Tax Policy and Administration:

IRS's Use of Information on Taxpayers Claiming Many Allowances or Exemption From Federal Income Tax Withholding

GAO-04-79R: Published: Nov 6, 2003. Publicly Released: Nov 6, 2003.

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In September 2003, we responded to a request from Representative Elton Gallegly to provide information on the number of taxpayers who claimed more than 10 withholding allowances and taxpayers who claimed exemption from federal income tax withholding. The Internal Revenue Service (IRS) calls such claims questionable Form W-4s. However, in the course of performing our work, we became concerned about the reliability of the information that IRS maintains on these taxpayers and decided that we could not use it to answer Representative Gallegly's questions. The objectives of this letter are to summarize our findings about the reliability of the information IRS maintains on taxpayers who claimed more than 10 withholding allowances or exemption from federal tax withholding and to bring to the attention of the Commissioner, Internal Revenue, some resulting questions about the value of IRS continuing to collect the information.

We have two concerns about the information that IRS maintains on taxpayers who claimed more than 10 withholding allowances or exemption from federal tax withholding that precluded us from using it to respond to Representative Gallegly's questions. First, we are concerned about the completeness of the information because a significant number of employers may not send IRS the required forms. According to IRS's information, about 75 percent of the large employers with 1,000 or more employees in its Large and Medium-Size Business (LMSB) and Small Business/Self-Employed (SB/SE) divisions that filed employment tax returns in tax year 2001 did not send IRS any forms. Although the number of questionable Form W-4s IRS might receive from individual employers can vary, it seems unlikely that 75 percent of employers with 1,000 or more employees could have no employees who submitted questionable Form W-4s. Second, some of the information may not be current--it may not reflect the current withholding status of some taxpayers. If an employee who previously claimed more than 10 allowances or claimed exemption from federal income tax withholding submitted a new Form W-4 claiming 10 or fewer allowances or not claiming exemption from withholding, the database would continue to show the earlier information. There is no requirement for employers to submit Form W-4s other than those claiming 10 or more allowances or exemption. We could not quantify the significance of our concerns about the reliability of IRS's data; however, the uncertainty about how complete and current the data were precluded us from using them to respond to Representative Gallegly's questions. Considering what we learned about the reliability of the data, questions may be raised about the value and fairness of IRS's enforcement efforts that rely on the database. One question is whether it is worth devoting IRS's resources to maintaining a database of questionable reliability. According to information IRS provided us in July 2003, 32 full time equivalent staff was dedicated to the Questionable Form W-4 program. A related question is whether it is worth the burden borne by those taxpayers who send IRS forms. Another question is about the evenhandedness of IRS's use of the database as a compliance tool. Taxpayers whose employers are not submitting questionable Form W-4s are less likely to face compliance checks under the program than taxpayers whose employers do submit the forms.

Status Legend:

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  • Review Pending-GAO has not yet assessed implementation status.
  • Open-Actions to satisfy the intent of the recommendation have not been taken or are being planned, or actions that partially satisfy the intent of the recommendation have been taken.
  • Closed-implemented-Actions that satisfy the intent of the recommendation have been taken.
  • Closed-not implemented-While the intent of the recommendation has not been satisfied, time or circumstances have rendered the recommendation invalid.
    • Review Pending
    • Open
    • Closed - implemented
    • Closed - not implemented

    Recommendation for Executive Action

    Recommendation: The IRS should assess the value of IRS's Questionable Form W-4 program and determine whether the program should continue in its current form.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Implemented

    Comments: In November 2003, GAO recommended that the IRS assess the value of its Questionable Form W-4 program and determine whether the program should continue in its current form. The IRS implemented GAO's recommendation by establishing a withholding compliance task force to study the value of the Questionable Form W-4 program in its current form. The study concluded that employers file less than 10 percent of the questionable Form W-4s that should be filed and that the current Questionable Form W-4 program is not operating and cannot operate effectively without significant changes in employers' questionable Form W-4 compliance behavior. The IRS further acted on GAO's recommendation by subsequently changing the form of the program by not requiring employers to submit questionable Form W-4s. Instead of using the Form W-4, the IRS said that it will enhance its withholding compliance program by making more effective use of information reported on the Form W-2 wage statements to ensure that employees have enough federal income taxes withheld from their income. The IRS' new regulations to implement the Questionable Form W-4 program changes went into effect in April 2005.

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