Tax Administration: Many Taxpayers Rely on Tax Software and IRS Needs to Assess Associated Risks
Highlights
Individual taxpayers used commercial tax software to prepare over 39 million tax returns in 2007, making it critical to the tax administration system. The majority were then filed electronically, resulting in fewer errors and reduced processing costs compared to paper returns. GAO was asked to assess what is known about how pricing of tax software influences electronic filing, the extent to which the Internal Revenue Service (IRS) provides oversight of the software industry, and the risks to tax administration from using tax software. To do so, GAO analyzed software prices, met with IRS and software company officials, examined IRS policies, and reviewed what is known about the accuracy, security, and reliability of tax software.
IRS has little information about how the pricing of tax software affects taxpayers' willingness to file tax returns electronically. In 2009, the two largest tax software companies eliminated separate fees to file federal tax returns electronically when using software purchased from retail locations or downloaded from a Web site. As a result, IRS has an opportunity to study whether this and other changes are effective in increasing electronic filing. Additionally, IRS would benefit from being able to identify which software package the taxpayer used to better target research and efforts to increase software use and electronic filing. IRS provides some oversight of the tax software industry but does not fully monitor compliance with established security and privacy standards. Further, IRS has not developed a plan to monitor compliance with new standards, which are optional in 2009 but may be mandatory in 2010. Without appropriate monitoring, IRS has limited assurance that the standards are being implemented or complied with. IRS has not conducted an assessment to determine whether taxpayers' use of tax software poses any risks to tax administration. Risks include that IRS may be missing opportunities to systemically identify areas to improve software guidance and enhance information security. IRS officials said the likely benefits of an assessment would not warrant the costs but have not determined either the benefits or costs of such an assessment. Moreover, IRS has also said that it is in the agency's best interest to ensure that taxpayers can rely on commercial software to make electronic filing accurate, easy, and efficient. Further, if even small improvements in the accuracy of tax returns could be made by clarifying the guidance in tax software, the effect on revenue could be substantial. Without a risk assessment, IRS does not know whether its existing oversight of the tax software industry is sufficient or needs to be expanded.
Recommendations
Recommendations for Executive Action
| Agency Affected | Recommendation | Status |
|---|---|---|
| Internal Revenue Service | To help increase electronic filing and allow IRS to better target its efforts, the Commissioner of Internal Revenue should direct the appropriate officials to require tax software companies, as soon as practical, to include a software identification number that specifically identifies the software package used to prepare tax returns, which can be used in IRS research efforts. |
The Internal Revenue Service (IRS) updated its Publication 1167, General Rules and Specification for Substitute Forms and Schedule, on December 27, 2011. Many tax preparation software firms already printed an IRS issued 3-letter source code on paper returns that are generated by their individual tax software. However, beginning in January 2012, IRS will require all tax preparation software companies to include the 3-letter source code on the bottom left corner on page one of each paper form that is created by the software. In its publication, IRS explicitly stated that it instituted the requirements in response to GAO's recommendation.
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| Internal Revenue Service | To help increase electronic filing and allow IRS to better target its efforts, the Commissioner of Internal Revenue should direct the appropriate officials to ensure that, as part of the second phase of IRS's Advancing E-file Study, surveys ask taxpayers the effect of tax software pricing changes and the opportunity to file for free using online tax forms on IRS's Web site on their decision to either file or not file tax returns electronically. |
While the Internal Revenue Service agreed with this recommendation, officials stated it is challenging to isolate the specific factors that cause a taxpayer to eventually choose to electronically file (e-file). As part of the Advancing E-file Study Phase 2, which was made public in December 2010, IRS worked with the MITRE Corporation to survey taxpayers about their reasons for not electronically filing their tax returns. The survey found that cost was a barrier to e-filing mostly for those taxpayers who prepared their returns on a computer and mailed them to IRS (self v-coders). Evidence of this was captured, for example, by this verbatim response, "It costs about $16 to send my taxes electronically when I can mail it for $0.42. So why would I do it electronically?"
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| Internal Revenue Service | To help increase electronic filing and allow IRS to better target its efforts, the Commissioner of Internal Revenue should direct the appropriate officials to the extent possible, study the effect of the 2009 pricing changes and the opportunity to file for free using online tax forms on IRS's Web site on taxpayers' use of tax software and electronic filing rates. |
In December 2009, the Internal Revenue Service (IRS) studied the impact of cost on migration between filing methods in the "Impact of Eliminating Separate E-file Fee for Self-Prepared E-filed Returns for Tax Year 2008." While IRS did not draw any conclusions from this study, it did list a number of observations. From these observations we were able to conclude that there is a strong possibility that the about 5 million returns that were previously filed on paper and now e-filed could have e-filed due to the change in the software companies fee structure. The 2009 filing season saw 19 percent increase of people filing from their home computers, which may be related to the elimination of separate fees for electronic filing. There could have been some other circumstances that would have moved some of these returns to e-file even without the fee structure changes. Based on professional judgment and reviewing the electronic filing rates for the past several years, we can conclude that the pricing structure changes likely did have a positive effect on e-filing rates.
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| Internal Revenue Service | To help increase electronic filing and allow IRS to better target its efforts, the Commissioner of Internal Revenue should direct the appropriate officials to determine if tax software companies that are authorized to participate in online filing are adhering to advisory security and privacy standards for the 2009 filing season. |
IRS officials implemented a plan to monitor the voluntary standards for the 2009 filing season. Further, officials visited a sample of software developers sites and reviewed them for compliance with recommended security standards. IRS officials provided us a copy of the monitoring results and stated that they will continue monitoring the software developers in 2011 when they standards become mandatory.
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| Internal Revenue Service | To help increase electronic filing and allow IRS to better target its efforts, the Commissioner of Internal Revenue should direct the appropriate officials to develop and implement a plan for effectively monitoring compliance with recommended security and privacy standards for the 2010 filing season. |
In April 2014, IRS officials reviewed the feasibility of implementing the recommended privacy and security standards. In April 2016, IRS reported it established a working group to begin putting into place the security standards over a 3-year period. During the first year, the working group implemented 45 security and privacy controls, and it plans to implement a total of 139 controls over 3 years. In addition, IRS requires members to conduct annual self-assessments of the status of security control implementation. They are expected to provide the results to IRS around the first of each calendar year. In January 2017, working group members reported that they had implemented or were in the process of implementing nearly 90 percent of the year 1 controls. As a result of implementing these standards, IRS has a higher amount of assurance that taxpayers' information is being protected against fraud.
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| Internal Revenue Service | To help increase electronic filing and allow IRS to better target its efforts, the Commissioner of Internal Revenue should direct the appropriate officials to assess the extent to which the reliance on tax software creates significant risks to tax administration, particularly in the areas of tax return accuracy, the security and privacy of taxpayer information, and the reliability of electronic filing. |
IRS contracted with the MITRE Corporation to conduct a study of the risks to tax administration created by the reliance on tax software, particularly in the areas of tax return accuracy, the security and privacy of taxpayer information, and the reliability of electronic filing. The first phase of MITRE's work will focus on software developers and transmitters, and the second phase will focus on Electronic Return Originators (ERO), paid preparers, and taxpayers. As of May 2011, MITRE had completed the survey phase of the study and officials were analyzing the data. In January 2012, officials provided us the Phase I briefing prepared by MITRE. MITRE recently began the Phase II analysis, and officials expect a final briefing to be issued in May or June 2012.
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