The Internal Revenue Service’s Modernized e-File system is facing “significant challenges” processing individual tax returns, according to a new government report.

The report, by the Treasury Inspector General for Tax Administration, found that the MeF system erroneously rejected a large number of tax returns. The system has been processing business tax returns since February 2004. In February of this year, the system was expanded to begin accepting transmissions of the Form 1040 and 22 related individual forms and schedules, replacing the existing electronic filing system.

However, while the IRS anticipated processing 9.3 million tax returns through its MeF system as of April 15, 2010, the IRS received only a fraction of that amount: 752,320 tax returns, or about 8.1 percent. Due to the low volume of tax returns received through the MeF system, the IRS was not able to assess its capability to handle large volumes of tax returns.

“The IRS is counting on the Modernized e-File system to become the dominant system for processing tax returns; however, our report found that, so far, it is not performing up to expected levels," said TIGTA Inspector General J. Russell George in a statement.

The migration of individual tax returns to the MeF system is a joint venture among the IRS, the tax return preparation industry and the states. The IRS established a number of tools to share information and assist its stakeholders during the development and implementation of MeF Release 6.1.

Of the 29 MeF system business rules that TIGTA reviewed, 19 (66 percent) appeared to either reject tax returns in error or reject tax returns without providing accurate explanation as to why the tax returns were rejected.  For example, some tax returns were erroneously rejected for couples when the Making Work Pay Credit was claimed and one spouse had an Individual Taxpayer Identification Number.

TIGTA recommended that the IRS establish processes to monitor the transmitting and processing of individual tax returns through the MeF system on a timely basis; work with the tax return preparation industry and the states to identify and address issues that prevented them from using the system; and encourage its use during the 2011 filing season.

The IRS agreed with TIGTA’s recommendations. “The challenges and types of processing errors identified in your report were the kind of issues we anticipated,” wrote IRS deputy inspector general for audit Michael R. Phillips.

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