A pilot project at the Internal Revenue Service to send out so-called “soft notices” to taxpayers whose tax returns appear to disagree with the information forms from their employers and banks could provide some benefits in terms of improved tax compliance.

However, questions about the cost and benefits of the pilot project remain, according to a new government report from the Treasury Inspector General for Tax Administration. The pilot project aims to improve taxpayer compliance by mailing informational materials to them when an income discrepancy is spotted in their tax returns.

The pilot project calls for the Automated Underreporter Program to send out notices designed to serve as educational tools to taxpayers whose returns show income discrepancies between the information they report to the IRS on their tax returns and related information that employers and financial institutions provide the IRS. Such “soft notices” do not require the taxpayer to pay more taxes, provide additional documentation, or even respond. The notices instead are designed to act as educational tools, as well as encourage self-correction by taxpayers, and improve voluntary tax compliance.

In tax year 2007, as a result of the pilot project, "over 6,000 taxpayers corrected their current-year tax returns, resulting in more than $1 million in revenue that would not have been collected otherwise," according to Richard Byrd Jr., the commissioner of the IRS's Wage and Investment Division.

TIGTA’s report found that the IRS did an adequate job of planning, implementing, and managing the initiative through its initial phase. However, auditors found that the IRS has not yet obtained sufficient information to evaluate the burden that the soft notices place on taxpayers. The IRS also has yet to commit to taking specific actions or establishing a specific date defining how or when it will ensure that all the costs of the program are quantified and used to determine its net benefit.

“I commend the IRS for using a creative alternative approach to address compliance issues in an effort to reduce the Tax Gap,” said TIGTA Inspector General J. Russell George in a statement. “Now it must follow through by developing appropriate cost-benefit measures so that the pilot program’s full impact can be evaluated.”

The TIGTA report recommended that IRS officials obtain a more complete picture of the time and costs taxpayers are spending on soft notices, and determine the net benefit of using soft notices in the AUR program as an alternative approach for addressing compliance issues.

IRS officials agreed with TIGTA’s recommendations and said they plan corrective actions. However, TIGTA said it remains concerned that that the IRS’s planned corrective actions do not address the conditions that gave rise to the recommendations.

TIGTA noted that if the pilot program is determined to be successful, the initiative could result in permanently using soft notices in the IRS Automated Underreporter Program to address a large number of taxpayers each year who would not ordinarily be contacted by the IRS due to resource constraints. Given this possibility, reliable cost-benefit information may help alleviate concerns that could be raised about why the IRS risks burdening taxpayers and incurring the costs of sending soft notices that result in little or no tax revenue or impact on taxpayer behavior.

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