Tax Administration: IRS' Use of Nonaudit Contacts (Letter Report,
03/16/2000, GAO/GGD-00-7).

Pursuant to a congressional request, GAO provided information on the
Internal Revenue Service's (IRS) use of nonaudit contacts with
taxpayers, focusing on: (1) the frequency of use, variation in timing,
and types of taxpayer responses for three major types of nonaudit
contracts; and (2) analyzing the IRS' use of data from the three types
of nonaudit contacts to improve compliance and service to taxpayers.

GAO noted that: (1) during 1998, IRS contacted almost 11 million
taxpayers through at least one of the nonaudit or audit contact
programs; (2) about 6 million contacts were made through the math error
program, which is designed to correct arithmetic and other errors, such
as incorrect social security numbers; (3) about 2 million contacts were
made through the underreporter program, which is designed to match
income data reported on information returns by payers, such as employers
and banks, to income reported by taxpayers on tax returns; (4) about 2
million contacts were made through two types of soft notices; (5) about
1 million contacts were made through audits, which involve examinations
of taxpayer books and records for one or more income, deduction, credit,
or other tax issue on the tax return; (6) the timing of the types of
contacts varies; (7) a number of reasons can explain the different
starting times for each type of contact; (8) these contacts also vary in
how taxpayers are to respond; (9) math error and soft notice contacts do
not ask taxpayers to respond by providing additional information; (10)
both underreporter and audit contacts usually ask taxpayers to provide
information about the reported tax liability and to eventually either
agree or disagree with any changes to it; (11) depending on the type of
contact, taxpayers have different ways to dispute any changes to their
tax liability; (12) IRS collects some data on nonaudit contacts, such as
caseload and the amount of tax change, to help administer the programs;
(13) IRS does not regularly collect data that could be used to identify
ways to improve taxpayer compliance and service; (14) IRS does not
always collect data on why taxpayers did not comply or whether they
repeated their noncompliance in the future; (15) without such data, IRS
cannot know the areas in which taxpayers need clarification or how well
the programs are meeting the goals of improving compliance and serving
taxpayers; and (16) IRS officials said that such data has not been
collected because of problems in their information systems and questions
about the cost-effectiveness of collecting the data for all types of
contacts.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  GGD-00-7
     TITLE:  Tax Administration: IRS' Use of Nonaudit Contacts
      DATE:  03/16/2000
   SUBJECT:  Taxpayers
	     Tax return audits
	     Voluntary compliance
	     Customer service
	     Tax administration systems
	     Tax violations
	     Data collection
IDENTIFIER:  Earned Income Tax Credit
	     IRS Underreporter Program
	     IRS Soft Notice Program
	     IRS Math Error Program
	     IRS Audit Program
	     EIC

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United States General Accounting Office
GAO

Report to Congressional Requesters

March 2000

GAO/GGD-00-7

TAX ADMINISTRATION
IRS' Use of Nonaudit Contacts

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Contents
Page 161GAO/GGD-00-7 IRS' Use of Nonaudit Contacts
Letter                                                                      1
Appendix I                                                                 18
Summary of Program
Operations for Selected
Nonaudit Contacts
Appendix II                                                                23
Comments From the
Internal Revenue Service
Appendix III                                                               28
GAO Contacts and Staff
Acknowledgments
Tables                                                                      1
Figures                                                                     1

Abbreviations

EIC       Earned Income Credit
IRS       Internal Revenue Service
SSN       Social Security Number

B-283064

Page 15 GAO/GGD-00-7 IRS' Use of Nonaudit Contacts
B-283064

March 16, 2000

The Honorable Bill Archer
Chairman, Committee on Ways and Means
House of Representatives

The Honorable Amo Houghton
Chairman, Subcommittee on Oversight
Committee on Ways and Means
House of Representatives

In 1998, over 123 million individual taxpayers
filed income tax returns. For most, this ended
their interaction with the Internal Revenue
Service (IRS) for the year. However, IRS audits
about 1 percent of taxpayers with respect to the
tax liability reported on their returns.1 IRS also
uses several types of nonaudit contacts to notify
millions of additional taxpayers about potential
errors in their reported tax liability.2 IRS has
publicly provided little information about such
nonaudit contacts.

In 1998, Congress passed the IRS Restructuring and
Reform Act to better balance compliance and
service to taxpayers, among other things. As
required by the act, IRS developed a new mission
statement, providing for equal treatment of
taxpayers with respect to compliance and taxpayer
service as well as for operating efficiency.
Although both audit and nonaudit contacts
primarily focus on ensuring that taxpayers report
the correct tax liability, they also must reflect
mission objectives, such as balancing compliance
and taxpayer service.

You asked us to describe IRS' use of nonaudit
contacts with taxpayers. In response to your
request, this report discusses the math error
program, underreporter program,3 and notices sent
to taxpayers regarding duplicate Social Security
Numbers (SSN) and potential errors on self-
employment taxes. These programs are the major
types of nonaudit contacts about reported tax
liability. Specifically, the report describes the
frequency of use, variation in timing, and types
of taxpayer responses for the three major types of
nonaudit contacts; to provide a frame of
reference, we also describe these features for
audit contacts. Also in response to your request,
this report analyzes IRS' use of data from the
three types of nonaudit contacts to improve
compliance and service to taxpayers.

Results in Brief
During 1998, IRS contacted almost 11 million
taxpayers through at least one of the nonaudit or
audit contact programs we reviewed.

ï¿½    About 6 million contacts were made through
the math error program, which is designed to
correct arithmetic and other errors, such as
incorrect SSNs.
ï¿½    About 2 million contacts were made through
the underreporter program, which is designed to
match income data reported on information returns
by payers, such as employers and banks, to income
reported by taxpayers on tax returns.
ï¿½    About 2 million contacts were made through
two types of soft notices4-one when more than one
taxpayer claimed the same SSN for tax exemptions
or other tax benefits and the other when a
taxpayer had a potential self-employment tax
liability but had not paid it.
ï¿½    About 1 million contacts were made through
audits, which involve examinations of taxpayer
books and records for one or more income,
deduction, credit, or other tax issue on the tax
return.

The timing of the types of contacts varies. For
example, math error notices are issued shortly
after a return is filed. Initial underreporter
notices are sent between 8 and 10 months after the
April due date for the return. Soft notices are
sent from 4 to 8 months after a return is filed.
The start of audit contacts can range from months
to years after a return is filed, but the audits
are usually required to be finished within 3 years
of filing. A number of reasons explain the
different starting times for each type of contact.

These contacts also vary in how taxpayers are to
respond. Math error and soft notice contacts do
not ask taxpayers to respond by providing
additional information. Nevertheless, some
taxpayers may respond, for example, by filing
amended returns or asking questions. Both
underreporter and audit contacts usually ask
taxpayers to provide information about the
reported tax liability and to eventually either
agree or disagree with any changes to it. In
addition, depending on the type of contact,
taxpayers have different ways to dispute any
changes to their tax liability.

IRS collects some data on nonaudit contacts, such
as caseload and the amount of tax change, to help
administer the programs. However, IRS does not
regularly collect data that could be used to
identify ways to improve taxpayer compliance and
service. For example, IRS does not always collect
data on why taxpayers did not comply or whether
they repeated their noncompliance in the future.
Without such data, IRS cannot know the areas in
which taxpayers need clarification or how well the
programs are meeting the goals of improving
compliance and serving taxpayers. IRS officials
said that such data has not been collected because
of problems in their information systems and
questions about the cost-effectiveness of
collecting the data for all types of contacts.

We are recommending that IRS start to collect and
analyze data on targeted types of contacts for
each program in order to help meet its compliance
and service goals. For the longer term, we are
recommending that IRS, as it modernizes its
information systems, determine a cost-effective
way to collect such data for the types of contacts
that can affect these goals.

Background
IRS' efforts to check whether taxpayers reported
the correct tax liability begin as tax returns for
a specific year are being processed and can
continue for up to 3 years. Throughout this time,
IRS must maintain staff to respond to taxpayer
questions, process payments and amended returns,
and prepare refund checks associated with these
notices.

Historically, IRS' primary mission has been to
collect the proper amount of tax at the least cost
to the government. With the passage of the
Restructuring and Reform Act, Congress sought to
provide a more balanced environment in which IRS
would focus on both compliance and taxpayer
service. In addition to mandating that IRS revise
its mission statement to achieve this balance, the
act directed IRS to reorganize its structure,
moving away from a geographical organization to
one that focuses more on groups of similar
taxpayers (e.g., individuals and small business).
IRS has revised its mission statement and plans to
have a new organization operational by the 2002
filing season.

Scope and Methodology
To determine the frequency of use, variation in
timing, and types of taxpayer responses for the
three major types of nonaudit contacts as well as
for audit contacts, we talked to responsible IRS
officials. We obtained regulations governing the
programs and requested information on the mission,
objectives, and features for each program. We
concentrated on math error, underreporter, and
soft notices because they were the major IRS
nonaudit contacts involving the reported tax
liability on filed returns. We also included the
soft notices because they were a new approach that
IRS might use increasingly in the future.

To analyze information on IRS' use of data on
these nonaudit contacts to improve compliance and
service to the taxpayer, we talked to officials in
IRS' Customer Service Division, Submission
Processing Division, Research Division, and the
Office of Program Evaluation and Risk Analysis. We
also obtained the data available for each of the
programs and discussed how the data could be used
with these IRS officials.

We performed our work at IRS' headquarters offices
in Washington, D.C., and New Carrollton, Maryland;
the Western Region; and IRS' Fresno Service
Center. We chose the Western Region and Fresno
Service Center because we had staff available in
these areas. Our work was done between June and
December 1999 in accordance with generally
accepted government auditing standards.

We requested comments on a draft of this report
from the Commissioner of Internal Revenue. We
received written comments from the Commissioner
and on February 15, 2000, we received oral
comments from representatives of the Commissioner
in the Customer Service Division, Forms and
Submission Processing Division, and the Office of
Legislative Affairs. These comments are discussed
near the end of this letter, and the written
comments are reprinted in appendix II.

Frequency, Timing, and Taxpayer Responses for
Major Types of Nonaudit and Audit Contacts
IRS uses various types of contacts to check
whether taxpayers reported the correct tax
liability on their filed returns. IRS' most
commonly used taxpayer contact programs include
math error, underreporter, soft notice, and
audits. The following defines each program.

ï¿½    In the math error program, IRS uses computer
comparisons and calculations to correct clerical
and mathematical errors on tax returns. These
corrections involve addition and subtraction
errors; incorrect SSNs, filing status and
exemptions; and missing schedules or forms. IRS
analysts review the validity of the proposed
correction identified by the computer before IRS
notifies taxpayers.
ï¿½    In the underreporter program, IRS matches
income reported on tax returns with income
reported by third-party payers, such as banks and
employers. If a return amount does not match the
amount reported by a payer, the taxpayer may be
sent a notice requesting additional information or
indicating that IRS is proposing a change in the
tax liability. IRS' analysts review the
discrepancies noted by the computer to see whether
they can resolve the discrepancies and avoid
contacting taxpayers.
ï¿½    IRS currently sends two types of soft
notices, one to taxpayers whose return cites a
dependent or spouse SSN that has been used on at
least one other return and another to taxpayers
who report business-type income but fail to pay
self-employment tax. Soft notices ask taxpayers to
review their returns for errors but do not assess
additional tax. IRS cannot assess the tax because
it does not know for sure that an error has been
made or which taxpayer made an error. For example,
it is likely that at least one of the two or more
taxpayers claiming the same SSN is entitled to
claim it. Rather than assessing tax, soft notices
are intended to educate taxpayers about their
responsibilities for filing a correct return and
to encourage them to correct any errors.
ï¿½    Audits are reviews of a taxpayer's books and
records through either correspondence from 1 of
IRS' 10 service centers or through face-to-face
meetings at 1 of IRS' 33 field offices or at the
taxpayer's place of business. Audits often cover
tax issues that are more complex than those
covered by other types of contacts and generally
require a more complete review of the taxpayer's
support for claims made on the tax return.

IRS uses nonaudit and audit contacts to help check
whether taxpayers are reporting the correct tax
liability. The features of each type of contact
differ. The following sections discuss these
differences as well as any similarities in the
frequency of the contacts, the timing of the
contacts, and the ways in which taxpayers can
respond to the contacts.

Frequency of Contacts
As part of its responsibility to ensure that
taxpayers neither overstate nor understate their
reported tax liability, IRS contacted almost 11
million taxpayers in 1998 through the math error,
underreporter, soft notice (duplicate SSN and self-
employment tax), and audit programs. Table 1
summarizes the frequency of each of these types of
contacts.5

Table 1: Frequency of Contacts in IRS' Three
Nonaudit and Audit Programs
Type of contact                        Contacts
                                    Number  Percent
Math error                          5,659,    52.7
                                      674a
Underreporter                       1,978,    18.4
                                      752b
Soft notice                                       
Duplicate SSN                       1,586,    14.7
                                      015c
Self-employment tax                 329,00     3.1
                                        0c
Audits                                        11.1
                                    1,192,
                                       780
Total contacts                      10,746   100.0
                                      ,221
aThe number of taxpayers contacted during calendar
year 1998 about their tax year 1997 income tax
return. IRS sent notices to another 300,000
taxpayers for pre-1997 tax returns filed during
1998.
bThe number of taxpayers contacted during calendar
year 1998 about their tax year 1995 and 1996
income tax returns.
cThe number of taxpayers contacted during calendar
year 1998 on tax year 1996 and 1997 income tax
returns.
Source: GAO analysis of IRS data.

The number of actual or potential errors that IRS
identifies when processing returns drives the
frequencies for math error and soft notice
contacts. Notices are to be sent for almost all
such errors identified. For underreporter and
audit contacts, the frequencies depend, among
other things, on the resources available to make
the contacts. For example, in 1998, IRS'
underreporter program identified almost 12 million
taxpayers whose reported income on tax returns did
not match income reported by payers, but IRS
contacted fewer than 2 million of these taxpayers
about the discrepancies. Ten million cases were
excluded for such reasons as the discrepancy being
less than IRS' minimum tolerance amount and IRS
not having the resources available to review
returns and respond to taxpayer questions.

Variation in the Timing of the Contacts
The timing of audit and nonaudit contacts varies
in terms of when they start and end. Math error
contacts start shortly after a return is filed and
often end when the contact is made. Audit contacts
can start as late as several years after returns
are filed and last more than a year. Other types
of contacts fall between these timeframes. Figure
1 shows the range of time periods during which IRS
can start the audit and nonaudit contacts.

Figure 1: Range of Time Periods for Starting IRS
Contacts

Source: GAO analysis of IRS data from each of the
programs.

Math error notices are the earliest nonaudit
contact that IRS initiates. IRS prepares and mails
math error notices as tax returns are being
processed. As a result, the starting point for
making these contacts depends on when taxpayers
file their returns. The contacts end when
taxpayers receive the notice, unless they have
questions for IRS, file an amended tax return to
make corrections, or otherwise disagree with the
changes that IRS made to their return.

IRS sends the two types of soft notices at
different times. Notices for self-employment tax
are to be sent in August of the year the return is
filed. Duplicate SSN notices are to be sent in
December of the year the return is filed and
January of the following year. Although duplicate
SSN notices could be sent sooner, IRS wants to
send the notices as close to the next filing
season as possible to maximize the impact on
taxpayer behavior.6 These contacts are also
considered as completed when taxpayers receive the
notice, unless they have questions, file an
amended return, or otherwise disagree with IRS.

IRS begins sending initial underreporter notices
in December of the year the return is filed. IRS
finishes sending initial notices by October of the
next year. The first notices are not sent until
December because IRS must wait until all tax
returns and information returns have been filed
and correctly entered into the computer before
making the match. Depending on the type of notice
and how quickly and completely taxpayers respond,
these contacts can end in a few months or more
than a year later.

Overall, audits have the longest period during
which taxpayer contacts are started. Audit notices
can be sent shortly after returns are filed7 or
more than 2 years after filing.8 IRS is usually
limited by statute from auditing returns more than
3 years after the return was filed.9 This statute
of limitations as well as audit scope and
complexity affect when audits end.

The start of a contact can also vary by type of
audit. Contacts for correspondence audits can
start shortly after returns have been filed and
continue throughout the calendar year. Contacts
for field audits can start within months after
return filing and continue for more than 2 years
after filing. Most audit notices for a tax year
are sent between September of the filing year and
April of the following year. According to IRS
officials, notices are not sent earlier because
auditors are still working on prior year returns,
and notices are not sent later because they would
overlap with audits of subsequent year returns.

Types of Taxpayer Responses to Contacts
The contacts vary in how taxpayers can respond.
Math error and soft notice contacts do not ask
taxpayers to respond. Both underreporter and audit
contacts usually ask taxpayers to provide
information about the reported tax liability and
to eventually inform IRS of their agreement or
disagreement with any changes to it. Depending on
the type of contact, taxpayers are afforded
different ways to challenge changes to their tax
liability.

For most math error notices, taxpayers do not need
to respond. One exception would be when taxpayers
ask for clarification about the error. Another
exception would be when IRS' changes to tax
returns are not correct because the taxpayers
provided incorrect information or IRS erred in its
analysis of the return. In such cases, taxpayers
may contact IRS or submit amended returns to
correct the errors.10

If taxpayers provide corrected information or
evidence of an IRS error, IRS can reverse its math
error decision by abating the tax change or
allowing the tax credit or exemption that it
initially disallowed. If IRS does not reverse a
decision, tax law does not grant taxpayers the
right to appeal or petition the tax court for an
independent review of math error determinations.11
However, within 60 days after the math error
notice is sent, taxpayers may request an abatement
of any assessment specified in the notice, even if
IRS was correct. Upon receipt of the request, IRS
must abate the assessment. IRS can make a
reassessment using its general procedures for
assessing deficiencies,12 which would give
taxpayers the right to petition the Tax Court.

Responses under the soft notice program are
encouraged but not required. IRS provides
information about claiming dependents and self-
employment tax and an amended return form. If
taxpayers determine, after reviewing their returns
and the information enclosed in the soft notice,
that they have provided incorrect information on
the original return, they may file an amended
return.

IRS requires taxpayers to become more involved in
the underreporter and audit programs.
Underreporter notices either request that
taxpayers provide additional information about the
potentially underreported income or inform
taxpayers that IRS proposes to assess additional
tax. When IRS' notice proposes an additional tax
assessment, taxpayers can agree with it, provide
information to support their filed return, or
appeal the proposed assessment to IRS' Office of
Appeals and the Tax Court.

The initial audit notice asks for specified
information from the taxpayer's books and records
about one or more issues on the return (such as
income, deductions, or credits) rather than
proposing a change to the reported tax assessment.
If the audit later results in a notice that
proposes such a tax change, as with the
underreporter program, taxpayers can agree with
the tax change, provide information to support the
filed return, or appeal the proposed change to
IRS' Office of Appeals and the Tax Court.

IRS' Use of Data From the Major Types of Nonaudit
Contacts to Improve Compliance and Taxpayer
Service
IRS collects data on the major types of nonaudit
contacts, such as number of cases closed and
amount of additional taxes assessed. IRS primarily
uses the data to plan and administer the contact
caseload. In general, IRS has not collected data
to use in identifying ways to improve taxpayer
compliance and service to taxpayers (e.g.,
reducing taxpayer burden and increasing taxpayer
satisfaction). Such data could include changes in
taxpayers' compliance behavior after the contacts,
reasons for the errors, and levels of taxpayer
burden and satisfaction. Table 2 summarizes the
data routinely collected for each program.

While some data are collected for nonaudit
contacts, the data are not routinely used to
identify ways to improve taxpayer compliance or
service. Examples in the underreporter program are
the data on abatements and on taxpayers who
repeatedly do not comply. Similarly, some data
from the math error and underreporter contact
programs are not used, even though they raise
questions about compliance or service. For example

ï¿½    In the 1998 math error program, IRS reversed
about 46 percent of its decisions to reduce or
disallow the Earned Income Credit (EIC) claims
after taxpayers provided corrected information,
such as SSNs and names for themselves and
dependents, to support these claims. IRS does not
determine why taxpayers make such errors (such as
incorrect SSNs and names) that result in their EIC
being initially reduced or disallowed.
Consequently, IRS does not know whether some
change in the Schedule EIC or the program
instructions would make it easier for taxpayers to
comply in claiming eligibility for EIC.13 Further,
over half the taxpayers that had all or part of
their EIC disallowed did not challenge the
disallowance. IRS does not determine whether these
taxpayers were afraid to respond, assumed IRS was
correct, did not understand the forms and EIC
requirements, or were trying to illegally claim
EIC.
ï¿½    In the underreporter program for tax year
1996, IRS refunded almost $97 million. Almost $37
million of these refunds resulted from taxpayers
reporting less withheld tax on their tax returns
than payers reported on information returns. IRS
does not know why these taxpayers reported lower
withheld amounts than reported by payers. IRS
officials believe one reason may be that taxpayers
do not understand their W-2s and confuse their
withheld amounts with their payments to the Social
Security Trust Fund. If this was one of the
reasons, IRS' analysis of the data might lead to
redesigning the W-2 to more clearly show the
withheld amount. This could help taxpayers more
accurately complete their returns.

Table 2: Data Routinely Collected for Nonaudit
Contact Programs
Type of data         Math  Underrepor  Soft notices
routinely collected  erro  ter
                    r
                                      Duplic  Self-
                                   ate     employm
                                   SSN     ent tax
Number of cases      Yes   Yes        Yes     Yes
closed
Amount of            Part  Yes        Yes     Yes
assessments or       iala
refunds
Amount of            Part  Yes        Not     Not
abatementsb          iala            applic  applica
                                   able    ble
Changes in taxpayer  Nod   Yese       Yesf    Yes
compliance behaviorc
Reason(s) for the    Nod   No         Yes     Yes
error
Level of taxpayer    No    No         Yes     Yes
burden
Level of taxpayer    No    Nog        No      No
satisfaction
a IRS collects information on assessments and
abatements only for those math error codes related
to some EIC, SSN, and child care credit errors.
This represents about 27 percent of the math
errors.
bAbatements are a reduction of any tax, interest,
or penalty assessment on a taxpayer's account.
There are no abatements attributable to the soft
notice program.
cThe primary compliance behavior that IRS could
track is whether the taxpayer made the same error
in a later tax year.
dIRS' Office of Research has prepared a profile
report for selected types of math errors
associated with EIC and is currently working on a
report on math errors associated with invalid
SSNs. However, these do not include data that are
routinely collected as part of the math error
program.
eIRS officials indicated that this information is
available by comparing the results for different
tax years, but such comparisons are not used.
fThe behavior tracked in the duplicate SSN program
was whether the taxpayer continued to claim an
exemption that was also claimed on other tax
returns.
gIRS did conduct a one-time, customer satisfaction
survey that focused on how well taxpayers
understood the notification letter. Also, IRS
officials told us that they plan to begin
routinely conducting customer satisfaction surveys
by 2001.
Source: GAO discussions with IRS staff and
analysis of data provided for each program.

At our exit conference in January 2000, IRS
officials identified two recent efforts that (1)
researched how the math error program has improved
EIC compliance and (2) changed the Schedule EIC to
help taxpayers complete it. However, IRS officials
did not have evidence to show that these efforts
were initiated by using math error program data.14
Rather, these efforts seemed to be initiated in
response to concerns or complaints about the EIC
program. While these efforts might have been
necessary as well as useful, they do not
illustrate the use of nonaudit program data to
provide a comprehensive perspective on the types
of issues that most affect taxpayer compliance or
service.

In the soft notice program, IRS does appear to
have given more consideration to compliance and
taxpayer service issues in data collection and
analysis. For the self-employment tax soft notice,
IRS researchers gathered data to identify the
reasons that taxpayers had not shown self-
employment tax on their returns. Their analysis
led to recommendations on changing how IRS screens
returns to identify taxpayers as potentially owing
self-employment tax. This change might help avoid
contacting compliant taxpayers that did not
actually owe self-employment tax, which could
reduce their burden.15

Also, for taxpayers sent soft notices on duplicate
SSNs, IRS tracked how often more than one taxpayer
continued to claim an exemption for the same SSN
during the following tax year. This tracking
helped IRS to determine changes in taxpayer
compliance behavior involving duplicate SSN
claims.

We did not determine the cost of collecting and
analyzing data from nonaudit contacts to improve
compliance and taxpayer service because it was
outside the scope of our work. We recognize that
collecting and analyzing such data would involve
some additional costs.

Whether the costs should be incurred would depend
on the likelihood that the resulting improvements
in compliance and taxpayer service would be worth
those costs. The costs and improvements from
collecting and analyzing such data could differ
for each type of nonaudit contact, particularly
for certain types of math error or underreporter
contacts. For example, IRS might decide that
collecting and analyzing data from certain types
of contacts would not be cost-effective in helping
identify significant improvements in compliance
and taxpayer service while doing so for other
types of contacts would only be cost-effective in
a targeted fashion.

Also, IRS officials indicated that they are
limited in the amount and type of data they can
collect on these programs until IRS modernizes its
information systems under its ongoing effort to
modernize the entire agency. They noted that it
might not be cost-effective to collect new data
about all types of nonaudit contacts until these
systems are in place.

IRS recognizes the need to use data from programs
to evaluate ways to improve compliance and
taxpayer service. Its modernization plan indicates
that each of the four new operating divisions is
to have a Taxpayer Education and Communication
unit. IRS plans to have this unit use data from
enforcement programs to improve compliance and
taxpayer assistance. The unit is to continually
analyze program data to ensure that the products
and services being developed will meet taxpayer
needs. This plan does not yet describe whether and
how the Taxpayer Education and Communication unit
would use data from nonaudit contacts in its
efforts. IRS officials involved in the planning
for these divisions told us that those types of
decisions would be made, at the earliest, for the
2002 filing season.

Conclusions
IRS' nonaudit contacts account for the majority of
contacts with taxpayers about their reported tax
liability on filed returns. In 1998, the three
types of nonaudit contacts we reviewed affected
almost 10 million taxpayers by increasing or
decreasing the tax amounts owed or questioning
claims made on the tax return. In comparison,
audits affected just over 1 million taxpayers.

Data from the millions of nonaudit contacts could
be helpful for learning more about how compliance
and taxpayer service can be improved. However,
only in the soft notice programs has IRS been
routinely collecting and analyzing some data that
could be used to identify such improvements.

Collecting and analyzing more data would impose
some costs, which IRS could minimize by targeting
the types of contacts within each program that are
most likely to provide data that could lead to the
greatest improvements in compliance and taxpayer
service. Also, IRS may not be able to collect all
such desirable data on nonaudit contacts until its
information systems have been modernized. As it
modernizes these systems, IRS also could consider
how to cost-effectively collect these nonaudit
data.

Recommendations
We recommend, while IRS completes its
modernization effort, that the Commissioner of
Internal Revenue start to collect and analyze
available data from each of the three major
nonaudit programs to help identify ways to improve
compliance and taxpayer service. To minimize the
costs, IRS could target the types of contacts
under each of the three programs that have the
greatest potential for generating such
improvements. We also recommend that the
Commissioner determine how the modernized
information systems can cost-effectively collect
such data on the various types of contacts in each
of these nonaudit programs, and how the data can
be used to improve compliance and increase
customer service.

Agency Comments and Our Evaluation
IRS agreed with both of our recommendations and
identified efforts to implement each one. These
efforts generally were separate, one-time studies
by IRS' Office of Research. However, IRS officials
told us that these studies are to be linked
efforts in which one study builds upon the results
of earlier studies. If these efforts are indeed
linked in the future and provide routine data
collection on how these programs are contributing
to IRS' mission to improve compliance and customer
service, then the intent of our recommendations
would be met. In this regard, IRS officials also
said that they are currently trying to better
coordinate efforts undertaken by the Office of
Research with the data needs of the Customer
Service Division.

In addition, IRS identified other efforts to
improve compliance and service. We have no comment
on these other efforts because they fall outside
the scope of our review and recommendations.
Finally, IRS provided technical comments on the
data collected for the math error and the soft
notice programs. We made changes to the report on
the basis of these comments where appropriate.

We are sending copies of this report to
Representative Charles B. Rangel, Ranking Minority
Member, House Committee on Ways and Means, and
William J. Coyne, Ranking Minority Member of the
Subcommittee on Oversight, House Committee on Ways
and Means. We are also sending copies to the
Honorable Lawrence H. Summers, Secretary of the
Treasury; the Honorable Charles O. Rossotti,
Commissioner of Internal Revenue; the Honorable
Jacob J. Lew, Director, Office of Management and
Budget; and other interested parties. We will also
send copies to those who request them.

If you or your staff have any questions concerning
this report, please contact me or Tom Short on
(202) 512-9110. Key contributors to this report
are acknowledged in appendix III.

Sincerely yours,

Cornelia M. Ashby
Associate Director, Tax Policy and
 Administration Issues
_______________________________
1Audits are examinations of taxpayers' books and
records by IRS auditors, either face-to-face or by
correspondence.
2IRS makes many types of nonaudit contacts to
improve compliance and to help it better serve
taxpayers. We focused only on three of the
programs where IRS contacts taxpayers about their
reported tax liability. App. I provides a fuller
description of these nonaudit contacts.
3In 1997, IRS changed the name of the
Underreporter Program to the Individual Master
File/Business Master File Reconciliation Program.
Because we are dealing only with contacts of
individual taxpayers, we use the previous name of
the program in this report to help avoid
confusion.
4IRS refers to these contacts as "soft notices"
because the notices do not make demands. Instead,
the notices provide information about the
potential error to the taxpayers involved and ask
them to review their records and make corrections,
if necessary. IRS does not assess tax in this
program because it is not sure which taxpayer is
entitled to the exemption or whether the taxpayer
actually owes the self-employment tax.
5App. I also provides more detailed information on
the frequencies for the various types of math
error and underreporter contacts.
6IRS officials said they would like to send the
self-employment notices in December also, but send
them in August to spread out the workload for IRS
staff that will have to deal with any taxpayer
responses to the notices.
7These returns usually involve the Earned Income
Credit (EIC) claims and begin soon after the
return is filed in an attempt to finish the audit
before releasing any refunds.
8Such delays are to allow IRS enough time to enter
the return data into its computers, associate the
tax returns with information returns, process
returns filed after April 15, and identify returns
with the greatest potential for noncompliance.
9The law generally requires that IRS complete
audits within 3 years after the return is filed or
obtain an extension from the taxpayer. IRS also is
required to notify the taxpayer of the right to
refuse to extend the statute of limitations or to
limit the extension to particular issues or to a
particular period of time. If the taxpayer denies
an extension, IRS can assess additional tax on the
amount in question, requiring taxpayers to file an
appeal if they disagree. Congress' 1998
legislation to restructure IRS contains provisions
that suspend the accrual of interest and some
penalties if IRS fails to notify the taxpayer of
additional tax liabilities within 18 months after
a return is filed. In 2004, suspension will begin
12 months after a tax return is filed.
10IRS does not maintain data on how often responses
are received in the math error program.
11While IRS does not maintain data on abatements
for the overall math error program, such data are
available for certain types of math errors, such
as those related to EIC. In 1998, IRS reversed
about 46 percent of its decisions to disallow EIC
and abated about 54 percent of the associated tax
increase after the taxpayer provided corrected
information in response to the notice.
12After determining that a deficiency exists, IRS
must send the taxpayer a notice of deficiency
before it may assess the tax or seek to collect.
This notice gives the taxpayer 90 days to file a
petition with the Tax Court contesting the
deficiency. Upon expiration of the 90 days without
the taxpayer filing or a determination by the Tax
Court that the deficiency exists, IRS is
authorized to officially assess the tax and send
the taxpayer a notice and demand for payment. If
these requirements are met and the tax is still
unpaid, IRS may initiate enforced collection
action.
13The Schedule EIC is the form that taxpayers must
complete to be eligible to claim EIC.
14IRS officials told us they have used a District
Office of Research and Analysis to support the
decision to redesign EIC material. However, this
analysis apparently did not use math error data to
identify specifically what was wrong with the
Schedule EIC and related instructions. Also, IRS
officials indicated that other efforts were under
way to improve service to taxpayers and increase
compliance.
15Researchers looked at why IRS identified several
groups of taxpayers as potentially owing self-
employment tax when the taxpayers were not liable.
These groups included farmers who rent their farms
and erroneously show farm rental income on the
schedule F instead of on a form 4835 and Schedule
E and taxpayers under age 18 who are employed by
their parents or as a newspaper carrier.

Appendix I
Summary of Program Operations for Selected
Nonaudit Contacts
Page 21 GAO/GGD-00-7 IRS' Use of Nonaudit Contacts
This appendix contains additional information on
how math error, underreporter, and soft notice
contacts work and provides additional data on the
frequency of these contacts.

Math Error Contacts
The purpose of the math error program is to
correct certain errors on tax returns in returns
processing before issuing refunds. Section
6213(b)(1) of the Internal Revenue Code allows IRS
to make changes to tax returns for clerical and
mathematical errors without following the normal
assessment procedures.1 In 1996, Congress amended
the term "mathematical or clerical error" to
include incorrect Social Security Numbers (SSN)
required when claiming dependency exemptions2 or
the Earned Income Credit (EIC).3 In 1997, Congress
also amended the term to include incorrect SSNs
used when claiming the Child Tax Credit.4

IRS uses computer processing to identify errors
involving addition and subtraction, SSNs, filing
status, exemptions, and incomplete schedules and
forms. Once the computer has identified an error,
the tax return package is to be sent to the Error
Resolution office, where an IRS employee is to
review the return, correct the error, and notify
the taxpayer.

Some examples of math errors and how IRS treats
them are discussed below:5

ï¿½    If the taxpayer makes an addition or
subtraction error or transfers an amount from one
schedule to another incorrectly, the IRS employee
is to make the correction, recalculate the tax
liability, resubmit the return for processing, and
notify the taxpayer of the correction.
ï¿½    If a dependent SSN is incorrect, the IRS
employee is to attempt to find the correct number
on the return or other documents attached to it.
If the correct number cannot be found, the
dependent exemption is to be disallowed.
Disallowing this exemption may change several
items on the return, including filing status and
eligibility for the child care tax credit and EIC.
After the changes are made, the return is to be
resubmitted and the taxpayer is to be notified
about the nature of the error and the changes made
to the return.
ï¿½    If the IRS employee determines that IRS made
a transcription error or that other information on
the return explains the error identified by the
computer, the IRS employee is to resubmit the
return for processing with either a correction or
an indication that the return is correct. No
notification is to be sent to the taxpayer.

While some taxpayers make more than one error on
their tax return, the taxpayer receives only one
notice. For example, of the 7.5 million math error
notices in 1998, about 1 million notices reported
two errors, 260,000 reported three errors, and
75,000 reported four or more errors. Table I.1
summarizes the math errors identified in 1997 and
1998 by category.

Table I.1: Major Types of Math Errors for 1997 and
1998
Math errors                             Number
                                     1997     1998
  Earned Income Credit              2,729,  2,042,9
                                      148       38
  Exemptions and SSNs               2,028,  1,460,6
                                      441       69
  Taxable income and tax            1,708,  1,846,5
calculationsa                         553       27
  Standard or itemized deductions   590,71  564,635
                                        2
  Child care credit                 389,73  235,969
                                        4
  Filing status                     334,87  232,210
                                        9
  Social Security benefits          302,20  310,042
                                        2
  Self-employment tax calculation   263,04  240,558
                                        5
  Income section of the tax return  261,85  243,064
                                        5
  Schedules C, D, E, or Fb          116,89  151,065
                                        5
  Tax credit calculation (other     56,318   59,822
than child care and EIC)
  Retirement related income         17,278   15,348
  Form on household employees       11,365   10,036
All other errors                    55,896   51,185
Total                               8,866,  7,464,0
                                      321       68
aThese numbers include 138,066 instances in 1997
and 124,773 in 1998 in which taxpayers asked IRS
to calculate their tax liability rather than do
their own calculation.
bSchedule C is used to report income from
business. Schedule D is used to report capital
gains and other income from sale of assets.
Schedule E is used to report income from rental
property and income from partnerships and S
corporations. Schedule F is used to report income
from farming activities. These errors do not
include missing schedules.
Source: IRS math error code report.

Underreporter Program Contacts
Each year, IRS receives over a billion information
returns from third-party payers, such as banks and
employers. These information returns show payments
made to individuals, including wages that
employers report to the Social Security
Administration on Form W-2. In October of the year
the return is due and February of the following
year, IRS uses computer software to match these
payments to income reported on the taxpayer's
return.

The computer match annually identifies 11 million
to 13 million tax returns with reported income
amounts that either overstate or understate the
reported tax liability. According to IRS
officials, returns that understate the tax
liability (for which the taxpayer owes additional
tax) are treated with the same priority as those
involving an overstated liability (for which IRS
owes the taxpayer a refund).

Once identified, returns with discrepancies that
meet certain criteria are to be sent to an IRS
service center for screening.6 These criteria
include the historic amount of underreported tax
in this area and likelihood that the discrepancy
is real and not explained on the tax return.
During screening, IRS employees are to review the
tax returns to see whether they can resolve the
discrepancy.7 If it can be explained by
information on the return, the case is to be
closed; if not, the taxpayer is to be sent a
notice requesting more information or indicating
IRS' proposed change. The taxpayer can agree with
IRS, provide IRS with clarifying information, or
appeal the decision to IRS' Office of Appeals.

In recent years, IRS has reduced the number of
discrepant returns screened. In large part, this
reduction has been due to staffing cutbacks and
temporary reassignment of staff to other
functions, such as answering phones during filing
season.8 Table I.2 summarizes the number of
discrepant returns identified and screened, and
the number of contacts made for tax year 1996, the
most recent year for which data is most complete
and available.

Table I.2: Discrepant Returns Identified and
Screened and Taxpayer Contacts Made by Type of
Issue, Tax Year 1996
Discrepancy                    Discrepant returnsa         Screened returns
                            Number       Number  Percent       Number Percen
                       identified    screenedb             contacted      t
Earned incomec          2,946,268    1,532,167       52    1,029,757     67
Pension and             1,211,925      639,271       53      443,108     69
retirement incomed
Payments from             540,956      229,312       42      203,931     89
statese
Investment incomef      3,622,029      261,727        7      191,746     73
Discrepancies in          380,183      143,514       38       84,803     59
withholdingg
Income from rents         117,507       23,201       20       12,864     55
and royalties
Mortgage interest       1,675,097          494        h          237     48
payments
All other types of      1,380,014      282,324       20      227,277     81
incomei
Total                  11,873,979    3,112,010       26    2,193,723     70
aIRS summarizes data by the tax year of the
discrepancy, in this case, tax year 1996.
bIRS employees screen returns to see if
discrepancies can be resolved without contacting
taxpayers.
cIncludes wages, nonemployee compensation,
business gross receipts, and other earned income.
dIncludes errors on Individual Retirement
Accounts, Social Security, and other retirement
income.
eIncludes state unemployment compensation and
state tax refunds.
fIncludes interest, dividends, capital gains, and
other types of investment income.
gThis is the largest category of refunds.
hLess than 1 percent of cases identified were sent
for screening.
iIncludes such income as gambling winnings,
agricultural subsidies, prizes, and awards.
Source: IRS data collected on the underreporter
program.

Contacts Through Soft Notices
In recent years, IRS has increasingly focused its
efforts on alternative enforcement strategies,
such as the soft notice. In 1998, IRS sent one of
two soft notices to 2 million taxpayers. IRS sent
one type of soft notice to taxpayers whose return
cited a dependent or spouse SSN that had been used
on at least one other return. IRS sent the other
type of soft notice to taxpayers that reported
business income but failed to pay self-employment
taxes.9

Both types of soft notice started as research
projects in IRS' Research Division, which
continues to be involved by identifying taxpayers
that may have made errors and evaluating the
results of the notices. Both types of soft notice
are operational programs managed by IRS' Taxpayer
Services Division.

Soft notices get their name because they do not
demand that the taxpayer pay more tax, provide
documentation, or file an amended return. Instead,
they are designed to educate the taxpayer and,
ultimately, improve voluntary compliance. While
the notice may contain wording asking that the
taxpayer file an amended return if appropriate, it
is not required. In contrast, "hard" notices such
as those from the math error and underreporter
programs indicate that IRS has made or is
proposing a change and that the taxpayer owes
additional tax or has an additional refund due.
These notices focus primarily on compliance rather
than taxpayer education.

Shortly after individual tax returns are received,
IRS begins to screen them for duplicate SSNs and
unpaid self-employment tax. Once taxpayers that
appear to meet the criteria have been identified,
IRS sends them notice packages. These packages are
sent in August (self-employment tax) and December
(duplicate SSN). Each notice package is to contain
a letter indicating IRS' concern and provide
information from IRS publications related to the
issue, and, if needed, a form for use in preparing
an amended tax return. The notice is also to list
a toll-free number for taxpayers to call if they
have questions.

IRS sent almost 1.6 million notices in 1998 when
the same SSN was used to claim exemptions on more
than one tax return.10 Duplicate use of SSNs can
occur when (1) two or more taxpayers claim the
same dependent, (2) dependents claim themselves at
the same time they are claimed by another
taxpayer, or (3) taxpayers make a transcription
error on their return.

IRS mailed 329,000 notices in 1998 to taxpayers
who had self-employment income on their returns
but had not completed a schedule SE or paid self-
employment tax. The self-employment income might
be reported on the other income line of the income
tax return or on IRS schedules (e.g., schedules C
and F) used for reporting this type of income.

_______________________________
1Under normal assessment procedures, a tax
deficiency may not be assessed until the taxpayer
has been sent a notice of the deficiency and has
been given a 90-day period to file a petition for
redetermination in the Tax Court.
2P.L. 104-188.
3P.L. 104-193.
4P.L. 105-34.
5Changes made through the math error program to
the reported tax liability may result in a
reduction or increase in the taxes owed. If
reduced, the notice will explain why and by how
much. If the taxpayer owes money in excess of the
amount already paid, the notice will explain how
much is owed and why. The notice will also explain
the options for paying any additional amount due.
6IRS operates the underreporter program in 6 of
its 10 service centers-Atlanta, Austin,
Brookhaven, Fresno, Ogden, and Philadelphia.
7IRS reviewers also check the Automated
Underreporter System, which is a computer system
that shows amounts reported by taxpayers and third-
party payers. It automatically recalculates the
correct tax liability and drafts correspondence to
be sent to the taxpayer.
8The filing season typically runs from January 1
to April 15, except for taxpayers who get
extensions to file until as late as October 15.
9Self-employment taxes are paid by sole
proprietors filing a schedule C, farmers,
individuals receiving nonwage compensation
regardless of whether they file a business return,
and certain business income claimed on a schedule
E.
10IRS does not send soft notices when the same SSN
appears on more than four returns. These returns
generally are referred for audit.

Appendix II
Comments From the Internal Revenue Service
Page 27 GAO/GGD-00-7 IRS' Use of Nonaudit Contacts

Appendix III
GAO Contacts and Staff Acknowledgments
Page 28 GAO/GGD-00-7 IRS' Use of Nonaudit Contacts
GAO Contacts
Cornelia M. Ashby (202) 512-9110
Tom Short (202) 512-9110

Acknowledgments
     In addition to those named above, Lou
Roberts, Kathleen Seymour, and Rodney Hobbs made
key contributions to this report.

*** End of Document ***