Tax Administration: IRS Could Do More to Verify Taxpayer Identities
(Letter Report, 08/30/95, GAO/GGD-95-148).

GAO reviewed the Internal Revenue Service's (IRS) procedures for
processing and posting tax returns with missing or incorrect social
security numbers (SSN), focusing on: (1) the growth in accounts with
missing or incorrect SSN on IRS individual master file (IMF); (2) IRS
procedures for verifying the identities of tax return filers; and (3)
the potential effect of these procedures on IRS plans to modernize the
tax system and on the income-matching program.

GAO found that: (1) the average annual growth rate for invalid IMF
accounts was significant from 1986 through 1994; (2) IRS has revised its
procedures to require taxpayers with missing or incorrect SSN or
temporary numbers to provide documentation that verifies their identity;
(3) these revised procedures could help reduce the number of invalid IMF
accounts when fully implemented; (4) the IRS Tax Modernization System is
in jeopardy because the current master file structure allows two or more
taxpayers to have accounts under the same number, or one taxpayer to
have several accounts under different numbers; (5) the IRS
income-matching program is hampered by posting returns to IMF invalid
accounts; and (6) IRS plans to assign permanent taxpayer identification
numbers to filers that are ineligible to obtain SSN and encourage the
use of these numbers on information returns.

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

 REPORTNUM:  GGD-95-148
     TITLE:  Tax Administration: IRS Could Do More to Verify Taxpayer 
             Identities
      DATE:  08/30/95
   SUBJECT:  Tax returns
             Tax evasion
             Social security number
             Documentation
             Tax refunds
             Tax administration systems
             Personal income taxes
             Accountability
             Taxpayers
             Information processing operations
IDENTIFIER:  IRS Individual Master File
             IRS Tax System Modernization Program
             Earned Income Tax Credit
             IRS Earned Income Credit Unallowable Program
             TSM
             
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Cover
================================================================ COVER


Report to the Commissioner
Internal Revenue Service

August 1995

TAX ADMINISTRATION - IRS COULD DO
MORE TO VERIFY TAXPAYER IDENTITIES

GAO/GGD-95-148

Taxpayer Identities


Abbreviations
=============================================================== ABBREV

  EIC - Earned Income Credit
  IMF - Individual Master File
  IRS - Internal Revenue Service
  ITIN - Individual Taxpayer Identification Number
  SSA - Social Security Administration
  SSN - Social Security Number
Cover
================================================================ COVER



Letter
=============================================================== LETTER


B-260131

August 30, 1995

The Honorable Margaret M.  Richardson
Commissioner of Internal Revenue
Department of the Treasury

Dear Mrs.  Richardson: 

This report, prepared under our basic legislative authority,
discusses the Internal Revenue Service (IRS) procedures for
processing and posting tax returns in which the primary filer does
not provide a Social Security number (SSN) or provides a name and SSN
that do not match Social Security Administration (SSA) records.\1 In
particular, the report discusses (1) the growth in accounts with
missing or incorrect SSNs on IRS' Individual Master File (IMF), (2)
IRS' procedures for verifying the identities of tax return filers,
and (3) the potential effects of the procedures on IRS' plans to
modernize the tax system and on IRS' income-matching program. 


--------------------
\1 Hereafter, we refer to these returns as returns with missing or
incorrect SSNs. 


   BACKGROUND
------------------------------------------------------------ Letter :1

IRS relies on data from SSA to determine the accuracy of SSNs and
names recorded on tax documents submitted by individual taxpayers. 
IRS uses this information to establish the identity of each taxpayer
and to ensure that each transaction is posted to the correct account
on the IMF. 

When processing paper tax returns with missing or incorrect SSNs, IRS
service centers first try to make corrections by researching IRS
files or other documents (for example, Form W-2 wage and tax
statements) that accompany a tax return.\2 Returns that can be
corrected, along with those that match SSA records, are posted to the
"valid" segment of the IMF.  Returns that cannot be corrected are
posted to the "invalid" segment of the IMF, using either the
incorrect SSN on the tax return or a temporary number assigned by
IRS.\3 As of January 1, 1995, 4.3 million accounts were posted on the
invalid segment of the IMF, and 153.3 million accounts were posted on
the valid segment. 

IRS created the invalid segment of the IMF to store the accounts of
taxpayers who had changed their names, because of marriage or divorce
for example, and had not yet informed SSA of the name change. 
However, IRS has posted returns to the invalid segment of the IMF to
cover other situations, such as when a taxpayer (1) uses the SSN of
another individual, (2) uses an SSN that is not issued by SSA, or (3)
is assigned a temporary number.  IRS tries to resolve invalid
accounts and move them to the valid segment of the IMF by
corresponding with taxpayers to verify their identities, periodically
matching invalid accounts against updated SSA records, and reviewing
tax documents subsequently filed by taxpayers. 


--------------------
\2 IRS follows more stringent procedures for electronically filed
returns.  Returns filed electronically with missing or incorrect SSNs
are rejected and sent back to the filer for correction. 

\3 IRS assigns temporary numbers when a taxpayer (1) cannot legally
obtain an SSN from SSA (such as in the case of an illegal or
nonresident alien), (2) is in the process of obtaining an SSN from
SSA, (3) has been issued the same SSN by SSA as another person, (4)
files a return with a missing SSN (and IRS cannot identify one
through research), or (5) files with an SSN already used to post
another taxpayer's return to the IMF invalid segment. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

From 1986 through 1994, the average annual growth rate for accounts
on the invalid segment of the IMF was more than twice the growth rate
for accounts on the valid segment--5 percent versus 2 percent,
respectively.  The growth in IMF invalid-segment accounts stemmed in
part from (1) IRS' increasing use of temporary numbers, (2) a 1990
decision not to ask filers who received temporary numbers to verify
their identities, and (3) procedures that did not require filers
whose returns were posted with incorrect numbers to provide proof of
identity sufficient to resolve the invalid condition.  IRS paid $1.4
billion in refunds on returns that were posted to the invalid segment
of the IMF for tax year 1993.  No one knows how much, if any, of this
amount was erroneously paid, but the risk of issuing erroneous
refunds was higher because IRS was less certain of these filers'
identities than of the identities of filers who matched SSA's
records. 

As part of its efforts to combat refund fraud, IRS revised its
procedures in 1995 to require that taxpayers who file returns with
(1) missing or incorrect SSNs or (2) temporary numbers provide
documentation to verify their identities.  When fully implemented,
the revised procedures could help reduce the number of accounts on
the IMF invalid segment.  However, the notice IRS sends to filers
does not clearly convey that they are required to provide
documentation to verify their identities.  Thus, IRS has to contact
some of these filers more than once to obtain the information it
needs.  This practice increases processing costs, adds to taxpayer
burden, and further delays the issuance of some refunds.  IRS has a
revised notice under review that would better notify filers of this
requirement, but IRS' notice-review process has been lengthy, and the
resources available to do the necessary computer reprogramming have
been limited.  IRS officials told us that they expect the notice to
be available for use in the 1996 tax-filing season, which begins in
January 1996. 

IRS is not applying the revised documentation requirements to the
1995 filers' returns posted to the IMF invalid segment before 1995. 
The accounts of these filers, whose identities IRS verified using
pre-1995 procedures, are coded to automatically issue a refund when
one is requested on a return.  As of January 1, 1995, at least 3.2
million accounts on the IMF invalid segment were so coded.  We
analyzed 58 returns that were posted to the IMF invalid segment in
the first 6 months of 1994 and that had accounts coded for automatic
refund issuance.  Our results suggest that IRS should subject these
filers to the revised documentation requirements--27 of the returns
were filed by persons who either used SSNs not issued by SSA or used
another individual's SSN, including the SSNs of children or deceased
persons. 

Developing complete and accurate account information on every
taxpayer and being able to respond accurately to taxpayer account
inquiries are goals IRS hopes to achieve in its modernization
efforts, known as Tax Systems Modernization (TSM).  Achieving these
goals is jeopardized by the current master file structure, which
allows two or more taxpayers to have accounts under the same number
or one taxpayer to have several accounts under different numbers. 

IRS' income-matching program is hampered by posting returns to the
IMF invalid segment.  For example, IRS cannot, in most cases, match
income claimed by taxpayers with temporary numbers against income
reported by third parties on information returns because the
temporary numbers are unique to IRS and are not recorded on
information returns.  Omitting these taxpayers from matching programs
hampers IRS' efforts to detect underreported income and nonfiling. 
IRS plans to assign permanent taxpayer identification numbers to
filers who are not eligible to obtain SSNs and to encourage the use
of those numbers on information returns. 


   OBJECTIVES, SCOPE, AND
   METHODOLOGY
------------------------------------------------------------ Letter :3

Our objectives were to (1) measure the growth of accounts on the
invalid segment of the IMF, (2) assess IRS' procedures to verify the
identities of tax return filers whose returns were posted to the IMF
invalid segment, and (3) identify any effects the procedures may have
on IRS' TSM goals and its income-matching program. 

To measure the growth of accounts on the IMF invalid segment, we
reviewed IRS management and internal audit reports about the growth
and composition of accounts on the IMF.  We also interviewed
officials at IRS' National Office on the makeup of the IMF invalid
segment and the reasons for the growth in these accounts. 

To assess IRS' procedures for verifying taxpayer identities, we
reviewed (1) IRS procedures (1995 and pre-1995) for processing
returns with missing or incorrect SSNs, (2) the notice IRS uses to
verify taxpayer identities, and (3) other pertinent documents.  We
also interviewed officials at IRS' National Office and at IRS'
Austin, TX; Cincinnati, OH; Fresno, CA; Ogden, UT; and Philadelphia,
PA service centers on the process for posting returns to the IMF
invalid segment and changes implemented in 1995 to verify taxpayer
identities.  We chose Cincinnati because of its proximity to the
audit team conducting the work.  We chose the other 4 centers
because, out of IRS' 10 service centers, they processed and posted
more than 60 percent of the accounts on the IMF invalid segment in
1994. 

To identify the potential effects of IRS' posting procedures, we did
the following: 

  We selected a random sample of 400 tax year 1993 returns from
     accounts that were posted to the IMF invalid segment before IRS
     implemented its new procedures.  Our sample results are not
     projectable to the universe of accounts on the IMF invalid
     segment.  Our objective was to determine whether the filers
     accurately reported their wages and withheld taxes.  The sample
     consisted of returns with refunds of more than $1,000 that were
     posted to the IMF invalid segment by the Austin, Fresno, Ogden,
     and Philadelphia service centers between January 1, 1994, and
     June 30, 1994.  The 400 returns included 50 from each center
     that had been posted with IRS temporary numbers and 50 from each
     center that had been posted with incorrect SSNs.  The Cincinnati
     service center's Criminal Investigation Branch contacted
     employers of the 400 filers to verify employment and wage
     information.  The branch obtained responses on 357 returns.  For
     the 43 returns with no response, we verified the wage
     information using information return transcripts. 

  We analyzed 100 of the 400 returns to determine why they posted to
     the IMF invalid segment and to profile some of the filers'
     characteristics.  The 100 returns included 25 returns (12 that
     had been posted with temporary numbers and 13 that had been
     posted with incorrect numbers) randomly selected from each of
     the 4 service centers.  Among the 100 returns were 58 that were
     posted to accounts containing a computer code that automatically
     released refunds. 

  We also interviewed cognizant officials from IRS' National Office
     and the previously mentioned service centers regarding any
     effects that returns with missing or incorrect SSNs may have on
     IRS' income-matching programs and its TSM plans.  We reviewed
     IRS reports on TSM plans and analyzed documents relating to IRS'
     processing costs. 

We did our audit work from December 1993 through May 1995 in
accordance with generally accepted government auditing standards.  We
requested comments on a draft of this report from you or your
designee.  On June 21, 1995, the Assistant Commissioner for Taxpayer
Services, the Staff Chief for the National Director of Submission
Processing, and other IRS staff, including representatives from the
Office of Chief Counsel, provided us with oral comments.  Their
comments are summarized and evaluated on pages 13 and 14 incorporated
in this report where appropriate. 


   NUMBER OF IMF INVALID SEGMENT
   ACCOUNTS GROWING AT FASTER RATE
   THAN THE NUMBER OF VALID
   SEGMENT ACCOUNTS
------------------------------------------------------------ Letter :4

From 1986 through 1994, according to IRS data, the average annual
growth rate of accounts on the invalid segment of the IMF was more
than twice the growth rate of accounts on the valid segment--5
percent versus 2 percent, respectively.  Figure 1 shows year-to-year
growth rates since 1986.  During this period, the number of accounts
on the invalid segment of the IMF grew from 2.8 million on January 1,
1986, to 4.3 million on January 1, 1995, while the number of valid
accounts grew from 130.2 million to 153.3 million. 

   Figure 1:  Annual Growth Rates
   of Accounts on the Valid and
   Invalid Segments of the IMF
   (1986 through 1994)

   (See figure in printed
   edition.)

Source:  IRS data. 

From 1990 through 1994, the size of the IMF invalid segment grew by
about 821,000 accounts.  Most of that growth (52 percent) resulted
from IRS' increased use of temporary numbers to process and post
returns.  Accounts with incorrect numbers made up the other 48
percent. 

The IRS National Office official responsible for monitoring accounts
on the master file explained that the increase in accounts with
temporary numbers stemmed from IRS' decision in 1990 to not send
verification notices to taxpayers whose returns were processed with
temporary numbers.  Many of these filers, he said, cannot obtain SSNs
because they are not legal residents of the United States but are
entitled to refunds of withheld taxes or earned income credits.  He
said that most of these taxpayers were using temporary numbers
verified in previous years and that requiring reverification each
year would have unduly increased taxpayer burden.  He speculated that
when IRS' decision not to require verification became more widely
known, more taxpayers who could not obtain SSNs began filing tax
returns. 

Another factor affecting the number of accounts on the invalid
segment of the master file was IRS' willingness to release refunds
and allow the accounts to remain on the invalid segment, even though
taxpayers' responses to the verification notice did not resolve the
invalid condition.  Before 1995, IRS accepted a taxpayer's response
that a return was "correct as filed," and taxpayers were not required
to provide documentation (marriage certificate, birth certificate,
etc.) to verify their identities. 

In 1994, IRS paid out $1.4 billion in refunds on returns posted to
the IMF invalid segment. 


   REVISED VERIFICATION PROCEDURES
   NOT COMPLETELY IMPLEMENTED
------------------------------------------------------------ Letter :5

As part of its efforts to combat refund fraud, IRS revised its
procedures in January 1995 to require that taxpayers provide
documentation to verify their identities.  In announcing that IRS
would delay refund claims for individuals lacking proper
identification numbers, you stated that, consistent with the way
financial institutions manage withdrawals of funds, IRS should not
permit refunds from the federal treasury without a valid taxpayer
identification number. 

Under the revised procedures, when a taxpayer's return with a refund
request is posted to the IMF invalid segment for the first time, IRS
is to freeze the refund and correspond with the taxpayer in an
attempt to verify the taxpayer's identity.\4

Filers with missing or incorrect SSNs who request a refund are to be
required to provide a reasonable explanation for the discrepancy and
proof of their identity (such as a marriage certificate, birth
certificate, earnings statement, or passport) before the refund will
be released.\5 The requirement applies to filers whose returns are
posted with temporary numbers as well as filers whose returns are
posted with incorrect numbers.  Once a taxpayer responds
satisfactorily to IRS' verification notice, IRS is to release the
refund.  Previously, IRS automatically issued refunds to filers with
temporary numbers and did not require proof of identity from filers
with incorrect numbers before releasing their refunds. 


--------------------
\4 When processing a tax return with a missing or incorrect SSN that
is accompanied by a payment, according to procedures, IRS is to
deposit the payment, post the return to the IMF invalid segment, and
send the taxpayer an information notice about the invalid condition. 

\5 An example of a reasonable explanation might be "I recently
married and have not yet changed my name with SSA," accompanied by a
copy of a marriage certificate. 


      REVISED VERIFICATION NOTICE
      NOT FINALIZED
---------------------------------------------------------- Letter :5.1

IRS uses the CP54B notice to verify taxpayers' identities before
issuing a refund.  The current version of the CP54B notice does not
reflect IRS' revised procedures.  It does not clearly convey that
persons who file with missing or incorrect numbers, including filers
who were issued temporary numbers, are required to provide
documentation verifying their identities.  (Appendix I contains a
copy of the CP54B notice annotated to show misleading or potentially
confusing sections.)

A revised version of the CP54B notice has been developed that
reflects IRS' revised procedures but, as of July 1995, had not been
finalized.  Until the revised notice is available, IRS National
Office officials told us that they plan to use the current version of
the notice, followed by additional correspondence if the taxpayer
does not respond in accordance with the revised procedures.  This
practice will increase IRS' processing costs, create additional
taxpayer burden, and delay the issuance of some refunds.  IRS expects
to send out about 616,000 CP54B notices in 1995. 

IRS officials said that review and approval of the revised notice was
taking longer than expected.  As of June 21, 1995, the revision had
been approved by the National Office Notice Clarity Unit and was
being reviewed by the National Automation Advisory Group.  That group
is to assign a priority for making the computer programming changes
necessary to finalize the notice.  If the notice is not assigned the
highest priority, we are concerned, on the basis of past work, that
it will not be revised in time for use during the 1996 tax-filing
season, beginning in January 1996. 

In December 1994, we reported on the lengthy notice-review process
and noted that many recommended notice revisions were delayed or
never made because of IRS' limited computer-programming resources.\6
As one way of avoiding computer-programming delays, we recommended
that IRS test the feasibility of transferring notices to its
Correspondex System--a more modern computer system that produces
other types of IRS correspondence. 


--------------------
\6 Tax Administration:  IRS Notices Can Be Improved (GAO/GGD-95-6,
Dec.  7, 1994). 


      REVISED PROCEDURES NOT
      APPLIED TO CERTAIN PRE-1995
      FILERS
---------------------------------------------------------- Letter :5.2

IRS National Office officials told us that they do not plan to apply
the revised procedures to filers with prior accounts on the IMF
invalid segment who file again using the same name and number
combination.  Thus, these filers would not need to verify their
identities before receiving future refunds, although the mismatch
with SSA records may continue to exist.  According to IRS data, at
least 3.2 million of the 4.3 million accounts on the IMF invalid
segment, as of January 1, 1995, will not be subject to the new
procedures.  Instead, IRS placed a permanent computer code on the
accounts so that the system will automatically release future
refunds. 

IRS' rationale for exempting these accounts from the revised
verification procedures is that most of these filers had already
responded to a previous CP54B and requiring them to respond again
would increase taxpayer burden.  But responses to the previous CP54B
were done under IRS' old verification procedures, which, as we noted
previously, did not require proof of identity.  Thus, IRS has no
assurance that the earlier responses were satisfactory. 

Our analysis of the reasons 58 tax year 1993 returns were posted to
the IMF invalid segment with automatic refund release codes raised
questions about IRS' plans.  We noted, for example, that 27 of the
returns were filed by persons who either used SSNs not issued by SSA
or used another individual's SSN, including 11 filers who used SSNs
belonging to children and 5 filers who used SSNs belonging to
deceased taxpayers.  Under these circumstances, IRS was less certain
of filers' identities than if taxpayers had filed using names and
numbers that matched SSA files.  Table 1 shows the circumstances
under which those 58 returns were posted to the invalid segment of
the IMF. 



                           Table 1
           
            Reasons Returns With Automatic Refund
              Release Codes in GAO's Sample Were
           Posted to the Invalid Segment of the IMF

                                                      Number
Type of                                                   of
posting         Reason for posting                   returns
--------------  ----------------------------------  --------
Temporary       Filers used a temporary number             6
 number          assigned prior to 1990\a
Incorrect       Filers had not changed their names        22
 number          with SSA
                Filers used another individual's          21
                 SSN
                Filers used an SSN not issued by           6
                 SSA
                Other                                      3
============================================================
                Total postings with automatic             58
                 refund releases
------------------------------------------------------------
\a Filers whose returns were posted with temporary numbers from 1990
through 1994 did not have automatic release codes placed on their
accounts because they did not receive a CP54B notice.  They are
subject to IRS' revised documentation requirements. 

Source:  GAO sample of 100 returns from 4 IRS service centers. 

Another reason for IRS to reconsider its decision to exclude some
filers from the revised procedures is the fraud risk associated with
accounts on the IMF invalid segment. 

Our analysis of 400 refunds of $1,000 or more that were issued to
taxpayers whose returns were posted on the IMF invalid segment
surfaced only one instance in which a taxpayer appeared to have
misstated his wages and withheld taxes.  In that instance, a return
was filed with a wage and tax statement that had been issued to
another person.  However, there are other ways to get fraudulent
refunds besides claiming improper wages and/or withholdings. 

IRS has developed a profile of high-risk filers that it uses to help
identify potentially fraudulent returns.  According to that profile,
many filers whose returns are posted to the invalid segment of the
IMF pose a higher risk of fraud than filers whose returns are posted
to the valid segment.  For example, IRS has determined that filers
claiming the Earned Income Credit (EIC) are more likely to claim
fraudulent refunds than those who do not.  In April 1995, IRS'
Internal Audit Office reported that returns on the IMF invalid
segment are four times more likely than returns on the valid segment
(54 percent versus 12 percent, respectively) to include an EIC claim. 
Internal Audit also noted that 41 percent of the cases identified
through September 1994 by IRS' EIC Unallowable Program were filed
with invalid SSNs.  In contrast, according to Internal Audit, returns
with invalid SSNs represented only 1 percent of the total individual
Form 1040 population.  Of the unallowable cases closed by IRS, 84
percent with invalid SSNs had EIC amounts reversed, compared with 69
percent with valid SSNs. 

Of the 100 returns posted to the IMF invalid segment in our sample,
90 claimed the EIC.  Also, the filing status claimed on 40 of the
returns in our sample matched another characteristic in IRS' profile
of high-risk filers.  IRS' new verification procedures, if applied to
filers with pre-1995 accounts on the IMF invalid segment, could help
to limit these risks because they would enable IRS to more easily
identify filers who attempt to claim duplicate refunds. 


   FAILURE TO CLEAN UP MASTER FILE
   ACCOUNTS COULD ADVERSELY AFFECT
   IRS' MODERNIZATION PLANS
------------------------------------------------------------ Letter :6

Under TSM, IRS plans to access account information on taxpayers,
using either the primary or secondary\7 SSN.  IRS also plans to
consolidate existing, separate taxpayer databases into a single
database.  With a single database and the ability to access account
information on every taxpayer, IRS would be in a much better position
to maintain accurate, up-to-date accounts and respond to taxpayer
inquiries. 

Before IRS can effectively implement its plans, it will have to
identify and merge multiple taxpayer accounts on its current files. 
For example, the current master file structure with its valid and
invalid segments allows two or more taxpayers to have accounts under
the same SSN, or one taxpayer to have several accounts under
different numbers.  To begin the clean-up process, IRS mailed out
189,000 letters in December 1994 to taxpayers whose returns were
posted to the IMF invalid segment because they used an SSN that had
not been issued by SSA.  The letter instructed taxpayers to contact
SSA to obtain a correct SSN.  This effort is only a first step,
however, and IRS will need to do much more to clean up the rest of
its IMF records. 

IRS' clean-up task is further complicated because IRS plans to
include secondary filers (generally the spouse on a joint return) in
its database.  According to IRS data, as of February 1995, IRS had at
least 47 million IMF accounts with secondary filers.  Presently, IRS
does not require that secondary IMF filers verify their identities. 
One particular complication, according to an IRS official, will
involve merging the accounts of taxpayers who are secondary filers on
the IMF valid segment and primary filers on the invalid segment. 
Currently, IRS does not try to merge these accounts. 


--------------------
\7 A secondary SSN is generally the one used by the spouse on a joint
return. 


   IRS' INCOME-MATCHING PROGRAM
   HAMPERED BY POSTING RETURNS TO
   THE IMF INVALID SEGMENT
------------------------------------------------------------ Letter :7

Each year, IRS matches the income claimed by taxpayers with the
income reported by third parties on information returns.  IRS relies
on a taxpayer's name and SSN, as reported on a tax return and
associated information returns, to perform the matches. 
Discrepancies in reported income are used by IRS to detect
underreported income or nonfiling of tax returns. 

In most cases, returns posted to the IMF invalid segment with
temporary numbers are not available for use in IRS' matching program. 
This occurs because temporary numbers are unique to IRS and cannot be
matched against taxpayer identifiers on information documents. 
Omitting these taxpayers from IRS' matching program hampers efforts
to detect underreported income and nonfiling.  In addition, posting
returns with incorrect SSNs may complicate IRS' matching program if
information returns report income for a different name and/or SSN. 
Unless IRS is able to make corrections through the additional
research it does to check for erroneous mismatches, false leads could
be generated that siphon IRS resources away from more productive
cases. 

IRS has developed a proposal that could alleviate some of the
problems associated with matching returns posted with temporary
numbers.  IRS officials told us that many of the returns assigned
temporary numbers involved nonresident or illegal aliens who are not
eligible to obtain SSNs.  Under the proposal, IRS would assign
permanent Individual Taxpayer Identification Numbers (ITIN) to these
taxpayers, following a process similar to that used by SSA to verify
identities and assign SSNs.  Taxpayers with ITINs would then be
required to use their ITINs when filing tax returns, and their
returns could be posted to the valid segment of the IMF.  Persons
with ITINs would also be encouraged to use their ITINs when engaging
in financial transactions that are subject to information reporting. 
Those who did so would be included in IRS' matching program.  IRS is
currently obtaining public comments on a regulation, signed by the
Department of the Treasury on March 9, 1995, to implement the ITIN
proposal. 


   CONCLUSIONS
------------------------------------------------------------ Letter :8

Since 1986, the number of accounts on the IMF invalid segment has
grown faster than the number of accounts on the valid segment.  IRS
risks errors when issuing refunds to filers on the IMF invalid
segment because it cannot verify a filer's identity against SSA
records.  Moreover, some accounts on the IMF invalid segment cannot
be included in IRS' income-matching program.  IRS took steps in 1995
that, when fully implemented, could help reduce the number of
accounts on the IMF invalid segment.  For example, IRS is doing more
to verify the identities of taxpayers who file returns with missing
or incorrect SSNs, and it plans to issue permanent identification
numbers to taxpayers that could be used in IRS' matching program.  We
identified several areas where IRS could make additional
improvements. 

IRS has not finished revising the notice used to verify taxpayer
identities, and our past work indicates that the revision process has
been lengthy.  The current version of the notice does not adequately
explain IRS' revised documentation requirements and is causing
additional taxpayer contacts.  To reduce taxpayer burden and IRS
costs, it is important that the revised notice be available for the
1996 filing season. 

IRS is not applying its revised documentation requirements to
taxpayers whose returns were posted to the IMF invalid segment prior
to 1995 and who have a permanent refund release code on their
accounts.  Our review of accounts posted on the IMF invalid segment
that would be exempted under IRS' plan and IRS' profile of high-risk
filers raises questions about whether IRS should exclude such filers
from its revised documentation requirements.  Verification of these
filers' accounts should also help complete the cleanup of taxpayer
accounts that will be necessary as part of IRS' modernization. 


   RECOMMENDATIONS TO THE
   COMMISSIONER OF INTERNAL
   REVENUE
------------------------------------------------------------ Letter :9

To improve the processing of returns with missing or incorrect SSNs
and help clean up accounts currently posted on the IMF invalid
segment, we recommend that you

  finalize the CP54B notice in time for use during the 1996 tax-
     filing season, and

  apply the revised documentation requirements to taxpayers who filed
     tax returns that were posted to the IMF invalid segment before
     1995 and whose accounts now have a permanent refund release
     code. 


   AGENCY COMMENTS AND OUR
   EVALUATION
----------------------------------------------------------- Letter :10

We requested comments on a draft of this report from you or your
designee.  The draft included three proposed recommendations.  IRS
officials, including the Assistant Commissioner for Taxpayer Services
and the Staff Chief for the Director of Submission Processing,
provided oral comments in a meeting on June 21, 1995.  On the basis
of their comments, which are summarized in this section, we modified
one of our proposed recommendations and withdrew another.  IRS agreed
with the other recommendation. 

Because of the delays inherent in IRS' current notice-revision
process, our draft report included a recommendation that IRS assess
the feasibility of producing the CP54B verification notice on the
Correspondex System, as discussed in our December 1994 report.  The
Assistant Commissioner for Taxpayer Services agreed that a revised
notice was needed, but she said that the best way to accomplish this
is to proceed with the revision process currently under way.  She
assured us that the revised notice would be available for use during
the 1996 filing season.  Given the Assistant Commissioner's
assurances, we have revised our recommendation to delete any
reference to the use of the Correspondex System. 

IRS agreed with our recommendation that it apply the revised
documentation requirements to the IMF invalid segment accounts with
permanent refund release codes.  The Staff Chief said that a task
force, working in cooperation with internal auditors, is determining
the best way to verify accounts placed on the IMF invalid segment
before 1995.  IRS plans to focus on verifying active accounts, which
they estimate make up 38 percent of the accounts on the IMF invalid
segment.  (An account containing a recent tax return, for example,
would be considered active.) IRS also plans to remove IMF invalid
segment accounts that have been inactive for a certain period,
similar to the treatment of accounts on the valid segment.  The task
force is also working to reverse the permanent refund release code on
the IMF invalid segment accounts that were established before 1995. 
IRS' actions, if properly implemented, would respond to our
recommendation. 

We also included a proposed recommendation in our draft report that
IRS send back to taxpayers returns that are filed with missing SSNs
or SSNs that were not issued by SSA.  IRS data indicated that it was
less costly to send these returns back to taxpayers than it was to
post the returns to the master file, send taxpayers a CP54B notice,
and process their responses.  IRS disagreed with our proposal on the
basis that an individual income tax return with a missing SSN or an
SSN that was not issued by SSA is considered a valid return under the
Internal Revenue Code.  Because the return is valid, they asserted
that a court would hold that the statute of limitations on assessment
and collection would begin when the return was first filed, even
though it was returned to the taxpayer because of the invalid
condition.  Thus, IRS might limit its ability to recover the return
from the taxpayer and take any necessary enforcement actions if the
process of resolving the invalid condition became lengthy.  We
considered IRS' argument persuasive and have withdrawn our proposed
recommendation. 


--------------------------------------------------------- Letter :10.1

This report contains recommendations to you.  The head of a federal
agency is required by 31 U.S.C.  720 to submit a written statement on
actions taken on these recommendations to the Senate Committee on
Governmental Affairs and the House Committee on Government Reform and
Oversight not later than 60 days after the date of this letter.  A
written statement also must be sent to the House and Senate
Committees on Appropriations with the agency's first request for
appropriations made more than 60 days after the date of this letter. 

We are sending copies of this report to various congressional
committees, the Secretary of the Treasury, the Director of the Office
of Management and Budget, and other interested parties.  We will also
make copies available to others on request. 

The major contributors to this report are listed in appendix II.  If
you or your staff have any questions about this report, you can reach
me at (202) 512-9110. 

Sincerely yours,

Lynda D.  Willis
Associate Director, Tax Policy and
  Administration Issues




(See figure in printed edition.)Appendix I
IRS NOTICE CP54B (1994 VERSION)
============================================================== Letter 

supplementing those in the report text appear at the end of this
appendix. 


The following are GAO's comments on IRS' Notice CP54B (1994 Version). 


   GAO COMMENTS
----------------------------------------------------------- Letter :11

1.  The wording "REFUND DELAYED" is the only indication at the
beginning of the notice that the taxpayer will not be receiving
his/her refund and that the refund will be delayed until the taxpayer
resolves the discrepancy to IRS' satisfaction. 

2.  The notice does not accommodate filers who were issued temporary
numbers.  It gives instructions on what to do when there are
differences in the last name or SSN, but it does not explain what
filers with temporary numbers must do to have their refunds released. 

3.  A taxpayer might presume from the wording in this section that
providing the information IRS requests will release the refund, when
in fact, the refund would be released only if the new information
matches SSA's records. 

4.  This section of the notice does not require that a taxpayer send
anything back to IRS and, again, does not make it clear that the
taxpayer's refund will not be released until the discrepancy is
cleared up.  All it says is "If you wish, you may provide IRS with . 
.  .  ." Service center staff told us that taxpayers are expected to
provide this kind of information, and if it is not provided, IRS will
correspond again with taxpayers to obtain it. 

5.  This section has problems similar to those described in comment
4.  It does not require that taxpayers send anything to IRS and thus
is not clear about how or on what basis IRS will decide to release
the refund. 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix II

GENERAL GOVERNMENT DIVISION,
WASHINGTON, D.C. 

David J.  Attianese, Assistant Director

CINCINNATI REGIONAL OFFICE

Deborah Y.  Smith, Evaluator-in-Charge
Robert I.  Lidman, Regional Assignment Manager
Mary C.  Morrison, Evaluator

OFFICE OF GENERAL COUNSEL,
WASHINGTON, D.C. 

Rachel DeMarcus, Assistant General Counsel
Shirley A.  Jones, Attorney Advisor

