TREASURY
INSPECTOR GENERAL FOR TAX ADMINISTRATION
Evaluation of the Characteristics of Unnecessarily Filed Individual Income Tax Returns
August 17, 2007
Reference Number: 2007-40-130
This report has cleared the Treasury Inspector General for Tax Administration disclosure review process and information determined to be restricted from public release has been redacted from this document.
Phone Number |
202-927-7037
Email Address | Bonnie.Heald@tigta.treas.gov
Web Site | http://www.tigta.gov
August 17, 2007
MEMORANDUM FOR COMMISSIONER, WAGE AND INVESTMENT DIVISION
FROM: Michael R. Phillips /s/ Michael R. Phillips
Deputy Inspector General for Audit
SUBJECT: Final Audit Report – Evaluation of the Characteristics of Unnecessarily Filed Individual Income Tax Returns (Audit # 200640037))
This report presents the results of our review to determine
the steps the Internal Revenue Service (IRS) has taken or plans to take to
reduce the number of unnecessary tax returns filed, including the means used to
notify and educate taxpayers that they may no longer be required to file tax
returns. This audit was included in our
2007 Annual Audit Plan.
Impact on the Taxpayer
Unless exempt, every individual with gross income that
equals or exceeds certain limits for a taxable year is required to file a
Federal income tax return. However, many
people who do not meet the filing requirements still file Federal income tax
returns, either to obtain a refund of taxes already paid or because they do not
understand the law. To reduce the cost
to taxpayers who file these tax returns, the IRS should direct them to free
electronic filing (e‑filing).
Synopsis
Our evaluation of a statistical sample of tax returns filed for Tax Years 2003 through 2005 showed more than 8 million individual income tax returns each year were filed unnecessarily. For the purposes of this report, an unnecessary tax return is defined as a return filed either to obtain a refund of taxes already paid or because the individual did not understand the tax law, even though the individual’s income did not meet the filing threshold. Collectively, taxpayers spent an average of $390 million and 75 million hours per year preparing and filing these unnecessary tax returns. The cost to taxpayers includes both time and money to prepare and file the tax returns (including fees paid to preparers). In turn, the IRS spent an average of $11 million to process the unnecessary tax returns filed each year.
Taxpayers may file unnecessary tax returns only to obtain a refund of taxes already paid or because they do not understand the tax law. Fifteen percent of the unnecessary tax returns filed did not generate a refund, while 85 percent of these returns were filed to obtain a full refund of withheld taxes. More than one-half of those filing to obtain a refund were under age 21, and 76 percent of those under age 21 indicated they could be claimed as dependents on other taxpayers’ returns. These taxpayers would have been exempt from tax withholding because they earned less income than the amount required to file a return and they could be claimed as dependents on other taxpayers’ return. More than 60 percent of the unnecessary tax returns were filed on paper.
Due to concerns about the potential negative consequences of advising taxpayers to claim exemption from withholding, we are making no related recommendations at this time. Nevertheless, the IRS could, at a minimum, reduce its burden if taxpayers moved from preparing and submitting their returns on paper to e-filing.
The IRS has a legally mandated goal to have 80 percent of Federal tax and information returns electronically filed (e-filed) by 2007.[1] It costs more to process a paper tax return than an e‑filed return. Fewer mistakes are made by both taxpayers and the IRS with e-filed tax returns, further reducing processing time and costs. Generally, all the taxpayers filing these unnecessary tax returns would qualify to use the IRS Free File Program, which is a free Federal tax preparation and e-filing program for eligible taxpayers. The Free File Program may offer the best opportunity to direct taxpayers from paper filing to e-filing. We previously recommended the IRS expand the marketing of the Free File Program by directing promotional materials to taxpayers who are eligible for the Free File Program but have filed their returns on paper.[2]
Response
We made no recommendations in this report. However, key IRS management officials reviewed it prior to issuance and agreed with the facts and conclusions presented.
Copies of
this report are also being sent to the IRS managers affected by the report
conclusions. Please contact me at (202)
622-6510 if you have questions or Michael E. McKenney, Assistant Inspector
General for Audit (Wage and Investment Income Programs), at (202) 622-5916.
Filing Unnecessary Tax
Returns Creates Burden for Taxpayers and the Internal Revenue Service
Appendices
Appendix
I – Detailed Objective, Scope, and Methodology
Appendix
II – Major Contributors to This Report
Appendix
III – Report Distribution List
Appendix
IV – 2007 Employee’s Withholding Allowance Certificate (Form W-4)
Abbreviations
|
e-file(d);e-filing |
Electronically file(d); electronic filing |
|
IRS |
Internal Revenue Service |
Unless exempt, every individual with income that equals or exceeds certain limits is required to file a Federal income tax return. However, many people file tax returns only to obtain a refund of taxes already paid or because they do not understand the tax law.
To determine whether
a Federal tax return must be filed for a particular tax year, a taxpayer must
consider three factors: filing status,
age at the end of the tax year, and amount of gross income.[3] Figure
1 shows the Tax Year 2006 filing requirements for most individuals.
Figure 1: Tax Year 2006 Filing Requirements for Most Individual Taxpayers
|
If the Taxpayer’s Filing Status Is
. . . |
And at the End of 2006, the
Taxpayer Was . . . |
Then File a Tax Return
if the Gross Income Was at Least . . . |
|
Single |
Under 65 |
$8,450 |
|
|
65 or Older |
$9,700 |
|
Married
Filing Jointly |
Under 65 |
$16,900 |
|
|
65 or Older |
$17,900 |
|
|
65 or Older |
$18,900 |
|
Married
Filing Separately |
Any Age |
$3,300 |
|
Head of
Household |
Under 65 |
$10,850 |
|
|
65 or Older |
$12,100 |
|
Qualifying
Widow(er) With Dependent Child |
Under 65 |
$13,600 |
|
|
65 or Older |
$14,600 |
Source: Your Federal Income Tax for Individuals, For
Use In Preparing 2006 Returns (Publication 17).
Depending on filing status and age, if a taxpayer’s gross
income is less than the standard deduction amount plus the personal exemption (these
sums are shown in the last column of Figure 1), he or she may not have to file
a Federal income tax return. The standard deduction amount depends on
filing status, whether the taxpayer is 65 or older or blind, and whether the
taxpayer’s personal exemption can be claimed by another taxpayer. The standard deduction is higher for
taxpayers who are 65 or older or blind.
If the standard deduction and the personal exemption exceed income, a taxpayer may not be required to file a tax return. For example, when filing a 2006 tax return, a single taxpayer has a standard deduction amount of $5,150 and a personal exemption of $3,300. As shown in Figure 1, the taxpayer may not need to file if his or her income is not above $8,450 ($5,150 plus $3,300).
However, taxpayers are required to file tax returns, even if they owe no tax, in the following instances:
· To report any special taxes (such as Alternative Minimum Tax, Household Employment Tax, or Social Security or Medicare tax on tips not reported to the employer).
· To report the receipt of Advance Earned Income Tax Credit. The Earned Income Tax Credit is a refundable Federal tax credit for low-income working individuals and families. The Advance Earned Income Tax Credit allows those taxpayers who expect to qualify for the Credit and have at least one qualifying child to receive part of the Credit in each paycheck during the year in which the taxpayer qualifies for the Credit.
· To report self-employment income of more than $400.
· To report wages of $108.28 or more from a church or qualified church-controlled organization that is exempt from employer Social Security and Medicare taxes.
· To report the sale of a principal residence.
If an individual
does not meet the filing status, age, and income criteria specified, he or she
does not need to file a tax return but may want to file to get withheld tax
back. The Internal Revenue Service (IRS)
states on IRS.gov (its public Internet web site) that many people will file a 2006
Federal income tax return although the income on the tax return is below the
filing requirement. IRS.gov provides
assistance to help taxpayers determine if they need to file or if they need to
stop or adjust their tax withholding, so they will not have to file an
unnecessary tax return in the future.
This review was performed at the Wage and Investment
Division Headquarters office in
Filing Unnecessary Tax Returns Creates Burden for Taxpayers and the Internal Revenue Service
Our evaluation of a statistical sample of tax returns filed for Tax Years 2003 through 2005 showed more than 8 million individual income tax returns each year were filed unnecessarily. For the purposes of this report, an unnecessary tax return is defined as a return filed either to obtain a refund of taxes already paid or because the individual did not understand the tax law, even though the individual’s income did not meet the filing requirement (or threshold). Figure 2 shows the projected number of unnecessary tax returns based on our statistical sample of 310 tax returns.[4]
Figure 2: Projected
Number of Unnecessary Tax Returns Filed
(Tax Years 2003-2005)
|
Tax |
Total |
Estimated Number of |
Percentage of |
|
2003 |
130,043,000 |
8,262,083 |
6.4% |
|
2004 |
130,583,000 |
8,278,095 |
6.3% |
|
2005 |
132,105,000 |
8,537,837 |
6.5% |
|
Total |
392,731,000 |
25,078,015 |
6.4% |
Source: IRS Data Books[5] and our
analysis of IRS Master File[6]
data.
Collectively, taxpayers spent an average of $390 million and 75 million hours per year preparing and filing these unnecessary tax returns, which consisted of the “Form 1040 series,” including U.S. Individual Income Tax Return (Form 1040), U.S. Individual Income Tax Return (Form 1040A), and Income Tax Return for Single and Joint Filers With No Dependents (Form 1040EZ). The cost to taxpayers includes both time and money to prepare and file the tax returns (including fees paid to preparers). Taxpayer monetary costs vary depending on the type of tax return filed and the method used to file the tax return. Taxpayer time includes all aspects of filing a tax return, including recordkeeping, learning the tax law, and preparing and submitting the tax return.
The IRS spent an average of $11 million to process the unnecessary tax returns each year. According to the IRS, in Fiscal Year 2004, it cost $2.65 to process a paper tax return and $0.29 to process an electronically filed (e‑filed) tax return; in Fiscal Year 2005, the costs were $2.87 and $.25, respectively.[7] The IRS costs are summarized as “Processing Costs” and exceed $33 million for the 3 years reviewed.
Figure 3 shows the costs of the unnecessary tax returns to both taxpayers and the IRS.
Figure 3: Costs of
Filing Unnecessary Tax Returns
(Tax Years 2003-2005)
|
Tax Year |
IRS |
Taxpayer |
Taxpayer |
|
2003 |
$11,044,231 |
76,459,456 |
$396,092,431 |
|
2004 |
$11,700,800 |
79,287,713 |
$379,813,944 |
|
2005 |
$11,025,745 |
70,055,447 |
$394,901,076 |
|
Total |
$33,770,776 |
225,802,616 |
$1,170,807,451 |
Source:
Our analysis of cost data provided by the Wage
and Investment Division Research and Customer Account Services
functions.
Our analyses of a statistical sample of 310 Tax Year 2003 through 2005 tax returns identified 289 (93 percent) unnecessary tax returns. Projected to the entire population of tax returns as shown in Figure 2, this represents about 6 percent, or 8 million, unnecessary tax returns filed each year.[8] Additionally, test results on a second statistical sample of 271 unnecessary filers for Tax Years 2003 through 2005 showed 258 (95 percent) of these taxpayers were considered repeaters (i.e., the taxpayers had filed more than 1 unnecessary tax return in the 3 years tested); 26 percent had filed unnecessary tax returns in all 3 years.
Of additional significance is the population of unnecessary tax returns exhibits common characteristics or trends the IRS could use to help market its electronic filing (e-filing) products, modify taxpayers’ filing behaviors, and reduce costs to both the IRS and taxpayers.
Fifteen percent of the tax returns that did not meet the income threshold for filing generated no refunds
Of the 289 unnecessary tax returns tested, 42 (15 percent) did not generate refunds, and 30 (71 percent) of these 42 returns were filed by taxpayers over age 64. Almost one-half of the 42 returns were prepared by paid preparers, and 76 percent were filed on paper. Figure 4 provides the characteristics of the 42 returns that did not generate refunds.
Figure 4:
Characteristics of Tax Returns That
Did Not Generate Refunds (Tax Years
2003-2005)
|
|
Number
of Returns |
|
|
|||
|
Characteristic |
2003 |
|||||