to IRS
officials, the results to date show that the quality of service has
improved at volunteer sites compared to previous years, but they
acknowledge that challenges remain in terms of volunteers' adherence to
IRS's procedures and use of IRS materials. As in previous years, TIGTA
will conduct limited quality reviews at volunteer sites. While the results
of those reviews are based on a judgmental sample, TIGTA has concluded in
the past that, while significant improvements have been made in the
oversight of volunteer sites, continued effort is needed to ensure the
accuracy of tax return assistance provided.21

17GAO, Tax Administration: IRS Improved Performance in the 2004 Filing
Season, but Better Data on the Quality of Some Services Are Needed,
GAO-05-67 (Washington, D.C.: Nov. 15, 2004).

18Treasury Inspector General for Tax Administration, Coordination and
Monitoring Are Needed for Continued Improvement in the Tax Return
Preparation Process at the Taxpayer Assistance Centers, Reference No.
2004-40-147, (Washington, D.C.: 2005), and  Treasury Inspector General for
Tax Administration, Customer Accuracy at Taxpayer Assistance Centers
Showed Little Improvements During the 2005 Filing Season, Reference No.
2005-40-146, (Washington, D.C.: 2003).

19See GAO-05-67 and GAO-06-51 .

20The different types of reviews include site reviews to measure the
administrative aspects of a volunteer site such as readiness. IRS plans on
conducting 825 of these site reviews. IRS also plans on conducting 2,475
return reviews, approximately 3 during each site review, which will
involve on-site review of the return for accuracy and discretionary
reviews for problem sites not operating in accordance with the IRS's
guidelines.

Taxpayers Using Chain Paid Tax Preparers May Receive Incorrectly Completed Tax
Returns

In addition to service from IRS, millions of taxpayers receive service,
such as tax return preparation, from paid preparers. About 56 percent of
about 130 million individual tax returns filed for tax year 2002 used a
paid tax preparer, with higher paid preparer usage among taxpayers with
more complicated returns.22

We recently reported, however, that some preparers make serious errors
when completing returns. Based on our very limited sample of 19 paid tax
preparers, taxpayers who rely on tax preparers to provide them with
accurate, complete, and fully compliant tax returns may not get what they
pay for. For example, during visits to paid preparers, tax returns
prepared for GAO often varied widely from what we determined the returns
should and should not include, sometimes with significant consequences.
Their work resulted in unwarranted extra refunds of up to almost $2,000 in
5 instances, while in 2 cases they cost the taxpayer over $1,500.

Some of the most serious problems involved paid preparers:

           o  not reporting business income in 10 of 19 cases;
           o  not asking about where a child lived or ignoring GAO's answer
           to the question therefore allowing an ineligible child to be
           claimed for the Earned Income Tax Credit in 5 out of the 10
           applicable cases;
           o  failing to take the most advantageous postsecondary education
           tax benefit in 3 out of the 9 applicable cases; and
           o  failing to itemize deductions at all or failing to claim all
           available deductions in 7 out of the 9 applicable cases.

21Treasury Inspector General for Tax Administration, Significant
Improvements Have Been Made in the Oversight of the Volunteer Income Tax
Assistance Program, but Continued Effort Is Needed to Ensure the Accuracy
of Services Provided, Reference No. 2006-40-004, (Washington, D.C.: 2005).

22 As noted in our report, complicated returns are defined as those using
the Form 1040 as opposed to the Form 1040EZ, those claiming itemized
deductions and not the standard deduction, and those claiming the earned
income credit.

Many of the problems we identified put paid preparers, taxpayers, or both
at risk of IRS enforcement actions. According to IRS officials, paid
preparers and taxpayers risk enforcement action by filing a tax return
that includes the types of misstatements or omissions we reported.
According to the officials, if IRS were to uncover problems with the
preparation of real tax returns similar to several that we found, the
preparers would be subject to civil sanctions. If an erroneous return was
prepared, in addition to paying the correct tax due and any related late
payment interest, the taxpayer may also be assessed a penalty, depending
on the facts and circumstances of each situation, according to IRS
officials. For example, if taxpayers substantially understate income,
overstate deductions, or provide other incorrect information resulting in
decreased tax or improperly high refunds, they may be assessed an
accuracy-related penalty. The penalty could be assessed for any failure to
comply with the tax laws, including the failure to report self-employment
income (further discussion on the consequences of the errors of paid tax
preparers is provided in the discussion on the tax gap).

    IRS's Budget Proposes Decreases in Staffing and Identifies Savings, but
                   Opportunities for Additional Savings Exist

IRS's fiscal year 2007 budget request is a small decrease compared to 2006
enacted levels after adjusting for expected inflation. It proposes to
reduce overall staffing levels, as well as staffing levels for taxpayer
service and enforcement activities, while maintaining or improving
taxpayer service and enforcement. As it has in prior years, IRS has
identified some savings, but additional opportunities exist for enhancing
savings.

IRS's Budget Proposes Decreases in Funding After Adjusting for Expected
Inflation and in Staffing

IRS's proposed fiscal year 2007 budget is $11 billion (a 1.6 percent
increase), but after adjusting for expected inflation, it reflects a
slight decrease over last year's enacted budget. The $11 billion includes
$417 million from new and existing user fees and reimbursable agreements
with other federal agencies.23 The 2007 budget request for IRS's
appropriation accounts is shown in table 2 (see app. II for more
details).24

Table 2: IRS's Changes in Funding and FTEs for Fiscal Years 2006 through
2007

Source: GAO analysis of IRS data.

Notes: For fiscal year 2007, the figures shown for requested FTEs reflect
an IRS adjustment and differ slightly from what IRS reported in its budget
request. The Congressional Budget Office projects the inflation rate to be
1.8 percent in 2007; therefore, IRS's proposed increases are less than the
rate of inflation.

aReimbursables are payments IRS receives for providing services to other
federal agencies and states.

The real decrease in the proposed budget can be seen in staffing. IRS
proposes to fund 95,476 FTEs in fiscal year 2007, down over 2 percent from
97,754 FTEs in enacted fiscal year 2006 (see table 5 in app. II for
comparisons in enacted FTE levels for fiscal years 2002 through 2007).
Actual FTEs tend to be lower than enacted FTEs, in part, because of how
IRS absorbs unbudgeted costs (see table 6 in app. II for actual FTEs).

23According to IRS, the $417 million estimate is based on receiving $135
million from increasing existing user fees and establishing new ones. IRS
has committed to distributing the $135 million over its PAM, TLE, and IS
accounts, exclusively for taxpayer service. The remaining user fees will
be used as needed by IRS.

24The PAM appropriation account primarily funds functions related to
taxpayer service which includes funding for enforcement; TLE primarily
funds enforcement activities but includes funding for taxpayer services;
IS funds information technology support and improvements for legacy
systems which support both taxpayer services and enforcement; BSM funds
the new modernized business system; and HITCA administers a refundable tax
credit for health insurance for qualified individuals. We did not review
the HITCA account as part of our work.

The decrease in FTEs may be greater than shown in IRS's fiscal year 2007
budget request. Every year agencies, including IRS, are expected to absorb
some costs that are not included in their budget requests. For fiscal year
2007, IRS officials currently anticipate having to absorb over $117
million in costs, including about $41 million for homeland
security-related controls over physical access to government facilities.
Absorbing such costs reduces the actual number of FTEs that IRS can
support. For example, for fiscal year 2005, the enacted level of FTEs was
96,435 but the actual level was 94,282.

  IRS's Budget Request Proposes to Maintain or Improve Taxpayer Services with
  Fewer Resources

IRS is requesting $4.2 billion for PAM, including some user fees, which is
funding primarily spent on providing service to taxpayers.25 The amount
requested is about a 1.6 percent increase over fiscal year 2006 enacted
levels, but is a slight decrease after adjusting for expected inflation.
This funding level translates into reduced staffing, down over 4 percent
from an enacted level of 38,796 FTEs in fiscal year 2006 to 37,126
proposed FTEs in fiscal year 2007. Since fiscal year 2002, FTEs devoted to
PAM have declined over 15 percent from an enacted level of 43,866 FTEs.

Despite the proposed inflation-adjusted decrease in funding in 2007, IRS
is planning to maintain or improve taxpayer services. For every one of the
major taxpayer services listed in the budget, 2007 planned performance
goals are higher or equal to 2006 performance goals. These services
include telephone assistance and refund issuance.

25IRS has funding in other appropriation accounts that support its
taxpayer service programs.

  IRS's Budget Request Reduces Enforcement Staffing Slightly, While Increasing
  Major Enforcement Activities

IRS is requesting $4.8 billion for TLE. 26 The 2007 budget request
proposes an overall decrease in enforcement FTEs, down over 2 percent to a
proposed 49,479 FTEs from last year's enacted level of 50,559 FTEs. For
its three main categories of skilled enforcement staff, IRS is proposing a
marginal increase in staffing of 0.2 percent (see fig. 3). For special
agents (those who perform criminal investigations), the increase is 1.7
percent. For the other two categories-revenue agents (those who examine
complex returns), revenue officers (those who perform field collection
work)-IRS is proposing to keep the number of staff the same as in 2006.

26In his recent testimony, the IRS Commissioner said that if the Congress
failed to provide funding outside the program integrity cap adjustment it
could potentially jeopardize past gains. This year, IRS is seeking $137
million outside the cap.

Figure 3: Revenue Agents, Revenue Officers, and Special Agents, Fiscal
Years 1998- 2007

Notes: Numbers for 2006 and 2007 are IRS estimates. IRS recalculated the
figures since GAO reported them last year. GAO is using the new figures
because IRS has validated those figures using its new cost accounting
system.

Despite keeping skilled enforcement staff virtually unchanged, IRS is
proposing to maintain or increase its major enforcement activities. For
all the major enforcement activities listed in the budget, IRS is
establishing goals in 2007 that are higher or equal to 2006 planned
performance goals. Major enforcement activities include individual
taxpayer examinations, collection coverage,27 and criminal investigations
completed. IRS officials anticipate increased revenue collected and other
performance improvements as a result of using data from IRS's most current
compliance research effort, known as the National Research Program
(NRP).28

27The number of collection cases closed or otherwise eliminated compared
to the total number of collection cases in inventory.

  Budget Request for IS Funding is Up Slightly, and IRS Has Taken Additional
  Steps to Improve Budgeting for IS Operations and Maintenance

IRS is requesting about $1.6 billion for IS in fiscal year 2007, which is
intended to fund information technology (IT) staff and related costs for
activities such as information security and maintenance and operations of
its current tax administration systems. Although the number of FTEs
proposed in 2007 is up when enacted FTEs are considered, it is virtually
the same as the operating level currently assumed in 2006 (see app. II for
more details).

In 2002, we reported that the agency did not develop its fiscal year 2003
IS operations and maintenance budget request in accordance with the
investment management approach used by leading organizations. We
recommended that IRS prepare its future budget requests in accordance with
these best practices.29 To address our recommendation, IRS agreed to take
a variety of actions, which it has made progress in implementing. For
example, IRS planned to develop a capital planning guide to implement
processes for capital planning and investment control, budget formulation
and execution, business case development, and project prioritization. In
August 2005, IRS issued the initial version of its IT Capital Planning and
Investment Control (CPIC) Process Guide, which (1) provides executives
with the framework within which to select, control, evaluate, and maintain
the portfolio of IT investments to best meet IRS business goals and (2)
defines the governance process that integrates the agency's IT investments
with the strategic planning, budgeting, and procurement processes.
According to IRS officials and documentation, the agency formulated its
prioritized fiscal year 2007 IT portfolio and associated budget request,
including operations and maintenance requirements, in accordance with this
CPIC Process Guide. We will continue to monitor the implementation of
IRS's CPIC process as its IT investment management process matures.

28 NRP replaced the Taxpayer Compliance Measurement Program, which last
measured compliance for individuals for 1988 but was canceled because of
concerns about costs and burdens on taxpayers. GAO, Tax Administration:
New Compliance Research Effort Is on Track, but Important Work Remains,
GAO-02-769 (Washington, D.C.: June 27, 2002) and Tax Administration:
Status of IRS' Efforts to Develop Measures of Voluntary Compliance,
GAO-01-535 (Washington, D.C.: June 18, 2001) discuss the development of
the NRP study.

29GAO, Internal Revenue Service: Improving Adequacy of Information Systems
Budget Justification, GAO-02-704 (Washington, D.C.: June 28, 2002).

In addition, IRS stated that it planned to develop an activity-based cost
module to plan, project, and report costs for business tasks/activities
funded by the IS budget. During fiscal year 2005, as part of the first
release of the Integrated Financial System (IFS),30 IRS implemented a cost
module that is potentially capable of allocating costs by activity.
However, agency officials stated that they needed to accumulate 3 years of
actual costs to have the historical cost data necessary to provide a basis
for meaningful future budget estimates. Since then, according to the
Office of the Chief Financial Officer, IRS has (1) populated the cost
module with all actual fiscal year 2005 expenses; (2) identified the data
needed from IFS to support its budget requests; and (3) developed a system
to capture, test, and analyze the cost data to devise a standard
methodology to provide the necessary data from the cost module. IRS still
expects to have the requisite 3 years of historical cost data available in
time to support development of the fiscal year 2010 budget request.
Although IRS has made progress in implementing best practices in
developing its IS operations and maintenance budget, until IRS completes
the actions necessary to fully implement the activity-based cost module,
the agency will not be able to ensure that its request is adequately
supported.

  IRS's Proposed BSM Budget Reduction Could Impede Future Progress

BSM is a high-risk, highly complex effort that involves developing and
delivering a new set of information systems that are intended to replace
the agency's aging tax processing and business systems. The program is
critical to supporting IRS's taxpayer service and enforcement goals. For
example, BSM includes projects to allow taxpayers to file and retrieve
information electronically and to provide technology solutions to help
reduce the backlog of collections cases. It also helps IRS considerably in
providing the reliable and timely financial management information needed
to account for the nation's largest revenue stream and better enable the
agency to both determine and justify its resource allocation decisions and
budget requests.

IRS's fiscal year 2007 budget request of $167.3 million for the BSM
program reflects a reduction of about 15 percent (and even greater when
adjusted for expected inflation), or about $30 million, from the enacted
fiscal year 2006 budget of $197 million.

30IFS replaces aspects of IRS's core financial systems and is ultimately
intended to operate as its new accounting system of record. The first
release of this system became fully operational in January 2005.

Over the past year, IRS has made further progress in implementing BSM,
although some key projects did not meet short-term cost and schedule
commitments. During 2005 and the beginning of 2006, IRS deployed
additional releases of several modernized systems that have delivered
benefits to taxpayers and the agency, including CADE, e-Services (a new
Web portal and electronic services for paid tax preparers), and Modernized
e-File (a new electronic filing system). While three BSM project releases
were delivered within the cost and/or schedule commitments presented in
the fiscal year 2005 expenditure plan, others experienced cost increases
or schedule delays. For example, two IFS and Modernized e-File project
release segments experienced cost increases of 93 percent31 and 29
percent, respectively. As we have previously reported,32 the BSM program
has had a history of cost increases and schedule delays that have been
due, at least in part, to deficiencies in various management controls and
capabilities that have not yet been fully corrected. IRS is in the process
of implementing our prior recommendations to correct these deficiencies.

IRS has identified significant risks and issues that confront future
planned system deliveries. For example, according to IRS, schedule delays
and contention for key resources between multiple releases of CADE
necessitated the deferral of some functionality. This deferral, in
conjunction with additional recently reported risks and issues, may
negatively impact the cost, schedule, and functionality for future CADE
releases. The agency recognizes the potential impact of these project
risks and has developed mitigation strategies to address them. We will,
however, continue to monitor the various risks IRS identifies and the
agency's strategies to address them and will report any concerns.

IRS also has made additional progress in addressing high-priority BSM
program improvement initiatives during the past year, including
initiatives related to shifting the role of systems integrator from the
prime contractor to IRS and establishing requirements management
standards-an initiative on which we recently issued a report to you, Mr.
Chairman, and made a number of recommendations for improvement.33 IRS's
program improvement process appears to be an effective means of assessing,
prioritizing, and addressing BSM issues and challenges. However, much more
work remains for the agency to fully address these issues and challenges.

31IRS recently reported that it plans to redirect about $5 million of
unobligated funding from the IFS project to program management reserve,
which would reduce this cost overrun.

32For example, see GAO, Business Systems Modernization: Internal Revenue
Service's Fiscal Year 2005 Expenditure Plan, GAO-05-774 (Washington, D.C.:
July 22, 2005).

In addition, in response to our prior recommendation, IRS is developing a
new Modernization Vision and Strategy to address BSM program changes and
provide a modernization roadmap. According to the Associate Chief
Information Officer for BSM, the agency's new strategy focuses on
promoting investments that provide value in smaller, incremental releases
that are delivered more frequently, with the goal of increasing business
value. IRS is currently finalizing a high-level vision and strategy as
well as a more detailed 5-year plan for the BSM program. We believe these
actions represent sound steps toward addressing our prior recommendation
to fully revisit the vision and strategy and develop a new set of
long-term goals, strategies, and plans consistent with the budgetary
outlook and with IRS's management capabilities. Further, this strategy is
important because it will describe how and when IRS will receive the full
benefits from its modernization efforts, such as when CADE will be able to
replace the Individual Master File.

While the requested fiscal year 2007 BSM budget will allow IRS to continue
the development and deployment of the CADE, Modernized e-File, and Filing
and Payment Compliance (F&PC)34 projects, the proposed reduced funding
level would likely affect the agency's ability to deliver the
functionality planned for the fiscal year and could result in project
delays and/or scope reductions. This could, in turn, impact the long-term
pace and cost of modernizing tax systems and of ultimately improving
taxpayer service and strengthening enforcement. For example, according to
IRS documents, the agency had planned to spend $85 million in fiscal year
2007 to develop and deploy additional CADE releases that would enable the
system to process up to 50 million individual tax returns by the 2008
filing season and issue associated refunds faster. However, with a
proposed budget of $58.5 million-over 30 percent less than anticipated-IRS
would likely have to scale back its planned near-term work on this
project. In addition, the reductions to the planned budgets for the
Modernized e-File and F&PC projects may also result in IRS having to
redefine the scope and/or reassess schedule commitments for future project
releases.

33GAO, Business Systems Modernization: IRS Needs to Complete Recent
Efforts to Develop Policies and Procedures to Guide Requirements
Development and Management, GAO-06-310 (Washington, D.C.: Mar. 20, 2006).

34F&PC is a series of projects expected to provide support for detecting,
scoring, and working nonfiler (filing compliance) and delinquency (payment
compliance) cases. The first phase of F&PC is Private Debt Collection,
which will use advanced software to analyze tax collection cases and
divide them into the complex cases requiring IRS involvement and the less
complex (balance due) cases that can be handled by private collection
agencies.

The proposed BSM budget reduction would also significantly reduce the
amount allotted to program management reserve by about 82 percent (from
$13 million in fiscal year 2006 to $2.3 million in fiscal year 2007). If
BSM projects have future cost overruns that cannot be covered by the
depleted reserve, this reduction could result in increased budget requests
in future years or delays in planned future activities.

While the BSM program still faces challenges, IRS has recently made
progress in delivering benefits and addressing project and program-level
risks and issues. Reducing BSM funds at a time when benefits to taxpayers
and the agency are being delivered could adversely impact the momentum
gained from recent progress and result in delays in the delivery of future
benefits. However, until IRS addresses our prior recommendation by clearly
defining its future goals for the BSM program as well as the impact of
various funding scenarios on meeting these goals in its new Modernization
Vision and Strategy, the long-term impact of the proposed budget reduction
is unclear.

IRS's Budget Request Identified Some Savings, but Opportunities Exist for
Enhancing Savings

In its 2007 budget request, IRS identified savings as it has done in prior
years and plans to redirect some of those savings to front-line taxpayer
service and enforcement activities. IRS is proposing to save over $121
million and 1,424 FTEs by, for example, automating the process of
providing an individual taxpayer identification number to those taxpayers
ineligible for a Social Security number and improving data collection
techniques and work processes for enforcement activities through increased
financial reporting requirements and scanning and imaging techniques.

IRS's history of realizing savings proposed in past budget requests
provides some confidence that the agency will be able to achieve savings
in fiscal year 2007. For example, IRS reported it realized 88 percent of
the anticipated dollar savings and 86 percent of the anticipated staff
savings identified in the fiscal year 2004 budget request. IRS also
reported exceeding the savings targets in the fiscal year 2005 budget
request (see app. III).

In addition to the areas identified by IRS in its budget request, there
may be additional opportunities for efficiency gains.

           o  Increasing electronic filing: In an era of tight budgets,
           continued growth in electronic filing may be necessary to help
           fund future performance improvements. One proposal for continuing
           to increase electronic filing is additional use of electronic
           filing mandates. Currently, IRS mandates electronic filing for
           large corporations. The 2007 budget request proposes a legislative
           change that would expand its authority to require electronic
           filing for businesses. Moreover, 12 states now mandate electronic
           filing for certain classes of tax preparers (see app. IV for more
           information on state mandates). As we have reported,35 although
           there are costs and burdens likely to be associated with
           electronic filing mandates for paid tax preparers and taxpayers,
           state mandates have generated significant increases in electronic
           filing. IRS has an electronic filing strategy, which the agency is
           updating.

           o  Changing the menu of taxpayer services: IRS currently lacks a
           comprehensive strategy explaining how its various taxpayer
           services (including its telephone, walk-in, volunteer, and Web
           site assistance) will collectively meet taxpayer needs. In
           response to a Congressional directive,36 IRS is developing such a
           strategy. The strategy is important because some taxpayers may not
           be well served by the current service offerings. IRS's attempts to
           reduce some taxpayer services, namely reducing the hours of
           telephone operations and closing some walk-in sites, have met with
           resistance from the Congress. Although congressional directives to
           study the impact of IRS's actions exist,37 we still believe there
           may be opportunities to adjust IRS's menu of services to reduce
           costs, without affecting IRS's ability to meet taxpayers' needs.

           o  Consolidating telephone call sites: IRS operates 25 call sites
           throughout the country. Consistent with earlier plans, IRS closed
           two of its smallest call sites-Chicago and Houston-in March 2006,
           to realize savings in its toll-free telephone operations. Also,
           IRS has gained efficiencies from using a centralized call router
           located in Atlanta. As a result, there are currently more than 850
           workstations that are not being used; consequently, IRS may have
           the potential to close several additional call sites.
           Consolidations would not affect telephone service and would be
           invisible from the taxpayer's perspective.

35 GAO-06-51 .

36In the H.R. Conf. Rep. No. 109-307 (2005), the Congress directed the
IRS, in conjunction with the IRS Oversight Board and the National Taxpayer
Advocate, to develop a 5-year plan for taxpayer service activities and
report to the House and Senate Committees on Appropriations by April 14,
2006. According to IRS officials, the Department of the Treasury has
reviewed an initial report; that report is now under review at the Office
of Management and Budget, prior to being submitted to the Congress.

  Accurate Cost Information Would Help IRS Make Resource Allocation Decisions,
  and Help Provide Some Information about the Return on Investment for its
  Programs

Managing a federal agency as large and complex as IRS requires managers to
constantly weigh the relative costs and benefits of different approaches
to achieving the goals mandated by the Congress. Management is constantly
called upon to make important long-term strategic as well as daily
operational decisions about how to make the most effective use of the
limited resources at its disposal. As constraints on available resources
increase, these decisions become correspondingly more challenging and
important. In order to rise to this challenge, management needs to have
current and accurate information upon which to base its decisions, and to
enable it to monitor the effectiveness of actions taken over time so that
appropriate adjustments can be made as conditions change.

In its ongoing effort to make such increasingly difficult resource
allocation decisions and defend those decisions before the Congress, IRS
has long been hampered by a lack of current and accurate information
concerning the costs of the various options being considered. Instead,
management often has relied on a combination of the limited existing cost
information; the results of special analysis initiated to establish the
full cost of a specific, narrowly defined task or item; and estimates
based on the best judgment of experienced staff. This has impaired IRS's
ability to properly decide which, if any, of the options at hand are worth
the cost relative to the expected benefits. For example, accurate and
timely cost information may help IRS consider changes in the menu of
taxpayer services that it provides by identifying and assessing the
relative costs, benefits, and risks of specific projects. Without reliable
cost information, IRS's ability to make such difficult choices in an
informed manner is seriously impaired and IRS cannot prepare cost-based
performance measures to assist in measuring the effectiveness of its
programs over time.

37In Pub. L. No. 109-115, S: 205, (Nov. 30, 2005), the Congress directed
the IRS not to reduce taxpayer services as the IRS proposed in fiscal year
2006 until TIGTA completed a study on the impact of such reductions on
taxpayer compliance and services. Further, IRS was directed, to consult
with stakeholder organizations, including, but not limited to, the IRS
Oversight Board, National Taxpayer Advocate, TIGTA and Internal Revenue
employees with respect to any efforts by the IRS to terminate or reduce
significantly any taxpayer service activity. Pub. L. No. 109-148, S: 5021
(Dec. 30, 2005) extends above provisions to include any reduction in
available hours of telephone taxpayer assistance below the levels in
existence during the month of October 2005. In March 2006, TIGTA released
its study on IRS's plans to close 68 of its 400 walk-in sites, concluding
that in IRS's plan was based on inaccurate data (see Treasury Inspector
General for Tax Administration, The Taxpayer Assistance Center Closure
Plan Was Based on Inaccurate Data, Reference No. 2006-40-061 (Washington,
D.C.: 2005)).

Further, IRS does not have the capability to develop reliable information
on the return on investment for each category of taxpayer service and
enforcement. IRS lacks reliable information on both the return from
services (the additional revenue collected by helping taxpayers understand
their tax obligations) and the investment or cost of the services. While
developing return on investment information is difficult, the cost
component of that equation may be the least complex to develop. Having
such cost information is a building block for developing return on
investment estimates. For its enforcement programs, IRS has developed a
rough measure of return on investment in terms of tax revenue that is
directly assessed from uncovering noncompliance. Continuing to develop
return on investment measures could help officials make more informed
decisions about allocating resources.38 Even without return on investment
information, cost information can help IRS determine if, for example, IRS
should change the menu of services provided.

As discussed in the BSM section, in fiscal year 2005, IRS implemented a
cost accounting module as part of IFS. However, while this module has much
potential and has begun accumulating cost information, IRS has not yet
determined what the full range of its cost information needs are or how
best to tailor the capabilities of this module to serve those needs. Also,
IRS does not have an integrated workload management system which would
provide the cost module with detailed allocation of personnel cost
information.39 In addition, as noted in developing its IS budget, because
it generally takes several years of historical cost information to support
meaningful estimates and projections, IRS cannot yet rely on IFS as a
significant planning tool. It will likely require several years,
implementation of additional components of IFS, and integration of IFS
with IRS's tax administration activities before the full potential of
IFS's cost accounting module will be realized. Furthermore, IRS's fiscal
year 2007 BSM budget request does not include funding for additional
releases of IFS. In the interim, IRS decision making will continue to be
hampered by inadequate underlying cost information.

38Developing such measures is difficult because of incomplete information
on all the costs and all the tax revenue ultimately collected from
specific enforcement efforts, as well as incomplete information on the
indirect tax revenues generated when current enforcement actions prompt
voluntary compliance improvements in the future.

 IRS Sets Long-Term Goals, but Lacks a Data-Based Plan for Achieving the Goals,
 and Addressing the Tax Gap Requires Solutions Beyond Funding and Staffing for
                                      IRS

For the first time, IRS's budget request sets long-term goals aimed at
reducing the tax gap, although IRS does not have a data-based plan for
achieving the goals. However, because of its persistence, reducing the tax
gap requires solutions which go beyond funding and staffing for IRS.

IRS's Budget Proposes Long-Term Goals, but Lacks a Data-Based Plan for Achieving
Them

IRS established two agencywide, long-term performance goals, as shown in
table 3. IRS plans to improve voluntary compliance from 83 percent in 2005
to 85 percent by 2009, and reduce the number of taxpayers who think it is
acceptable to cheat on their taxes from 10 percent in 2005 to less than 9
percent in 2010. According to IRS, these are the first in a series of
quantitative goals that will link to its three strategic goals-improve
taxpayer service, enhance tax law enforcement, and modernize IRS through
technology and processes.

39 IRS had planned to develop a workload management system, but has
postponed this project indefinitely, due to budget constraints.

Table 3: IRS Agencywide Goals for Fiscal years 2004 through 2010

Source: IRS.

These goals will be challenging to meet, because for three decades, IRS
has consistently reported a persistent, relatively stable tax gap.
Although IRS has made a number of changes in its methodologies for
measuring the tax gap, which makes comparisons difficult, regardless of
methodology used, the voluntary compliance rate that underpins the gap has
tended to range from around 81 percent to around 84 percent.

Because of a lack of quantitative estimates of how changes to its service
and enforcement programs affect compliance, IRS is unable to show in a
data-based plan how it will use those programs to reach the two long-term
goals shown in table 3. If IRS could quantify the impact of its service
and enforcement programs on the compliance rate or attitudes towards
cheating, it could use the information to show the kinds of changes to the
programs needed to achieve the long-term goals and how best to direct
resources towards achieving those goals. Unfortunately, quantifying the
impact of IRS's service and enforcement programs on compliance or cheating
is very challenging. The type of data needed to make such a link does not
currently exist, and may not be easy to collect.

Lacking such quantitative estimates, IRS must take a more qualitative
approach in its plans for increasing compliance, which would likely also
involve changing attitudes towards cheating. IRS's overall approach to
reducing the tax gap consists of improving service to taxpayers and
enhancing enforcement of the tax laws. We recently reported that IRS has
taken a number of steps that may improve its ability to reduce the tax
gap.40 Favorable trends in staffing of IRS enforcement personnel;
examinations performed through correspondence, as opposed to more complex
face-to-face examinations; and the use of some enforcement sanctions such
as liens and levies are encouraging. Also, IRS has made progress with
respect to abusive tax shelters through a number of initiatives and recent
settlement offers that have resulted in billions of dollars in collected
taxes, interest, and penalties. Finally, IRS has continually improved
taxpayer service by increasing, for example, the accuracy of responses to
tax law questions.

The effect of this overall approach and the 2007 budget proposal will have
on voluntary compliance has not been quantified by IRS. Therefore, the
Congress will have to rely on the IRS Commissioner for qualitative
explanations, of why, in his judgment, IRS's mix of taxpayer service and
enforcement and overall approach for reducing the tax gap, including the
2007 budget proposal, will be sufficient to start IRS on a path towards
achieving its long-term goals. More specifically, such explanations could
include a clear statement of which service and enforcement programs have
priorities for expansion because they are expected to contribute the most
to increasing the compliance rate and the evidence that supports that
judgment.

In addition, IRS lacks a plan for measuring progress towards one
goal-improving voluntary compliance. IRS plans to measure progress towards
the second goal-reducing the percentage of taxpayers who think it is
acceptable to cheat-via the IRS Oversight Board's annual Taxpayer Attitude
Survey.

Nevertheless, IRS recently estimated voluntary compliance as part of the
NRP study, which reviewed the compliance of a random sample of individual
taxpayers and used those results to estimate compliance for the population
of all taxpayers. The study took several years to plan and execute. In
addition to providing an estimate of the compliance rate, the study's
results will be used to better target IRS's audits of potentially
non-compliant taxpayers. Better targeting reduces the burden on taxpayers
because IRS is better able to avoid auditing compliant taxpayers.

40 GAO-06-453T .

At this time, however, IRS has not made plans to repeat the study in time
to measure compliance by 2009. Furthermore, doing compliance studies once
every few years does not give IRS or others information about what is
happening in the intervening years. Annual estimating of the compliance
rate could provide information that would enable IRS management to adjust
plans as necessary to help achieve the goal in 2009. One option that would
not increase the cost of estimating compliance would be to use a rolling
sample. IRS Oversight Board officials and we agree that instead of
sampling, for example, once every 5 years, one-fifth of the sample could
be collected every year. The total sample could include 5 years worth of
data-with each passing year the oldest year would be dropped from the
sample and the latest year added. The availability of current research
data would allow IRS to more effectively focus its service and compliance
efforts.

Addressing the Tax Gap Requires Solutions Beyond Funding and Staffing for IRS

For years, we have reported that tax law enforcement is a high-risk area,
in part because of the size of the gross estimated tax gap, which IRS most
recently estimated to be $345 billion for tax year 2001. IRS estimated it
would recover around $55 billion through late payments and enforcement
revenue, resulting in a net tax gap of around $290 billion.41 Reducing the
tax gap would yield significant revenue and even modest progress, such as
a 1 percent reduction, would likely yield nearly $3 billion annually. In
recent years, IRS reported increases in enforcement revenue-revenue
brought in as a result of IRS taking enforcement action. Between fiscal
years 2003 and 2005, IRS reported that enforcement revenue grew from $37.6
billion to $47.3 billion, with a level of $48.1 billion estimated for
2006. However, the voluntary compliance rate has persisted at a relatively
stable level.

Further, GAO recently reported that tax returns prepared by paid tax
preparers often contained errors such as unwarranted extra refunds and
underreported income. These findings are consistent with NRP data which
indicate that tax returns prepared by paid preparers contained a
significant level of errors. These errors, whether they are the fault of
the preparer or the result of taxpayers providing incomplete or inaccurate
information, contribute to the tax gap.

41 GAO-06-453T .

We have reported that significant reductions in the tax gap will likely
require exploring new and innovative solutions.42 Such solutions that may
not require significant additional IRS resources, but are nonetheless
difficult to achieve, include

           o  simplifying the tax code to make it easier for individuals and
           businesses to understand and comply with their tax obligations;

           o  increasing tax withholding for income currently not subject to
           withholding;

           o  improving information reporting; and

           o  leveraging technology to improve IRS's capacity to receive and
           process tax returns.

IRS's 2007 budget request includes five new legislative proposals to
address some of these solutions to reduce the tax gap, along with a
proposal to study independent contractor compliance that would not require
additional resources. In recent testimony, the IRS Commissioner stated
that the amount of enforcement revenue IRS expects from the legislative
proposals will be $3.6 billion over the next 10 years (about 0.1 percent
of the tax gap). However, the proposals should also increase revenue
voluntarily paid without any IRS enforcement actions. The amount of that
revenue is uncertain. The IRS Commissioner recognizes the implications of
the tax gap and states in the budget that addressing it is a top priority.
Although IRS's 2007 budget request does not propose allocating IRS
resources to new initiatives to reduce the tax gap, according to IRS
officials, they plan to continue initiatives identified in prior budgets.
For example, IRS has two ongoing BSM projects-F&PC and Modernized
e-File-which, according to IRS's Associate Chief Information Officer for
BSM, could help reduce the tax gap. F&PC is expected to increase IRS's
capacity to resolve the growing backlog of delinquent taxpayer cases and
increase collections, while Modernized e-File is expected to help make it
easier for IRS to process tax returns, look for irregularities, and track
down unpaid taxes.

The budget request states that the administration will study the standards
used to distinguish between employees and independent contractors for
purposes of paying and withholding income taxes. We have long supported
efforts aimed at improving independent contractor compliance.43 Past IRS
data have shown that independent contractors report 97 percent of the
income that is reported on information returns to IRS, while contractors
that do not receive these information returns report only 83 percent of
income. We have also identified other options for improving information
reporting by independent contractors, including increasing penalties for
failing to file required information returns, lowering the $600 threshold
for requiring such returns, and requiring businesses to separately report
on their tax returns the total amount of payments to independent
contractors.44 We previously reported that clarifying the definition of
independent contractors and extending reporting requirements for those
contractors could possibly increase tax revenue by billions of dollars.45

42 GAO-06-453T .

Two of the legislative proposals call for more information reporting on
payment card transactions from certain businesses and on payments by
federal, state, and local governments to businesses. Information reporting
has been shown to significantly reduce noncompliance. Although information
reporting is highly effective in encouraging compliance, such reporting
imposes costs and burdens on the businesses that implement it. However,
information reporting is a way to significantly increase voluntary
compliance without increasing IRS's budget.

Mr. Chairman, this completes my prepared statement. I would be happy to
respond to any questions you or other members of the subcommittee my have
at this time.

                          Contacts and Acknowledgments

For further information regarding this testimony, please contact James R.
White, Director, Strategic Issues, on 202-512-9110 or [email protected]
David A. Powner, Director, Information Technology Management Issues, on
202-512-9296 or [email protected]. Contact points for our Offices of
Congressional Relations and Public Affairs may be found on the last page
of this statement. Individuals making key contributions to this testimony
include Joanna Stamatiades, Assistant Director; Amanda Arhontas; Paula
Braun; Terry Draver; Paul Foderaro; Chuck Fox; Tim Hopkins; Kathryn Horan;
Hillary Loeffler; Sabine Paul; Cheryl Peterson; Neil Pinney; Steve
Sebastian; Tina Younger.

43GAO, Tax Administration: Approaches for Improving Independent Contractor
Compliance, GAO/GGD-92-108 (Washington, D.C.: July 23, 1992).

44 GAO-06-453T .

45GAO, Opportunities for Congressional Oversight and Improved Use of
Taxpayer Funds, GAO-04-659 (Washington, D.C.: May 7, 2004).

Appendix I: Differences Between the 2002 and 2005 Free File Agreements

In 2002, Internal Revenue Service (IRS) entered into a 3-year agreement
with the Free File Alliance, a consortium of 20 tax preparation companies
to provide free electronic filing to taxpayers who access any of the
companies via a link on IRS's Web site. The 2002 Free File Agreement
stated that as part of the agreement, IRS would not compete with the
Consortium in providing free, online tax return preparation and filing
services to taxpayers.

IRS and the Consortium amended the agreement in 2005. Key differences
between the two agreements are: the new income limitation of $50,000 and
new language in the amendment that states the Alliance members must
disclose early on if state tax return services are available, and if so,
whether a fee will be charged for such services; and provide the necessary
support to accomplish a customer satisfaction survey. It also added
language pertaining to the marketing and offering of Refund Anticipation
Loans (RALs)1 whereby:

           o  No offer of free return preparation and filing of an electronic
           return in the free file program shall be conditioned on the
           purchase of a RAL; and
           o  RALs will be offered with clear language indicating, for
           example, that RALs are loans, not a faster way of receiving an IRS
           refund; must be repaid even if the IRS does not issue a full
           refund; are short-term loans interest rates may be higher and
           customers may wish to consider using other forms of credit; and
           may be offered but not promoted.

IRS tests each Consortium member's software to ensure it is in accordance
with the Free File provisions, including those cited previously, before
allowing a link to IRS's Web site. In addition, IRS officials monitor
complaints about the Free File program received via IRS.gov, including
allegations regarding false, deceptive, or misleading information or
advertising. While IRS does not track the number of complaints it
receives, according to IRS officials, most of the complaints received thus
far were a result of the taxpayer either not carefully reading or
following instructions, or incorrectly entering information. GAO conducted
limited testing of the Free File program and found that the Consortium
members were complying with the terms outlined in the amended Free File
agreement pertaining to RALs.

1 Refund Anticipation Loans are very short-term loans issued while
taxpayers wait for their refunds.

The amended Free File agreement contains provisions that enable IRS to
monitor taxpayer participation beginning in the 2006 filing season, unlike
prior years where Free File Alliance members self-reported filing figures.
IRS also tracks the number of free file users who are accepting any
financial products, such as RALs. As of April 17, IRS reported that
207,814 free file returns accepted financial products. This represents
about 5 percent of all returns filed through the Free File program.

The number of taxpayers using free file to electronically file their
individual income tax returns has increased steadily from 2.8 million in
2003, to 3.5 million in 2004, to 5.1 million in 2005. The substantial
growth between 2004 and 2005 was due to, in part, several Consortium
members offering free filing to all taxpayers through the free file
program regardless of their income in 2005. However, according to IRS
officials, the lack of income limitation created conflict among Consortium
members as it put pressure on all Alliance members to offer free service,
which may not have been economically feasible for some, threatening
competition if members were to drop out of the Alliance.

IRS projected that 6.1 million taxpayers would use free file in 2006.
However, this projection may be optimistic, because between January 1 and
April 13, IRS has reported receiving only 3.5 million free file returns
compared to 4.6 million during the same period last year, a decline of 24
percent. According to IRS officials, contributing factors to this decline
are, in part, due to decreased press attention and advertising by the
participating companies and the income limitation. The income limitation
provides coverage to 70 percent of the nation's taxpayers, or more than 92
million people. This coverage includes taxpayers with an adjusted gross
income of $50,000 or less.

Appendix II: Comparison of IRS's Actual and Enacted Funding and Full-Time
Equivalents, Fiscal Years 2002 through 2007

For fiscal year 2007, the Internal Revenue Service (IRS) has requested
$10.7 billion in its appropriation accounts. This request consists of
$10.6 billion in direct appropriations and $135 million in revenue from
new user fees, which IRS will commit to taxpayer service activities in its
Processing, Assistance, and Management (PAM), Tax Law Enforcement (TLE),
and Information System (IS) accounts. In addition, IRS is projecting to
collect and use $282 million from existing user fees and reimbursable
agreements with states and other federal agencies. This brings IRS's
proposed fiscal year 2007 budget to approximately $11 billion (a 1.6
percent increase over fiscal year 2006). After adjusting for expected
inflation, IRS's $11 billion budget request reflects a slight decrease
from last year's enacted budget.

IRS's enacted budgets for its appropriation accounts from fiscal years
2002 through 2007 are shown in table 4. IRS's enacted budget has increased
almost 8 percent since fiscal year 2002. By far, the biggest percentage
increase has been in TLE-almost 21 percent-and is reflective of the shift
in resources devoted to TLE from PAM during this period. The biggest
percentage decrease was in the Business Systems Modernization (BSM)
program, down almost 58 percent.

Table 4: IRS's Funding for Fiscal Years 2002 through 2007

Source: GAO analysis of IRS data.

Notes: Numbers may not add due to rounding. Fiscal year 2007 includes $135
million in new user fee revenue distributed in PAM, TLE, and IS accounts.
Without user fees, IRS is requesting $4,045,122 for PAM, $4,762,327 for
TLE, and $1,602,232 for IS.

Tables 5 and 6 show IRS's enacted and actual Full-time Equivalents (FTEs)
for fiscal years 2002 through 2007. Overall, actual FTEs tend to be lower
than enacted FTEs due in part to the way IRS funds its unbudgeted costs.
When both enacted and actual FTEs are considered, FTEs for PAM have
steadily decreased and, for the most part, FTEs for TLE have increased
since fiscal year 2002. However, steady trends are not apparent when
comparing enacted and actual FTEs in IRS's IS account. For example, when
enacted FTEs are considered, IS staffing appears to fluctuate up and down
between fiscal years 2002 through 2007; yet, when actual FTEs are
considered, IS staffing decreased from fiscal year 2002 through 2005 and
increased from fiscal years 2005 to 2006. IRS officials attribute these
fluctuations in FTEs to reorganizations and other factors.

Tables 5 and 6 also show significant differences in percentage changes
between enacted and actual FTEs in some of IRS's appropriations accounts
from fiscal years 2006 to 2007. The enacted level of FTEs is the number
IRS projected it could support given the level of funding the Congress
enacted. According to IRS officials, enacted levels tend to be overstated
compared to actual FTEs for several reasons. First, IRS, like most federal
agencies, does not receive its budgets when expected and cannot fill all
positions. Also, as the costs of maintaining current FTE levels increase
annually, IRS is not able to realize all of the FTEs it projects to fund
with the appropriations the Congress enacts.

Table 5: IRS's Enacted FTEs for Fiscal Years 2002 through 2007

Source: GAO analysis of IRS data.

Notes: Fiscal year 2007 requested FTEs reflect an adjustment after the
budget was printed. Also, we are not reporting FTEs for user fees and
reimbursable as shown in an earlier section of this statement, because we
were unable to obtain this information for all years in time for this
statement.

Table 6: IRS's Actual FTEs from Fiscal Years 2002 through 2007

Source: GAO analysis of IRS data.

Notes: Fiscal year 2007 requested FTEs reflect an adjustment after the
budget was printed. Also, we are not reporting FTEs for user fees and
reimbursable as shown in an earlier section of this statement, because we
were unable to obtain this information for all years in time for this
statement.

In its fiscal year 2006 budget request, IRS showed its budget distributed
by taxpayer services and enforcement, including IS funding for those
areas, because the agency's current appropriation accounts are not divided
clearly between taxpayer service and enforcement. As table 7 shows,
funding for enforcement increased 15 percent between fiscal years 2004 and
2007 to $6.96 billion, while funding for taxpayer service declined over 3
percent to almost $3.6 billion.

Table 7: IRS's Funding for Taxpayer Service and Enforcement for Fiscal
Years 2004 through 2007

Source: GAO analysis of IRS data.

Note: IRS's taxpayer service and enforcement programs are funded through
its PAM, TLE, and IS accounts.

Appendix III: IRS's Estimated and Actual Savings and Reinvestments

In its 2007 budget request, the Internal Revenue Service (IRS) is
proposing to save over $121 million and 1,424 Full-time Equivalents (FTEs)
and reinvest over $12 million and 11 FTEs. Based on IRS's ability to
achieve prior year savings and reinvestments as shown in table 8, we have
a basis to believe that IRS will achieve most, if not all, of these
savings. For example, IRS reported it realized 88 percent of its
anticipated budget savings and 86 percent of its anticipated staff savings
for savings identified in its fiscal year 2004 budget request, and IRS
reported exceeding savings targets in fiscal year 2005.

Table 8: IRS's Estimated and Actual Savings and Reinvestments for Fiscal
years 2004 through 2007

Source: GAO analysis of IRS data.

Note: Fiscal year 2007 FTE savings reflect an adjustment after the budget
was printed.

aIRS considers savings to be gained through process or systems
improvements and reinvestments to be those savings that were realized and
available for other purposes.

bIRS reported actuals for 2004 and 2005, and year-end projections for
2006.

Appendix IV: State Mandates

Of the 50 states, 12 have electronic filing mandates for tax preparers in
effect for the 2006 filing season (see fig. 4). The mandates differ in
their implementation dates and schedules, thresholds for filing, and
penalties. The differences between mandates may affect the magnitude of
electronic filing increases in each state.

Figure 4: States with Electronic Filing Mandates for Tax Preparers

We recently reported that state mandates encourage electronic filing of
federal tax returns and recommended that IRS develop better information
about the costs to paid tax preparers and taxpayers of mandatory
electronic filing of tax returns for certain categories of tax preparers.1
These mandates require tax practitioners who meet certain criteria, such
as filing 100 individual state tax returns or more, to file individual
state returns electronically.

1 GAO-06-51 .

Between tax years 2001 and 2004, electronic filing had grown in the 9
states with mandates from an average of 36.7 percent to 56.8 percent, or
an increase of over 20 percentage points, compared to an increase of 14
percentage points for the 41 non mandated states over the same time
period. We expect this trend to continue as 3 additional states-New York,
Utah and Connecticut-implemented mandates in time for the 2006 filing
season. Of these 3 states, New York may have the most to gain because it
currently has the lowest rate of electronic filing rate, with fewer than
38 percent of its nearly 9 million federal individual income tax returns
electronically filed last year.

Appendix V: Bibliography of GAO Resources

                           Filing Season Performance:

Tax Administration: IRS Improved Some Filing Season Services, but
Long-Term Goals Would Help Manage Strategic Trade-offs, GAO-06-51
Washington, D.C.: November 14, 2005.

Tax Administration: IRS Improved Performance in the 2004 Filing Season,
but Better Data on the Quality of Some Services Are Needed, GAO-05-67
Washington, D.C.: November 10, 2004.

Tax Administration: IRS's 2003 Filing Season Performance Showed
Improvements, GAO-04-84 Washington, D.C.: October 31, 2003.

IRS's 2002 Tax Filing Season: Returns and Refunds Processed Smoothly;
Quality of Assistance Improved, GAO-03-314 Washington, D.C.: December 20,
2002.

                             IRS's Budget Requests:

Internal Revenue Service: Assessment of Fiscal Year 2006 Budget Request,
GAO-05-566 Washington, D.C.: April 27, 2005.

Internal Revenue Service: Assessment of Fiscal Year 2006 Budget Request
and Interim Results of the 2005 Filing Season, GAO-05-416T Washington,
D.C.: April 14, 2005.

Internal Revenue Service: Assessment of Fiscal Year 2005 Budget Request
and 2004 Filing Season Performance, GAO-04-560T Washington, D.C.: March
30, 2004.

                            Tax Gap and Compliance:

Tax Gap: Making Significant Progress in Improving Tax Compliance Rests on
Enhancing Current IRS Techniques and Adopting New Legislative Actions,
GAO-06-453T Washington, D.C.: February 15, 2006.

Tax Gap: Multiple Strategies, Better Compliance Data, and Long-Term Goals
Are Needed to Improve Taxpayer Compliance, GAO-06-208T Washington, D.C.:
October 26, 2005.

Tax Compliance: Reducing the Tax Gap Can Contribute to Fiscal
Sustainability but Will Require a Variety of Strategies, GAO-05-527T
Washington, D.C.: April 14, 2005.

Taxpayer Information: Data Sharing and Analysis May Enhance Tax Compliance
and Improve Immigration Eligibility Decisions, GAO-04-972T Washington,
D.C.: July 21, 2004.

Compliance and Collection: Challenges for IRS in Reversing Trends and
Implementing New Initiatives, GAO-03-732T Washington, D.C.: May 7, 2003.

                          Financial Statement Audits:

Financial Audit: IRS's Fiscal Years 2005 and 2004 Financial Statements,
GAO-06-137 Washington, D.C.: November 10, 2005.

Internal Revenue Service: Status of Recommendations from Financial Audits
and Related Financial Management Reports, GAO-05-393 Washington, D.C.:
April 29, 2005.

Financial Audit: IRS's Fiscal Years 2004 and 2003 Financial Statements,
GAO-05-103 Washington, D.C.: November 10, 2004.

Internal Revenue Service: Status of Recommendations from Financial Audits
and Related Financial Management Reports, GAO-04-523 Washington, D.C.:
April 28, 2004.

Financial Audit: IRS's Fiscal Years 2003 and 2002 Financial Statements,
GAO-04-126 Washington, D.C.: November 13, 2003.

                        Business Systems Modernization:

Business Systems Modernization: IRS Needs to Complete Recent Efforts to
Develop Policies and Procedures to Guide Requirements Development and
Management, GAO-06-310 Washington, D.C.: March 20, 2006.

Business Systems Modernization: Internal Revenue Service's Fiscal Year
2006 Expenditure Plan, GAO-06-360 Washington, D.C.: February 21, 2006.

Business Systems Modernization: Internal Revenue Service's Fiscal Year
2005 Expenditure Plan, GAO-05-774 Washington, D.C.: July 22, 2005.

IRS Modernization: Continued Progress Requires Addressing Resource
Management Challenges, GAO-05-707T Washington, D.C.: May 19, 2005.

Business Systems Modernization: IRS's Fiscal Year 2004 Expenditure Plan,
GAO-05-46 Washington, D.C.: November 17, 2004.

Business Systems Modernization: Internal Revenue Service Needs to Further
Strengthen Program Management, GAO-04-438T Washington, D.C.: February 12,
2004.

IRS Modernization: Continued Progress Necessary for Improving Service to
Taxpayers and Ensuring Compliance, GAO-03-796T Washington, D.C.: May 20,
2003.

                                     Other:

Paid Tax Return Preparers: In a Limited Study, Chain Preparers Made
Serious Errors, GAO-06-563T Washington, D.C.: April 4, 2006.

Tax Administration: IRS Can Improve Its Productivity Measures by Using
Alternative Methods, GAO-05-671 Washington, D.C.: July 7, 2005.

21st Century Challenges: Reexamining the Base of the Federal Government,
GAO-05-325SP Washington, D.C.: February 2005.

High Risk Series: An Update, GAO-05-207 Washington, D.C.: January 21,
2005.

Internal Revenue Service: Challenges Remain in Combating Abusive Tax
Schemes, GAO-04-50 Washington, D.C.: November 19, 2003.

Tax Administration: IRS Is Implementing the National Research Program as
Planned, GAO-03-614 Washington, D.C.: June 16, 2003.

Tax Administration: IRS Needs to Further Refine Its Tax Filing Season
Performance Measures, GAO-03-143 Washington, D.C.: November 22, 2002.

The Results Act: An Evaluator's Guide to Assessing Agency Annual
Performance Plans, GAO/GGD-10.1.20 Washington, D.C.: April 23, 1998.

For more information on Department of the Treasury major management
challenges, see http://www.gao.gov/pas/2005/treasury.htm

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Highlights of GAO-06-499T , a statement for the record for the
Subcommittee on Transportation, Treasury, the Judiciary, and Housing and
Urban Development, and Related Agencies, Committee on Appropriations, U.S.
Senate

April 27, 2006

INTERNAL REVENUE SERVICE

Assessment of the Interim Results of the 2006 Filing Season and Fiscal
Year 2007 Budget Request

The Internal Revenue Service's (IRS) filing season performance affects
tens of millions of taxpayers who expect timely refunds and accurate
answers to their tax questions. IRS's budget request is a planning tool
showing how it intends to provide taxpayer service and enforce the tax
laws in 2007. It is also the first in a series of annual  steps that will
determine whether IRS meets its new long-term goals of increasing tax
compliance and reducing taxpayers' acceptance of cheating on their taxes.
Tax law enforcement remains on GAO's list of high-risk federal programs,
in part, because of the persistence of a large tax gap. IRS recently
estimated the gross tax gap, the difference between what taxpayers owe and
what they voluntarily pay, to be $345 billion for 2001.

GAO assessed (1) IRS's interim 2006 filing season performance; (2) the
budget request; and (3) how the budget helps IRS achieve its long-term
goals. GAO compared performance and the requested budget to previous
years.

What GAO Recommends

GAO is not making any new recommendations, but notes past recommendations
and their implementation status where relevant and identifies
opportunities for additional savings.

IRS has improved its filing season performance so far in 2006, continuing
a trend. More refunds were directly deposited, which is faster and more
convenient. Electronic filing continued to grow, but at a slower rate than
in previous years. IRS's two most commonly used services-telephone and Web
site assistance-continued to improve. IRS estimates that the accuracy rate
for its telephone answers is now at 90 percent or more. Taxpayers
continued the recent pattern of using IRS's walk-in sites less and
community-based volunteer sites more. While millions of taxpayers use
chain paid tax preparers, taxpayers may not be receiving accurate and
complete assistance, putting them at risk of owing back taxes, interest,
and penalties.

The 2007 budget request of $11 billion (a small decrease after adjusting
for inflation) sets performance goals for service and enforcement that are
all equal to or higher than the 2006 goals. The budget reduces funding by
15 percent for Business Systems Modernization, the ongoing effort to
replace IRS's aging information systems. The reduction could impede
progress delivering improvements to taxpayers. The budget request
identified over $121 million in savings; however, opportunities exist for
further savings. For example, IRS officials told us IRS's 25 call centers
have underutilized space. Those centers could be consolidated without
affecting service to taxpayers.

Achieving IRS's long-term compliance goals will be challenging because the
tax gap has persisted for many years at about its current level. In
addition, because the effect of taxpayer service and enforcement on
compliance has never been quantified, IRS does not have a data-based plan
demonstrating how it will achieve its goals. Nor does IRS have a plan for
measuring compliance by 2009, the date for achieving the goals. Reducing
the tax gap will likely require new and innovative solutions such as
simplifying the tax code, increasing income subject to withholding, and
increasing information reporting about income.

Changes in Funding and Full-time Equivalent (FTE) Staff for the Fiscal
Year 2007 Budget Request Compared to Fiscal Year 2006 Enacted Budget

Source: GAO analysis of IRS data.

Notes: Fiscal year 2007 FTEs reflect an adjustment made after the budget
was printed. Enacted FTEs differ from actual FTEs.
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