Tax Administration: Ways to Simplify the Estimated Tax Penalty
Calculation (Letter Report, 05/27/98, GAO/GGD-98-96).

Pursuant to a legislative requirement, GAO reviewed the: (1) Internal
Revenue Code and the Internal Revenue Service (IRS) administrative
requirements that cause some of the complexity associated with estimated
tax (ES) penalty calculations; and (2) likely effects of corresponding
changes to the requirements that would make it easier for taxpayers to
calculate their ES penalties.

GAO noted that: (1) to help ensure compliance with the Internal Revenue
Code and IRS administrative requirements, form 2210 requires numerous
calculations to track individual ES underpayments and to determine
precise ES penalty amounts; (2) GAO identified three requirements where
the additional calculations did not seem to be justified because they
resulted in either little or no effect on ES penalty amounts; (3) the
form 2210 underpayment schedule, which currently requires that taxpayers
track each underpayment individually, results in a complicated
procedure, involving numerous calculations, to comply with the
definition of underpayment in the Code; (4) GAO found that if taxpayers
were allowed to track the accumulated underpayment amounts rather than
if individual amounts and if a corresponding change were made to the ES
penalty underpayment period, taxpayers could reduce the number of
calculations without affecting ES penalty amounts; (5) taxpayers
currently have to make additional ES penalty calculations to account for
three of the four 15-day periods between ES interest rate effective
dates and ES payment dates; (6) if interest rates change, this
requirement increases the number of calculations taxpayers must make but
only increases or decreases the penalties by small amounts; (7) in 1986,
Congress eliminated this requirement for the 15-day period between April
1 and April 15 by aligning the interest rate effective date with the ES
payment date; (8) similar alignments for the other three 15-day periods
during the year would eliminate the calculations taxpayers must make for
the 15-day periods and have little effect on ES penalty amounts; (9) to
account for leap years, taxpayers currently have to make additional ES
penalty calculations when underpayment balances extend either through
the end of the leap year or the end of the year preceding a leap year;
and (10) GAO found that, if taxpayers were allowed to use a 365-day year
in all ES penalty calculations, they could eliminate the additional
calculations and the penalties for the periods affected would increase
by a very small amount--only 0.3 percent.

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

 REPORTNUM:  GGD-98-96
     TITLE:  Tax Administration: Ways to Simplify the Estimated Tax 
             Penalty Calculation
      DATE:  05/27/98
   SUBJECT:  Taxpayers
             Reporting requirements
             Underpayments
             Fines (penalties)
             Tax administration
             Interest rates
             Income taxes

             
******************************************************************
** 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 Chairmen and Ranking Minority Members, Committee on
Finance, U.S.  Senate, and Committee on Ways and Means, House of
Representatives

May 1998

TAX ADMINISTRATION - WAYS TO
SIMPLIFY THE ESTIMATED TAX PENALTY
CALCULATION

GAO/GGD-98-96

Estimated Tax Penalty Calculation

(268822)


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

  ES - estimated tax
  IRS - Internal Revenue Service

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


B-278804

May 27, 1998

The Honorable William V.  Roth, Jr.
Chairman, Committee on Finance
United States Senate

The Honorable Daniel Patrick Moynihan
Ranking Minority Member
Committee on Finance
United States Senate

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

The Honorable Charles B.  Rangel
Ranking Minority Member
Committee on Ways and Means
House of Representatives

In 1996, about 5.9 million taxpayers were assessed almost $1.1
billion in estimated tax (ES) penalties.  The Internal Revenue
Service's (IRS) Taxpayer Advocate's Annual Report to Congress in 1996
described the ES penalty rules as extraordinarily complex, and it
characterized the Form 2210 used for calculating ES penalties as one
of the most difficult forms taxpayers have to complete. 

This report, which we prepared under our basic legislative
responsibilities, identifies (1) Internal Revenue Code and IRS
administrative requirements that cause some of the complexity
associated with ES penalty calculations and (2) the likely effects of
corresponding changes to the requirements that would make it easier
for taxpayers to calculate their ES penalties. 


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

For more than 50 years, IRS has collected estimated taxes on income
not subject to withholding, which is known as nonwage income. 
Nonwage income generally includes income from pensions, interest,
self-employment, capital gains, dividends, and partnerships.  In
1994, these six categories accounted for 91 percent of all nonwage
income.  Nonwage income has represented a growing proportion of total
U.S.  income in recent years, increasing from 16.7 percent to 23.3
percent between 1970 and 1994.  The percentage of tax returns
reporting only nonwage income has likewise increased from 10 percent
to 14 percent over the same period. 

The ES process requires taxpayers to make four payments to IRS at
regular intervals during the tax year.  At the beginning of the tax
year, taxpayers are to estimate their annual income, determine their
potential tax liability, and compute their ES payments.  For tax
years beginning on January 1, ES payments are due on April 15, June
15, September 15, and January 15 of the following year.  If taxpayers
underpay their ES payments, they may be liable for ES penalties.\1

Taxpayers who underpay can choose either to have IRS calculate any
penalty they owe or to self-assess their own penalty using a Form
2210.  Taxpayers using the form to self-assess their ES penalties can
use either the short or regular method to calculate their ES penalty
amounts.\2 The ES penalty equals the interest on the underpaid amount
for the number of days it is outstanding.  The interest rate used to
compute the penalty is based on the federal short-term interest rate,
which is subject to change the first day of each quarter, that is,
January 1, April 1, July 1, and October 1.  IRS updates the Form 2210
annually to account for changes in the federal short-term interest
rate.  (See app.  I for a copy of a Form 2210.)

In 1994, about 4 million taxpayers self-assessed their ES penalties. 
We could not determine how many of them used the short or regular
method because IRS does not collect the data necessary to make that
determination.  However, to provide a rough approximation of how many
taxpayers used the regular method, we examined 100 tax returns from
the 1994 Statistics of Income database--the latest information
available.  The 100 returns were selected to represent taxpayers who
either paid ES penalties or were otherwise affected by the ES
process.  Of the 75 taxpayers who self-assessed their ES penalties,
we found that over half used the regular method. 


--------------------
\1 Generally, taxpayers are not liable for ES penalties if either (1)
their current year's tax liability minus their withholding is less
than $1,000 or (2) their withholding covered at least 90 percent of
their current year's tax liability or 100 percent of their prior
year's tax liability. 

\2 Only taxpayers who either made no ES payments or made four equal
ES payments on time can use the short method to compute their
penalties.  Taxpayers using the short method merely apply a
percentage rate shown on the Form 2210 to their ES underpayment to
determine their ES penalty.  Taxpayers who use the regular method are
required to make additional calculations on the Form 2210.  These
extra calculations entail taxpayers calculating an underpayment for
each of the four ES payment periods and a separate ES penalty amount
for each period in which there is an underpayment. 


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

To help ensure compliance with the Internal Revenue Code and IRS
administrative requirements, Form 2210 requires numerous calculations
to track individual ES underpayments and to determine precise ES
penalty amounts.  We identified three requirements where the
additional calculations did not seem to be justified because they
resulted in either little or no effect on ES penalty amounts. 

First, the Form 2210 underpayment schedule, which currently requires
that taxpayers track each underpayment individually, results in a
complicated procedure, involving numerous calculations, to comply
with the definition of "underpayment" in the Code.  We found that if
taxpayers were allowed to track the accumulated underpayment amount
rather than if individual amounts and if a corresponding change were
made to the ES penalty underpayment period, taxpayers could reduce
the number of calculations without affecting ES penalty amounts. 

Second, taxpayers currently have to make additional ES penalty
calculations to account for three of the four 15-day periods between
ES interest rate effective dates and ES payment dates.  If interest
rates change, this requirement increases the number of calculations
taxpayers must make but only increases or decreases the penalties by
small amounts.  In 1986, Congress eliminated this requirement for the
15-day period between April 1 and April 15 by, in essence, aligning
the interest rate effective date with the ES payment date.  Similar
alignments for the other three 15-day periods during the year would
eliminate the calculations taxpayers must make for the 15-day periods
and have little effect on ES penalty amounts. 

Third, to account for leap years, taxpayers currently have to make
additional ES penalty calculations when underpayment balances extend
either through the end of a leap year or the end of a year preceding
a leap year.  We found that, if taxpayers were allowed to use a
365-day year in all ES penalty calculations, they could eliminate the
additional calculations and the penalties for the periods affected
would increase by a very small amount--only 0.3 percent. 


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

Our objectives were to identify causes for the complexity in the ES
penalty process and to determine whether changes could be made to
simplify the process for taxpayers who use the regular method to
calculate their ES penalties.  To achieve our objectives, we

  -- reviewed IRS reports on the estimated tax process;

  -- analyzed the instructions for preparing the Form 2210 and
     discussed the ES process with IRS officials; and

  -- reviewed a random sample of 100 taxpayer returns subject to the
     ES process to obtain a rough approximation of how many taxpayers
     used the regular method.  The sample, which was too small to
     reliably project to the universe, was extracted from IRS' tax
     year 1994 Statistics of Income database. 

We did our audit work in Washington, D.C., and San Francisco between
September 1997 and March 1998 in accordance with generally accepted
government auditing standards. 

We requested comments on a draft of this report from the Commissioner
of Internal Revenue.  The comments we received are in appendix II and
are evaluated at the end of this letter. 


   THREE REQUIREMENTS THAT
   INCREASE THE NUMBER OF
   CALCULATIONS ON THE FORM 2210
   CAN BE CHANGED WITH LITTLE OR
   NO EFFECT ON PENALTY AMOUNTS
------------------------------------------------------------ Letter :4

The Form 2210 includes three requirements that complicate the ES
penalty process and result in additional calculations that need to be
made by taxpayers who use the regular method.  Simplifying the
underpayment schedule, changing the effective dates of the ES penalty
interest rates, and using a 365-day year for all ES penalty
calculations would make the form easier to understand and reduce the
number of ES penalty calculations taxpayers have to make.  The
changes to the underpayment schedule and the ES penalty calculations
could be made administratively by IRS, while changing the effective
dates of the ES penalty interest rates would require legislative
action.  These changes would have either little or no effect on ES
penalty amounts. 


      TRACKING INDIVIDUAL
      UNDERPAYMENTS ADDS
      CALCULATIONS TO THE FORM
      2210 THAT DO NOT AFFECT ES
      PENALTY AMOUNTS
---------------------------------------------------------- Letter :4.1

The Form 2210 underpayment schedule is used to determine taxpayers'
underpayments in each of the four ES payment periods.  The
underpayment calculation first requires taxpayers to apportion the
required annual payment amount--the amount of taxes that should have
been paid during the year--to each of the four ES payment periods.\3
The apportioned amounts are the required ES installments--the taxes
that should have been paid in each of the ES payment periods. 

Conceptually, the basis for the underpayment calculation is
relatively straightforward.  To determine the underpayment amount,
taxpayers essentially compare the ES installment with the ES payments
made and any withholding during the payment period.  When the
installment amount is greater than the combined amounts of ES
payments and withholding, taxpayers have an underpayment and are
liable for ES penalties. 

However, in actual practice, taxpayers must follow a more complicated
procedure to calculate their underpayments.  This procedure entails
additional calculations to account for underpayment balances that may
remain from previous payment periods.  These additional calculations
are necessary to comply with the definition of the term
"underpayment" in section 6654(b)(1) of the Internal Revenue Code. 
The definition precludes existing underpayment balances from being
used in underpayment calculations for succeeding ES payment periods. 
To illustrate the complexity of this procedure, a completed Form 2210
for a hypothetical taxpayer is shown in figure III.1 in appendix III. 

The underpayment schedule would be simplified by changing the form so
as to allow taxpayers to carry forward underpayment balances to
succeeding ES payment periods.  To calculate their underpayments
using this simplified approach, taxpayers would subtract the combined
amount of their ES payment and withholding from the total of their
current ES installment and their underpayment balance from the
previous payment period.  This change would reduce the number of
calculations taxpayers have to make on the underpayment schedule but
would, in some cases, make the computed underpayment amounts
different.  Figure III.2 in appendix III shows our revised
underpayment schedule for a hypothetical taxpayer. 

To avoid a difference in the ES penalty amounts calculated using the
different underpayment amounts, a corresponding change to the ES
penalty underpayment period would be needed.  The change would
further simplify the process for taxpayers by eliminating additional
ES penalty calculations, while ensuring that ES penalty amounts are
not affected.  Appendix IV shows a comparison of ES penalty
calculations required under the current and simplified approaches. 

Although simplifying the Form 2210 underpayment schedule and changing
the underpayment period in the ES penalty calculation schedule would
reduce the number of calculations taxpayers need to make, it would
require that taxpayers and tax preparers adjust to a revised Form
2210, which has not changed since 1986.  However, we believe the
recurring advantages of simplifying the form outweigh this one-time
adjustment. 


--------------------
\3 The required annual payment is allocated either (1) equally to the
four ES payment periods, if the taxpayer's income was earned evenly
throughout the year or (2) unequally in accordance with the
proportion of the taxpayer's income that was earned in each of the ES
payment periods. 


      THE 15-DAY PERIODS BETWEEN
      ES INTEREST RATE DATES AND
      ES PAYMENT DATES INCREASE
      THE NUMBER OF CALCULATIONS
      TAXPAYERS HAVE TO MAKE
---------------------------------------------------------- Letter :4.2

To determine their ES penalties, taxpayers must calculate the
interest on the underpayment amount for the number of days it was
outstanding, that is, the number of days between when the taxpayer
should have made the ES payment and the earlier of (1) when the
payment was actually made, or (2) the 15th day of the 4th month
following the close of the taxable year (April 15 for a taxpayer
using a calendar-year basis).  The interest rate used in the
calculation is based on the federal short-term interest rate, which
is subject to change on the first day of each quarter. 

Under the current approach, if interest rates change while an
underpayment is outstanding, taxpayers are required to make separate
calculations for the periods before and after the interest rate
change.  Typically, in such instances, the separate calculations are
necessary to cover only 15-day periods because the applicable ES
payment dates occur either 15 days immediately before or after the
effective dates of interest rate changes.  For example, the July 1
interest rate change occurs 15 days after the June 15 payment date. 

This use of different dates for ES payment dates and interest rate
effective dates has the effect of increasing the number of penalty
calculations taxpayers must make.  Table 1 illustrates the
calculations that would have to be made by a hypothetical taxpayer
with underpayments in three ES payment periods.  To compute the ES
penalty for the June 15 underpayment, the taxpayer would need to make
two calculations, numbers 1 and 2, because the April 1 interest rate
was in effect during the first period the underpayment was
outstanding and the July 1 interest rate was in effect for the second
period the underpayment was outstanding.  Similarly, three
calculations, numbers 3, 4, and 5 would be necessary to compute the
taxpayer's ES penalty for the September 15 underpayment because three
different interest rates were in effect during the period the
underpayment was outstanding. 



                                Table 1
                
                Calculations Necessary to Compute an ES
                  Penalty for a Hypothetical Taxpayer

Calculation  Interest     Date
number and   rate         underpaymen
underpaymen  effective    t balance
t date       date         paid         Period covered by calculation
-----------  -----------  -----------  -------------------------------
1. June 15   April 1      September    June 16-June 30
                          15

2. June 15   July 1       September    July 1-September 15
                          15

3.           July 1       January 15   September 16-September 30
September
15

4.           October 1    January 15   October 1-December 31
September
15

5.           January 1    January 15   January 1-January 15
September
15

6. January   January 1    April 15     January 16-April 15
15
----------------------------------------------------------------------
Source:  GAO analysis of IRS Publication 505, Tax Withholding and
Estimated Tax. 

Unlike the ES penalty calculations previously discussed, penalty
calculation number 6 is different.  For that penalty, only one
calculation at the January 1 interest rate would be required for the
entire period the underpayment was outstanding because of a special
rule in section 6621(b)(2)(B) of the Internal Revenue Code.  The
special rule, in essence, changes the effective date of the April 1
interest rate change to April 15, thereby allowing IRS to use the
January 1 interest rate for the 15-day period between April 1 and
April 15.\4

Expansion of the special rule to cover all ES payment dates and
interest rate dates would reduce the number of calculations taxpayers
would have to make.  Specifically, aligning the July 1, October 1,
and January 1 interest rate effective dates with the June 15,
September 15, and January 15 ES payment dates, respectively, would
eliminate the 15-day ES penalty calculations.  Instead, taxpayers
would make only one calculation at the interest rate, which becomes
effective at the end of the affected 15-day period.  To illustrate
the effect of the change, we used the hypothetical taxpayer case
shown in table 1.  Under an expanded special rule, the taxpayer would
be required to make only three calculations rather than six, as shown
in table 2. 



                                Table 2
                
                Calculations Necessary to Compute an ES
                    Penalty If the Special Rule Were
                                Expanded

Calculation    Interest
number and     rate         Date
underpayment   effective    underpayment  Period covered by
date           date         balance paid  calculation
-------------  -----------  ------------  ----------------------------
1. June 15     July 1       September 15  June 16-September 15

5. September   October 1    January 15    September 16-January 15
15

6. January 15  January 1    April 15      January 16-April 15
----------------------------------------------------------------------
Source:  GAO analysis of revised changes and IRS Publication 505. 

Expanding the special rule would have little effect on ES penalty
amounts, either increasing or decreasing them for the affected 15-day
periods, depending on the direction of the interest rate change.  For
example, if the interest rates increased on July 1, the rate used to
calculate ES penalties for June 15 underpayments would be the higher
July 1 rate rather than the lower rate effective before July 1. 
Conversely, if the interest rates decreased on July 1, ES penalties
would be based on the lower July 1 rate.  Expressed in terms of the
ES underpayment, a 1-percent change for the 15-day period increases
or decreases an ES penalty by 0.04 percent of the underpayment
amount, or $4.11 on a $10,000 underpayment.\5

We analyzed the effect of expanding the special rule on actual ES
penalty amounts for 32 taxpayers in our sample of 100 taxpayers
subject to the ES process who used the regular method in 1994 and who
had submitted Form 2210s with their tax returns.  A comparison of the
ES penalty amounts computed using the expanded special rule with the
actual ES penalties showed that changes were relatively small.  In 15
cases, the ES penalties did not change.  In the 17 other cases, the
changes ranged from an increase of $1 on a $49 penalty to an increase
of $163 on a $8,573 penalty.  In 24 cases, the use of the expanded
rule reduced the number of penalty calculations taxpayers needed to
make.  In 1 case, the number of penalty calculations declined from 11
to 4.  (See app.  VI for more details on the comparison and the ES
penalty calculation schedules required on the current and revised
Form 2210 for a sample case.)

The comparison reflects 1994 interest rates, which increased from 7
to 9 percent during the year.  If interest rates had decreased, the
ES penalty amounts would have similarly decreased.  Over the 10-year
period 1987 through 1996, changes in the interest rate used to
compute ES penalties varied, increasing in 2 years, decreasing in 2
years, both increasing and decreasing in 4 years, and not changing in
2 years.  (See app.  V for a summary of interest rate changes over
the 10-year period.)


--------------------
\4 The special rule was implemented to facilitate the Form 2210
update process, which concludes in December.  To have the Form 2210
available to taxpayers in January, IRS must use the January 1
interest rate because the interest rate for the April 1-April 15
period is not known in December. 

\5 In the past 10 years, interest rates used to compute ES penalty
amounts have increased by 1 percent 8 times and decreased by 1
percent 8 times.  This pattern would tend to equalize this change's
effect on ES penalty amounts.  Appendix V shows the changes and when
they occurred. 


      THE REQUIREMENT TO ADJUST
      THE ES PENALTY FORMULA FOR
      LEAP YEAR RELATED CHANGES
      INCREASES THE NUMBER OF
      CALCULATIONS TAXPAYERS HAVE
      TO MAKE
---------------------------------------------------------- Letter :4.3

Under current IRS procedures, taxpayers who have outstanding
underpayment balances that extend through the end of a leap year must
make separate calculations to account for the change from a 366- to a
365-day year regardless of whether there is an interest rate change
on January 1.  For example, if a taxpayer has an underpayment on
September 15 that extends through January 15, the taxpayer would have
to make two calculations to compute the ES penalty.  For the first
calculation, which would cover the period September 15 through
December 31, the taxpayer would need to use a 366-day year in the
formula.  For the second calculation, which would cover the period
January 1 through January 15, the taxpayer would need to use a
365-day year in the formula.  In years preceding a leap year,
taxpayers would have to use a similar calculation method to account
for the change from a 365- to a 366-day year. 

The current process could be simplified by allowing taxpayers to use
a 365-day year for all ES penalty calculations, regardless of the
year.  If there were no interest rate change on January 1, this
change would eliminate an extra calculation for taxpayers with
outstanding underpayment balances extending either through the end of
a leap year or the end of a year preceding a leap year. 

This change would increase ES penalty amounts by 0.3 percent during
the period affected.\6 For example, the ES penalty computed using the
current method would be $2,557 on a $40,000 underpayment outstanding
for 260 days at 9 percent.  Using a 365-day year in the same
calculation results in an ES penalty of $2,564.  The dollar amount of
the increase would vary depending on the underpayment amount and how
long it was outstanding. 


--------------------
\6 The maximum number of days affected by this change would be 260
days in a leap year (April 15 through December 31).  In a year
preceding a leap year, 106 days would be affected by this change
(January 1 through April 15).  The ES penalty formula would use a
365-day year rather than a 366-day year during these periods if the
change were made. 


      ONE-TIME ADJUSTMENT TO THE
      ES PENALTY CALCULATION
      PROCESS WOULD PROVIDE
      RECURRING BENEFITS
---------------------------------------------------------- Letter :4.4

Modifying the ES penalty calculation would require taxpayers and tax
preparers to adjust to a revised Form 2210, which has not been
changed since 1986.  Making the adjustment would not be difficult
because it would occur one time and would affect only the calculation
of the ES penalty.  The rules governing application of the ES penalty
process would not be affected by the change.  The effect on IRS would
also be minimal, since they currently revise the Form 2210 annually
to account for interest rate changes. 

The benefits of modifying the ES penalty calculation process would be
recurring for taxpayers who use the regular method.  Revising the
underpayment schedule would make it easier to understand and would
reduce the number of calculations taxpayers have to make on the
schedule.  Similarly, adjusting the effective dates for interest
rates used to compute ES penalties and using a 365-day year to
calculate all ES penalties could further reduce the number of
calculations taxpayers would have to make. 


   CONCLUSIONS
------------------------------------------------------------ Letter :5

To help ensure compliance with the Internal Revenue Code and IRS
administrative requirements, the Form 2210 requires taxpayers to
perform numerous calculations to track individual underpayment
amounts and to determine precise ES penalty amounts.  In three
instances, the additional calculations did not seem to be justified
because they resulted in either little or no change in penalty
amounts. 

Administrative changes and legislative action would be needed to
reduce the number of calculations required on the Form 2210 and make
it easier for taxpayers to complete.  Although the changes would
require taxpayers and tax preparers to adjust to using a new form, we
believe the recurring advantages of the change would outweigh that
one-time adjustment. 


   RECOMMENDATIONS TO THE
   COMMISSIONER OF INTERNAL
   REVENUE
------------------------------------------------------------ Letter :6

To simplify the ES penalty process for taxpayers, we recommend that
the Commissioner of Internal Revenue

  -- revise the Form 2210 underpayment schedule to allow taxpayers to
     track the accumulated underpayment amount rather than individual
     underpayment amounts and

  -- revise the Form 2210 ES penalty calculation schedule to allow
     taxpayers to use a 365-day year in all ES penalty calculations. 


   RECOMMENDATION TO CONGRESS
------------------------------------------------------------ Letter :7

To further simplify the ES penalty process for taxpayers, we
recommend that Congress amend section 6621(b)(2)(B) of the Internal
Revenue Code to include the periods June 15 through June 30,
September 15 through September 30, and January 1 through January 15. 


   AGENCY COMMENTS AND OUR
   EVALUATION
------------------------------------------------------------ Letter :8

We obtained written comments on a draft of this report from the
Commissioner of Internal Revenue (see app.  II).  The Commissioner
said that he generally agreed with all of our recommendations. 

The Commissioner commented, however, that IRS would not consider
revising the Form 2210 underpayment schedule before legislative
action is taken to amend section 6621(b)(2)(B) and expand the ES
special rule to the new periods.  IRS believes that expanding the
special rule would provide the greatest relief to taxpayers and that
revising the Form 2210 without incorporating that change would not be
justified by the lesser benefits derived from revising the
underpayment schedule. 

We concur with IRS' position and believe that all changes should be
made at the same time to minimize the adjustment required by
taxpayers and tax preparers to the revised Form 2210. 


---------------------------------------------------------- Letter :8.1

We are sending copies of this report to the Secretary of the
Treasury, Commissioner of Internal Revenue, and other interested
parties.  We will make copies available to others upon request. 

The major contributors to this report are listed in appendix VII.  If
you have any questions, please contact me on (202) 512-9110. 

James R.  White
Associate Director, Tax Policy and
 Administration Issues


IRS FORM 2210
=========================================================== Appendix I

   Figure I.1:  IRS Form 2210,
   Schedule to Compute Required
   Annual Payment and ES Penalty
   Using the Short Method

   (See figure in printed
   edition.)

   Figure I.2:  IRS Form 2210,
   Schedule to Compute
   Underpayments and ES Penalty

   (See figure in printed
   edition.)




(See figure in printed edition.)Appendix II
COMMENTS FROM THE INTERNAL REVENUE
SERVICE
=========================================================== Appendix I


COMPARISON OF A CURRENT FORM 2210
UNDERPAYMENT SCHEDULE TO A REVISED
UNDERPAYMENT SCHEDULE
========================================================= Appendix III

In figures III.1 and III.2, we compare section A, lines 21-29, of the
current Form 2210 Underpayment Schedule with our revised section A
for a hypothetical taxpayer.  The hypothetical taxpayer had
underpayments of $5,000 in each ES payment period, and made ES
payments of $3,000 on April 15, $1,000 on June 15, $2,000 on July 30,
$4,500 on September 15, and $9,500 on January 15. 

   Figure III.1:  Steps Required
   on the Current Form 2210
   Underpayment Schedule

   (See figure in printed
   edition.)

   Source:  GAO analysis of IRS
   Publication 505.

   (See figure in printed
   edition.)

   Figure III.2:  Steps Required
   on Our Revised Form 2210
   Underpayment Schedule

   (See figure in printed
   edition.)

   Source:  GAO analysis of IRS
   Publication 505.

   (See figure in printed
   edition.)


COMPARISON OF ES PENALTY
CALCULATIONS USING THE CURRENT AND
REVISED INSTRUCTIONS
========================================================== Appendix IV

In tables IV.1 and IV.2, we compare the ES penalty calculations
necessary using the instructions on the current Form 2210 with the ES
penalty calculations necessary if the instructions for the
calculations were revised in accordance with the revisions made to
simplify the form's underpayment schedule. 



                                    Table IV.1
                     
                     Calculations Necessary Using Current ES
                               Penalty Instructions

 ES
paym
ent
peri
 od     Apr. 15 -June 30        July 1 -Sept. 30       Oct. 1 -Jan. 15
----  --------------------  -------------------------  ----------------
Unde
rpay
ment
amou
 nt          $2,000                  $5,000                 $4,500
----  --------------------  -------------------------  ----------------
Calc
ulat
ion
numb
er        1        2        3        4        5        6        7        8
----  --  -------  -------  -------  -------  -------  -------  -------  -------
Amou      $1,000   $1,000   $1,000   $5,000   $1,000   $4,000   $4,500   $4,500
nt
used
in
calc
ulat
ion
(pay
ment
or
resi
dual
unde
rpay
ment
)

Reas      P        I        P        I        P        P        I        P
on
for
calc
ulat
ion-
-
paym
ent
(P)
or
inte
rest
rate
chan
ge
(I)

Peri      4/15-    4/15-    7/1-     6/15-    7/1-     7/1-     9/16-    10/1-
od        6/15     6/30     7/30     6/30     7/30     9/15     9/30     1/15
cove
red
by
the
calc
ulat
ion

Numb      61       76       30       15       30       77       15       107
er
of
days
cove
red
by
the
calc
ulat
ion

Inte      .07      .07      .08      .07      .08      .08      .08      .09
rest
rate

Pena      $12      $15      $7       $14      $7       $68      $15      $119
lty
Tota
l
pena
lty
=
$257
(dif
f.
due
to
roun
ding
)
--------------------------------------------------------------------------------
Source:  GAO analysis of IRS Publication 505. 

Eight calculations are necessary under the current instructions to
determine the total ES penalty.  Three calculations for the $2,000
underpayment are needed to account for (1) the $1,000 payment on June
15, (2) the interest rate change on July 1, and (3) the $2,000
payment on July 30.  Three calculations for the $5,000 underpayment
are needed to account for (1) the interest rate change on July 1, (2)
the $1,000 payment on July 30, and (3) the $4,500 payment on
September 15.  Two calculations for the $4,500 underpayment are
needed to account for (1) the interest rate change on October 1, and
(2) the $9,500 payment on January 15. 



                                    Table IV.2
                     
                     Calculations Necessary Using ES Penalty
                     Instructions Revised in Accordance With
                     Simplifications Made to the Form 2210's
                              Underpayment Schedule

   ES
payment   Apr. 15 -
 period    June 15            June 16 -Sept. 15              Oct. 1 -Jan. 15
--------  ----------  ----------------------------------  ----------------------
Underpay
  ment
 amount     $2,000                  $6,000                        $4,500
--------  ----------  ----------------------------------  ----------------------
Calculat
ion
number    1           2           3           4           5           6
--------  ----------  ----------  ----------  ----------  ----------  ----------
Amount    $2,000      $6,000      $6,000      $4,000      $4,500      $4,500
used in
calculat
ion
(underpa
yment
or
residual
underpay
ment)

Reason    P           I           P           P           I           P
for
calculat
ion--
payment/
end of
ES
period
(P) or
interest
change
(I)

Period    4/15-       6/15-       7/1-        8/1-        9/16-       10/1-
covered   6/15        6/30        7/30        9/15        9/30        1/15
by the
calculat
ion

Number    61          15          30          47          15          107
of days
covered
by the
calculat
ion

Interest  .07         .07         .08         .08         .08         .09
rate

Penalty   $23         $17         $39         $41         $15         $119
Total
penalty
= $254
(diff.
due to
rounding
)
--------------------------------------------------------------------------------
Source:  GAO analysis of IRS Publication 505. 

The revised instructions affect underpayments outstanding through
more than one ES payment period, and the difference involves the
period used to calculate the ES penalty.  The difference is
illustrated in tables IV.1 and IV.2 by the calculations used to
compute the ES penalty for the $2,000 underpayment.  In table IV.1,
the $2,000 underpayment is outstanding from April 15, the ES payment
due date, to July 30, when the underpayment balance was paid.  Under
the revised instructions, the underpayment is outstanding from April
15 to June 15, the next ES payment due date. 

Under the revised instructions, there is a $1,000 underpayment
balance outstanding on June 15 that is not paid until July 30.  This
$1,000 balance is accounted for by carrying it forward to the next ES
payment period, as shown in appendix III.  In figure III.2, the
underpayment for June 15 is $6,000, while the underpayment for the
same period in figure III.1 is $5,000.  As a result, the ES penalty
for the $1,000 balance is included in the ES penalty calculated for
the $6,000 underpayment, shown in table IV.2. 

The number of calculations necessary for the June 15 and September 15
underpayments are the same under both methods because the
underpayments are not outstanding through more than one ES payment
period.  However, calculation numbers 2 and 5 in table IV.2 could be
eliminated by expanding the ES special rule (see pp.  6-9). 


SUMMARY OF CHANGES IN THE INTEREST
RATE USED TO COMPUTE ES PENALTIES
FOR THE PERIOD 1987 THROUGH 1996
=========================================================== Appendix V

          Change in Interest Rate and New Interest Rate     Number of changes
          ----------------------------------------------  ----------------------
Year          Apr. 1      July 1      Oct. 1      Jan. 1   Increases   Decreases
--------  ----------  ----------  ----------  ----------  ----------  ----------
1987                                 +1(10%)     +1(11%)           2           0
1988         -1(10%)                 +1(11%)                       1           1
1989         +1(12%)                 -1(11%)                       1           1
1990                                                               0           0
1991         -1(10%)                              -1(9%)           0           2
1992          -1(8%)                  -1(7%)                       0           2
1993                                                               0           0
1994                      +1(8%)      +1(9%)                       2           0
1995         +1(10%)      -1(9%)                                   1           1
1996          -1(8%)      +1(9%)                                   1           1
================================================================================
Total              2           2           3           1           8
 increas
 es
Total              4           1           2           1                       8
 decreas
 es
Total              6           3           5           2          16
 changes
--------------------------------------------------------------------------------
Source:  GAO analysis of Form 2210s from 1987 through 1996. 


ANALYSIS OF HOW EXPANDING THE ES
SPECIAL RULE AFFECTED THE ES
PENALTIES COMPUTED FOR A RANDOM
SAMPLE OF 32 TAXPAYERS
========================================================== Appendix VI

In table VI.1, we compare the ES penalty amounts computed for 32
sampled taxpayers using the current Form 2210 and the penalties
computed using the expanded special rule.  In tables VI.2 and VI.3,
we compare the ES penalty schedule required on the current Form 2210
and on the revised Form 2210 for sample case number 13. 



                                    Table VI.1
                     
                         Comparison of ES Penalty Amounts
                     Computed for 32 Sampled Taxpayers Using
                      the Current Form 2210 and the Expanded
                                   Special Rule

                                                        Calculations required by
      Penalty calculations           Difference                 taxpayer
    ------------------------  ------------------------  ------------------------
Ca
se
nu                     Using                Percent of                     Using
mb                  expanded                 Form 2210                  expanded
er   Form 2210  special rule      Amount        amount   Form 2210  special rule
--  ----------  ------------  ----------  ------------  ----------  ------------
1       $8,573        $8,736        $163           1.9           6             3
2        5,098         5,188          90           1.8           6             3
3        6,801         6,886          85           1.3           8             4
4        1,779         1,816          37           2.1           2             1
5        1,668         1,695          27           1.6           3             2
6          770           791          21           2.7           6             3
7        1,207         1,225          18           1.5           5             3
8        1,447         1,462          15           1.1           6             4
9          822           835          13           1.6           3             2
10       1,270         1,282          12           0.1           8             4
11         765           772           7           0.1           6             4
12         233           237           4           1.8           2             1
13         251           254           3           1.4          11           4\a
14         100           102           2           2.3           9             4
15         168           170           2           1.1           5             3
16         188           189           1           0.7           6             4
17          49            50           1           1.6           3             2
18           3             3           0             0           2             1
19          61            61           0             0           4             4
20          45            45           0             0           5             3
21          11            11           0             0           4             2
22           2             2           0             0           1             1
23           1             1           0             0           1             1
24           2             2           0             0           1             1
25         757           757           0             0           1             1
26          19            19           0             0           2             1
27          44            44           0             0           2             2
28          82            82           0             0           1             1
29           3             3           0             0           2             1
30           3             3           0             0           2             1
31          43            43           0             0           6             4
32           1             1           0             0           3             3
--------------------------------------------------------------------------------
\a See tables VI.2 and VI.3 for a comparison of the ES penalty
calculations required on the current Form 2210 and the revised Form
2210 for this sampled case. 

Source:  GAO analysis of selected tax returns and GAO ES penalty
computations using the simplified underpayment schedule and revised
interest rate effective dates. 



                                    Table VI.2
                     
                       ES Penalty Calculations Required for
                     Sample Number 13 Using the Current Form
                                       2210

                                  (a)         (b)
                                  4/15/94     6/15/94     (c)         (d)
                    --------  --  ----------  ----------  ----------  ----------
April 16, 1994 -          30      Days:       Days:
June 30, 199430.                  61          15
Number of days                                15
FROM the date
shown above line
30 TO the date the
amount on line 28
was paid or 6/30/
94, whichever is
sooner.

31. Underpayment          31      $13         $5
Number of days                                $1
on line 28 X days
on line 30 X.07
365

                                  6/30/94     6/30/94     9/15/94

July 1, 1994 -            32      Days:       Days:       Days:
September 30,                                 77          15
1994                                          92\         15
32. Number of days
FROM the date
shown above line
30 TO the date the
amount on line 28
was paid or 6/30/
94, whichever is
sooner.

33. Underpayment          33                  $31         $5
Number of days                                $7          $5
on line 28 X days
on line 32 X.08
365

                                  9/30/94     9/30/94     9/30/94     1/15/95

October 1, 1994 -         34      Days:       Days:       Days:       Days:
April 15, 1995                                107         107         90
34. Number of days                                        197
FROM the date
shown above line
30 TO the date the
amount on line 28
was paid or 6/30/
94, whichever is
sooner.

35. Underpayment          35                  $9          $39         $65
Number of days                                            $71
on line 28 X days
on line 34 X.09
365

36. Penalty: Add                                          36          $251
all amounts on
lines 31, 33, and
35 in all columns.
Enter the total
here and on Form
1040, line 65;
Form 1040A, line
33; Form 1040NR,
line 66; or Form
1041, line 26
--------------------------------------------------------------------------------
Source:  GAO analysis of IRS Publication 505, Tax Withholding and
Estimated Tax. 

On the current Form 2210, 11 calculations (results in bold) were
necessary to compute the total ES penalty because the underpayments
in columns (b) and (c) were outstanding through January 15 and April
15, respectively, and interest rates changed twice during that
period. 



                                    Table VI.3
                     
                       ES Penalty Calculations Required for
                       Sample Number 13 on the Revised Form
                                       2210

                                  (a) 4/15/   (b) 6/15/   (c) 9/15/   (d) 1/15/
                                  94          94          94          95
                    --------  --  ----------  ----------  ----------  ----------
29. Number of days        29      Days:       Days:       Days:       Days:
FROM the date                     61          92          122         90
shown above line
29 TO the date the
amount on line 27
was paid or the
next ES payment
date.

30. Interest rate         30      .07         .08         .09         .09

31. Underpayment          31      $13         $44         $99         $98
Days on Interest
on line 27 X line
29 X Rate on 365
line 30

32. Penalty: Add                                          32          $254
all amounts on
lines 31 in all
columns. Enter the
total here and on
Form 1040, line
65; Form 1040A,
line 33; Form
1040NR, line 66;
or Form 1041, line
26
--------------------------------------------------------------------------------
On the revised Form 2210, only four calculations would be necessary
to compute the ES penalty because rather than tracking each
underpayment until it is paid, the ES penalty is calculated for the
underpayment at the end of each ES payment period.  Any remaining
underpayment balance is carried forward, and the ES penalty for the
accumulated balance would be calculated at the end of the next ES
payment period. 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================= Appendix VII

SAN FRANCISCO FIELD OFFICE

Ralph Block, Assistant Director
John Zugar, Senior Evaluator
Susan Mak, Evaluator
Gerhard Brostrom, Communications Analyst


*** End of document. ***