The Internal Revenue Service should reexamine the "tolerance levels" it uses to request missing tax forms and schedules from taxpayers, the Treasury Department's inspector general recommended in a new report.

The Treasury Inspector General for Tax Administration noted that the IRS determines and adjusts its tolerance levels for various tax forms and schedules in order to increase taxpayer compliance, reduce processing costs, and use limited resources effectively.

However, the IRS does not maintain documentation detailing the methodology used to determine the tolerance levels and could not provide any evidence to show that it monitors the effectiveness of the tolerance levels it has established. TIGTA warned that the IRS might be needlessly expending limited resources and incurring unnecessary costs, perhaps resulting in loss of revenue and inequitable treatment of taxpayers.

For many of the credits, deductions, payments and taxes due claimed by taxpayers, the IRS requires taxpayers to provide substantiation by attaching certain forms and schedules to their tax returns. But the IRS does not have the resources to address every identified case of potential taxpayer compliance and must apply its limited resources to areas in which noncompliance is greatest, while still maintaining adequate coverage in other areas. Therefore, the IRS sets tolerance levels to control the volume of cases requiring follow-up actions by IRS employees so that all selected cases can be handled.

Tolerance levels are considered and changed, if warranted, annually by the IRS. However, the IRS was unable to provide documentation to support any reviews or analysis performed during this process.

Based on TIGTA's analysis, the IRS does not always take into account the overall level of taxpayer compliance with the requirements to provide additional forms and schedules or the associated cost/benefit when setting the tolerance levels for issuing correspondence to taxpayers requesting missing forms and schedules.

In addition, the IRS does not maintain data showing the results of its correspondence with taxpayers for these forms and schedules. As a result, the IRS is using limited resources and incurring additional costs by requesting missing forms and schedules from some otherwise-compliant taxpayers while allowing unsubstantiated deductions of far-less compliant taxpayers. The IRS is also burdening some taxpayers with demands for substantiation to support insignificant entries on their tax returns, while allowing other more significant entries with no substantiation.

TIGTA recommended that the IRS evaluate its tolerance levels to ensure that they are meeting established goals, document the methodology used to establish and revise tolerance levels, and adjust the tolerance levels based upon the cost/benefit and degree of taxpayer compliance with the requirement to attach supporting documentation.

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