Tax Administration: IRS Can Improve Information Reporting for Original
Issue Discount Bonds (Letter Report, 03/15/96, GAO/GGD-96-70).

GAO provided information on the Internal Revenue Service's (IRS) efforts
to ensure that taxpayers report investment income earned from bonds sold
at original issue discount (OID), focusing on the completeness and use
of IRS Publication 1212.

GAO found that: (1) IRS asserts that OID bond issuers can rely on
Publication 1212 to identify all publicly offered OID bonds and compute
OID income, but Publication 1212 did not list at least 37 bonds worth
billions of dollars; (2) although IRS primarily relies on its sizable
penalty to ensure that OID bond issuers file IRS Form 8281 to report OID
bond issues, no IRS organization has primary responsibility for
monitoring such compliance and there is no evidence that IRS has ever
assessed the penalty; (3) IRS has not assessed penalties for late
filings of Forms 8281; (4) IRS does not use other information it
receives, such as corporate tax returns, to help ensure compliance with
Form 8281 reporting requirements; (5) because Publication 1212 is not
complete, those relying on the publication to determine their
information reporting requirements may not be reporting on all OID
bonds; and (6) although some banks and middlemen consider Publication
1212 to be incomplete, they indicated that the publication does serve as
a starting point, authority, and reference source.

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

 REPORTNUM:  GGD-96-70
     TITLE:  Tax Administration: IRS Can Improve Information Reporting 
             for Original Issue Discount Bonds
      DATE:  03/15/96
   SUBJECT:  Bonds (securities)
             Tax returns
             Income taxes
             Investments
             Government publications
             Reporting requirements
             Tax administration
             Tax nonpayment
             Voluntary compliance

             
******************************************************************
** This file contains an ASCII representation of the text of a  **
** GAO report.  Delineations within the text indicating chapter **
** titles, headings, and bullets are preserved.  Major          **
** divisions and subdivisions of the text, such as Chapters,    **
** Sections, and Appendixes, are identified by double and       **
** single lines.  The numbers on the right end of these lines   **
** indicate the position of each of the subsections in the      **
** document outline.  These numbers do NOT correspond with the  **
** page numbers of the printed product.                         **
**                                                              **
** No attempt has been made to display graphic images, although **
** figure captions are reproduced.  Tables are included, but    **
** may not resemble those in the printed version.               **
**                                                              **
** Please see the PDF (Portable Document Format) file, when     **
** available, for a complete electronic file of the printed     **
** document's contents.                                         **
**                                                              **
** A printed copy of this report may be obtained from the GAO   **
** Document Distribution Center.  For further details, please   **
** send an e-mail message to:                                   **
**                                                              **
**                                            **
**                                                              **
** with the message 'info' in the body.                         **
******************************************************************


Cover
================================================================ COVER


Report to the Commissioner
Internal Revenue Service

March 1996

TAX ADMINISTRATION - IRS CAN
IMPROVE INFORMATION REPORTING FOR
ORIGINAL ISSUE DISCOUNT BONDS

GAO/GGD-96-70

OID Bond Income Reporting

(268654)


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

  ABA - American Bankers Association
  CUSIP - Committee on Uniform Security Identification Procedures
  IRS - Internal Revenue Service
  OID - Original Issue Discount
  SIA - Securities Industry Association

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


B-260162

 March 15, 1996

The Honorable Margaret M.  Richardson
Commissioner of Internal Revenue

Dear Ms.  Richardson: 

Information reporting is a vital tool for the Internal Revenue
Service (IRS) in promoting voluntary compliance with our nation's
income tax laws.  This reporting, which is done through a series of
information returns designed to report specific types of nonwage
income on IRS Forms 1099, is intended to help ensure that taxpayers
know of and report their investment and other income on their tax
returns. 

This report, which is based upon work we initiated under our basic
authority, discusses IRS' efforts to ensure that information
reporting occurs for investment income earned from bonds\1 sold at
"original issue discount" (OID).  Those efforts center on IRS
Publication 1212, List of Original Issue Discount Instruments, which
furnishes data for use in preparing Form 1099-OID information
returns.  Specifically, our objectives were to determine (1) whether
Publication 1212 provides data on a complete list of existing OID
bonds, (2) how IRS ensures that its list of OID bonds is complete,
and (3) whether the publication's target audience relies on data from
the publication to generate Forms 1099-OID. 


--------------------
\1 We use the term "bond" generically to designate various debt
instruments offered to the public by private and public entities. 


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

Generally, the term "OID" covers bonds sold at a discount, that is,
below their redemption value.  For example, an OID bond issue with a
face value of $100 million may be sold for $60 million.  The $40
million difference is OID income.  Taxpayers are to pay taxes on OID
income as it accrues over a bond's life, even though they will not
actually receive it until the bond matures or is sold. 

Issuers of OID bonds and brokerage firms and banks that act as
"middlemen"\2 for bond owners are responsible for determining the
amount of OID income that accrues during a year and reporting it on
Form 1099-OID to IRS and to certain bond owners, primarily
individuals and partnerships.  Because middlemen frequently lacked
the information needed to do this reporting, IRS created Publication
1212.  The publication, which is updated annually, has included a
list of OID bonds by issuer name and, for each bond, data for use in
determining OID income. 

Bonds are to appear in Publication 1212 after bond issuers, primarily
corporations, supply IRS with information by filing Form 8281.\3
Issuers are required by law to report qualifying\4 OID bonds to IRS
within 30 days of issuance and face a penalty of up to $50,000 for
failing to do so on time. 

Information reporting is one of only a few key means available to IRS
to ensure that taxpayers fully report income on their tax returns,
and Publication 1212 is IRS' primary tool for promoting information
reporting on OID bonds.  In this connection, figure 1 illustrates
what will or may occur when the process for filing Form 8281 and Form
1099-OID works, or does not work, as IRS intended. 

   Figure 1:  Impact of Form 8281
   and Form 1099-OID on
   Publication 1212 and Tax
   Compliance

   (See figure in printed
   edition.)

Source:  GAO analysis of information from Publication 1212 and IRS'
information returns program. 

Appendix I contains more information about the importance of
information reporting;\5 the requirements, procedures, and practices
associated with Forms 8281 and 1099-OID; and the contents of
Publication 1212. 


--------------------
\2 Middlemen, such as brokerage firms and banks, hold the bonds in
their roles as investment managers or as an accommodation to their
customers to facilitate recordkeeping and subsequent transactions. 
In these cases, middlemen act as "street holders" of the bonds. 
Issuers regard street holders as the holders of record, or owners,
and may be unaware of the true owners' identities.  For that reason,
the tax code requires middlemen to assume the information reporting
responsibilities.  Middlemen are Publication 1212's primary target
audience. 

\3 Form 8281 is titled "Information Return for Publicly Offered
Original Issue Discount Instruments."

\4 Appendix I discusses the categories of OID bonds that are not
included in Publication 1212.  Generally, Form 8281 does not have to
be filed for bonds that fall into those categories. 

\5 Over the years, we have supported the use of information returns
to promote greater voluntary compliance by taxpayers and have
recommended changes to make IRS' information and matching program
more effective.  Appendix II contains a list of products we have
issued since 1982 that discussed information reporting for tax
purposes. 


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

According to IRS, middlemen can rely on Publication 1212 to identify
publicly offered OID bonds and to compute OID income for Form
1099-OID.  However, many OID bonds are missing from Publication 1212,
and IRS has done little to ensure that bond issuers file Form 8281,
IRS' source of information for Publication 1212.  Because many
middlemen do rely on the publication to prepare Forms 1099-OID and it
is incomplete, they may not be reporting all OID income to IRS or to
bond owners. 

Using several public information sources, we identified 37 OID bonds
that should have been listed in the latest Publication 1212 but were
not.  Most of the 37 bonds were issued after 1990, with 28 issued in
1993 and 1994.  If the 28 bonds had been included in Publication
1212, the number of bonds listed for 1993 and 1994 would have been 20
percent larger.  The public information did not show every
characteristic, such as the issuer's right to defer interest
payments, that would identify an OID bond.  For that reason, there
may have been more bonds missing from Publication 1212 than we
identified. 

The 37 missing bonds we identified were issued with about $10 billion
in total OID, part of which would accrue as income to bond owners
each year over the bonds' lives.  We could not quantify how much tax
revenue, if any, was lost as a result of accrued OID income from
bonds not listed in Publication 1212 going unreported to owners and
the IRS. 

In some instances, information reporting may still have occurred
through bond issuers rather than middlemen, or through middlemen
large enough to use an OID information source other than Publication
1212.  In other cases, information reporting of OID income may not
have been required, such as when bonds were held in tax-exempt
accounts or owned by corporations and certain other institutions
that, according to the law, need not receive Forms 1099-OID. 
However, IRS encourages corporations owning OID bonds to use
Publication 1212 to compute OID income.  In any event, to meet IRS'
intent of providing a source of information that middlemen can rely
on to prepare Forms 1099-OID, all publicly offered OID bonds should
be listed in the publication. 

The 37 bonds were not included in Publication 1212 because IRS had no
record of receiving Forms 8281 from the issuers.  There was no
evidence that IRS was aware of the bond issues or took action to
ensure that the forms were filed.  Instead, IRS relied on the
existence of the substantial penalty--up to $50,000--to deter
noncompliance.  Although two IRS offices shared responsibility for
issuing Publication 1212, no IRS office was directly responsible for
making certain that Forms 8281 were filed in a timely manner or for
imposing the penalty.  IRS officials knew of no case when the penalty
was ever imposed, either for nonfiling or for late filing. 

Some members of two significant middlemen groups--the securities and
banking industries--said they use other sources for identifying and
computing OID income.  However, industry representatives told us that
many securities firms and banks, especially smaller ones, rely on
Publication 1212 data to generate Forms 1099-OID.  In addition, many
of the securities and banking industry representatives we spoke with
said that Publication 1212 serves a continuing need for OID data by
providing a single, authoritative source of OID information. 


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

Our primary objectives on this self-initiated assignment were to
determine (1) whether the list of OID bonds in Publication 1212 is
complete, (2) how IRS ensures that it is receiving Forms 8281 on new
OID bond issues, and (3) whether middlemen rely on Publication 1212
data to compute and report OID income on Forms 1099-OID.  The latest
edition of Publication 1212 at the time of our review was revised as
of November 1994 and it contained several listings.  We focused
solely on section I-B of the 1994 edition, which lists the OID bonds
issued after 1984 that are covered by the Forms 8281 filed by
issuers.\6

To determine the completeness of the listing of OID bonds in
Publication 1212, we reviewed publicly available information such as
Moody's Bond Record and Investment Dealers Digest to identify OID
bonds and then determine whether these bonds were included in
Publication 1212.  Because the sources we used did not contain
detailed characteristics of the bond issuances, we were only able to
identify bonds as having OID if they were described as discount
issues or if they were initially offered for significantly less than
their face value.  We were unable to look for other characteristics,
such as deferred interest payments, that may have generated OID
income in other bonds.  At our request, IRS' Office of Chief Counsel
reviewed the bonds we identified as eligible for inclusion in
Publication 1212 to verify that they were issued with OID, the
issuance had not been reported to IRS as required, and the bonds were
not included in the November 1994 edition. 

To determine how IRS ensures it is receiving Forms 8281 on new OID
bond issues, we

  held discussions with officials of the Office of Chief Counsel, the
     Forms and Publications Division, and other IRS offices to obtain
     information on the processes IRS uses to obtain data for
     Publication 1212 and on how it enforces Form 8281 filing
     requirements;

  visited IRS' Detroit Computing Center, where Forms 8281 are
     initially processed, to ascertain the center's responsibilities
     in the reporting and enforcement process;

  spoke with the contractor that maintains IRS' Form 8281 database to
     ascertain its duties and responsibilities; and

  analyzed all readily available Forms 8281 filed with IRS since 1985
     to determine total OID dollars for the bonds listed in
     Publication 1212 and the timeliness of form filings. 

To determine whether middlemen relied on Publication 1212 data to
generate Forms 1099-OID, we held discussions with representatives of
financial service companies and securities, banking, and mutual fund
trade associations and firms to obtain insight on the use they made
of the publication.  We obtained information from or through 3
financial service companies, 20 securities firms, 9 banks, the
American Bankers Association (ABA), and the Securities Industry
Association (SIA).  We also interviewed other OID experts in the
accounting and legal communities to obtain their perspectives on OID
taxation and reporting and the market for OID bonds. 

We identified the associations, financial service companies, and
individual experts through discussions with IRS officials and others
and our review of relevant literature.  The securities firms we
contacted were SIA members and judgmentally selected to include
various types and sizes of firms.  The banks we obtained information
from were members of the ABA Tax Committee and were surveyed through
the ABA, or were referred to us by the Chairman of IRS' Information
Reporting Advisory Committee or by a private information reporting
consultant.  We identified the OID legal and accounting experts
through discussions with IRS officials and our review of relevant
literature. 

We did our work in Chicago, Detroit, and Washington, D.C., from
September 1994 through July 1995 in accordance with generally
accepted government auditing standards.  We requested comments on a
draft of this report from you or your designee.  On January 23, 1996,
we met with IRS National Office officials to obtain their comments on
a draft of this report.  IRS representatives at that meeting included
the National Director for Service Center Compliance and the National
Director of the Tax Forms and Publications Division.  Their comments
are summarized on pages 16-17 and incorporated into this report where
appropriate. 


--------------------
\6 There were nine other listings in Publication 1212 covering
corporate bonds issued before 1985, U.S.  Treasury stripped bonds,
and various types of short-term federal bonds.  With stripped bonds,
the right to receive interest payments and the right to receive
principal values at maturity are sold separately.  None of the nine
listings were based on the tax code requirement that OID issuers
inform IRS of new OID issues.  They, therefore, were outside the
scope of this assignment. 


   PUBLICATION 1212 WAS INCOMPLETE
   AS A SOURCE FOR PREPARING FORMS
   1099-OID
------------------------------------------------------------ Letter :4

According to both the regulations covering Publication 1212 and the
publication itself, middlemen can rely on the publication to
determine whether a publicly offered bond was issued at a discount
and, if so, the amount of OID income to be reported.  Further,
according to IRS, middlemen can avoid penalties for incomplete or
inaccurate information reporting by relying on information in
Publication 1212.  IRS' statements of reliance imply that the
publication's list of OID bonds is complete.  However, we found it to
be incomplete because it was missing many bonds. 

Using publicly available information in sources such as Moody's Bond
Record, we found 37 OID bonds that should have been listed in the
November 1994 edition of Publication 1212 but were not.  The bonds
were not included because IRS had no record that the issuers had
filed Forms 8281.  Attorneys from IRS' Office of Chief Counsel
reviewed this information and saw no reason why the issuers should
not have filed Forms 8281. 

Most of the 37 bonds were issued after 1990, although some dated back
to 1985.  Twenty-eight were issued in 1993 through 1994.  If the
excluded bonds were added to those already listed in Publication
1212, the number of bonds in the 1994 edition would increase by

  8 percent for bonds listed as issued after 1985, and

  20 percent for bonds listed as issued in 1993 through 1994. 

Why the percentage increased for 1993 through 1994 was unknown. 

The 37 bonds were issued with about $10 billion of OID.  For tax
purposes, the OID should be recognized as income over the lives of
the bonds, which was up to 20 years for some.  To put this $10
billion into better perspective, the 464 bonds in Publication 1212
for which data were available were issued with about $40 billion in
OID.  The 28 bonds issued in 1993 through 1994 that should have been
included in Publication 1212 were issued with $7.1 billion of OID. 
In comparison, the 145 bonds added to the publication for those years
were issued with $9.1 billion of OID. 

We could not determine how much tax revenue, if any, was lost because
accrued OID income from bonds not listed in Publication 1212 might
have gone unreported to owners and IRS.  In part, this is because
information reporting would be unnecessary on some portion of the $10
billion when bonds were held in tax-exempt accounts or owned by
tax-exempt organizations, corporations, and other institutions that
are not required to receive information returns.  Even so, bonds are
not excludable from the publication merely because some eventual
owners may not need to receive information returns.  In its
Publication 1212, IRS encourages owners of publicly offered OID bonds
who do not receive Forms 1099-OID to use the publication to determine
the amount of OID to report on their income tax returns. 

Although we could not estimate the amount of tax revenue, if any,
that may have been lost, there is evidence to suggest that loss of
tax revenue can occur when a Form 1099-OID is not provided.  In an
earlier report on income resulting from the cancellation of
indebtedness, we found that information returns increased taxpayer
reporting of such income from less than 1 percent of income to almost
50 percent.\7 This result underscores the importance of information
reporting when the taxpayer may be unaware that taxable income has
been received or recognized, as in the case of OID income.  Although
cancellation of indebtedness income differs significantly from OID
income, the two types of income are similar in that they are taxable
even though the taxpayer does not receive cash in the tax year. 
Clearly, by requiring information reporting for OID, Congress saw the
need for taxpayers and IRS to be informed of accrued but unreceived
OID income. 

More bonds may have been missing from Publication 1212 than the 37 we
found.  Various features of a bond, such as deferred interest
payments, can give rise to OID.  The sources we reviewed allowed us
to look for some of these features but not all.  Also,
representatives of a service company that maintains its own OID
database and prepares information returns for middlemen estimated
that the company's database contained more than 150 OID bonds that
Publication 1212 should have included but did not.  The bonds in this
database included a few predating the 1985 issuance notification
requirement. 


--------------------
\7 Tax Administration:  Information Returns Can Improve Reporting of
Forgiven Debts (GAO/GGD-93-42, Feb.  17, 1993). 


   IRS LACKED AN EFFECTIVE PROCESS
   FOR IDENTIFYING NONFILING OF
   FORM 8281 AND ENSURING
   PUBLICATION 1212 WAS COMPLETE
------------------------------------------------------------ Letter :5

The tax code and related regulations require issuers to inform IRS
within 30 days after they publicly issue OID bonds and subject them
to a penalty of up to $50,000 for not doing so.  According to IRS
Chief Counsel officials, IRS generally relied on the existence of the
sizable penalty to ensure reporting compliance and, therefore,
presumed that Publication 1212 was substantially complete.  In our
opinion, such reliance might be appropriate if the penalty were
enforced.  However, we found no IRS organization with primary
responsibility for monitoring issuers' compliance and assessing the
penalty, and no evidence that IRS had ever assessed the penalty.  In
addition, IRS did not take advantage of other information it received
that could help it identify unreported OID offerings to make the
publication more complete. 


      NO IRS ORGANIZATION WAS
      ASSIGNED PRIMARY
      RESPONSIBILITY FOR
      MONITORING COMPLIANCE
---------------------------------------------------------- Letter :5.1

When the reporting requirement was placed on bond issuers in 1984,
IRS officials discussed which part of the organization would have
responsibility for (1) developing and maintaining Publication 1212,
(2) monitoring Form 8281 filings from issuers, and (3) assessing
penalties for noncompliance.  Although IRS delegated responsibility
for developing and maintaining Publication 1212 to the Forms and
Publications Division, we found no evidence that it ever determined
which office would monitor filings and assess penalties.  IRS
auditors have general responsibility for making certain that
corporations under audit have filed all required forms, including
Form 8281.  However, as discussed more fully below, audits are more
likely to occur long after a Form 8281 is due and auditors have not
always identified a taxpayer's (issuer's) failure to file the form. 

According to officials of the two offices responsible for developing
and issuing Publication 1212--the Forms and Publications Division and
the Office of the Chief Counsel--neither office had authority to
assess the penalty.  Similarly, officials at the Detroit Computing
Center responsible for processing Forms 8281 were unaware of the
penalty when we brought it to their attention and did not believe
they had authority to assess it.  Finally, the Office of Financial
Products and Transactions, which was established in March 1994 to,
among other tasks, identify and develop strategies for addressing tax
issues related to financial products, did not routinely receive
information necessary to monitor Form 8281 filing compliance. 

IRS auditors have the only documented responsibility (Internal
Revenue Manual, section 4034.5) for determining whether OID bond
issuers have filed required Forms 8281 and for imposing the penalty
if they have not done so.  As part of a standard check when auditing
corporate taxpayers, auditors are to determine whether all applicable
tax and information returns have been filed, including Form 8281.  If
a corporation does not file Form 8281 within 30 days of issuing
publicly offered OID bonds and lacks reasonable cause for not filing
the form, auditors are responsible for obtaining a completed form and
imposing the nonfiling penalty.  However, the audits are generally
initiated at least a year after the returns are filed.  In addition,
IRS does not audit the majority of the almost 47,000 large
corporations that are most likely to be issuers of publicly offered
OID debt, those with assets of over $10 million.  IRS does audit most
of the 1,700 largest corporations, those in its Coordinated
Examination Program.\8

IRS had no record of Forms 8281 being filed for the 37 bonds we found
missing from Publication 1212.  The bonds were issued by 34
corporations.  Of these, 3 had issued other bonds that were listed in
Publication 1212; the other 31 had not.  The total OID income payable
over the lives of these 37 bonds ranged from $27.1 million for one
bond to $1.5 billion for another. 

We asked the IRS Examination Division to determine whether any of the
34 issuers had been audited for the year of bond issuance and, if so,
whether the audit identified a failure to file Form 8281.  According
to the Examination Division, of the 34 issuers,

  two issuers had been audited, but IRS had neither identified nor
     addressed their apparent failure to file Form 8281;

  one issuer was under audit, but the firm's apparent failure to file
     Form 8281 had not been identified; and

  two other issuers were under audit, and because we brought the
     matter to IRS' attention, IRS planned to determine whether each
     was responsible for filing Form 8281. 

This lack of checking by auditors for required submissions was an
issue that we discussed in 1989.  At that time, we said IRS had
missed identifying businesses that failed to file required
information returns in about 50 percent of the 932 business return
audits we reviewed.\9

As a result of our review, IRS auditing officials were going to
determine whether there were reasonable causes for the corporations
not filing the 37 Forms 8281.  As of August 1995, IRS had not
resolved any of the 37 cases.  However, as a result of our review,
the Assistant IRS Commissioner for Examination issued a memorandum
reminding audit staff of the Form 8281 filing requirement and
reemphasizing the need to check for filing compliance when auditing
corporate taxpayers.  A reminder was also included in an internal
newsletter that was to be sent to auditors who audit the largest
corporations.  In addition, IRS' Financial Products and Transaction
Office included training on Form 8281 requirements as part of its
continuing education program for its auditors.  Financial Products
and Transactions staff are generally responsible for addressing OID
and other financial product issues during corporate audits.  Finally,
the Director of the Office of Financial Products and Transactions
said that IRS needed to improve the completeness of Publication 1212,
and said that it would be productive to match OID bonds listed in
Publication 1212 with those contained in financial databases
maintained outside of IRS. 


--------------------
\8 See Tax Administration:  Audit Trends and Taxes Assessed on Large
Corporations (GAO/GGD-96-6, Oct.  13, 1995). 

\9 Tax Administration:  Missing Independent Contractors' Information
Returns Not Always Detected (GAO/GGD-89-110, Sept.  8, 1989). 


      LATE FILING OF FORMS 8281
      DID NOT RESULT IN PENALTIES
---------------------------------------------------------- Letter :5.2

In addition to not identifying and penalizing Forms 8281 nonfiling,
IRS did not consider imposing penalties when filings were late,
sometimes seriously so.  We reviewed the filing dates of 460 Forms
8281 filed between 1985 and 1994 and listed in the November 1994
Publication 1212.  Of the 460 forms, 108 (23 percent) were filed from
12 to 816 days after the 30-day deadline, with an average delinquency
of about 180 days.  We also found six forms, with about $488 million
in total OID, that were not listed in the publication because they
were filed too late.\10 IRS could provide no evidence that it had
attempted to determine whether a penalty was warranted in any of the
114 cases. 

Thirty-three of the 108 issuers that filed late Forms 8281 included
with their filings explanations of why they were late.  The most
common reason given was that the company was unaware of the filing
requirement.  Other reasons were inadvertent oversight and confusion
between the company and its attorneys over who would file the form. 


--------------------
\10 These six Forms 8281 were filed more than 30 days after the bonds
were offered and reached IRS after IRS' cutoff date for inclusion in
the 1994 edition. 


      FORM 8281 PENALTY WAS NOT IN
      IRS' PENALTY HANDBOOK
---------------------------------------------------------- Letter :5.3

The issuance reporting requirement and related penalty were not
addressed in IRS' Penalty Handbook, a reference tool for IRS
employees who impose and assess penalties.  The handbook, which was
issued in 1992, is intended to encompass all civil penalties. 
According to an IRS official, the Form 8281 penalty was omitted from
the 1992 issuance because it was of lesser priority.  IRS planned to
add the penalty to the handbook in fiscal year 1996 as part of a
chapter on miscellaneous penalties. 


      IRS DID NOT USE OTHER MEANS
      TO OBTAIN COMPLIANCE
---------------------------------------------------------- Letter :5.4

IRS receives other information that it could use to help ensure that
OID issuers file Forms 8281.  The corporate tax return, Form 1120,
asks taxpayers to mark a checkbox if they issued any publicly offered
OID debt during the fiscal year and reminds corporations of their
responsibility to file Form 8281 when OID debt is issued.  A mark in
the checkbox would not necessarily mean that a Form 8281 had to be
filed because, as discussed in appendix I, some publicly offered OID
bonds do not require the filing of a Form 8281.  However, a checkmark
would provide a lead that IRS could pursue.  IRS did not attempt to
use this information to identify potentially missing Forms 8281. 
Historical information was not available on the reasons for placing
the checkbox on the corporate tax return and its intended use. 

Form 1099-OID also provides a potential cross-check on whether Forms
8281 are filed.  Middlemen that rely on commercially available OID
databases can generate Forms 1099-OID for bonds in those databases
that may be missing from Publication 1212.  Form 1099-OID contains
the same bond CUSIP\11 number as Form 8281 does.  However, IRS cannot
readily compare the CUSIP numbers by computer because the number is
not easily located on Form 1099-OID.  That is, it can be anywhere
within a section of the form that describes the bond.  IRS had no
plans to revise the form to make extraction of the CUSIP number
easier. 


--------------------
\11 The CUSIP is the ABA's Committee on Uniform Security
Identification Procedures, and it assigns identification numbers to
security issues. 


   MIDDLEMEN'S RELIANCE ON
   PUBLICATION 1212 MAY RESULT IN
   OID UNDERREPORTING
------------------------------------------------------------ Letter :6

Because Publication 1212 is incomplete, middlemen relying on its
information to meet their OID information reporting requirements may
not be reporting on all OID bonds they hold for their customers. 
Bond holders, consequently, may not report such income on their tax
returns.  According to information provided by members of the
securities and banking communities, many securities firms and banks,
especially the smaller ones that make up the greatest number in both
industries, rely on information in Publication 1212 to fulfill their
Form 1099-OID reporting responsibilities.  Many of those we
interviewed said that the issuance of OID bonds will increase in the
foreseeable future. 


      SECURITIES INDUSTRY RELIANCE
      ON PUBLICATION 1212
---------------------------------------------------------- Letter :6.1

According to SIA representatives,\12 small- and medium-sized
securities firms who frequently act as middlemen for bond owners
substantially relied on Publication 1212 to prepare their information
returns.  These firms, the representatives said, make up a relatively
large proportion of the thousands of existing securities firms, and
they probably cannot afford to use the commercial services for
information reporting that major securities firms generally use. 

Of the 20 mostly large securities firms we contacted, 3 said that
they either used Publication 1212 directly or relied on commercial
services that used it to prepare information returns.  The remaining
17 firms relied on commercial firms that had developed or bought OID
databases to assist in information reporting.  Their reasons for
doing so varied but included the perception that Publication 1212 was
incomplete, the need for assistance in calculating OID accruals and
processing Forms 1099-OID, and the need for information that was
beyond the publication's scope.  However, as discussed below, the
majority of these firms said Publication 1212 was useful for other
purposes. 

The representatives of the SIA and securities firms we interviewed
could offer no definitive reasons why issuers might not file Form
8281.  Some speculated that because they lacked knowledge of the
filing requirement, smaller regional firms or firms using a new
investment banker might fail to file the form.  Others said that the
more unusual or complex OID issues were the ones missing from
Publication 1212. 


--------------------
\12 According to an SIA representative, the 700+ SIA member firms
account for more than 90 percent of the U.S.  securities industry's
revenue. 


      BANKS' RELIANCE ON
      PUBLICATION 1212
---------------------------------------------------------- Letter :6.2

As we learned from nine banks--five that the ABA surveyed for us and
four that we contacted directly--banks' reliance on Publication 1212
to identify OID bonds and determine OID income varied.  Three of the
five banks surveyed by ABA said they used Publication 1212, either
directly or through an information reporting service.  The other two
used a source other than the publication.  Two of the four large
banks we contacted relied primarily on Publication 1212 to identify
and calculate OID on bonds for information reporting, and two relied
on commercial firms. 

According to an information reporting consultant working with small
banks, many small banks use Publication 1212 to identify OID
instruments and determine the amount of OID to report.  Small banks,
the consultant said, generally cannot afford to use commercial
services to identify OID bonds or to prepare their information
returns. 


      PUBLICATION 1212 CONTINUES
      TO SERVE A NEED
---------------------------------------------------------- Letter :6.3

Representatives of the organizations we interviewed saw a continuing
need for Publication 1212.  According to representatives of one of
the large service firms, Publication 1212 was the anchor of the OID
information reporting process and, without it, OID reporting would
result in a "wild west" situation, with no single reliable
information source.  According to representatives of this firm and
the SIA, without Publication 1212, reporting compliance would
decrease and OID information reported would become more inconsistent. 

The securities firms and banks we contacted generally supported the
need for Publication 1212.  Their reasons included

  the authoritativeness of the publication due to the safe harbor
     provisions\13 of the Department of the Treasury's information
     reporting regulations,

  the need for a reference source with which to address their
     questions or their customers' questions, and

  the importance of having a source that they and their customers
     could use to verify the accuracy of OID income data that service
     companies provided. 

Publication 1212 is important in helping ensure proper corporate
reporting of OID income.  Corporate bond holders are encouraged by
IRS to use the publication to calculate OID income.  SIA
representatives told us that most corporate taxpayers do not receive
Forms 1099-OID or equivalent information and, therefore, have to rely
on Publication 1212 to determine their reportable OID income.  In
addition, IRS auditors use Publication 1212 to ensure that
corporations' OID income is properly reported. 

Finally, many of the individuals we interviewed from service
companies and the banking and securities industries expected that the
number of OID issues will increase as new types of debt instruments
appear.  Also, representatives of IRS' Office of Chief Counsel said
finalization of the contingent debt regulations may increase Form
8281 filings for these instruments.\14

Middlemen's continuing reliance on Publication 1212 and the
anticipated increase in the issuance of OID bonds heighten the
importance of Publication 1212 as a complete and accurate data source
for information reporting.  Without a complete and accurate
publication, IRS and middlemen cannot be assured that all OID income
has been reported.  Incomplete reporting may result in taxpayers
understating their income and the resulting tax liability. 


--------------------
\13 These provisions mean that middlemen relying on Publication 1212
cannot be penalized by IRS due to faults of the publication. 

\14 Contingent debt instruments are those whose redemption values
depend on the market value of some other security or security index. 
Under IRS' proposed regulations, all such debt instruments would be
considered as issued with OID. 


   CONCLUSIONS
------------------------------------------------------------ Letter :7

IRS created Publication 1212 to promote information reporting of OID
income and to generate greater voluntary compliance on the part of
taxpayers.  Information reporting is especially important for OID
income because this type of income is accrued and, therefore, not as
visible to taxpayers as other forms of income.  It is also important
to IRS because IRS has few other means available to make certain that
taxpayers report OID income on their tax returns. 

Although IRS has continued to issue the publication, it has done
little to ensure that the publication contained information on all
the appropriate OID bonds.  It did not monitor and enforce Form 8281
filing requirements.  Although discussions occurred in the mid-1980s,
we found no IRS organization that had been assigned the
responsibility for monitoring and ensuring timely Form 8281 filing,
such as ensuring that bond issuers were generally aware of the filing
requirement or assessing penalties when IRS became aware that
taxpayers had not filed Forms 8281 on time.  As a result, we found
that the publication was missing many bonds issued with billions of
dollars of OID, and middlemen's information reporting was very likely
not as comprehensive as it could have been. 

According to middlemen and securities industry representatives we
contacted, many middlemen rely on Publication 1212 information to
meet their OID information reporting requirements.  However, as long
as IRS does not ensure that the publication is complete, the
publication's value will be lessened, both to middlemen that must
provide information reports and to IRS in its efforts to improve
voluntary compliance. 


   RECOMMENDATIONS TO THE
   COMMISSIONER OF INTERNAL
   REVENUE
------------------------------------------------------------ Letter :8

To help IRS better meet its responsibility to provide middlemen with
complete and reliable information that can be used for OID
information reporting, and to help better ensure that the billions of
dollars of OID income are properly reported for tax purposes, we
recommend that you

  assign organizational responsibility for monitoring and enforcing
     the OID bond issuance reporting requirement to specific
     organizational units and establish formal linkages between the
     units so that each can effectively carry out its
     responsibilities;

  develop procedures, such as periodically matching the list of OID
     bonds in Publication 1212 with those contained in databases
     outside of IRS, to improve and help ensure the completeness and
     reliability of Publication 1212 as an authoritative source of
     OID information for middlemen; and

  work with representatives of the securities industry to develop a
     means to inform and remind OID bond issuers of their
     responsibility to file Forms 8281. 


   AGENCY COMMENTS AND OUR
   EVALUATION
------------------------------------------------------------ Letter :9

We requested comments on a draft of this report from you or your
designated representative.  We met with your designated
representatives, including the National Director for Service Center
Compliance and the National Director of the Tax Forms and
Publications Division, on January 23, 1996, to receive and discuss
IRS' comments.  They said the report was comprehensive and agreed
with the intent of all three proposed recommendations.  The officials
also said the draft report was generally accurate except for some
clarifications, which we incorporated in this report where
appropriate. 

We modified one of the recommendations that we proposed in the draft
report so that we no longer recommend that monitoring and enforcement
responsibilities should be assigned to "a specific organizational
unit." Although IRS officials agreed that monitoring and enforcement
of Form 8281 filings should be improved, they said monitoring should
be assigned to one IRS function and enforcement to another, in
keeping with IRS' traditional operating structure.  They also agreed
that formal linkages between functions should be established so that
when one identifies problems the other would be made aware.  We
revised our final recommendation to (1) acknowledge IRS' policy of
separating monitoring and enforcement responsibilities and (2) call
for the establishment of formal linkages between the monitoring and
enforcement units. 


---------------------------------------------------------- Letter :9.1

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 must also 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 III.  If
you have any questions about this report please call me on (202)
512-9110. 

Sincerely yours,

Lynda D.  Willis
Director, Tax Policy
 and Administration Issues


INFORMATION ON THE IMPORTANCE OF
INFORMATION RETURNS, CONTENTS OF
PUBLICATION
1212, AND REQUIREMENTS AND
PRACTICES ASSOCIATED WITH FORMS
8281 AND 1099-OID
=========================================================== Appendix I

Information reporting is one of only a few key means available to IRS
to ensure that taxpayers fully report income on their tax returns. 
Over the last 15 years or so, IRS' audit coverage has dropped
substantially.  During that period, however, expanded
information-reporting requirements and IRS' use of that information
has allowed IRS to increase its checks for unreported income in a
more cost-effective manner. 

For some financial products,\1 IRS depends on receiving information
returns--Forms 1099--for income data that it matches against
corresponding data on tax returns.  We have supported the use of
information returns to promote greater voluntary compliance and have
recommended changes in IRS' information reporting and matching
program to make it more effective.  (See app.  II for a list of
related reports.)

Publication 1212 is IRS' primary tool for ensuring complete
information reporting on OID bonds.  The OID bonds that appear in
Publication 1212 are limited to publicly offered, long-term (more
than 1 year) issues that accrue more OID income than "de-minimis"
amounts (.25 percent annually).  They are issued by corporations,
government, and quasi-government entities (such as the Federal Farm
Credit Bank and the Student Loan Marketing Association) and cover a
broad range of complexity, from the relatively simple to the very
complicated.  According to the November 1994 edition of Publication
1212, OID bonds to be included cannot be

  long-term OID instruments issued before May 28, 1969;

  original issue U.S.  Treasury notes and bonds;

  U.S.  savings bonds;

  debt instruments issued at a discount by states or their political
     subdivisions;

  mortgage-backed securities and mortgage participation certificates;

  real estate mortgage investment conduits with regular interest and
     collateral debt obligations;

  commercial paper and banker's acceptances that may have been
     originally issued at a discount;

  obligations issued by tax-exempt organizations;

  obligations issued at a discount by individuals;

  certificates of deposit and other face amount certificates issued
     at a discount, including syndicated certificates of deposit;
     and,

  foreign obligations not traded in the United States and obligations
     not issued in the United States. 

Publication 1212 is to be updated annually and is to be used to
prepare tax returns for a specific year.  For example, at the time of
our review, the latest publication was revised as of November 1994
and was to be used in preparing 1994 tax returns.  It included a list
of OID bonds by issuer name and, for each bond, data for use in
determining the OID income to be reported.  These data included the
amount of OID accruing per $1,000 of maturity value on a daily and
annual basis for 1994 and 1995. 

Under the Internal Revenue Code and related regulations, issuers of
OID bonds, or the brokers and other middlemen that hold them for bond
owners, are responsible for annually reporting to certain
owners--primarily individuals and partnerships--and IRS the income
that accrued or was paid.\2 They are to report this information using
a paper or computerized IRS Form 1099-OID.  Annual information
returns are not required for OID income earned by tax-exempt
organizations or certain taxable entities such as corporations and
financial institutions.  Nonetheless, taxable entities are
responsible for reporting and paying appropriate taxes on OID income. 

When the Form 1099-OID reporting requirement was first placed on
middlemen in the early 1980s, middlemen said they had no practical
source of information with which to meet the requirement.  For
example, they said that although they might obtain the necessary data
from the issuer's prospectus statement for each bond, the effort
could be burdensome.  Responding to the securities industry's
requests for a practical source of information, IRS agreed to publish
Publication 1212, which it first did in 1983. 

The Internal Revenue Code and related regulations require issuers of
OID bonds, except for those noted above, to tell IRS when the bonds
are first publicly offered to buyers.  This mandatory requirement was
established to ensure that information would be obtained on the 300
to 400 new issues expected each year.  Reporting is to occur within
30 days of issuance, and issuers who willfully report late or not at
all are subject to a penalty of 1 percent of the issue price, up to a
maximum of $50,000. 

To inform IRS of a new OID bond, issuers are to send IRS Form 8281 to
the Detroit Computing Center.  After the Center performs some
clerical processing, a company under contract with IRS analyzes the
forms and accompanying information to decide which bond issues fit
the criteria for inclusion in Publication 1212 and follows up with
the issuers as needed.  Using a computerized file of Form 8281 data,
the contractor also determines the OID income-accrual rates that are
to appear in Publication 1212.  The contractor has no responsibility
for identifying OID bonds that have not been reported to IRS on Form
8281 and including them in Publication 1212. 

The November 1994 edition of Publication 1212 included about 780
long-term OID bonds, including 478 issued since 1985.  According to
IRS' files, 464 of the 478 bond issues were issued with about $40
billion of OID.  Information on the remaining 14 issues was not
readily available from the files. 

Since IRS began issuing Publication 1212, some brokerage and
financial service companies have developed proprietary databases of
OID debt issues for use in preparing Forms 1099-OID (1) for their own
customer accounts or (2) as a paid-for service to middlemen.  These
brokerage and service companies may also sell their databases to
middlemen or other financial service companies for their use in
preparing information returns.  We did not determine how every firm
built its database, but two of the largest firms (a brokerage firm
and a service company) said they used financial market reporting
services, Securities and Exchange Commission filings, and Publication
1212. 

Appendix II GAO PRODUCTS ISSUED SINCE 1982 THAT DISCUSSED INFORMATION
REPORTING FOR TAX PURPOSES

Tax Administration:  Information Returns Should Increase Proper
Reporting of Farm Income (GAO/GGD-86-69, July 22, 1986). 

The Merits of Establishing a Business Information Returns Program
(GAO/T-GGD-87-4, Mar.  17, 1987). 

Tax Administration:  IRS' Efforts to Establish a Business Information
Returns Program (GAO/GGD-88-102, July 22, 1988). 

Tax Administration:  State and Local Compliance With IRS' Information
Reporting Requirements (GAO/GGD-89-63, May 4, 1989). 

Tax Administration:  Missing Independent Contractors' Information
Returns Not Always Detected (GAO/GGD-89-110, Sept.  8, 1989). 

Tax Administration:  Information Returns Can Be Used to Identify
Employers Who Misclassify Workers (GAO/GGD-89-107, Sept.  25, 1989). 

Tax Administration:  Status of IRS' Test of a Business Information
Returns Program (GAO/GGD-90-38, May 29, 1990). 

Information Returns:  Correcting Taxpayer Identification is Possible
Without Disclosing Tax Data (GAO-GGD-90-90, June 5, 1990). 

Tax Policy and Administration:  IRS' Compliance Programs to Reduce
the Tax Gap (GAO/T-GGD-91-11, Mar.  13, 1991). 

Tax Administration:  IRS Can Improve Its Program to Find Taxpayers
Who Underreport Their Income (GAO/GGD-91-49, Mar.  13, 1991). 

Tax Administration:  Expanded Reporting on Seller-Financed Mortgages
Can Spur Tax Compliance (GAO/GGD-91-38, Mar.  29, 1991). 

Tax Policy and Administration:  IRS' Efforts to Ensure Corporate Tax
Compliance (GAO/T-GGD-91-21, Apr.  17, 1991). 

Tax Policy:  Refund Offset Program Benefits Appear to Exceed Costs
(GAO/GGD-91-64, May 14, 1991). 

IRS Needs to Implement a Corporate Document Matching Program
(GAO/T-GGD-91-40, June 10, 1991). 

Tax Administration:  Benefits of a Corporate Document Matching
Program Exceed the Costs (GAO/GGD-91-118, Sept.  27, 1991). 

Tax Administration:  Federal Agencies Should Report Service Payments
Made to Corporations (GAO/GGD-92-130, Sept 22, 1992). 

Tax Administration:  Information Returns Can Improve Reporting of
Forgiven Debts (GAO/GGD-93-42, Feb.  17, 1993). 

Tax Administration:  Computer Matching Could Identify Overstated
Business Deductions (GAO/GGD-93-133, Aug.  13, 1993). 

Tax Administration:  Options Reporting to IRS (GAO/GGD-95-145R, May
5, 1995). 


--------------------
\1 As discussed in our letter, Options Reporting to IRS
(GAO/GGD-95-145R, May 5, 1995), options transactions are not subject
to annual information reporting requirements. 

\2 Congress began requiring the annual accrual and information
reporting of OID income in 1969 in order to preclude taxpayers'
deferral of the income or their reporting of it as capital gains
rather than ordinary income.  Then, as now, capital gains were
subject to preferential tax rates.  Over the years, Congress has
included more types of instruments under the accrual and reporting
requirements, and in 1982, it gave IRS the authority to impose the
reporting requirement on middlemen. 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================= Appendix III

GENERAL GOVERNMENT DIVISION,
WASHINGTON, D.C. 

Michael Brostek, Assistant Director
Jose Oyola, Assistant Director
Mary Phillips, Assignment Manager
Anthony Assia, Senior Evaluator
Robert Floren, Evaluator

CHICAGO FIELD OFFICE

Thomas Venezia, Core Group Manager
Neal Gottlieb, Evaluator-in-Charge
Donald Kittler, Senior Evaluator


*** End of document. ***