Inspector General Report: IRS Needs Service-Wide Strategy to Address Electronic Filing Challenges

(Parker Tax Publishing June 2022)

The Treasury Inspector General for Tax Administration (TIGTA) issued a final audit report recommending that the IRS (1) develop a Service-wide strategy to prioritize and incorporate all forms for e-filing; (2) develop processes and procedures to identify and address potentially noncompliant corporate filers; and (3) develop processes and procedures to ensure that penalties are consistently assessed against business filers that are noncompliant with e-filing requirements. The IRS only agreed with the first recommendation. TIGTA Report No. 2022-40-0036 (May 2022).

Background

The IRS continues to receive large volumes of paper-filed tax and information returns, resulting in significant costs to process each year. For example, in Fiscal Year 2020, the IRS expended more than $226 million to process the most frequently paper-filed tax returns. The cost per paper-filed return ranges from $3.04 to $15.21, whereas the cost to process the same tax return electronically ranges from less than $0.01 to $0.37.

As a result of the IRS's continued inability to process backlogs of paper-filed tax returns and management's decision to destroy an estimated 30 million paper-filed information return documents, the Treasury Inspector General for Tax Administration (TIGTA) initiated an audit (TIGTA Audit). That audit resulted in a report being issued in early May 2022 (TIGTA Report). In the report, titled "A Service-Wide Strategy Is Needed to Address Challenges Limiting Growth in Business Tax Return Electronic Filing," TIGTA noted that since reopening its Tax Processing Centers in June 2020 (after being closed because of Covid), the IRS continues to have a significant backlog of paper-filed individual and business tax returns that remain unprocessed.

With respect to the destruction of the 30 million paper-filed information returns, TIGTA noted that the IRS uses information returns to conduct post-processing compliance matches such as the IRS's Automated Underreporter Program to identify taxpayers not accurately reporting their income. The report did not state which information returns were destroyed so it's unknown if any Forms W-2 or Forms 1099 were among those destroyed. IRS management advised TIGTA that once the tax year concludes, the information returns, e.g., Forms 1099-MISC, Miscellaneous Information, can no longer be processed due to system limitations. This is because the system used to process these information returns is taken offline for programming updates in preparation for the next filing season.

TIGTA had previously reported that there were actions the IRS could take to reduce paper filings and/or convert paper tax returns into an electronic format. In addition, TIGTA reported that, while the electronic filing (e-filing) of business tax returns continued to increase, the e-filing rate still lags behind that of individual tax returns and repeated efforts to modernize paper tax return processing have been unsuccessful.

What TIGTA Found

The TIGTA Report noted that the IRS has taken a number of actions and developed initiatives in an effort to increase e-filing. Furthermore, legislative requirements have resulted and will continue to result in increases in e-filing. The backlogs of paper tax and information returns to be processed along with the inability to ship paper tax returns and/or retrieve paper tax returns from Federal Records Centers due to the pandemic demonstrated to TIGTA the need for the IRS to develop a Service-wide strategy to further increase e-filing. However, the IRS does not have a Service-wide strategy that identifies, prioritizes, and provides a timeline for the addition of tax forms for e-filing nor an accurate and comprehensive list of tax forms not available to e-file.

Since 2014, the overall percentage of business tax returns e-filed increased from 41 percent to 63 percent. Employment tax returns continue to provide the most significant opportunity for growth in business e-filing. According to the TIGTA Report, the IRS has yet to establish processes and procedures to identify and address corporate, employer, and Heavy Highway Vehicle Use Tax filers that do not comply with e-file mandates. TIGTA's analysis of tax return filings identified 15,108 filers that paper-filed 22,569 tax year 2018 returns that were required to be e-filed. TIGTA estimated that the processing of these returns cost the IRS $30,196 in comparison to the $3,405 to process the required e-filed tax returns.

TIGTA Recommendations

TIGTA recommended that the IRS take the following three actions:

(1) develop a Service-wide strategy to prioritize and incorporate all forms for e-filing;

(2) develop processes and procedures to identify and address potentially noncompliant corporate filers; and

(3) develop processes and procedures to ensure that penalties are consistently assessed against business filers that are noncompliant with e-filing requirements.

The IRS agreed with the first recommendation, but did not agree to the other two. IRS management stated that they did not need to develop processes and procedures to identify noncompliant corporate filers because all requirements needed to assess penalties are not known at the time of filing and the IRS also has systemic processes in place for e-filed partnership returns, which were found to be working as intended. Other types of business returns, the IRS said, have differing criteria for e-filing requirements and exceptions to the requirements, which prevent the implementation of a standard process for all business filers. TIGTA stated that the IRS management's justification for taking no action on two recommendations was insufficient. In view of the backlogs of paper tax returns, TIGTA said, the IRS should take additional steps in an effort to continue to reduce paper return filings.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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