Internal Revenue Service:

Procedural Changes Could Enhance Tax Collections

GAO-07-26: Published: Nov 15, 2006. Publicly Released: Nov 15, 2006.

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GAO previously testified that federal contractors abused the tax system with little consequence. While performing those audits, GAO noted that the Internal Revenue Service (IRS) records sometimes contained inaccurate or outdated tax information that prevented IRS from taking appropriate collection actions against those contractors, including submitting their tax debt to the Federal Payment Levy Program (FPLP) for collection. As a result, GAO was asked to review IRS's coding of tax debt excluded from the FPLP to determine whether (1) IRS tax records contain inaccurate status or transaction codes that exclude tax debt from the FPLP, (2) IRS's monitoring could be strengthened to ensure the accuracy of its status and transaction codes, and (3) other opportunities exist to increase the amount of tax debt included in the FPLP.

IRS tax records had inaccurate information that resulted in it erroneously excluding cases from the FPLP and other tax collection actions. The FPLP is a cost-effective automated system used to collect unpaid taxes from certain federal payments. GAO estimates that as of September 30, 2005, over 500,000 tax records' equating to about $2.4 billion in tax debt--contained inaccurate codes that IRS systems used to exclude tax debts from the FPLP. Inaccuracies included tax debts coded as having active installment agreements even though the tax debtor had stopped making payments. IRS's monitoring of cases was insufficient to identify and correct the coding errors GAO identified. Additionally, IRS's monitoring of financial hardship cases is not sufficient to ensure their ongoing accuracy. IRS grants tax debtors experiencing financial difficulty a hardship designation that excludes them from the FPLP and other tax collection activities until their income increases. To measure this, IRS solely uses the income reported on the tax debtor's annual tax returns. However, IRS does not monitor those tax debtors to ensure they are filing and paying current taxes. For 31 financial hardship cases GAO examined, 24 had ceased to file tax returns. Although IRS has increased the amount of tax debt it submits to the FPLP, additional policy changes could further improve the program's effectiveness. Since 1992, IRS has almost tripled the maximum income it allows tax debtors in financial hardship to earn; raising it to $84,000 in 2004--almost double the national median income. As a result, whereas in 1992 no one earning above the median income was considered to be in financial hardship (and therefore excluded from the FPLP), in 2005 almost two-thirds of the tax debt in financial hardship was owed by individuals earning over the median income. Although a financial hardship designation may be appropriate in many situations, allowing relatively high-income tax debtors to avoid tax collection action, including the FPLP, calls into question the fair application of the tax system and may contribute to noncompliance. IRS policy also limits the amount of tax debt in the FPLP by excluding $5 billion in tax debt from the program while IRS is pursuing levies from other assets or income sources. Additionally, during notification IRS excludes individuals' tax debt from the FPLP about twice as long as legally necessary.

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

    Recommendations for Executive Action

    Recommendation: To increase the amount of tax debt eligible for, and to expedite the entry of tax debt into, the FPLP, the Commissioner of Internal Revenue should monitor the timely termination of defaulted installment agreements to help ensure tax debt is made available to the FPLP as soon as possible.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Implemented

    Comments: IRS database searches identified and flagged for additional tax collection actions over 15,000 cases as of December 2008 in which the tax debtor had not made a payment within the last 120 days.

    Recommendation: To increase the amount of tax debt eligible for, and to expedite the entry of tax debt into, the FPLP, the Commissioner of Internal Revenue should place tax debt in the notice phase into the FPLP as soon as legally possible.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Not Implemented

    Comments: IRS disagreed with this recommendation, stating that it would not be cost-effective since three-fourths of tax debtors pay their accounts in full during the notice phase.

    Recommendation: To increase the amount of tax debt eligible for, and to expedite the entry of tax debt into, the FPLP, the Commissioner of Internal Revenue should consider adding language to IRS's second communication in the notice process informing the tax debtor that IRS has the authority to collect the debt by levying the tax debtor's income and assets if the tax debt is not paid voluntarily.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Not Implemented

    Comments: IRS agreed to consider adding stronger language regarding possible enforcement activity to the notices sent out after the 1st Notice. However, as of October 2012, IRS had not added stronger language to the 2nd Notice.

    Recommendation: To increase the amount of tax debt eligible for, and to expedite the entry of tax debt into, the FPLP, the Commissioner of Internal Revenue should modify FPLP exclusion policy to allow tax debt in automated collection system subcategories R-5 and I-6 that is being considered for a levy on financial assets through paper levies to be concurrently included in the FPLP.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Not Implemented

    Comments: IRS disagreed with this recommendation, stating that it could result in duplicate levies, which would result in unanticipated hardship for the tax debtor. We are closing this recommendation because we acknowledge that there is some potential for duplicate levies that could potentially result in unanticipated hardship for the tax debtor were a duplicate levy to occur.

    Recommendation: To help ensure that IRS's financial hardship FPLP exclusions are appropriate, the Commissioner of Internal Revenue should reevaluate whether the dollar ranges for existing financial hardship income thresholds, especially those that exceed the national median income, are appropriate and reasonable.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Implemented

    Comments: IRS completed a research project in September 2008 entitled "Reactivation of Currently Not Collectible Hardship Cases" to determine what changes IRS should make in its financial hardship program. The project provided IRS updated data on its financial hardship designation that led IRS to retain its income thresholds and reactivation criteria, but it also led IRS to update the Financial Hardship Analysis section of the IRS Internal Revenue Manual in 2009 to modify the guidance on conducting financial hardship reviews. As such, IRS's actions met the intent of our recommendation.

    Recommendation: To help ensure that IRS's financial hardship FPLP exclusions are appropriate, the Commissioner of Internal Revenue should consider changing the financial hardship closing codes for tax debtors designated as being in financial hardship prior to the 2004 income threshold increases to a closing code that most closely corresponds to the originally designated income threshold--for example, tax debtors who were in a threshold of $50,000 prior to the change would be given a different subcode (closing code) so that the tax debtor's income ceiling stays as close to the original $50,000 ceiling as possible under the new income thresholds.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Implemented

    Comments: IRS completed a research project in September 2008 entitled "Reactivation of Currently Not Collectible Hardship Cases" to determine what changes IRS should make in its financial hardship program. The project provided IRS updated data on its financial hardship designation that led IRS to retain its income thresholds and reactivation criteria, but it also led IRS to update the Financial Hardship Analysis section of the IRS Internal Revenue Manual in 2009 to modify the guidance on conducting financial hardship reviews. As such, IRS's actions met the intent of our recommendation.

    Recommendation: To help ensure that IRS's financial hardship FPLP exclusions are appropriate, the Commissioner of Internal Revenue should establish a policy so that in implementing future financial hardship income threshold changes, tax debtors' financial hardship subcodes (closing codes) are changed to ones that maintain the tax debtor's income ceiling as close as possible to the ceiling prior to the change.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Not Implemented

    Comments: IRS stated that it agreed in concept with the recommendation and would consider it during any future changes in the financial hardship closing codes. IRS's May 2012 revision to its Internal Revenue Manual section that contains the hardship thresholds did not change the thresholds and closing codes; they remain the same as they were as of the date of our original report, and as of October 2012, they continue to remain the same.

    Recommendation: To help ensure that IRS's financial hardship FPLP exclusions are appropriate, the Commissioner of Internal Revenue should establish a policy to review tax debtors' financial condition periodically to verify the continued validity of the financial hardship designation.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Not Implemented

    Comments: IRS stated that it would consider implementing this recommendation during its evaluation of its Currently Not Collectible (CNC) reactivation process, but stated that the change would add approximately 200,000 additional cases into IRS's workload. IRS did not believe this change would improve the collection potential of hardship cases. IRS completed its evaluation of its CNC reactivation process in 2009, but as of June 2012, it had not changed the reactivation criteria in its Internal Revenue Manual. IRS continues to reactivate a case only when the taxpayer's tax return indicates an income that exceeds the threshold used to declare the case CNC due to financial hardship.

    Recommendation: To help ensure that IRS's financial hardship FPLP exclusions are appropriate, the Commissioner of Internal Revenue should evaluate the ongoing validity of the financial hardship designations whenever tax debtors fail to file their annual tax returns by comparing third-party income information to the tax debtors' designated financial hardship income threshold ceilings.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Implemented

    Comments: IRS agreed with this recommendation, stating that a team was exploring implementation strategies to use 3rd party information in the CNC reactivation process. IRS completed a research project in September 2008 entitled "Reactivation of Currently Not Collectible Hardship Cases" to determine what changes IRS should make in its financial hardship program. The project provided IRS updated data on its financial hardship designation that led IRS to retain its income thresholds and reactivation criteria, but it also led IRS to update the Financial Hardship Analysis section of the IRS Internal Revenue Manual in October 2009 to modify the guidance on conducting financial hardship reviews. IRS's actions met the intent of our recommendation.

    Recommendation: To help ensure that IRS's financial hardship FPLP exclusions are appropriate, the Commissioner of Internal Revenue should refer tax debtors with a financial hardship designation to IRS's withholding compliance program for special attention if those tax debtors do not pay their current income tax obligations.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Implemented

    Comments: IRS agreed with the recommendation and stated it would research the feasibility of expanding the withholding compliance program to include hardship cases. Based on IRS's research, the agency established a new 2010 requirement in the Internal Revenue Manual that tax debtors with financial hardship designations are to be referred to IRS's Withholding Compliance Program if they do not pay their current income tax obligation.

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