Tax Administration: Most Filing Season Services Continue to	 
Improve, but Opportunities Exist for Additional Savings 	 
(15-NOV-06, GAO-07-27). 					 
                                                                 
In 2006, the Internal Revenue Service (IRS) spent about 38	 
percent of its $10.8 billion budget on processing returns and	 
providing taxpayer assistance. GAO was asked to (1) assess IRS's 
2006 filing season performance processing paper and		 
electronically filed tax returns and providing telephone, Web	 
site, and face-to-face assistance relative to 2006 goals and	 
prior years' performance; (2) identify potential cost savings or 
other improvements; and (3) report on the status of IRS's	 
Taxpayer Assistance Blueprint (TAB). To address these issues, GAO
collected relevant information from IRS and other sources,	 
reviewed performance measures and past filing season assessments,
and interviewed officials.					 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-07-27						        
    ACCNO:   A63406						        
  TITLE:     Tax Administration: Most Filing Season Services Continue 
to Improve, but Opportunities Exist for Additional Savings	 
     DATE:   11/15/2006 
  SUBJECT:   Cost analysis					 
	     Customer service					 
	     Electronic data processing 			 
	     Electronic forms					 
	     Performance measures				 
	     Program evaluation 				 
	     Tax administration 				 
	     Tax administration systems 			 
	     Tax returns					 
	     Taxpayers						 
	     Websites						 
	     Program implementation				 
	     IRS Taxpayer Assistance Blueprint			 

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GAO-07-27

                 United States Government Accountability Office

Report to the Chairman, Subcommittee

GAO

on Oversight, Committee on Ways and Means, House of Representatives

November 2006

TAX ADMINISTRATION

  Most Filing Season Services Continue to Improve, but Opportunities Exist for
                               Additional Savings

GAO-07-27

TAX ADMINISTRATION

Most Filing Season Services Continue to Improve, but Opportunities Exist
for Additional Savings

  What GAO Found

IRS improved most filing season services in 2006, continuing improvements
since 2001. IRS also generated efficiencies from increased electronic
filing and benefits for taxpayers through systems modernization. IRS's
processing of individual tax returns and refunds improved by most
measures, but the growth rate of electronic filing continued to slow in
part because of changes to the Free File Program, which reduced the number
of taxpayers eligible to use it and the elimination of a program that
allowed taxpayers to file via the telephone. Access to IRS's telephone
assistors was comparable to last year. The accuracy of responses to
telephone inquiries was 90 percent or over in 2006. Use of IRS's Web site
increased substantially and IRS reconfigured the site to improve service.
Continuing past trends, fewer taxpayers used IRS walk-in sites and more
used less-costly volunteer sites. Also, IRS completed Phase I of the TAB,
which identified strategic themes for improving taxpayer service; TAB
Phase II is expected to be completed by early 2007.

With the slowing growth rate in electronic filing, IRS is missing an
opportunity to generate additional savings. Federal and state mandates for
electronic filing have demonstrated success in increasing electronic
filing; however, IRS currently lacks the authority to mandate electronic
filing for certain income tax returns such as individual returns filed by
paid tax preparers. Using IRS estimates, savings from such a mandate could
be on the order of $60 million per year. IRS has another opportunity to
generate savings because of excess space at its call sites. However, IRS
lacks a strategy for eliminating that space by consolidating call sites.

To replace its aging legacy computer system, IRS continues to implement a
modernized system for processing tax returns and refunds. However, IRS
does not report information on the chief benefit realized to date, faster
refund issuance. Such information could be useful for the Congress when
making decisions about funding the completion of the individual tax return
processing part of the system, estimated by IRS to require at least
another $500 million.

                 United States Government Accountability Office

Contents

Letter 1
Results in Brief 2
Scope and Methodology 5
Background 6
Opportunities Exist to Generate Savings by Encouraging Electronic Filing;
Processing Performance Continued to Improve 10
Access to  IRS's  Telephone Assistors  Was  Comparable to  Last  Year  and
Accuracy Improved, but IRS Has Excess Space at Its Call Sites 20
IRS's Web Site Use Grew Substantially and Is Now a Major Component of
Taxpayer Service 26
Continuing Past Trends, Fewer  Taxpayers Used IRS  Walk-in Sites and  More
Used Volunteer Sites, but Data on Services Provided Remains Incomplete for
Both 28
IRS Has Completed the First Phase of the TAB and Has Begun Assessing
Taxpayers' Service Needs 33
Conclusions 34
Matter for Congressional Consideration 35
Recommendations for Executive Action 35
Agency Comments and Our Evaluation 35
Appendix I Differences between the 2002 and 2005 Free File Agreements 37
Appendix II Status of CADE Implementation and Future Releases 40
Appendix III State Mandates for Electronic Processing 44
Appendix IV IRS's Processing Performance Relative to 2001-2005 Performance
and 2006 Goals 48
Appendix V Telephone Access Varies Depending on the Time of Year and Type
of Call 51
Appendix VI Comments from the Internal Revenue Service 52

Tables                                                                  
                    Table 1: IRS Processing Performance Measures           17 
               Table 2: IRS Telephone CSRs Accessibility Performance,         
                              2001-2006 Filing Seasons                     21 
               Table 3: IRS Telephone CSRs Accuracy Performance, 2001-2006    
           Filing Seasons                                                  22 
              Table 4: Schedule of CADE Releases and Related Functionality 40 
             Table 5: Electronic Filing Rates of Growth in Federal Returns    
                                                                       for    
                        States with Mandates Compared to National Averages 45 
             Table 6: IRS's Processing Performance, Fiscal Years 2001-2006 49 
Figures                                                                    
                    Figure 1: IRS's 2006 Filing Season Activities           9 
            Figure 2: Number of Individual Returns and IRS Staff Years for    
                  Individual Paper and Electronic Processing, Fiscal Years    
           1999-2007                                                       11 
                     Figure 3: How IRS Handled Calls during 2006           24 
            Figure 4: Assistance Provided by IRS Walk-in Sites, 2001-2006     
           Filing Seasons                                                  29 
                 Figure 5: Direct FTEs Used for Assistance Provided at IRS    
                                                                   Walk-in    
                           Sites, 2001-2006 Filing Seasons                 30 
            Figure 6: States with Electronic Filing Mandates for Paid Tax     
           Preparers                                                       44 

                                 Abbreviations

BSM               Business Systems Modernization                           
CADE              Customer Account Data Engine                             
CSR               Customer Service Representative                          
EIN               Employer Identification Number                           
ETAAC                       Electronic Tax Administration Advisory Council 
ETLA              Electronic Tax Law Assistance                            
FTE               Full-time Equivalent                                     
IRS               Internal Revenue Service                                 
NTA               National Taxpayer Advocate                               
RAL               Refund Anticipation Loan                                 
RRA 98            IRS Restructuring and Reform Act of 1998                 
TAB               Taxpayer Assistance Blueprint                            
TIGTA                    Treasury Inspector General for Tax Administration 

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

United States Government Accountability Office Washington, DC 20548

November 15, 2006

The Honorable Jim Ramstad Chairman Subcommittee on Oversight Committee on
Ways and Means House of Representatives

Dear Mr. Chairman,

In fiscal year 2006, the Internal Revenue Service (IRS) spent
approximately $4.1 billion or 38 percent of its $10.8 billion budget on
processing income tax returns and providing taxpayer assistance, with most
of this occurring during the annual tax filing season.^1 During the 2006
filing season, taxpayers filed an estimated 131 million individual income
tax returns and received almost $218 billion in refunds. IRS's filing
season performance is a key indicator of how well IRS is serving taxpayers
and helping them fulfill their tax responsibilities.

In past reports and testimonies^2 we said that IRS has made significant
progress improving taxpayer service since passage of the IRS Restructuring
and Reform Act of 1998 (RRA 98).^3 However, we also described challenges
to continued progress. For example, the President's proposed fiscal year
2007 budget for IRS would cut staffing by over 2 percent. At the same
time, IRS has ambitious goals of maintaining or improving filing season
services, while also maintaining or increasing enforcement activities in
order to improve voluntary compliance by 2009. Another challenge is
continuing progress on the Business Systems

1

Most taxpayers file their tax returns between January 1 and April 15,
which is the deadline for filing individual income tax returns. However,
millions of taxpayers receive extensions from IRS, which allows them to
delay filing until as late as October 15.

^2See, for example, GAO, Tax Administration: IRS Improved Some Filing
Season Services, but Long-term Goals Would Help Manage Strategic
Trade-offs, GAO-06-51 (Washington, D.C.: Nov. 14, 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.: Apr. 14, 2005),
and Internal Revenue Service: Assessment of the Interim Results of the
2006 Filing Season and Fiscal Year 2007 Budget Request, GAO-06-615T
(Washington, D.C.: Apr. 6, 2006).

3

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

Modernization (BSM) program, IRS's ongoing effort to replace its aged
computer systems. Earlier this year we testified that proposed reduced
funding levels could affect the pace of modernization and ultimately of
improving service and enforcement.^4

In light of these challenges and the tax filing season's cost and
importance to taxpayers, you asked us to assess IRS's 2006 filing season
performance. Our objectives were to (1) assess IRS's 2006 filing season
performance in processing paper and electronically filed tax returns and
providing telephone, Web site, and face-to-face assistance relative to
2006 goals and prior years' performance; (2) identify potential cost
savings or other improvements; and (3) report on the status of IRS's
Taxpayer Assistance Blueprint (TAB), which is intended to be the long-term
strategy for cost effectively delivering services that meet taxpayer
needs. We testified on IRS's interim 2006 performance in a hearing held by
your Subcommittee on Oversight, House Committee on Ways and Means, on
April 6, 2006.^5

Our assessment is based on the reported results and analysis of key IRS
performance measures, observations of IRS's operations, interviews with
IRS officials, information from representatives of the paid tax preparer
community, and analyses by the Treasury Inspector General for Tax
Administration (TIGTA).^6 For the purpose of this report, we found IRS's
data to be sufficiently reliable for assessing IRS's 2006 filing season
performance and comparing to prior filing seasons. Further details on our
scope and methodology are provided later in this report. We performed our
work from January through October 2006 in accordance with generally
accepted government auditing standards.

  Results in Brief
  
IRS improved most of its primary filing season services, including returns
processing, telephone, Web site, and face-to-face operations. This
continues a trend of recent improvements. Opportunities exist to generate

^4GAO-06-615T.

^5GAO-06-615T.

6

We refer to paid tax preparers for both tax practitioners and commercial
preparers. According to IRS, tax practitioners complete tax returns for
money, are governed by the requirements outlined in U.S. Department of the
Treasury Circular 230, are authorized to represent taxpayers legally
before IRS, and include attorneys, certified public accountants and
enrolled agents. Commercial Preparers include corporations, self-employed
individuals, and electronic return originators; they are not regulated by
IRS or governed by Circular 230.

additional savings by increasing electronic filing of tax returns and
consolidating some operations.

Processing: Electronic filing continued to grow, which has resulted in
significant cost savings. Since 1999 IRS has eliminated approximately
1,600 staff years that were devoted to processing returns and closed two
paper processing centers, with a third center scheduled to close in 2007.
However, the growth rate of electronic filing in 2006 slowed to about 6
percent, lower than any of the previous 3 years. Two factors contributed
to the slower growth rate: fewer taxpayers being eligible for and using
the Free File Program, which allows some taxpayers to file for free
through IRS's Web site, and the elimination of a program that allowed some
taxpayers to file electronically via telephone. Slower growth limits
opportunities to generate additional savings from electronic processing.
Federal mandates requiring large corporations to electronically file and
state mandates requiring certain paid tax preparers to electronically file
individual returns have demonstrated success in increasing electronic
filing. State mandates imposed on paid tax preparers have also increased
electronic filing, including of federal returns. In eight of the nine
states with mandates in place by 2005, the growth rate of electronically
filed federal returns increased in the year the mandate was implemented.
In four of the states, the growth rate more than doubled. This experience
demonstrates that mandated electronic filing can generate savings. Using
IRS's estimates, if 90 percent of returns submitted by paid preparers that
are filed on paper were filed electronically, IRS would save about $68
million per year. However, IRS lacks the statutory authority to mandate
electronic filing of individual income tax returns by paid tax preparers.
With respect to processing performance, most measures show improvement.
However, IRS does not report the information to the Congress that would
clearly highlight the benefits of its new processing system, such as gains
in refund timeliness. As we previously reported, having estimates of the
benefits of large investment programs could be useful for the Congress
when making decisions about funding. IRS estimates the completion of the
individual tax return processing part of the new system will require at
least another $500 million.

Telephone service: The percentage of taxpayers who got through to IRS
customer service representatives (CSR) was slightly lower than last year,
but there were improvements both in wait times and in the rate at which
taxpayers abandoned their calls while waiting for an assistor. The
accuracy of responses to telephone tax law and accounts questions is 90
percent or over, an improvement since last year and more so since 2001.
However, IRS could reduce costs. IRS officials told us that during peak
staffing the agency had about 850 unused CSR workstations spread across
IRS's 25 call sites. Because IRS directs incoming calls through a
centralized routing system, the location of call sites does not affect the
level of service provided. As a result, IRS has the potential to generate
savings by closing some sites without negatively affecting customer
service even at peak times.

Web site: Taxpayer use increased, as indicated by a 36 percent growth in
the number of downloads for tax forms and publications. IRS reconfigured
its Web site and the site is performing well, according to independent
rating services. One indicator of success is that taxpayers searched less
to find the information they needed. The increased usage of IRS's Web site
is consistent with IRS's strategy to improve service by providing
taxpayers with an option for automated interaction at the convenience of
taxpayers.

Walk-in assistance: Continuing a trend since 2001, fewer taxpayers
received assistance at IRS's walk-in sites and more received return
preparation assistance at sites staffed by volunteers. In response to past
concerns raised by us and the TIGTA, IRS has initiatives underway intended
to provide detailed management data on the services offered at walk-in
sites, and reliable methods for assessing the quality of services offered
at walk-in and volunteer sites.

Taxpayer Assistance Blueprint (TAB): IRS has completed the first of two
phases of the TAB, its initiative to measure taxpayer services against the
needs and preferences of taxpayers and develop a 5-year plan for improving
services. Phase I provides information on taxpayer preferences and
identifies themes for improving service. IRS anticipates Phase II of its
TAB report will be released early 2007, and will include its research plan
designed to build on these strategic improvement themes and enhance
understanding of the effect of taxpayer service on compliance.

This report includes a matter that the Congress may want to consider to
reduce the costs of processing tax returns. Specifically, Congress should
mandate electronic filing by paid tax preparers meeting criteria such as a
threshold number of returns filed. We are also making recommendations that
the Commissioner of Internal Revenue direct the appropriate officials to
timely develop, validate, and implement a plan to consolidate call sites
and report to the Congress refund timeliness for its new system for
processing individual income tax returns compared to the Master File
legacy system.

In commenting on a draft of this report (see app. VI), the IRS
Commissioner said that, with respect to the matter for congressional
consideration, he appreciated our acknowledging the current statutory
limitation that is impeding electronic filing growth. The Commissioner
said he agreed with our recommendations and he generally outlined the
actions IRS plans to take to address those recommendations.

Scope and Methodology

To assess IRS's 2006 filing season performance in the key filing season
activities--paper and electronic processing, plus telephone, Web site, and
Methodology face-to-face assistance--compared to goals and past
performance, and report on the status of the TAB, we

     o reviewed and analyzed IRS reports, testimonies, budget submissions,
       and other documents and data, including workload data and data related
       to IRS's current suite of balanced performance measures and annual
       goals;
     o analyzed staffing data for paper and electronic processing, telephone
       assistance, and walk-in assistance;

          * tested for statistically significant differences between annual
            performance measures based on sample data;
          *  o observed operations at IRS's Atlanta and Cincinnati paper
            processing centers, the Atlanta Call Site and Joint Operations
            Center, and 4 of IRS's 400 walk-in locations;^7

     o reviewed legislation, policies, and procedures;
     o reviewed information from organizations that evaluate Internet
       performance;
     o reviewed related TIGTA reports and interviewed TIGTA officials about
       IRS's performance and initiatives;

7

Our review focuses on IRS's Wage and Investment Division, which serves
taxpayers whose income is from wages and investments, processes individual
income tax returns, and provides assistance to taxpayers who call on the
telephone or walk into an IRS office. During our audit work, we became
aware of problems with IRS's primary information system used to detect and
stop fraudulent claims for refunds on income tax returns. However, because
this system is largely an enforcement function and TIGTA had initiated an
audit on the system, we determined this work to be beyond the scope of our
audit.

     o reviewed prior GAO reports and followed up on our recommendations made
       in prior filing season and related reports;
     o interviewed IRS officials about current operations, performance
       relative to 2006 performance goals and prior filing season
       performance, trends, and significant factors and initiatives that
       affected or were intended to improve performance; and
     o interviewed representatives of the few larger private and nonprofit
       organizations that prepare tax returns including H&R Block and trade
       organizations that represent both individual paid tax preparers and
       tax preparation companies including the American Institute of
       Certified Public Accountants.

This report discusses numerous filing season performance measures and data
that cover the quality, accessibility, and timeliness of IRS's services.
We report on IRS's filing season measures that, based our prior work, we
consider to objective and reliable. To the extent possible, we
corroborated information from interviews with documentation and data and
where not possible, we report the information as attributable to IRS
officials. We reviewed IRS documentation, interviewed IRS officials about
computer systems and data limitations, and compared those results to GAO
standards of data reliability.^8 As a result, we determined that the IRS
data we are reporting are sufficiently reliable for assessing IRS's filing
season performance. Data limitations are discussed where appropriate.

We conducted our work at IRS headquarters in Washington, D.C., and New
Carrollton, Maryland; the Wage and Investment Division headquarters and
Joint Operations Center (which manages telephone service) in Atlanta,
processing centers in Atlanta and Cincinnati, and a telephone call site in
Atlanta; and walk-in locations in Georgia and Ohio. We selected these
offices for a variety of reasons, including the location of key IRS
managers, such as those responsible for telephone and walk-in site
services.

Background

The majority of taxpayers have their tax returns prepared by professional
preparers. In fiscal year 2005, about 59 percent of individual tax returns
were prepared by paid tax preparers. We have noted in previous testimony

8

GAO, Assessing  the  Reliability of  Computer-Processed  Data,  GAO-02-15G
(Washington, D.C.: Sept. 1, 2002).

Page 6 GAO-07-27 Tax Administration

that the rate of preparer usage is higher among taxpayers with more
complicated returns.^9

Once returns are prepared, taxpayers can file their returns by mailing
paper returns to one of IRS's submission processing centers or submitting
the returns electronically. Both taxpayers and paid tax preparers can
submit paper returns directly to IRS. However, taxpayers cannot submit
electronic returns directly to IRS. Instead, only paid tax preparers and
tax preparation software companies that IRS has designated as electronic
return originators can transmit tax returns electronically to IRS which
may involve a fee to the taxpayer. In addition, the Free File program is
offered by 20 companies that make up the Free File Alliance, a consortium
of tax preparation companies that agreed to offer free return preparation
and electronic filing for taxpayers that meet certain criteria. Taxpayers
can access the Free File program via IRS's Web site (see app. I for
further detail on the Free File program).

For 7 years, IRS has been modernizing its aging tax processing and
business systems. The BSM program is a high-risk, highly complex effort
critical to supporting IRS's taxpayer service goals. For example, the
program includes projects to allow taxpayers to file and retrieve
information electronically. To date, IRS has deployed releases of
modernized systems that have delivered benefits to taxpayers and the
agency, including e-Services (a new Web portal and electronic services for
paid tax preparers), Modernized e-File (a new electronic filing system),
and the Customer Account Data Engine (CADE), which is the new taxpayer
information database. CADE is intended to eventually replace IRS's
antiquated Master File legacy processing system that contains the agency's
repository of taxpayer account information and, therefore, is the BSM
program's cornerstone and highest priority project. CADE facilitates
faster refund processing and more timely response to taxpayer inquiries
(see app. II for more details on CADE).

In addition to processing tax returns, IRS provides a variety of taxpayer
services, including providing tax law assistance, account resolution,
limited return preparation, tax forms and publications distribution,
outreach, and education. IRS provides these services mainly via telephone,
its Web site, and face-to-face assistance. IRS automatically routes

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

Page 7 GAO-07-27 Tax Administration

taxpayers' calls from one of three toll-free lines--tax law, accounts, or
refunds. Depending on how taxpayers respond to menu choices, questions are
answered by a recorded message or taxpayers are directed to CSRs located
at 25 call sites around the country. Calls are centrally routed to the
site with the shortest wait times among CSRs assigned to answer particular
tax law, account, or refund status questions.

For face-to-face assistance, IRS has 400 walk-in sites where taxpayers can
ask basic tax law questions, get account information, receive assistance
with their accounts, and have returns prepared if annual income is $38,000
or less.^10 Also, low-income, elderly, and qualifying military taxpayers
can get returns prepared at over 12,000 volunteer sites run by
communitybased coalitions that partner with IRS. In addition, IRS
identifies and selects community partners, such as AARP, that meet
taxpayer needs, such as assistance for the elderly, and helps train,
provides resource materials, and oversees operations at these partners'
facilities. In some cases, IRS awards grants, trains and certifies
volunteers, and provides reference materials, computer software, and
computers.

IRS provides many Web services that have become popular, such as "Where's
My Refund" which enables taxpayers to use IRS's Web site to determine
whether the agency received their tax returns and processed their refunds.
Taxpayers can also download forms, instructions, and publications;
research their own tax law issues through Frequently Asked Questions or
Tax Topics; and receive help with specific tax law questions and
procedural questions via e-mail using Electronic Tax Law Assistance
(ETLA). One benefit of the Web site is that it reduces the number of phone
calls received.

IRS's 2006 filing season activities and associated workload volumes are
depicted in figure 1.

According to IRS, this limitation approximates the amount set in the
Internal Revenue Code for claiming the Earned Income Tax Credit. IRS has
required appointments for most taxpayers seeking this assistance since
2003.

Page 8 GAO-07-27 Tax Administration

                 Figure 1: IRS's 2006 Filing Season Activities

Source: GAO analysis of IRS data, IRS (images).

Note: The number of paper and electronic returns and refunds are estimated
for the time period January 1, 2006, to September 15, 2006; toll-free
calls for the time period January 1, 2006, to July 15, 2006; walk-in
contacts, which includes returns prepared at volunteer sites, for the time
period December 25, 2005, to April 22, 2006; and Internet downloads for
the time period January 1, 2006, to August 31, 2006. We sed different
dates for the various areas that best reflect IRS's filing season workload
in that area.

IRS evaluates taxpayer service against performance measures such as
timeliness and quality of telephone responses. IRS's definitions for some
of those measures vary. For example, IRS measures accuracy for telephone
and face-to-face assistance, but because of differences in the
methodologies used to collect the data, comparisons between the two types
of assistance are not possible. IRS also considers volume important when
assessing service delivery and recognizes that volume does not necessarily
reflect actual demand for services, but can reflect changes in taxpayer
behavior, such as more willingness to use IRS's Web site to receive
services. Finally, IRS uses other means to collect information, such as
surveys on taxpayer satisfaction.

  Opportunities Exist to Generate Savings by Encouraging Electronic Filing;
  Processing Performance Continued to Improve

The growth rate of electronic filing is important because electronic
filing eliminates costs associated with processing paper returns. IRS's
performance processing the paper and electronic returns it received in
2006 improved compared to earlier years.

    Electronic Filing Continues to Grow, but at a Slower Rate, Which Limits
    Opportunity to Achieve Additional Savings

As of September 15, 2006, IRS processed 131 million individual income tax
returns. Of those returns, 72 million or 55.1 percent were filed
electronically and the remaining 59 million returns were filed on paper.
The number of returns filed electronically increased by 6.3 percent over
the last year, which was less than the 9 percent increase forecasted by
IRS and less than last year's 11 percent increase, the 12 percent increase
in 2004, and the nearly 17 percent increase in 2003.

The growth rate has slowed and, according to IRS officials, it is getting
harder to convert additional taxpayers to electronic filing because those
who might convert most readily have already done so. Slower growth limits
IRS's progress toward achieving the goal set by the Congress in RRA 98,
which was for IRS to have 80 percent of all federal tax and information
returns filed electronically by 2007. We and IRS have previously reported
that IRS likely will not meet the 80 percent goal, but that the agency did
not want to abandon it because it serves as a symbol of IRS's
determination to increase electronic filing.^11

Growth of electronic filing is important because it generates savings from
reductions in staff needed for labor-intensive paper processing and
associated space. As shown in figure 2, as electronic filing increased
between fiscal years 1999 and 2006, IRS has greatly reduced the number of
staff years devoted to paper and electronic processing by 1,586, or 34
percent.

^11GAO-06-51.

Figure 2: Number of Individual Returns and IRS Staff Years for  Individual
Paper and Electronic Processing, Fiscal Years 1999-2007

Notes: 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.

a

Fiscal years 2006 and 2007 are IRS projections.

In addition to generating savings by reducing FTEs, IRS can and has
achieved ancillary space cost savings from the closing of submission
processing centers.^12 IRS estimates that the elimination of the
Brookhaven Submission Processing Center in 2003 resulted in savings of
$5.5 million in annualized rent and related savings. In addition, IRS
closed the Memphis Submission Processing Center in 2005, and IRS is
projecting annualized rent and related savings equal to $1.3 million
beginning in fiscal year 2007. IRS plans to close the Philadelphia
Submission Processing Center in 2007,

According to IRS, an FTE is the equivalent of one person working full-time
for 1 year with no overtime.

Page 11 GAO-07-27 Tax Administration

although IRS will not realize space savings until late 2011 because the
Service cannot close the entire facility or move other operations into the
space vacated by paper processing operations.^13

Two other factors that contributed to this year's slower growth in
electronic filing were (1) changes in the Free File program, which reduced
the number of taxpayers eligible to file electronically for free this
year, and

(2) termination of the TeleFile program, which had allowed taxpayers to
file their returns electronically via telephone. Through August, IRS
processed about 4 million returns filed through the Free File program,
which is a decrease of about 23 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, or almost a
million more than received last year, when some members of the Free File
program provided free electronic filing to all taxpayers. In 2005, IRS
renegotiated and amended the agreement with the tax preparation companies
participating in the Free File program. Among the important changes was a
new income limitation of $50,000 or less that resulted in 30 percent of
the nation's taxpayers not being eligible for the Free File Program. This
change left 92 million taxpayers eligible for the program and 39 million
taxpayers ineligible.^14

IRS also 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 TeleFile program had been decreasing--from
approximately 5.7 million in 1999 to 3.3 million in 2005. IRS estimated
the cost per tax return submitted through TeleFile, typically Form 1040EZ,
to be about 74 percent more than it costs IRS to process a return filed on
paper, largely due to telecommunications and other costs. IRS officials
stated that the reason for this year's increase in the number of 1040EZ
returns filed on paper is, in part, the elimination of TeleFile. According
to IRS officials, approximately 1.3 million or 40 percent of taxpayers who
formerly used Telefile in 2005 filed on paper in 2006.

13

Without being able to move the remaining offices or functions to a new
location, IRS will have to pay for unused space from the closure of the
Philadelphia processing center amounting to $3.8 million per year.

14

These calculations are based on IRS data on the number of filed returns. A
return may represent more than one taxpayer.

Page 12 GAO-07-27 Tax Administration

Over the years, IRS has taken numerous actions to encourage electronic
filing by taxpayers and tax practitioners. In addition, IRS has responded
to many of our recommendations to increase the use of electronic
filing.^15 Despite these actions, and as we have already noted, growth in
electronic filing has slowed as IRS's recent efforts have not resulted in
converting a large portion of tax filers from paper to electronic filing.

Nevertheless, IRS continues to look at options for increasing electronic
filing. A recent proposal is aimed at converting taxpayers and paid tax
preparers who prepare individual income returns on computer, print them
out, and then send them to IRS--a process known as V-coding--to electronic
filing. According to IRS officials, converting these taxpayers could be an
important step to reduce the number of paper returns filed. Between
January and May 2006, IRS estimates that nearly 39 million, or 72 percent
of all paper returns filed were V-coded returns. To help convert V-coders,
IRS officials stated that the agency is considering creating a secured
electronic mailbox where tax preparers could send in a return, the
taxpayer could review and sign it, then submit it to IRS electronically,
or return it to the preparer for additional work and subsequent electronic
filing to IRS. According to IRS officials, this initiative would be part
of e-Services.^16 Further, this and other proposals to expand electronic
filing and capitalize on new technologies will be contained in an update
to its E-Strategy for Growth, which is a long-term vision for providing
ways for taxpayers to interact electronically with IRS. While the proposal
may be an important tool for paid tax preparers and taxpayers,
participation remains on a voluntary basis as part of e-Services, IRS
officials did not have estimates as to its effect on reducing V-coding,
and it covers only practitioners and not taxpayers.

15

See for example, GAO, Tax Administration: Opportunities to Increase the
Use of Electronic Filing, GAO/GGD-93-40 (Washington, D.C.: Jan. 22, 1993).

16

The e-Services system, offered to paid tax preparers who have filed at
least 100 electronic returns, gives them the ability to conduct business,
such as electronic account resolution and transcription delivery, with IRS
electronically 24 hours a day 7 days a week.

Page 13 GAO-07-27 Tax Administration

    Mandates Have Demonstrated Success in Increasing Electronic Filing, but IRS
    Lacks the Authority to Impose Mandates for Individual Taxpayers

For the first time, in the 2006 filing season IRS mandated that
corporations with assets over $50 million file their corporate tax returns
electronically. As of September 15, 2006, over 12,000 large corporations
electronically filed their returns, up from 131 in 2005. Next year,
corporations with over $10 million in assets will be required to file
their returns electronically. Perhaps in anticipation of the mandate, over
16,000 of those corporations filed electronically, compared to just over
1,100 in 2005. According to the IRS Commissioner, electronic filing by
large corporations will cut many months off the audit process and will
allow IRS to develop analytical tools to better select areas of audit
inquiry. Consequently, those corporations will benefit by having
uncertainties on their tax returns resolved sooner, and the government
will benefit by more promptly identifying and responding to areas of
noncompliance.

Last year we reported that state mandates for electronic filing of state
tax returns also encourage electronic filing of both state and federal tax
returns.^17 Of the 50 states, 12 had electronic filing mandates for paid
tax preparers in effect for the 2006 filing season. These mandates require
preparers who meet certain criteria, such as filing 100 individual state
tax returns or more, to file individual state returns electronically (see
app. III for more information on state mandates).^18

State mandates have increased the electronic filing of federal individual
income tax returns. According to IRS officials, this increased growth is
because paid tax preparers converted their entire practice to electronic
filing. Nine states had electronic filing mandates in effect in 2005 or
earlier. In eight of these nine states, the growth rate of electronically
filed federal returns increased the year the mandate was implemented. For
one state, Virginia, the growth rate declined by 11 percent.^19 Four
states had increases of between 7 and 48 percent in their growth rates.
Four other states had their growth rates more than double including
California, which nearly tripled.

^17GAO-06-51.

18

The mandates differ in their implementation dates and schedules,
thresholds for filing, and penalties. These differences between mandates
may affect the magnitude of electronic filing increases in each state.

19

The decrease in the percent change in Virginia's electronic filing rate of
growth may be due in part to 2-D barcodes, which are attached to the paper
tax return. IRS does not consider paper returns filed with 2-D barcodes as
being electronically filed.

An alternative comparison of state growth rates to the nationwide growth
rate also shows the benefits of state mandates. For eight of the nine
states that have imposed a mandate, the growth rate of federal returns
electronically filed from that state was greater than the national growth
rate for the year the mandate took effect.

In the past, some tax preparers have voiced concern regarding the costs
and burdens associated with converting their businesses to electronic
filing. As a result, last year we recommended to IRS that it develop
better information about the costs to preparers and taxpayers of mandatory
electronic filing of tax returns for certain categories of preparers.^20
According to an IRS survey, cost was not the primary factor cited by
preparers for not converting their businesses to electronic filing;
instead, the major factor was that their clients did not ask for or want
electronic filing. However, once over the initial barrier of having
converted to electronic filing, several state tax officials we consulted
with, including New York and Minnesota, reported receiving very little
negative feedback from preparers. In fact, one state official noted that a
substantial number paid tax preparers have reported how easy electronic
filing is compared to filing returns on paper. Given the current rate of
growth in electronic filing of federal returns, mandates represent an
important option for realizing further growth.

Because mandates drive significant electronic filing increases, the
Electronic Tax Administration Advisory Council (ETAAC) recently
recommended a federal mandate for paid tax preparers that prepare
individual tax returns.^21 ETAAC estimated that if preparers filed all
individual returns electronically, IRS would be only 5 percentage points
below the 80 percent goal set by the Congress, instead of being 25
percentage points below the goal as it is currently.

IRS, however, is prohibited by law from requiring electronic filing of
income tax returns for individuals, estates, and trusts.^22 Because IRS
lacks the statutory authority to mandate electronic filing of individual
tax

^20GAO-06-51.

21

ETAAC provides input and a forum for discussion of electronic tax
administration issues. ETAAC provides an annual report to the Congress on
IRS's progress meeting the goals for electronic filing of tax returns set
forth in the IRS Restructuring and Reform Act of 1998. ETAAC, Annual
Report to Congress (Washington, D.C.: June 2006).

22

26 U.S.C. S 6011(e).

Page 15 GAO-07-27 Tax Administration

    Processing of Paper and Electronic Returns Continued to Improve, Although
    IRS Lacks a Refund Timeliness Measure for Its New Processing System

returns, it has not developed any plans or proposals for doing so. Any
proposal would likely have to consider such factors as to whom the mandate
should apply, thresholds for such mandates, if penalties should be
assessed for noncompliance, and the length of time needed to develop the
capacity to receive additional electronically filed returns.

State and federal experiences with mandates demonstrate that mandated
electronic filing can generate savings. By not requiring electronic filing
by paid preparers, IRS is missing an opportunity for generating savings
and efficiencies. IRS estimates that it saves $2.38 on every return that
is processed electronically.^23 Using IRS's estimates, if 90 percent of
returns submitted by preparers that are currently filed on paper were
filed electronically, IRS would have saved an estimated $68.5 million per
year.^24

Senate bill S. 1321 shows Congressional interest in increasing use of
electronic filing for preparers.^25 This bill provides IRS with the
authority to require tax preparers to file individual income tax returns
electronically.

Processing of Paper and Electronic Returns Continued to Improve, Although
IRS Lacks a Refund Timeliness Measure for Its New Processing System

In addition to processing 131 million tax returns, IRS has issued almost
99 million refunds, totaling over $218 billion. Over 56.4 million or more
than half of the refunds were directly deposited, up nearly 8 percent over
the same period last year. This increase is important, because direct
deposit is faster, more convenient for taxpayers, and less expensive for
IRS than mailing paper checks.

Of the nine processing performance measures listed in table 1 used by IRS
to assess performance, the agency met or exceeded eight out of its nine of
its 2006 goals, and equaled or exceeded its 2005 performance for seven of
the nine measures (see app. IV for further details). For one measure, the
letter error rate, IRS's performance declined and the 2006 goal was not

23

We could not independently verify this estimate using data from IRS's cost
accounting system because, in the past, IRS did not have such a
system--see GAO, Financial Audit: IRS's Fiscal Year 2005 and 2004
Financial Statements, GAO-06-137 (Washington, D.C.: Nov. 10, 2005).

24

IRS is able to process virtually all returns filed electronically with its
current processing system, exceptions being amended and prior year
returns, which the current system cannot process. With Modernized E-File,
IRS will be able to handle the amended and prior year 1040 returns, and
also have the ability to accept returns with attachments. IRS estimates
that it will begin implementing Modernized E-File for 1040s in 2009.

25

S. 1321, 109th Cong., S 309 (2006).

met. IRS officials said that computer system errors were partially to
blame for the higher letter error rate, along with some errors as a result
of the lack of training of new employees at one submission processing
center. More importantly, however, IRS's processing performance has
significantly improved for all nine measures compared to 2001 or for
measures not in existence in 2001, compared to their first year in
existence.

                  Table 1: IRS Processing Performance Measures

                            Measure name Definition

Deposit error rate Percentage of payments applied in error by, for
example, reimbursing a taxpayer who overpaid when the taxpayer wanted any
overpayment credited to next year's tax bill.

Deposit timeliness-- Interest foregone by not depositing monies the
business day after paper receipt, per $1 million in deposits. Measure
assumes an 8 percent interest rate.

Letter error rate Percentage  of letters issued  to taxpayers with  errors
(includes systemic errors).

Notice error  rate Percentage  of incorrect  notices issued  to  taxpayers
(includes systemic errors).

Refund error rate-- The percentage of refunds with IRS-caused errors in
the entity individual (paper) information (e.g., incorrect name, Social
Security number, or refund amount); includes systemic errors.

Refund interest paid Amount of refund interest IRS paid per $1 million  of
refunds issued.

Refund timeliness-- Percentage of  refunds issued within  40 days or  less
for returns individual (paper) filed on paper.

Productivity  Weighted  volume  of  documents  processed  per  staff  year
expended at the processing centers.

Individual Measure of individual Master  File returns processed per  staff
year Master File efficiency ^expended.

Source: GAO analysis of IRS data.

In addition to the processing measures results, representatives of the tax
preparer industry reported that returns processing went well. Groups and
organizations that we talked to included the National Association of
Enrolled Agents and the American Institute of Certified Public
Accountants. In addition, TIGTA testified and later reported no
significant problems during the filing season.^26 IRS officials
corroborated the view that returns processing went smoothly.

CADE, the cornerstone of IRS's investment in systems modernization, also
performed well. For the 2006 filing season, CADE processed about 7.4
million, or 5.6 percent, of the 131 million income tax returns filed
electronically or on paper, and disbursed about 6.6 million refunds
totaling over $3.4 billion.^27 While the percentage of returns CADE
processed is modest, CADE is important because it is ultimately expected
to replace IRS's antiquated Master File legacy system, which contains the
agency's repository of taxpayer account information.

A major benefit of CADE is that it is much faster compared to the Master
File legacy system, partly due to CADE's daily processing cycle, compared
to the Master File's weekly processing cycle. For example, according to
IRS officials, direct deposit refunds are issued by CADE 1-5 business days
faster than the current system, and paper check refunds are issued 4-8
business days faster. The benefits of CADE, in terms of faster processing,
are likely to expand to more taxpayers because the next release of CADE is
expected to process an estimated 33 million returns in 2007, over four
times more than the number processed through CADE in 2006. Because CADE
processes returns and refunds more quickly, it can help minimize the need
for Refund Anticipation Loans (RAL).^28 Reducing the need for RALs matters
because of the high interest rates that taxpayers are often charged for
these short-term loans, making them controversial.

26

See 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, and
Treasury Inspector General for Tax Administration, Individual Tax Returns
Were Timely Processed in 2006, but Opportunities Exist to Improve
Verification of Certain Tax Deductions, Reference No. 2006-40-164
(Washington, D.C.: Sept. 20, 2006).

27

CADE had the ability to process 13.5 million returns this year. However,
approximately 42 percent of those returns were returned to the Master File
legacy system for processing. IRS officials stated this was not unexpected
because certain returns that CADE should have been able to process had
changes, such as in filing status, had schedules, or had balances due,
which CADE cannot process without additional functionality.

28

Refund Anticipation Loans are very short-term loans offered by some paid
tax preparers while taxpayers wait for their refunds.

Systems modernization has been a key part of IRS's efforts to improve
taxpayer services. CADE is a major investment, with almost $200 million
spent on development and implementation through fiscal year 2006, and the
cornerstone of IRS's systems modernization program. CADE is only partially
completed, and IRS estimates that over $500 million more is required to
fully implement the individual tax return processing part of the system.

In its proposed fiscal year 2007 budget request to the Congress, IRS did
not report the benefits from CADE to date in terms of faster refund
timeliness. IRS had not established separate processing performance
measures for CADE that report the total time it takes CADE to process a
return and issue a refund. According to IRS officials, this was due to the
newness of CADE's implementation, the difficulty in separating CADE and
Master File processing information, and IRS's desire to keep performance
measures to a vital few. The refund timeliness measure included in table 1
covers only returns filed on paper, not electronically, and combines
refund timeliness information for all paper returns together.

Because of the substantial costs associated with fully implementing CADE,
the Congress could find information about the benefits useful. We have
previously reported the value in knowing estimates of benefits when making
decisions about whether to fund large investment programs.^29 The actual
benefits received from CADE may be useful as an indication of both the
magnitude and likelihood of the future benefits from full implementation.
As discussed above, IRS officials are aware of benefits from CADE.
Reporting such benefits in future budget requests could be done without
necessarily making changes to IRS's current refund timeliness measure.^30

29GAO-05-416T.

We have previously noted that IRS lacks a refund timeliness measure for
electronically filed returns, and recommended it adopt such a measure (see
GAO-06-51). At that time, IRS stated that a measure would not enhance
performance and, in fact, might be counterproductive if disappointed
taxpayers who had to wait longer than expected to receive their refunds
were to call or seek face-to-face assistance. Our position remains that
such a measure could help IRS better monitor and evaluate electronic
filing performance and determine the effect of initiatives intended to
increase electronic filing.

  Access to IRS's Telephone Assistors Was Comparable to Last Year and Accuracy
  Improved, but IRS Has Excess Space at Its Call Sites

Taxpayers' access to IRS's telephone assistors and the accuracy of answers
are both key indicators of IRS's filing season performance because of the
volume of calls and labor costs associated with answering them.

    Telephone Access, as Indicated by Three Performance Measures, Was About the
    Same as Last Year

Taxpayers' access to IRS's telephone assistors, as indicated by three IRS
performance measures, was more or less comparable to last year's, lower
than in 2004, but better than in 2002, as shown in table 2. The percentage
of taxpayers who wanted to talk with a CSR and actually got through and
received service--referred to as the CSR level of service or telephone
access--was 81 percent through mid-July as compared to 82 percent over the
same period last year--and slightly less than its 2006 goal of 82 percent.
This translated into 22.3 million calls being answered by CSRs. Taxpayers
gain access to a CSR depending on their responses to telephone prompts.
Some go through an automated system to determine if a CSR is needed, while
other taxpayers, such as those seeking tax law assistance, are screened
and transferred to a CSR who is trained to respond to their questions.

Other access measures showed improvement, such as the average speed of
answer and the abandon rate, also shown in table 2. IRS reported that,
through mid-July, the average speed of answer, the time taxpayers wait to
get their calls answered, was nearly 4 minutes, which is an 11.4 percent
decrease from last year. The abandon rate, or the percentage of callers
who hang-up after reaching the queue to wait for an assistor, was 10.5
percent, down from 12.2 percent from last year. The table below indicates
that as the average speed of answer decreases from 2005 to 2006, so does
the number of taxpayers who abandon their calls to IRS. However, this
relationship may be influenced by other factors as well, such as call
volume, staffing, or efficiencies, as well as an increased number of what
IRS refers to as courtesy disconnects. According to IRS, the Agency
disconnects some callers when wait times become excessive for particular
types of questions in order to improve taxpayers' experiences overall. IRS
disconnected 1.7 million calls through mid-July. While this is a 93
percent increase for the same period over last year, courtesy disconnects
represent only about 2 percent of the total call attempts, although IRS
has not estimated the impact of disconnects on call volume overall.

Table 2: IRS Telephone CSRs Accessibility Performance, 2001-2006 Filing
Seasons               
                           2001   2002  2003   2004    2005   2006     Fiscal 
                                                                         year 
Accessibility         Actual Actual Actual Actual Actual Actual 2006 goals 
measuresa                                                                  
CSR level of service      66     69     87     86     82     81         82 
(in percent)b                                                              
Average speed of         5.7    4.5  2.8      2.8    4.4    3.9        5.0 
answer (in minutes)c                                                       
Abandon rate (in        16.1   14.3  8.3      8.4   12.2   10.5            
percent)d                                                             n.a. 

Source: GAO analysis of IRS data.

Notes: n.a. = not applicable.

a

Based on actual counts from January through mid-July for 2001, 2002, 2003,
2004, 2005 and 2006. The composition of Customer Accounts Services has
changed, but prior year data represented here are comparable.

b

The percentage of callers wanting to speak to a CSR who get through and
receive service.

Average number of minutes a taxpayer waits in queue for a CSR.

d

The percentage of callers who hang up while waiting in queue for a CSR.

The level of service, average speed of answer, and other dimensions of
access experienced by individual taxpayers are likely to vary depending on
the time of year, type of call, and other factors. Consequently,
aggregated or annualized results may mask fluctuations in performance and
taxpayer experiences may vary (see app. V for further discussion)

IRS officials had planned to reduce toll-free telephone service from 15 to
12 hours a day this year because 93 percent of calls come in between 8

a.m. and 8 p.m. IRS created work plans under the assumption of a reduction
in telephone assistance hours.^31 Because of a congressional directive,^32
IRS had to adjust its work plans for a 15-hour day close to the start of
the filing season. According to a recent TIGTA report, after being unable
to implement the service hour reduction, IRS had insufficient time to
train new seasonal CSRs, resulting in a decline in the number of

31

The TIGTA recently issued a report on this matter. See Treasury Inspector
General for Tax Administration, The Savings Used to Recommend Reducing
Toll-Free Telephone Hours of Operation Are Not as Significant as
Projected, Reference No. 2006-40-169 (Washington, D.C.: Sept. 21, 2006).

32

Pub. L. No. 109-115 (2005) and Pub. L. No. 109-148 (2005).

Page 21 GAO-07-27 Tax Administration

assistors able to answer calls.^33 Nevertheless, according to IRS
officials, lower call volume during the filing season mitigated the
potentially negative effect on service they had expected from maintaining
a 15-hour day.

    Accuracy of Responses to Telephone Inquiries Improved since Last Year and
    More So since 2001

The accuracy of telephone CSR responses to tax law and account questions
either met or exceeded IRS's goals and past performance, as shown in table
3. Most notably, accounts accuracy and tax law accuracy have improved
since 2001 and now both are 90 percent or over, which is a statistical
improvement over last year. IRS officials said accuracy improved because
of their focus on identifying and informing the call sites of the top
defects made by CSRs, directing accounts inquiries away from calls sites
with a focus on tax law applications, and limited forms and tax law
changes.

Table 3: IRS Telephone CSRs Accuracy Performance, 2001-2006 Filing Seasons
                     2001  2002    2003    2004    2005    2006   Fiscal year 
Accuracy        Actual Actual  Actual  Actual  Actual  Actual   2006 goals 
measures a                                                                 
Tax law           79.1    84.9  81.3    79.5      89.5  90.6          90.0 
accuracy rate                                                              
(in percent)b                                                              
                  +/- 0.6 +/- 0.5 +/- 0.7 +/- 0.8 +/- 0.6 +/- 0.6             
Accounts          88.1    90.5  88.6    89.0      91.3  93.3          92.0 
accuracy rate                                                              
(in percent)b                                                              
                  +/- 0.6 +/- 0.4 +/- 0.4 +/- 0.5 +/- 0.4 +/- 0.3             

Source: GAO analysis of IRS data.

a

Based on representative samples  and from January  through June for  2001,
2002, 2003, 2004, 2005, and 2006.

b

The percentage of calls in which telephone CSRs provided accurate  answers
for the  call type  and took  the appropriate  action, with  a 90  percent
confidence interval.

While IRS Expects IRS Telephone Demand to Continue Declining, Telephone
Service Remains Important

IRS received almost 71 million  calls on its  toll-free
telephone lines through mid-July 2006 compared to 72
million in 2005. Of those calls, about    

   o 30.9 million  were from callers  trying to  obtain
information on the status of their tax refunds, 

33

Treasury Inspector General for Tax Administration, Appropriate Actions
Were Taken to Maintain Taxpayers' Level of Service, but Access is Lower
than in Prior Years, Reference No. 2006-40-162 (Washington, D.C.: Sept.
14, 2006).

Page 22 GAO-07-27 Tax Administration

     o 20.5 million were from callers seeking information about their
       accounts,
     o 14.4 million were about tax law questions, and
     o 4.9 million were miscellaneous inquiries to extensions, such as the
       National Taxpayer Advocate (NTA) and Tax Fraud Hotline.

IRS officials stated that this year's slight decline in call volume may be
due in part to more taxpayers getting through to a CSR the first time they
call, thus reducing the need for taxpayers to call again. According to IRS
officials, call demand will continue to decline, continuing a pattern
since 2002. Call volume is important because once staffing levels are
determined prior to the filing season, unexpected changes in call volume
affect IRS's ability to meet goals.

Figure 3 shows how IRS handled the 70.8 million calls. Toll-free telephone
calls from taxpayers typically are routed through IRS's telephone system
based on taxpayers' response to prompts and are then answered by CSRs or
automated recordings. Both the number of calls answered by IRS's automated
service and calls answered by CSRs were fairly consistent with IRS's
projections and slightly less than in 2005.

telephone service, IRS devotes significant resources to providing
telephone assistance. In fiscal year 2006, IRS planned to use almost 8,000
FTEs to handle telephone calls, which were similar to 2005, but 7 percent
less than in 2004.

    IRS Has  Excess  Space at  Its  Call Sites,  but  Lacks a  Strategy  for
    Consolidation

In a recent testimony we noted that IRS might have the potential to close
several more of its remaining 25 call sites.^36 This is because IRS
officials had determined that during peak staffing they had 850 unused CSR
workstations spread across IRS's 25 call sites. Moreover, we have noted
that call volume declined slightly this year and IRS officials forecast
that the decline will continue. This excess capacity represents
substantial costs without providing any benefits to IRS or taxpayers.

IRS could achieve savings through eliminating the excess workstations
without negatively affecting taxpayer service even at peak times. IRS
distributes all incoming calls through one central routing system and,
therefore, the actual location of call sites does not affect the service
received by taxpayers, particularly when other factors, such as the
overall number of CSRs and call volume, remain equal.

According to IRS officials, the agency is undertaking a workload analysis
designed to reevaluate telephone staffing levels, associated call site
locations and capacity. According to the Wage and Investment Commissioner,
the study has been expanded to include call site consolidation, although
IRS has not determined which factors should be considered or when the
study will be completed.

IRS could eliminate underutilized space by consolidating or closing call
sites. For example, a small IRS call site can have as few as 200 CSRs.
With 850 empty workstations, this means that IRS could consolidate or
close as many as four sites without eroding taxpayer service.

^36GAO-06-499T.

  IRS's Web Site Use Grew Substantially and Is Now a Major Component of Taxpayer
  Service

Use of IRS's Web site (IRS.gov) increased substantially this filing season
compared to last year based on the number of visits and downloads. From
January 1 through August 31, 2006, IRS's Web site was visited 161 million
times by visitors (a nearly 9 percent increase), who downloaded 170
million forms and publications (a nearly 36 percent increase).^37 Where's
My Refund, which allows taxpayers to check the status of their refunds
online, was accessed by 31.3 million taxpayers as of September 10, 2006,
an 11.9 percent increase over the same period last year. As we have
reported, the increased usage of IRS's Web site is consistent with IRS's
strategy to improve taxpayer service by providing taxpayers options for
automated interaction with IRS.^38 The Web site can be used at taxpayers'
convenience and can be used 24 hours a day.

IRS reconfigured its Web site for the 2006 filing season in order to
improve customer service through easier navigation and a more effective
search function. The Web site is performing well based on various data
including the following:

     o A Brown University Study that ranks federal agency's Web sites shows
       that IRS has improved its ranking from 25th in 2005 to 6th in 2006,
       based on such factors as the number of publications and online
       services provided.^39
     o An independent weekly study by Keynote, a company that evaluates Web
       sites, reported that IRS's Web site repeatedly ranked second out of 40
       government agencies evaluated in terms of average download time
       through mid-April 2006, and first out of the most commonly accessed
       government-related Web sites for response time and success rate
       through May 2006.^40
     o The American Consumer Satisfaction Index, which tracks trends in
       customer satisfaction, noted an increase in IRS's Web site consumer

37

We cannot make comparisons before 2005 because in October 2004, IRS
changed the way that it collects and analyzes Web site data in order to
provide a more accurate count of visits and downloads.

^38GAO-06-51.

39

Darrell M. West, State and Federal E-Government in the United States,
2006, Taubman Center for Public Policy, Brown University (Providence,
Rhode Island: August 2006).

40

Keynote Systems, Keynote Government 40 Internet Performance Index and
Keynote E-Government Web Transaction Performance Index.

satisfaction score from 68 percent to 72 percent after IRS reconfigured
the site.^41

        * As of August 31, 2006, the number of Web site searches has
          decreased by almost half, from 181 million to 95 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 added features to its Web site this year including the
          following:

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

          * Help for Hurricane Victims: This is a special link that provides
            victims of the recent hurricanes with information on special tax
            relief, assistance and how to get help with tax matters.
          * In addition to the Free File and Where's My Refund programs,
            discussed earlier, IRS's Web site has other important features
            including the following:

     o ETLA, where taxpayers can ask IRS general tax law questions through
       its Web site. From October 1, 2005, through August 31, 2006, IRS
       received 17,511 emails requesting ETLA (down over 41 percent compared
       to last year) and estimated the accuracy rate of its responses to be
       85.5 percent, comparable to 2005. We have previously reported that the
       ability of one taxpayer to forward an IRS e-mail response to many
       other taxpayers makes the accuracy of responding to inquiries
       submitted via e-mail important.^42 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 1.5 days in 2005 and IRS's goal of 3
       business days.
     o E-Services, which is a suite of Internet services that enable paid tax
       preparers to conduct business, such as electronic account resolution

American Consumer  Satisfaction  Index,  Special  Report  on  e-Government
Satisfaction, National  Quality Research  Center, University  of  Michigan
(Ann Arbor, Michigan: Mar. 21, 2006).

^42GAO-05-67.

Page 27 GAO-07-27 Tax Administration

and transcript delivery, with IRS electronically 24 hours a day, 7 days a
week. IRS is promoting e-Services to increase electronic filing among
preparers.

  Continuing Past Trends, Fewer Taxpayers Used IRS Walk-in Sites and More Used
  Volunteer Sites, but Data on Services Provided Remains Incomplete for Both

Shifting taxpayers from IRS walk-in sites to community sites staffed by
volunteers is part of IRS's strategy for reducing the costs of providing
taxpayers with face-to-face assistance, while providing taxpayers with
additional, and perhaps more convenient, options.

    Fewer Taxpayers Received Assistance at Walk-in Sites, and IRS Continues to
    Lack Comprehensive Management Data and a Reliable Method for Assessing
    Quality

Fewer taxpayers used IRS's 400 walk-in sites than last year. As reflected
in figure 4, the total number of contacts at IRS walk-in sites declined 12
percent from the previous year, continuing a decline of approximately 40
percent since 2001. The largest decrease since last year was in tax law
assistance, which declined by approximately 39 percent. Return preparation
assistance declined by more than 8 percent since last year and more than
70 percent since 2001. In the past 2 years, IRS has not reduced the types
of assistance offered at its walk-in sites, so the decline in usage is due
to other factors. For example, IRS officials attribute the decrease to
taxpayers' receiving alternative assistance from tax preparation software
and IRS's telephone service.

  Figure 4: Assistance Provided by IRS Walk-in Sites, 2001-2006 Filing Seasons

Note: For walk-in sites, "Other walk-in contacts" includes assistance for
account notices, tax law inquiries, forms, and other in-person contacts,
but not return preparation. 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; December 26, 2004, through April 23, 2005; and December
25, 2005, through April 22, 2006.

Accounts assistance was the only area of service that increased since last
year, up 66,000 contacts, or 7 percent, continuing an upward trend since
2004. IRS officials attribute the increase in accounts assistance to IRS's
increased enforcement efforts in recent years.

This year, IRS used 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, volunteer sites performed outreach and agreed to accept
referrals from IRS of disaster victims needing tax return preparation
assistance.

The decline and shift of taxpayers from walk-in sites to other service
options is important because it has allowed IRS to transfer timeconsuming
services, such as return preparation, from IRS to other less costly
alternatives that can be more convenient for taxpayers. This has allowed
IRS to devote fewer FTEs to providing return preparation services. As
figure 5 shows, direct FTEs decreased approximately 45 percent between
2001 and 2006, roughly proportional to the decreases in usage shown in
figure 4.

Figure 5: Direct FTEs Used for  Assistance Provided at IRS Walk-in  Sites,
2001-2006 Filing Seasons

Note: 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;
December 26, 2004, through April 23, 2005; and December 25, 2005, through
April 22, 2006.

In the past, we^43 and TIGTA^44 reported that IRS lacked (1) detailed
management data on the services offered its walk-in sites and (2) a
reliable method for assessing the quality of services offered at the
sites. With such information, IRS managers could make more informed
decisions about staffing and business operations including which services
to offer and where improvements are needed. TIGTA has recently reported
some improvement in service quality at walk-in sites.^45 And, to its
credit, IRS is in the process of taking steps intended to provide better
data on the services provided at walk-in sites and the quality of those
services. The steps include the following:

     o Q-Matic: IRS installed one of three versions of Q-Matic, its automated
       customer tracking system, at all 400 walk-in sites in time for the
       2006 filing season. According to IRS officials, in addition to helping
       control customer traffic, once this data is fully integrated with
       IRS's other management information systems IRS managers will have
       detailed data on the number, type, and duration of taxpayers'
       contacts.
     o Contact Recording: As we have previously reported, contact recording
       is a method for assessing quality at all walk-in sites.^46 For the
       2007 filing season, IRS plans to deploy contact recording at
       approximately 126 walk-in sites, which would cover approximately 45
       percent of IRS's total walk-in contacts. According to IRS, when fully
       implemented, contact recording should enable IRS to standardize its
       employee evaluation and quality assessment processes, establish
       performance baselines, and reliably assess the accuracy of the
       services it provides at its walk-in sites.

43

See, for example, GAO-05-67 and GAO-06-51.

44

See, for example, Treasury Inspector General for Tax Administration
(TIGTA), Customer Service at the Taxpayer Assistance Centers Is Improving
but is Still not Meeting Expectations, Reference No. 2005-40-021
(Washington, D.C.: Dec. 28, 2004) and Taxpayer Service Is Improving, but
Challenges Continue in Meeting Expectations, Reference No. 2006-40-052
(Washington, D.C.: Feb. 17, 2006).

45

See, for example, TIGTA Customer Service at Taxpayer Assistance Centers
Showed Improvement During the 2006 Filing Season, Reference No.
2006-40-122, (Washington, D.C.: Aug. 30, 2006).

^46GAO-06-51.

    More Taxpayers Continued to Receive Return Preparation Assistance at
    Volunteer Sites, yet Quality of Service Remains Unknown

In contrast to walk-in sites, the number of returns prepared at over
12,000 volunteer sites grew to 1.8 million returns. Although IRS has
changed the methodology it uses to count returns electronically filed from
volunteers sites, this still represents an overall increase over last
year.^47

As with its walk-in sites, IRS continues to lack complete data on the
quality of return preparation at its volunteer sites. We and TIGTA have
reported concerns about the quality of return preparation assistance
provided at volunteer sites and have made recommendations to remedy the
concerns.^48 At the same time, we have noted that IRS has had several
initiatives to improve the quality of services provided at volunteer
sites.^49 However, these initiatives have changed in purpose and scope as
IRS's efforts to centralize its partnerships with volunteers have evolved.
Furthermore, IRS has not always fully implemented these initiatives. For
example, in 2005, IRS intended to use observation reviews to assess tax
return preparation accuracy by watching volunteers prepare taxpayers'
returns. However, IRS cancelled observation reviews due to concerns raised
by some of its partners and the NTA, noting that observation reviews
violated taxpayer privacy and unfairly targeted low-income taxpayers.

The Volunteer Return Preparation Program Quality Improvement Process is
IRS's newest initiative to promote return preparation quality at its
volunteer sites. As part of this initiative, IRS conducted two types of
reviews--site and return reviews--to monitor and evaluate quality of
return preparation at volunteer sites. IRS used site reviews to measure
volunteer sites' adherence to IRS's quality standards, but the results
could not be generalized across volunteer sites because IRS did not use a
statistically valid sample. Return reviews, which are limited in scope,
compared the information taxpayers provided on the intake sheet to the
filing status, exemptions, and credits claimed on the completed return.
However, according to IRS officials, the results from the return reviews

47

According to IRS officials, IRS previously relied on volunteer sites to
manually enter their Site Identification Number on returns they filed
electronically or by paper which was then extracted from the Master File.
However, in May 2005, IRS changed its methodology to use an automated
data-based system to identify returns filed electronically at volunteer
sites. For paper returns, IRS retains this information in the Master File
data base.

^48See GAO-06-51 and Treasury Inspector General for Tax Administration,
Oversight and Accuracy of Tax Returns Continue to be Problems for the
Volunteer Income Tax Assistance Program, Reference No. 2006-40-125
(Washington, D.C.: Aug. 31, 2006).

^49GAO-06-51.

were too high to help identify specific improvements that may be needed.
In 2007, IRS plans to include additional testing of the accuracy of return
preparation.

  IRS Has Completed the First Phase of the TAB and Has Begun Assessing
  Taxpayers' Service Needs

A November 2005 law prohibited IRS from reducing taxpayer services until
TIGTA could complete a study on the impact of those proposed reductions,
and required IRS to consult with stakeholder organizations including NTA,
the IRS Oversight Board, and TIGTA, before terminating or significantly
reducing any taxpayer service activity.^50 An additional congressional
directive required IRS to work with the Oversight Board and NTA to develop
a 5-year plan for taxpayer service activities, which is to include
long-term goals that are quantitative and balance enforcement and
service.^51 In response IRS is developing the TAB to provide the agency
with information on taxpayers' needs and preferences to improve taxpayer
service at lower cost as part of a 5-year plan. IRS divided its TAB work
into two phases: The Phase I report outlines the results of preliminary
research on taxpayer expectations and establishes five strategic
priorities for improving service. Phase II research and review is in
progress and is expected to be released by early 2007.

    Phase I Targets Five Themes for Improving Service

In April 2006 IRS issued Phase I of the TAB, which includes an overview of
services provided and volume information for the different service
delivery channels. It also contains demographic information on the
population of individual taxpayers. Phase I included IRS's research on and
analysis of customer needs and preferences for service delivery and
outlined the results of IRS work to gather best practices for customer
service from other government agencies, nonprofit organizations, and
private sector firms. Finally, IRS developed the following five strategic
themes for improving taxpayer service:

    1. Improve and expand education and awareness activities.
    2. Optimize the use of services from community-based partners, paid tax
       preparers commercial preparers, and software vendors.
    3. Elevate self-service options to meet taxpayer expectations.

50

Pub. L. No. 109-115, S 205 (2005).

51

H. Rep. No. 109-307, 109th Cong. (2005).

    1. Improve and expand training and support tools to enhance assisted
       services.
    2. Develop short-term performance and long-term outcome goals and
       metrics.

The theme of elevating self-service options is consistent with IRS's new
long-term goal for increasing taxpayer self-assistance, introduced in
2006, as well as its strategy of matching services with taxpayer
technological proficiency. As previously noted, IRS's efforts to increase
taxpayer selfassistance is of concern to the NTA.

IRS Reports Phase II in Progress with Expected Report Release by Early
2007

Phase II of the TAB includes additional research to build on the strategic
improvement themes. IRS officials reported that to address the
congressional directive that the plan balance service and compliance,
Phase II includes a research agenda on the effect of taxpayer service on
compliance. The studies also include an analysis addressing respondents'
preferences among service delivery channels when other attributes change,
such as convenience or cost of service to the taxpayer.

IRS officials anticipate that the TAB Phase II report will be released to
the Congress by early 2007. They also confirm that it will include a
multiyear plan for taxpayer service activities and improvement
initiatives; the TAB team has identified over 70 projects for improving
taxpayer services, although none will be implemented in time for the 2007
filing season.

IRS anticipates that key outcomes of its Phase II work will be a process
for assessing customer preferences and subsequent research on those
preferences, because demographics are constantly changing. Furthermore,
taxpayer expectations are likely to shift with the advent of new
technology, as exemplified by the exponential availability and use of
Internet-provided services in recent years.

                                  Conclusions

IRS continues to make significant improvements in its filing season
performance. In an environment of tight budgets and demands to improve
service while maintaining or increasing enforcement activities, generating
savings by operating more efficiently is crucial. We have identified two
such savings opportunities.

First, despite numerous IRS initiatives to increase electronic filing,
there remains considerable room for further growth. Some states, federal
tax experts, and even IRS have recognized that mandatory electronic filing
can generate savings by reducing paper filing. However, IRS lacks the
statutory authority to expand its use of mandates. Requiring certain paid
tax preparers to file individual returns electronically could increase
electronic filing and generate savings for IRS.

Second, IRS could achieve efficiencies by reducing unnecessary spending on
the excess capacity at its telephone operations--without negatively
affecting taxpayer service--by consolidating its call sites.

In addition, IRS continues to implement CADE. As more taxpayer accounts
are put on CADE, the benefits to taxpayers will grow and more facts
regarding those benefits, such as information on refund timeliness and
improved taxpayer service, are likely to sustain congressional support.
However, IRS is not reporting on one of the chief benefits already
realized from CADE, issuing refunds faster. The Congress could benefit
from knowing this information as it makes decisions about funding the
completion of CADE.

Matter for Congressional Consideration

Given the efficiencies to be gained, the Congress should mandate
electronic filing  by  paid  tax  preparers meeting  criteria  such  as  a
threshold number of returns filed.

Recommendations for Executive Action
  
We  recommend  that  the  Commissioner  of  Internal  Revenue  direct  the
appropriate officials to



     o timely develop, validate, and implement a plan to consolidate call
       sites, and
     o report to the Congress refund timeliness for CADE compared to the
       Master File legacy system.

                       Agency Comments and Our Evaluation

The Commissioner of Internal Revenue provided written comments in a
November 3, 2006, letter. With respect to the matter for congressional
consideration, the Commissioner said he appreciated our acknowledging that
the current statutory limitation impedes electronic filing growth. The
Commissioner agreed with both of the report's recommendations to IRS. In
responding to our first recommendation, the Commissioner stated that

Page 35 GAO-07-27 Tax Administration

IRS would take steps to develop plans, including updating data and
projections, conduct a full cost analysis to determine projected savings,
and formulating a consolidation timeline and workload redistribution plan.
The Commissioner responded to the second recommendation stating that IRS
would develop a measure to show refund timeliness for CADE based on its
current sampling methodology. However, because the current methodology
includes only paper returns, the new measure would necessarily show CADE's
benefits for only paper returns, not all returns.

As agreed with your office, unless you publicly announce the contents of
this report earlier, we will not distribute it until 30 days from the date
of the report. At that time, we will send copies of this report to the
Chairmen and Ranking Minority Members of the Senate Committee on Finance,
the House Committee on Ways and Means, and the Ranking Minority Member,
Subcommittee on Oversight, House Committee on Ways and Means. We are also
sending copies to the Secretary of the Treasury; the Commissioner of
Internal Revenue; the Director, Office of Management and Budget; and other
interested parties. We will also make copies available to others on
request. In addition, the report will be available at no charge on the GAO
Web site at http://www.gao.gov.

If you have any questions regarding this report, please contact me at
(202) 512-9110 or at [email protected]. Contact points for our Offices of
Congressional Relations and Public Affairs may be found on the last page
of this report. Key contributors to this report include Amanda Arhontas,
Paula Braun, Amy Dingler, Evan Gilman, Tim Hopkins, Kathryn Horan, Hillary
Loeffler, Paul Middleton, Karen O'Conor, Cheryl Peterson, Neil Pinney,
Stephen Sallan, and Joanna Stamatiades.

Sincerely yours,

James R. White Director, Tax Issues Strategic Issues

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

In 2002, the 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
Alliance members in providing free, online tax return preparation and
filing services to taxpayers.

IRS stated that the original purpose of the Free File Alliance was to
increase electronic filing, and at the same time, assist low-income
taxpayers with filing their taxes electronically. One of the benefits for
Alliance members of belonging to the Free File Alliance is the ability to
advertise their software programs and products through IRS's Web site,
which receives heavy traffic each year.

In 2005, IRS renegotiated and amended the agreement. Key differences
between the agreements are

     o a new income limitation of $50,000;
     o new language 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

          * Alliance members must provide the necessary support to accomplish
            a customer satisfaction survey.
          * Another change is that new language pertaining to the marketing
            and offering of Refund Anticipation Loans (RAL) stated that 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.^1 Also, RALs are to be offered with clear
            language indicating, for example, that they

     o are loans, not a faster way of receiving an IRS refund;
     o must be repaid even if the IRS does not issue a full refund;
     o are short-term loans with high interest rates and, therefore,
       customers may wish to consider using other forms of credit; and

1

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

Page 37 GAO-07-27 Tax Administration Appendix I: Differences between the
2002 and 2005 Free File Agreements

o may be offered but not promoted.

IRS tests each Alliance member's software to ensure it is in accordance
with the Free File provisions 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 not following instructions, or incorrectly entering
information. GAO conducted limited testing of the Free File program and
found that Alliance members were complying with the terms outlined in the
amended Free File agreement pertaining to RALs.^2 In addition, according
to IRS, 9 of 20 Free File companies offer RALs.

The amended Free File agreement contains provisions that enable IRS to
monitor taxpayer participation beginning in the 2006 filing season, unlike
prior years where 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, 2006, 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 5.1 million in 2005. The substantial growth between 2003 and 2005
was due to, in part, several Alliance 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 as it put pressure on all Alliance members to offer free
service, which may not have been economically feasible for some.
Competition would be reduced if Alliance members were to drop out of the
Alliance.

We conducted limited testing on 13 out of 20 companies participating in
the Free File program using a scenario we constructed that represented a
low-income worker. Purposes of the testing included examining some
potential experiences of taxpayers, such as the length of time to complete
a return and whether any financial services, such as RALs, were marketed
during the filing of the return, examining what happened if we declined
the services, and evaluating our experience compared to the Free File
agreement.

Page 38 GAO-07-27 Tax Administration Appendix I: Differences between the
2002 and 2005 Free File Agreements

IRS projected that over 6 million taxpayers would use Free File in 2006.
However, this projection was overstated, because through August, IRS
processed about 4 million returns filed through the Free File program,
which is a decrease of about 23 percent from the same period last year.
According to IRS officials, the new income limitation contributed, in
large part, to this decline despite the fact that the income limitation
provides coverage to 70 percent of the nation's taxpayers, or more than 92
million people, and includes taxpayers with an adjusted gross income of
$50,000 or less. Moreover, IRS officials stated that it was this income
limitation that contributed to the overall lower rate of growth in
electronic filing this year.

Appendix II: Status of CADE Implementation and Future Releases

The IRS is developing and deploying its Customer Account Data Engine
(CADE) incrementally in multiple releases over several years, as shown in
table 4. IRS is planning for semiannual subrelease deployments in July and
January prior to each filing season. The July subreleases (x.1) focus on
new CADE functionality with some tax law changes, while the January
subreleases (x.2) contain primarily filing season and tax law changes with
minimal new functionality. Each incremental release builds upon and
expands the functionality contained in the prior releases. For example,
during the 2006 filing season, CADE Release 1 processed Form 1040EZ, 1040,
and 1040A tax returns with no schedules for single taxpayers with no
dependents. Release 2 is planned to add the capability to process Form
1040 and 1040A tax returns with various schedules and supporting forms for
taxpayers filing as single, married, or head of household in 2007. With
the deployment of Release 7 in 2012, CADE is expected to fully replace the
Individual Master File and process all individual tax returns.

Table 4: Schedule of CADE Releases and Related Functionality
                                                                    Estimated
                                                                    number of
                                                          Account     returns 
Release      Release Tax return  Filing       characteristics   (millions) 
Sub-release  date    types       status                                    
1  1.1   July 2004   Form 1040EZ Single       Refund or even-         n.a. 
                                    (never       balance returns          1.4 
      1.2  January 2005             married, no                      (actual) 
                                    dependents)  No account                   
                                                 issues                       
                                                 (open or closed)             
        1.3.1  September                         Address changes              
                    2005                                                      
        1.3.2  January   Forms 1040              Refund or even-          7.4 
                 2006    and 1040A                                   (actual) 
                       No schedules              balance returns              
                                                 Closed prior                 
                                                 account                      
                                                 issues                       
                                                 Extensions                   
                                                 without                      
                                                 payments                     
2  2.1      September Form 1040  Single       Extensions with           33 
                    2006                                                      
                Schedules A, B, and Head of      payments                     
                                                 full-paid                    
                   R and supporting Household    Name change                  
                                                 (first                       
                              forms (no          name)                        
                                    dependents)                               
                         Form 1040A                                           
                  Schedules 1 and 3                                           

Appendix II: Status of CADE Implementation and Future Releases

                                                                    Estimated
                                                                    number of
                                                           Account    returns 
Release         Release        Tax     Filing                              
Sub-release     date         return    status   characteristics (millions) 
                                 types                                        

       2.2     January Form 1040         Single          Married only once    
                  2007                                                        
                       Schedules C, E,   Head of                              
                       F, and SE         Household                            
                       (without Employer Married (joint)                      
                       Identification    Married                              
                       Number [EIN]) and (separate) (no                       
                       supporting forms  dependents or                        
                       Schedule D and    clean                                
                                         dependents)                          
                       supporting forms                                       
3 3.1 3.2 July 2007 Form 1040         Single Head of  Name change (last 50 
             January   Schedule EIC and  Household       name) Split          
             2008      supporting forms                  Refunds              
                       Decedent returns  Married (joint) Dependents           
                                                         expanded             
                       Full-paid with    Married                              
                       remittance Credit (separate)                           
                       election          Surviving                            
                                         Spouse                               
                              Additional                                      
                               schedules                                      
                        and forms (TBD)                                       
                       Form 1040A                                             
                       Schedule 2                                             
                       Form 1040-ES                                           
                       Form 1040-V                                            
                       Form 1040X                                             
                       Form 4868 with or                                      
without remittance 4.1 July 2008 4 Form 6251 Single Power of Attorney 70
       4.2     January Additional Form  Head of          Centralized       
                  2009 1040                                                
                       schedules and    Household        Authorization     
                       forms                             File              
                       (TBD)            Married (joint)  Balance due       
                                                         returns           
                                                 Married Math error        
                                              (separate) returns           
                                        Surviving Spouse                   

Appendix II: Status of CADE Implementation and Future Releases

                                                                    Estimated 
                                                                    number of 
                                                   Account            returns 
Release      Release Tax return      Filing     characteristics (millions) 
Sub-release  date    types           status                                
5.15         July    Form 1040       Single     Delinquent              90 
                2009                               returns                    
       5.2      January Schedules C, E, Head of                               
                2010    F, and SE (with Household                             
                        EIN) and        Married                               
                        supporting      (joint)                               
                        forms           Married                               
                        Additional      (separate)                            
                        schedules and                                         
                        forms (TBD)                                           
                        Forms 940 and   Surviving                             
                        720             Spouse                                
                        payroll,                                              
                        unemployment,                                         
                        and excise tax                                        
                        returns                                               
                        for Form 1040                                         
                        self                                                  
                        employed filers                                       

                      Page 42 GAO-07-27 Tax Administration

6   6.1    July 2010   Form 1040NR     Single           First-time     110 
                                                           filers             
       6.2   January 2011 Form 1040-PR    Head of                             
                          Form 1040-SS    Household                           
                          Additional Form Married (joint)                     
                          1040 schedules  Married                             
                          and forms (TBD) (separate)                          
                                          Surviving Spouse                    
7 7.1 7.2 July 2011    All additional   Single Head of  Foreign        135 
             January 2012 individual       Household       Address Open       
                          returns          Married (joint) account issues     
                                           Married         Taxpayers with     
                                           (separate)      history of         
                                                           multiple           
                                                           marriages          
                                         Surviving Spouse                     
                          Source: GAO analysis of IRS data.                   
                          Notes: n.a. = not applicable. TBD = to be           
                          determined.                                         
                          List of forms included above:                       
                          Form 720--Quarterly Federal Excise Tax Return       
                          Form 940--Employers Annual Federal Unemployment     
                          Tax Return Form 1040--U.S. Individual Income        
                          Tax Return                                          
                          Schedule A--Itemized Deductions                     
                          Schedule B--Interest and Ordinary Dividends         
                          Schedule C--Profit or Loss from Business            
                          Schedule D--Capital Gains and Losses Schedule       
                          E--Supplemental Income and Loss Schedule            
                          EIC--Earned Income Credit                           
                          Schedule F--Profit or Loss from Farming             
                          Schedule R--Credit for the Elderly or the           
                          Disabled Schedule SE--Self-Employment Tax Form      
                          1040A--U.S. Individual Income Tax Return            
                          Schedule 1--Interest and Ordinary Dividends for     
                                         Form 1040A Filers                    

Appendix II: Status of CADE Implementation and Future Releases

Schedule 2--Child  and  Dependent  Care Expenses  for  Form  1040A  Filers
Schedule 3--Credit for the Elderly or the Disabled for Form 1040A Filers

  Form 1040-ES--Estimated Tax for Individuals

Form 1040EZ--Income  Tax  Return  for  Single and  Joint  Filers  with  No
Dependents

Form 1040NR--U.S. Nonresident Alien Income Tax Return

  Form 1040-PR--Puerto Rico Resident Income Tax Return

Form 1040-SS--U.S. Se Payment lf-Employment Tax Return

Form 1040-V--Voucher

  Form 1040X--Amended U.S. Individual Income Tax Return

Form 4868--Application  for  Automatic  Extension of  Time  to  File  U.S.
Individual Income Tax Return

  Form 6251--Alternative Minimum Tax--Individuals

Appendix III: State Mandates for Electronic Processing

Twelve states had electronic filing mandates for paid tax preparers in
effect for the 2006 filing season (see fig. 6). State mandates differ but
require preparers who meet specified requirements, such as filing 100
individual income tax returns per year, to file individual income tax
returns electronically.

    Figure 6: States with Electronic Filing Mandates for Paid Tax Preparers

Nine states had electronic filing mandates in effect in 2005 or earlier.
In eight of these nine states, the mandates increased the growth rate of
electronically filed federal returns (see table 5).

Appendix III: State Mandates for Electronic Processing

 Table 5: Electronic Filing Rates of Growth in Federal Returns for States with
                     Mandates Compared to National Averages

Percent

          Tax year when state Nationwide mandates were Electronic filing rate
      Electronic filing rate Percent change electronic rate of implemented of
growth prior to the of growth in the tax in electronic growth the year the
tax year the mandate year the mandate was filing rate of mandate was State
                         was implemented^a implemented^b growth^c implemented

                        2004 Alabama 9.9 14.6 48.0 11.2

Massachusetts 11.2 28.1 150.9

New Jersey 12.7 35.0 176.5

Virginia 12.4 11.0 -10.6^d

                      2003 California 14.8 55.7 276.7 12.3

Michigan 14.2 40.3 184.1

Oklahoma 8.9 12.6 42.0

                       2002 Wisconsin 23.4 29.6 26.6 16.6

                       2000 Minnesota 32.6 34.9 7.2 13.6

Source: GAO analysis of IRS data.

a

The rate of growth compares the 2 years prior to the year the mandate was
implemented.

b

The rate of growth compares the year prior to the mandate's implementation
to the year the mandate was implemented.

c

The percent change in electronic filing rate is based on the change from
the year the mandate was implemented to year prior to implementation.

d

The decrease in the percent change in Virginia's electronic filing rate of
growth may be due in part to 2-D barcodes, which are attached to the paper
tax return. IRS does consider paper returns filed with 2-D barcodes as
being electronically filed.

According to a June 2005 study by the Federation of Tax Administrators,^1
many state tax administrators view electronic filing as a means to improve
tax return and refund processing, improve customer service, and reduce the
number of seasonal workers in part by making better use of staffing
resources. According to New York, California, and Minnesota officials,
given tight budget constraints, the opportunity to generate savings was
the main reason behind their decisions to implement mandates. For example,
in 2001 Minnesota estimated it saved $2.45 per return by mandating

1

Federation of  Tax  Administrators, Electronic  Filing  Mandates:  Lessons
Learned (Washington, D.C.: June 2005).

Page 45 GAO-07-27 Tax Administration Appendix III: State Mandates for
Electronic Processing

electronic filing for paid tax preparers.^2 Other states also reported
savings from electronic filing mandates.

While Minnesota was the first state to implement a mandate for individual
income tax returns, more states have adopted mandates and some have used
different methods to encourage electronic filing of state returns. Some
notable examples include the following:

     o Filing thresholds: States with mandates often differ in the minimum
       number of returns a paid tax preparer must file before having to
       comply with an electronic filing mandate. In most states, the
       threshold is often lowered gradually over time, increasing the base of
       preparers that fall under the mandate. For example, in New Jersey in
       2005, preparers who prepared more than 200 individual state income
       returns in the prior year had to electronically file all returns they
       prepared in the current year. The threshold will drop to 100 returns
       in 2007 and 50 returns in 2008.
     o Penalties: Some states do not impose penalties on noncompliant paid
       tax preparers; however, those states that do levy penalties for
       noncompliance often differ in amount and level of enforcement. For
       example, some states waive the penalty if a taxpayer chooses to optout
       of having their return electronically filed. In fact, most states
       include "opt-out" clauses in the legislation that allows a preparer to
       file a customer's return on paper at the customer's request. In
       contrast, if a preparer files a return on paper, absent of the
       customer's request, they could be subject to upwards of a $100 fine.
       Alternatively, the state of Minnesota charges a $5.00 fee for returns
       filed on paper returns prepared by mandated preparers regardless of
       the circumstances.
     o Including 2-D Barcodes as Electronic Filing: State mandates also vary
       in what they consider an electronically filed return. Utah, Alabama,
       and Virginia consider a paper return with a 2-D barcode produced by
       tax preparation software as an electronically filed return. New York
       also considered paper returns with 2-D barcodes as electronically
       filed returns for the 2006 filing season.

In its June 2005 report, the Federation of Tax Administrators noted that
many states reviewed existing state mandate legislation for guidance and
ideas, or best practices, prior to implementing their own mandates. For

We did not verify this estimate.

Appendix III: State Mandates for Electronic Processing

example, New York officials said they used the experiences reported by
California when deciding what provisions their mandate should or should
not include. The Federation of Tax Administrators reported several lessons
learned about implementing mandates, including,

     o having a phased-in approach over a period of several years,
     o providing the ability for a taxpayer to opt out of electronic filing
       if he or she chooses instead to file a paper return, and

          * having penalties for failure to file electronically.
          * Finally, the states' experience with mandates has shown the
            following

     o Communication and taxpayer education are vital. For example,
       California scheduled presentations and panels on mandatory electronic
       filing for tax professional organizations in order to achieve buy-in
       from the paid tax preparer community.
     o Lead time for implementation and the definition for the scope of the
       mandate are important. Most states currently use the federal Employer
       Identification Number (EIN) to define "paid tax preparer" and treat
       any office or branch of an entity operating under a single EIN as a
       "paid tax preparer" subject to the mandate.
     o Coordination between IRS and Electronic Return Originators is
       essential.^3

Electronic Return Originators originate the electronic submission of
income tax returns to the IRS and may originate the electronic submission
of income tax returns that are either prepared by the originator or
collected from the taxpayer.

Appendix IV: IRS's Processing Performance Relative to 2001-2005 Performance and
2006 Goals

IRS met or exceeded eight of the nine processing performance goals for
2006 as table 5 shows. For seven measures (i.e., deposit error rate,
deposit timeliness, notice error rate, refund interest paid, refund
timeliness, productivity, and efficiency), IRS exceeded its goal. For one
measure (refund error rate), IRS met its goal.

For one measure, the letter error rate, IRS's performance declined and the
2006 goal was not met. The letter error rate is calculated as the
percentage of letters issued to taxpayers with errors. IRS officials said
that computer system errors were partially to blame for the higher letter
error rate this filing season; however, most of those errors were caused
by one programming error that was corrected in the beginning of March. In
addition, according to IRS officials, most errors caused by employees were
attributed to one submission processing center, which had many new
employees.

Comparing actual 2006 performance to 2005 shows that IRS's performance
improved or remained about the same for eight of the nine measures in
effect in 2005. Table 6 also shows that IRS processing performance in 2006
has significantly improved compared to prior years.

Appendix IV: IRS's Processing Performance Relative to 2001-2005
Performance and 2006 Goals 

Table 6: IRS's Processing Performance, Fiscal Years 2001-2006
                                                                                        Fiscal
                                                                                          year
                                 Fiscal    Fiscal     Fiscal Fiscal   Fiscal   2006     Fiscal 
                                  year       year       year year     year     actual   year   
                                    2001     2002       2003     2004     2005 (through   2006 
Measure name       Definition    actuala   actual     actual   actual  actual     July)   goal 
Deposit error      Percentage       5.0% 4.8%     4.2%       3.5%     2.2%     1.7%       2.0% 
rateb              of payments           +/-0.3%  +/-0.3%    +/-0.31% +/-0.26% +/-0.28%        
                   applied in                                                                  
                   error by,                                                                   
                   for                                                                         
example,                                                                                       
reimbursing a                                                                                  
taxpayer who                                                                                   
overpaid when                                                                                  
the taxpayer                                                                                   
wanted any                                                                                     
overpayment                                                                                    
credited to next                                                                               
year's tax bill.                                                                               
Deposit      Interest             Not         Not        Not     $407     $390     $365   $390 
             foregone                                                                          
timeliness-- by not        comparable  comparable comparable                                   
             depositing                                                                        
paper        monies the    because of  because of because of                                   
             business day   revisions revisions   revisions                                    
                               to the to the      to the                                       
             after           measure.    measure.   measure.                                   
             receipt, per                                                                      
$1 million in                                                                                  
deposits.                                                                                      
Measure                                                                                        
assumes an 8                                                                                   
percent interest                                                                               
rate.                                                                                          
Letter     Percentage of              Not 7.4%    7.1%       6.6%     3.1%     3.6%       3.0% 
error      letters issued to   comparable +/-0.6% +/-0.5%    +/-0.38% +/-0.30  +/-0.36%        
rateb      taxpayers with      because of                                                      
            errors (includes  revisions                                                        
                              to the                                                           
           systemic errors).c  measure.                                                        
Notice     Percentage of              Not 18.7%   9.4%       9.5%     9.2%     5.6%       8.6% 
error      incorrect notices   comparable +/-2.4% +/-1.2%    +/-1.31% +/-1.6%  +/-1.08%        
rateb      issued to           because of                                                      
           taxpayers          revisions                                                        
                              to the                                                           
           (includes           measure.                                                        
               systemic errors).c                                                              

                                                                                           Fiscal
                                                                                             year
                            Fiscal year     Fiscal     Fiscal     Fiscal Fiscal   2006     Fiscal 
                                              year       year       year year     actual   year   
                                   2001       2002       2003       2004     2005 (through   2006 
Measure name     Definition     actuala     actual     actual     actual  actual     July)   goal 
Refund error     The               9.8%       8.0%       5.3%       4.9%     5.0%     4.5%   4.8% 
                 percentage                                                                       
rate--individual of refunds                                                                       
(paper)b         with                     +/-0.46%   +/-0.41%   +/-0.44% +/-0.48% +/-0.51%        
                 IRS-caused                                                                       
                 errors in                                                                        
                 the entity                                                                       
                 information                                                                      
                 (e.g.,                                                                           
                 incorrect                                                                        
                 name,                                                                            
                 Social                                                                           
                 Security                                                                         
                 number, or                                                                       
                 refund                                                                           
                 amount);                                                                         
                 includes                                                                         
                 systemic                                                                         
                 errors. c                                                                        
Refund interest  Amount of          Not        Not     $36.29     $20.55  $29.21    $29.88 $32.00 
                 refund                                                                           
paid             interest    comparable comparable                                                
                 IRS paid                                                                         
                 per $1      because of because of                                                
                 million of                                                                       
                 refunds     revisions  revisions                                                 
                 issued.     to the     to the                                                    
                               measure.   measure.                                                
Refund           Percentage       95.2%      98.2%      98.8%      98.3%    99.2%    99.4%  99.2% 
                 of                                                                               
timeliness--     refunds                  +/-0.32%   +/-0.26%   +/-0.17% +/-0.18% +/-0.13%        
individual       issued                                                                           
(paper)b         within 40                                                                        
                 days or                                                                          
                 less.                                                                            
Productivity     Weighted        30,133     28,389     30,179     30,405  31,444    33,011 32,000 
                 volume                                                                           
                 of                                                                               
                 documents                                                                        
                 processed                                                                        
                 per                                                                              
                 staff year                                                                       
                 expended at                                                                      
                 the                                                                              
                 processing                                                                       
                 centers.                                                                         
Individual       Measure of  Measure    Measure    Measure    Measure     14,965    17,538 15,622 
                             not in     not in     not in     not                                 
                 individual  existence. existence. existence. in                                  
Master File      Master File                                  existence.                          
efficiency       returns                                                                          
                 processed                                                                        
                 per                                                                              
                 staff year                                                                       
                 expended.                                                                        

Source: GAO analysis of IRS data.

Notes: The measures for fiscal year 2006 are through July 30, which were
the latest data available at the time we ended our audit work. According
to IRS officials, the 2006 results through July 30 are reflective of IRS's
performance during the filing season. In addition, IRS officials told us
that the results for the measures should not change significantly through
September 30.

a

According to IRS officials, they did not compute a margin of error for
these measures in 2001.

b

IRS estimates these measures to have a 90 percent confidence interval.

Systemic errors are computer-generated errors over which a particular
processing center would have no control.

Appendix V: Telephone Access Varies Depending on the Time of Year and Type of
Call

Level of service can vary during different periods of the year. For
example, from January 1 through April 22 the level of service was 82
percent, but was 75 percent from April 23 through June 10. Fewer taxpayers
called after the filing season deadline and those taxpayers who did
received a lower level of service compared to those who called during the
filing season. According to IRS officials, their work plans are built to
maximize IRS's telephone performance during the filing season when most
taxpayers call.

The average speed of answer varies between questions. IRS groups each type
of call into different applications, so that they can be answered by a
properly trained customer service representative (CSR). Taxpayers'
experiences may differ depending upon the availability of CSRs and the
number of calls received in the category. For example, according to IRS
data as of April 22, taxpayers wanting answers about capital gains and
losses on average waited 4 minutes longer than those wanting answers about
tax credits.

According to IRS, however, there may be opportunities to address these
variances with the implementation of a new workforce management system and
full deployment of a single queue for telephone service. The new system
should allow IRS to make staffing decisions at the corporate level, rather
than relying on the individual sites, and in turn, create benefits from
better staffing decisions and more flexible work plans. IRS expects to
have the new workforce management system fully implemented in fiscal year
2008. According to IRS officials, implementing a single queue for each
application across all call sites, rather than separate queues at each
site, will create a consistent average answer time within an application.
Currently, two taxpayers with the same question may have different wait
times because one waited for a CSR in the Jacksonville call site, for
example, while another waited for a CSR in Austin. With a single queue,
those taxpayers would wait the same amount of time irrespective of their
location. However, the single queue will not improve the variations in
wait time between the different applications. IRS officials said that
there will still be fluctuations but the new workforce management solution
and a single queue should help to better manage variances.

Appendix VI: Comments from the Internal Revenue Service

(450466)

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