THE IMPACT OF COMPUTERS ON FEDERAL INCOME TAXATION Thesis for the Degree of Ph. D. MICHIGAN STATE UNIVERSITY PAUL STEPHEN SPECE 1969 Mm swarm-'1' g: “but , . “d A; I If it": 2 . {I l‘J‘iiCIIEgm .' tc University II I III IIIIIIIII I III I III III III I This is to certify that the thesis entitled THE IMPACT OF COMPUTERS ON FEDERAL INCOME TAXAT ION presented by Paul Stephen Spece has been accepted towards fulfillment of the requirements for Ph. D. degree in Business Administration f /¢ Date £7. 0P], / 74 7 0-169 iv JIM & SBIIS' ‘ [III LIBRARY muons u "C'Ac. "a". "n‘. ' ‘1‘ ‘nu‘b- ‘~.~‘ n or. . "‘04. T ‘~'bb. cl- I ABSTRACT THE IMPACT OF COMPUTERS ON FEDERAL INCOME TAXATION BY Paul Stephen Spece The problem examined in this dissertation involves an investigation of the influence of computers on Federal income taxation from the viewpoint of the tax accountant so that he. will be equipped with timely knowledge of the latest techno- logical developments in his field. No major works have been written on this subject but substantial literature is avail- able in the form of short articles and news stories. It is the thesis of this study that the application of computers to Federal income taxes represents a revolutionary change that is causing repercussions in most all areas of Federal income tax activity. The primary objectives of this study are (l) to draw together some of the scattered descrip- tions and evaluations of the application of computers to Federal income tax activity; (2) to identify the major areas affected and analyze the repercussions induced therein; (3) to reach some conclusions about the deve10ping directions of the major emerging changes; and (4) to contribute to our un- derstanding of the impact of computers on Federal income taxes. The study is limited to the Federal income tax; no attempt is made to consider state or local taxes in detail or the highly technical aspects of computers. - o A I I no. I .,.--.,.,. .. '1 v.” u Hung”, . 'Vv-lu 1.. ,, ~V‘ "Aux. .‘ -..' 5'. ‘“‘ in. ..' a I ~ ~. “g. d- o. - " an “".v1 o *1. O 74“ 0‘ ‘ , . -.~\ u ‘ I ‘i.‘ I 9 Dr. ‘ t - \~‘ .0, u'. Paul Stephen Spece This study is especially significant because it affects aU.taXpayers and their relationship not only with the Federal government but also with their professional advisers-~lawyers, accountants, and other tax practitioners. Information was gathered and integrated from personal interviews, the various sources in the published literature, and the Annual Reports of the Commissioner of Internal Revenue and of the Secretary of the Treasury. The major areas of activity affected by computers are UJ tax collecting, (2) tax research, and (3) tax returns prep- arathnn The computer system of the Internal Revenue Service fin collecting income taxes is described, then evaluated, and found to be complex and vast but successful in handling the steadily increasing workload. Despite many problems, it is (aerating efficiently in the short-run but needs to be up- dated to achieve growth and continued efficiency in the long- nnh Present IRS plans call for installation of a completely mnvfourth generation computer system in the early 1970's. For the tax administrator, tax collecting has been greatly centralized, both the administrative control function auw.the efficiency of Operations have significantly improved. Under computerized Operations, public confidence in the tax laws and in the integrity of the IRS has resulted in increased vohnuary compliance and diminished tax evasion. The computer— ized tax system of the United States has become a model that representatives of other nations come to see and then try to imitate. Computers have increased the Opportunity for error Paul Stephen Spece cutthe part of both the Government and the taxpayers and this tms increased Government—taXpayer contacts through computer- generated notices. The application of computers to processing of tax data an:the National Computer Center and the Detroit Data Center rms enhanced tax research. It has induced many changes and technical improvements in the old programs and has created new programs, the major ones of which concern TaXpayer Com- ;fliance.Measurement, Taxpayer Assistance, Master File of Tax Exempt Organizations and Pension Trust Funds, Statistics of inmmme and Computerized Tax Models, Discriminant Function Audit Criteria, and Federal—State Cooperation. Major implications resulting from the study are: (l) eventual Government audits "through" rather than "around" the computer as the audit trail disappears into the computer; (2) wflflt"discriminant function" selection of returns for audit, the Government may employ the CPA of the taxpayer business :hwclved to do the auditing for the Government; (3) the pos- sflflJity exists that one combined tax return might be develOped anm.used for Federal, state, and local levels with the Federal levelcxfllecting and processing returns and then reimbursing lower levels; (4) direct payment at banks by individuals of fluur taxes due; and (5) tax bills issued by the Federal govern- ment to replace returns filed by taXpayers as computers provide this capability. Paul Stephen Spece Taxpayers have become more concerned about their tax re- sponsibilities as computerized review and examination of returns has become sharper and more comprehensive. All United States taxpayers are now identified and listed in the Master File at the National Computer Center with a tax account that contains enough personal data to constitute a tax dossier. TaXpayer re- liance on professional tax services for help has thus increased. Professional tax services have become inundated with many clients. To obtain relief from the increased workload, private tax practitioners have been seeking help, increasingly, from the computerized tax return preparation services. A new service-type industry has been emerging-~the computerized tax returns preparation industry. Computax is the leader among the field of eight firms all of which expect to grow rapidly in the future. The computer—printed tax return has the following effects: (1) it takes the drudgery out of the tax practitioner's tax season; (2) it enhances the prestige of the tax practitioner; (3) the computerized efficiency of the various services matches that of the Internal Revenue Service and constitutes a defense for the taXpayer against the growing efficiency of the Government computers; (4) it helps the Government to reduce errors and audits. The implications of computer-printed tax returns are: (1) tax forms replacement by computerized tape; (2) the standard- ization of state tax return forms; and (3) direct dealings with the public by service firms thus eliminating the need for the tax practitioner middleman. THE IMPACT OF COMPUTERS ON FEDERAL INCOME TAXATION BY Paul Stephen Spece A THESIS Submitted to Michigan State University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY Department of Accounting and Financial Administration 1969 : Copyright by PAUL STEPHEN SPECE 1970 '7’! 5.58 A h --. a ‘ w 'Ii' 'o . A... '3‘. I ‘Ia- - on». h... H... n._~ v.. , I A In; I 11' . ~‘. '1 . '0. ¥. \‘- u ACKNOWLEDGMENTS Many obligations have been incurred during the preparation of this dissertation. I wish to acknowledge my sincere gratitude to Professor Charles J. Gaa who pro- posed the tOpic, supervised the study, and made many helpful suggestions to improve the technical aSpects and clarity of style. I am also grateful for the valuable assistance and encouragement of the other members of my dissertation com- mittee: Professor James Don Edwards and Professor Milton Taylor. For the help and encouragement over crucial periods in the doctoral program, I owe a deep debt of gratitude eSpecially to Professors James Don Edwards, Charles J. Gaa, George C. Mead, and Milton B. Dickerson. I wish to acknowledge others who have provided valuable technical assistance and relevant data as follows: Mr. A. Wayne Lowry, Office of Assistant Commissioner for Data Processing, Internal Revenue Service, Pension Building, Washington, D. C.; Mr. Frank H. Burke, Assistant Director, Central Service Center, Internal Revenue Service, Covington, Kentucky (Cincinnati, Ohio); Professor John C. Lyons, Co- Director, Computers-in-Law Institute, The George Washington University; Messrs. Daniel R. Mason, Sidney Feldman, and iii Kenneth Krapohl of the Computax Corporation; and Messrs. George W. Kinnard and Maitland K. Flood of Autotax, Tax Computer Associates, Inc. iv TABLE OF CONTENTS LI ST OF TABLES O O O O O O O O O O O O O O O O O 0 LIST OF FIGURES O O O O O O O O O O O I O O O O O 0 Chapter I 0 INTRODUCTION 0 O O O O O O O O 0 O O I O O 0 II. Purpose Of This Study . . . . . . . . . . Influence of the Computer on Society . . . Application of Computers to Federal Income Taxes . . . . . . . . . . . . Statement of Need for Study . . . . . . . Statement of the Problem and Objectives . Limitations of the Study . . . . . . . . Literature Written on the Subject of Automation in Federal Income Taxation . . Description of PrOposed Study Project . . THE APPLICATION OF COMPUTERS IN THE TAX- COLLECTING ACTIVITY OF THE INTERNAL REVENUE SERVICE (IRS) . . . . . . . . . . . . . . . TaXpayer Self-Assessment Tax System . . . Need for Computers to Assist Tax Administrators . . . . . . . . . . . . . Organization of the IRS and Its Computer system C O O O C O O I O O O O O O O O O 0 Mission of the IRS . . . . . . . . . . National Office and Decentralized Field Offices . . . . . . . . . . . . . . . . Office of the Assistant Commissioner for Data Processing . . . . . . . . . . . Internal Revenue Service Programming . The National Computer Center (NCC) The Master File Concept . . . . . Consolidated Tax Accounts . . . TaXpayer Account Numbers . . . . Information Returns . . . . . . The IRS Data Center at Detroit . Page ix 14 15 16 18 19 20 22 23 27 36 38 39 42 51 53 57 60 62 67 72 Chapter Page The Regions of the IRS . . . . . . . . . . . 73 The Service Centers . . . . . . . . . . . . 77 Flow of Tax Returns through Centers . . . 78 District Offices . . . . . . . . . . . . 90 Computer Equipment Being Used by the IRS . . 92 IBM System/360 in the IRS Network of Computers . . . . . . . . . . . . . . . . 95 IBM 7074/Systems . . . . . . . . . . . . 97 Honeywell H-200 Systems . . . . . . . . . 98 Microfilm Printers . . . . . . . . . . 100 Expectations of the Automated Federal Tax System . . . . . . . . . . . . . . . . . . . 101 III. THE EFFECTS OF THE APPLICATION OF COMPUTERS IN THE TAX-COLLECTING ACTIVITY OF THE INTERNAL REVENUE SERVICE . . . . . . . . . . . 104 Results of Operations by Fiscal Years . . . 104 1962 Results . . . . . . . . . . . . . . . 104 1963 Results . . . . . . . . . . . . . . . 106 1964 Results . . . . . . . . . . . . . . . 108 1965 Results . . . . . . . . . . . . . . . 110 1966 Results . . . . . . . . . . . . . . . 115 1967 Results . . . . . . . . . . . . . . . 123 1968 Results . .* . . . . . . . . . . . 130 . . . . . 142 Evaluation of the System Results of Operations: Improvements 1n the Form of Efficiency Factors that have Contributed Toward Success . . . . . . . . 143 Man-Years Saved Through Automation Operating Costs and Volume Factors Other Factors Results of Operations: Difficulties Impeding the Operations Of the System . . 156 Taxpayer Errors IRS Problems with the System Are Functional Requirements for Infor- mation Being Met? . . . . . . . . . . 169 Are the Original Objectives of the System and the Mission of the IRS Being Met? . . . . . . . . . . . . . . . . 171 Limitations of the System . . . . 173 What Does the Future Hold for the IRS ADP SYstem? . . . . . . . . . . . . . . . . . . 175 IV} THE APPLICATION OF COMPUTERS TO TAX RESEARCH . 182 orientation 0 o o o o o o o c o c o o o o o 1 8 2 Taxpayer Compliance Measurement Program (TCMP) O O I o o o o o o o o o o o o o o o o 183 vi Chapter V. VI. Page Discriminant Function Selection by Computer of Returns for IRS Audit . . . . . . . . . . 188 Computerized Research in the Legal and Technical Areas . . . . . . . . . . . . . . 200 Reports and Information Retrieval Activity (RIRA) . . . . . . . . . . . . . 204 Tax Exempt Organizations and Pension Trust Fund Master File . . . . . . . . . . 213 Statistics of Income and Computerized Tax Models . . . . . . . . . . . . . . . . 220 Programs of Federal-State COOperation in Exchange of Tax Information . . . . . . 228 THE APPLICATION OF COMPUTERS TO THE PREP- ARATION OF TAX RETURNS . . . . . . . . . . . . 232 Orientation . . . . . . . . . . . . . . . . 232 The Firms: Computer Processed Income Tax Return Services in General . . . . . . . . . 238 Services Presently Offered . . . . . . . . 238 Definition of a Computer—Processing Tax Return Service . . . . . . . . . . . . . . 242 Input of Tax Data: Forms . . . . . . . . 243 Processing of Tax Data: Operations . . . 245 Programming Computer-Prepared Tax Returns . . . . . . . . . . . . . . . . . 249 Output: Printed Tax Returns . . . . . . . 251 Price Structure . . . . . . . . . . . . . 252 Difficulties That Retard Progress . . . . . 259 Major "Bugs" in the Systems Impeding Growth . . . . . . . . . . . . . . . . . . 260 Major Industry-Wid Problems Affecting A11 Firms . . . . . . . . . . . . . . . . 266 Development of the Industry and Opinion of the Services by Users . . . . . . . . . . . 278 1965 Tax Season . . . . . . . . . . . . . 278 1966 Tax Season . . . . . . . . . . . . . 279 1967 Tax Season . . . . . . . . . . . . . 281 1968 Tax Season . . . . . . . . . . . . . 285 1969 Tax Season . . . . . . . . . . . . . 286 Effects of Computer Applications to Tax Returns . . . . . . . . . . . . . . . . . . 291 SUMMARY, CONCLUSIONS AND IMPLICATIONS . . . . 295 Summary . . . . . . . . 295 Conclusions an Implications . . . . . . . . 295 Regarding Tax Collecting and Tax Research . . . . . . . . . . . . . . . . . 298 vii Chapter Regarding Computerized Preparation . . . . . APPENDIX A: THE COMPUTERIZED TAX AVAILABLE O O C O O C C C O O O O Computax . Autotax . Fast-Tax . Datatax . Unitax . . Systems and Ta es (S T) Computer Tax Service . . Programmed Tax Systems . Digitax . . . . . . . . APPENDIX B: GLOSSARY . . . . . . Tax Returns RETURN SERVICES BIBLIOGRAPHY OF LITERATURE CONSULTED viii Page 304 307 307 322 331 336 340 346 347 367 370 374 378 LIST OF TABLES 24” Summary of growth of IRS Operations for fiscal years 1930 through 1968 . . . . . . . 30 2-2. Number of information returns filed with Internal Revenue Service for fiscal years 1959 through 1968 . . . . . . . . . . . . . 69 2-3. 1967-68 regional returns and dollars collected - Internal Revenue Service . . . . 74 2-4. Internal Revenue Service computer equipment . 93 3-1. Costs and related information - covering the period of automation . . . . . . . . . . . . 145 3-2. Internal Revenue Service: report on Opera- tions,highlights 1958 to 1967 . . . . . . . 149 5'1. Selected types of tax returns filed with the Internal Revenue Service in 1965 through 1968 O O O I O O O O O O O O O O O O 234 5'2. Services provided by computer-processed tax return firms in the 1968 Tax Season . . 239 5-3. Comparative Operating criteria of computer- processed tax return services . . . . . . . 244 5‘4- Price structure--Computerized tax return preparation services in 1967 and 1968 . . . 255 ix LIST OF FIGURES Figure Page 2-1. Internal Revenue Service Organization . . . . 40 2-2. Map of Internal Revenue Service Regions and Districts . . . . . . . . . . . . . . . 41 2-3. Organization of Office of Assistant Commis- sioner for Data Processing - IRS . . . . . 44 2-4. Internal Revenue Service ADP phase-in SChedule O O O O O O O O O O O O O O O O O 49 2-5. Organization of the Office of Regional Commissioner . . . . . . . . . . . . . . . 76 ldk Organization of Office of Director at Service Center, Central Region, Covington, Kentucky . . . . . . . . . . . . 79 2-7. Work Flow of Central Service Center at Covington, Kentucky . . . . . . . . . . . . 81 2-8. Organization of the Office of District DireCtor O O O O O O O O O O O O O I O O O 91 5'1. .Automated Federal Tax System—-Interna1 Revenue . . . . . . . . . . . . . . . . . . 295 CHAPTER I INTRODUCTION Purpose of This Study The purpose of this study is to inquire into the causes and effects of the shift from manual to machine methods in Federal income taxation. It especially seeks to investigate the effects of computers on Federal income taxes from the point of View of the tax accountant in order that he will be equipped with timely knowledge of the latest technological develOpments in his field. Influence of the Computer on Society Society has witnessed one of the most significant Periods ever achieved by man for technological develOpment and innovation during the two decades following the end of Thuld War II in 1945. The electronic computer, since its inception in 1945,1 has sparkled brightly among the newest ‘ 1The Army became interested in computers in 1943 mxtawarded a development contract to the Moore School of EnSlneering at the University of Pennsylvania. In 1945 I’I'Ofessors Mauchly and Eckert completed the first all elec- tnxuc digital sequential computer which they called ENIAC (Electrical-Numerical Integrator and Computer). Eckert and thuchley resigned in 1946 from the University of Pennsylvania, 1 and most versatile tools to evolve during this period. It is having one of the greatest impacts on society of any contemporary development because of its unlimited potential to increase man's capacity to handle information. The computer has been inducing revolutionary changes in the fields of business, science, education, and government.2 Its influence has been so divergent in each one of these broad areas that leaders in these fields are only beginning to assess the possible results. The computer revolution, it has been predicted, will prove to be more important than the industrial revolution.3 Contemporary society has assimilated the computer without hesitation and is being reshaped by it. The electronic computer, just past its twenty-first birthday, has come of age, progressing from scientific curiosity to essential part of human life in a remarkably cnganized their own company which was purchased in 1950 by Femington-Rand, now Sperry Rand Corporation. At this firm they produced UNIVAC (Universal Automatic Computer), which became generally recognized as the first of our present line of computers. The early computers developed up to EWIVAC‘were used for scientific and engineering purposes. The first business oriented computer was delivered in 1951 to the United States Bureau of Census. It was called EWIVAC I. It operated 24 hours a day, 7 days a week, for 12'1/2 years, until 1963, when the Bureau of Census pre- sented it to the Smithsonian Institution, Washington, D. C. 2See the following for applications in each one of these fields: F. Robert Crawford, Introduct1on to Data m (Englewood Cliffs: PrentIce-Hall Incorporated, 68 . p. 5. 3"Tomorrow's Management," Fortune. LXXIV: NO- 1 (July 1. 1966), pp. 2, 88. short time. No single technological development in history has had a greater impact on man and on the way he lives. In many respects, computers have erased time, altered the ordinary boundaries and relationships that affect our lives and our organization, and accel- erated the rate of change . . .4 The computer has become a familiar part of modern man's daily life. .A computer is almost certain to be involved each time contemporary man, for example, receives a pay- check, purchases goods on credit with a bankard, makes a telephone call, pays an electric bill, deposits or withdraws nmney from the bank, subscribes to a book or record club, invests in corporate stock, makes an airline reservation, buys gasoline on credit or purchases insurance, registers at a university, watches astronauts launched in space- guobing satellites or election returns on television, answers a census taker, or files his Federal income tax return. A noted scientist-educator contends that the com- PUter is already having a profound impact on the operation Of our society and will herald a new form Of society. He says, "Technological develOpments always eliminate some kind of limitation that previously existed in what society 5 mnfld.do, what the individual could do." Then he cites as ¥ . 4"The Information Explosion: The Computer in $xnety," The General Electric Forum, X, No. 4 (Winter, 1967-68) I p. 3. 5Robert M. Fano, "The World At Our Fingertips?" The QEEHal Electric Forum, X, No. 4 (Winter, 1967-53): P- 5° [”3 Fano is Ford Professor of Engineering at Massachusetts InStitute of Technology. examples telephones and various forms of transportation as eliminating distances; the printing press as providing opportunity for mass transfer of information and exchange cm'ideas. The invention of the wheel and electric power eliminated man's need to do certain kinds of physical work. The operation of society changes and achieves a new equi- librium when previously existing limitations are erased. Computers are beginning to make a similar impact on society for two related reasons: first, because they deal with information——the glue that holds society together--and secondly, because they are beginning to allow us to deal more successfully with complexity. My feeling is that the structural complexity of today's society, and the multitude of interactions that take place within it, are really straining the ability of each of us to comprehend and deal successfully with the variety of problems that confront us in our daily lives-~as individuals, as members of working organiza- tions, as citizens. I see the computer as the essential tool that can provide the intellectual assistance needed to make each of us more capable of dealing with these growing complexities of life. Computers are aiding society today in many ways. Ikminess organizations, financial institutions, labor or- mnuzations, scientific and professional organizations, sduxfls and universities, and government agencies are all benefiting from computer systems, and many have their own installations. Some observers feel that one reason for anagrowth of the economy of the United States in the past seven years has been due to the use of computers in Ibid. inventory control by individual businesses.7 The printing press provided the Opportunity for mass transfer of infor- mation and ideas and the ability to accumulate data into a static inventory of books and papers. The more SOphisticated electronic computer permits massive quantities of informa- tion to be gathered, transferred, stored, retrieved, and then manipulated at will. The computer has made information mobile. The computer has enhanced the utility value of information by making it operational and fluid. The com- puter has shifted data from a static, remote concept into a moving, readily accessible concept. The computer is an efficient information processing device, an intellectual tool that helps modern man to think more logically, to make more valid decisions, to success- fully solve his problems of life and work. It enables contemporary man to undertake much more complex tasks than his predecessors. Just as the wheel and electric power have taken the drudgery out of man's physical work, the computer is taking the drudgery out of man's mental tasks. The computer is a creative force for human enrichment which makes society more productive and life more satisfying. 7J. Sanford Smith, "Man and Computer: The New Partnership," The General Electric Forum, X, No. 4 (Winter, 1967-68) , p. 8. Mr. Smith is Vfce—Presfdent and Group Executive, Information Systems, General Electric Company. Greatest benefits of the computer to society are expected to come from placing the computer at the direct service of the individual himself. The individual must use the computer as a knowledgeable and skillful assistant to make him adept in his particular activities. The com— puter*will, in such a manner, give the individual more freedom of choice by providing more data and a better means Of information processing. Conformity in society due to lack of information will give way to diversity which is nude possible by more data through the computer. Fano says, ". . . in an information-rich society, the individual will have much more freedom of choice because society will be able to stand much more diversity among its members without the results being chaotic."8 The limitation of the necessity to conform is erased by substantially improved nethods Of information processing and information flow. A closer look at the computer and computer technol- cpy is in order. The elements of a computer system include aicomputer and several related machines called peripheral anupment. The system sometimes is called a computer con- figuration. The computer is the center of the system. Basic components of the computer are the memory, control, and arithmetic unit. The memory is the storage place for the data and results. The control unit consists of the 8Fano. "The World At Our Fingertips," p.5. q. '1 to ‘r “.- . ‘t o '- 'V- . circuitry which controls the Operations. The arithmetic unit is where all calculations take place. The basic com- puter functions can be summarized as memory, control, and calculation. The peripheral equipment includes the input devices and the output devices. Common input devices are card reader, paper tape reader, typewriter, character 7 reader, magnetic tape unit. Common output devices are card punch, paper tape punch, typewriter, magnetic tape unit, and printer. All peripheral devices operate at much lower speeds than the internal speed of the computer itself. Computer technology can be divided into two parts, hardware and software. Hardware refers to the machines and software refers primarily but not exclusively to the pro- gramming. Software, in the broadest terms, refers to the method of controlling the components of the system's hard— ware to produce results. In this sense, software includes not only the computer program but also feasibility studies, training materials such as films and manuals, studies of equipment requirements, and everything about the system other than the hardware and the personnel. Great progress has been achieved in computer hardware technology. Devel— opment of computer software technology has lagged behind that of hardware. The computer can do only what it is told to do. The program tells the computer what to do. It is fitting, therefore, to consider the program next. A computer program can be defined as an exact se- quence of instructions that the computer follows to solve a problem. Linguistic compounds of the word "program" have become familiar, such as the verbal form "programming" and the noun "programmer." Programming for automatic digital computers has developed into an important and well-paying occupation in the computer field. It is a highly technical phase of the computer occupation. On this point, the editor of the journal, Computers and Automation, said, A good deal of knowledge, common sense, and training is needed to program well for it requires: 1. Understanding the operations of a business or the steps of a scientific calculation; 2. Understanding the best ways for having a computer carry out these operations and steps; 3. Arriving at a good sequence of commands for the computer to solve the problem; and 4. Adequately translating these commands into computer language. In fact, programming has proved a bottleneck in many applications of computers, and so a good deal of effort among computer manufacturers has gone into methods of automatic programming . . . The methods of automatic programming have taken three main forms: (1) compilers, (2) interpreters, and (3) common languages. The construction of “compiling pro- grams" or compilers involves the use of the computer to take subprograms, which are portions of a main program, mnzof a library of machine programs and connect them 9Edmund C. Berkeley, The Computer Revolution Khrden City, New Jersey: Doubleday and Company, 1962), p. 18. together in such a way as to solve a new problem. The construction Of automatic programs designed as "interpre- ters" involves the acceptance of instructions in particular standard words and then the translation of these words into nachine language so that the computer can understand what the words mean. Common languages have been developed for automatic programming of problems which when expressed in such languages, are solved by the computer. The two most mddely used problem languages are FORTRAN and COBOL. Most computers manufactured in the United States have FORTRAN and COBOL capability. FORTRAN is an acronym fOr FORmula TRANslation system. It is the leading scien- tific-mathematic language. COBOL is an acronym for 99mmon Business Oriented Language. It was develOped in 1959 by a committee composed of computer manufacturers, government agencies, user organizations and universities. COBOL was designed to be a tool of the business data processing com- nmnity. In 1960, the Department of Defense, the world's largest single user of computers, announced it would not lease nor purchase computers without COBOL capability. The Federal Government has thus given a great deal of impetus to the swing toward COBOL. Most of the large manufacturers CE computers rushed to fulfill this requirement as the (kwernment is their biggest customer. Programming Language 1-(PL/l) was developed in the middle of the 1960's by IBM and a committee of users for the IBM System/360 family of 10 computers. It can be used for solving all types of business and scientific problems and is being promoted as a universal language. There is the possibility that PL/l could replace both FORTRAN and COBOL and for this reason it is being watched closely. Other computer languages developed by IBM for its System 360 are Autocoder, Assembler Language, and Report Program Generator (RPG) . Stages in the development of computer hardware ‘ F technology are referred to as generations. Computer tech- nology of the first generation featured vacuum tubes. The first electronic computers of the 1940's were, therefore, large and bulky and very costly; they required considerable power and produced heat in quantities that created air conditioning problems. To overcome these limitations re- searchers produced the second generation of computers, which were characterized by transistors instead of vacuum tubes. Transistors were much smaller, lower in cost, re- quired less power, produced less heat, and had greater reliability. The third generation is characterized as one which miniaturized and refined the components of the second generation. This miniaturization and refinement became known as Solid Logic Technology, sometimes called Solid State. Also characteristic of this generation is the in- creased software or programming sophistication. We are presently in the latter stages of this third generation. Researchers are busy seeking to introduce the fourth 11 generation. They are busy working to develop an improved, mmre versatile computer which will calculate faster, store larger volumes of information, consume less power, occupy less space, and cost fewer dollars. Computers, in the future, are expected to be made available to the public on an individual basis and will be programmed to act as helpful assistants. The most feasible way for personal use of computers to be implemented is expected to be achieved through "time sharing." This is the technique which distributes the use of a large central computer over several users or subscribers. Each subscriber operates from a remote teletypewriter terminal. Computer time—sharing service is at present being Offered on a com- umrcial basis by some pioneer companies. Research and development work on more powerful and more sophisticated systems is being conducted currently. Networks of time- sharing computer systems, interconnected, and capable of communicating not only with each other but with remote mtmcribers anywhere in the system can be expected in the rear future. These systems will have a huge memory capable ct'storing data from.individuals or groups of subscribers. Telephone systems are interconnected into national and international networks. Electric power systems are linked together into vast networks that go beyond national borders. likewise, computers, on a timeesharing basis, will be linked ngether into national and international systems, perhaps a 12 universal network. Such a system called Multics is cur- rently being researched and developed by the Massachusetts Institute of Technology in collaboration with the General Electric Company and Bell Telephone Laboratories.10 A universal network of computer time—sharing systems can lead to important changes and new things. Some of these new possibilities are (l) the "checkless method of payment" or the "checkless society," (2) the computerized Federal income tax declaration or the Government's billing taxpayers fOr taxes due instead of taxpayers preparing their returns, (3) educational opportunities vested in self-monitoring of students when they use computers, (4) information utilities, and (5) data banks. The electronic computer, like other major technolog- ical improvements and innovations, is going to reshape society as it revamps the patterns of modern man's private, business, and public lives. Ray Eppert, former President cm Burroughs Corporation, made the judgment that, "The electronic computer has a more beneficial potential for the human race than any other invention in history“; an increas- ingrnmber of people with special competence in computer . , . 11 curcles are com1ng to the same conclu31on. “From the loRobert M. Fano, "The World At Our Fingertips,“ p.6, llGilbert Burck and Editors of Fortune, The Computer 533 (New York: Harper & Row, Publishers, 1965) , p. l. 13 point of view of the general management of a business, however, we are still probably only on the threshold of really significant use.“12 There has been swift technological progress and intense competition in the computer industry. In the past 10 or 15 years, computer speeds have increased by a factor of 1,000 to 1. Costs of compu— tation have gone way down, on the order of 400 to 1. Memory capacity is up 1,000 to 1.13 The first electronic computer began Operating in 1946.14 TWenty years later in 1966, approximately 35,000 computers were in use on a world-wide basis, with 28,000 installations located in the United States.15 Few technologies have experienced such swift prog- ress. As a measure of the present commitment to elec— tronic information systems-—there are now over 40,000 such systems installed on a world-wide basis with an if-sold value of almost $20 billion. Those numbers are expected to more than double by 1975.16 12Hershner Cross, "A General Management View of Ythe application of computers in the realm of the tax- mfllection activity of the Internal Revenue Service. 18 Second, the effects of these tax-collection changes will be noted. Third, tax research methods and procedures will be considered. Fourth, the effects Of these tax research changes will follow. Fifth, a consideration of the changes induced by the application of computers to the preparation of tax returns by practitioners for their taxpaying clients will be in order. Sixth, the effects of these changes regarding tax returns preparation will be noted. Seventh, some general conclusions will emerge about the repercussions amitme developing directions of the changes caused by com- puters applied to Federal income taxation. This study is especially significant because it affects all taxpayers and their professional advisers-- accountants and lawyers. It is imperative that all three groups realize fully the revolutionary changes that are taking place for the repercussions will necessitate perma- rent modifications not only in their work but also in the instruments used at work. Limitations of the Study This study is limited to a consideration of the Federal income tax only. There is no intention to consider state or local income taxes in detail. Nor is any attempt nude to get into the highly technical aspects of computers. In. 19 Literature Written on the Subject of Automation in Federal Income Taxation A canvass of the literature reveals that no major works have been written on this subject. Some articles have been written on particular phases of the Operational, technical, and professional aspects of the computerization cfi'taxes. Most of what has been written is authored pri- marily by officials of the Government, who are primarily with the Internal Revenue Service, and some accountants and attorneys, in the professional journals and proceedings of tax institutes and conferences. News notes, short accounts, and some articles about computerized tax returns have appeared in the Journal of Accountancy, The National Public Accountant, Business Week, [mtamation, and The Wall Street Journal. Empirical accounts cm'some of the results and effects obtained in regions where the computers were first installed and Operated, like the pilot region in Georgia, have been recently reported in the United States News and World Report and The Wall Street JOurnal. These two journals also carried reports of tax- payer errors and law violations disclosed as the computers became fully Operational nationally. They also indicated some Of the problems the IRS has been having with the computerized system. Because taxes are a topic of popular interest to aLlincome recipients and because the Government wants to 20 nmke widely known its use of computers to check more effi- ciently on taxpayers, stories of the "new machines and tax returns" appear in many popular magazines, journals, news- papers and business advisories. Description of Proposed StudyiProject The purpose of the study and an introduction and orientation into the proposed study is taken up in this chapter. Description and analysis of the IRS's new computer system to identify the main elements of change in the tax— collecting activity of gathering and processing returns represents the first phase of this study project and is the subject of Chapter II. Identification and analysis of the effects of these changes, along with an evaluation of the computerized system, is the second phase of this study and is covered in Chapter III. Chapter IV provides a descrip- tion and analysis of the application of computers to tax research and information coordination, the third phase of the study. The information is to be obtained largely from Internal Revenue Service personnel through integration of mnflished interviews, short articles and speeches of gov- ernment officials, and from news accounts in the public Euints. Reliable information is also to be obtained from the Official government documents such as the Annual Reports :.l I I! b. '8 ‘I 21 of the Commissioner of Internal Revenue and the Annual Reports of the Secretary of the Treasury. Identification, description, and analysis of the changes induced by the application of computers to the preparation of Federal income tax returns by the computer- ized tax return preparation services represent the fourth phase of this study. Analysis and implications of these changes is the fifth phase. The information is to be ob— tained largely through interviews with practitioners and the computer services; also from an integration of published accounts, interviews, and speeches by practitioners and officials of the computerized services. This is the scope of Chapter V. Integration and synthesis into summary, conclusions and implications regarding this technological change from annual to machine methods in Federal income taxation is the sixth phase and Chapter VI of this study project. CHAPTER II THE APPLICATION OF COMPUTERS IN THE TAX-COLLECTING ACTIVITY OF THE INTERNAL REVENUE SERVICE (IRS) The automated methods under the computer system1 in the Internal Revenue Service are a welcome change from the manual methods for handling the almost impossible task of processing mountains of paper. The Internal Revenue Service has completed its second full year of computerized opera- tions. This computer installation has been heralded as the greatest change in a century of tax collection,2 and has been characterized as the most complicated application of its type in the world.3 Five years were required to lFor early details at the inception of the new sys— tem's installation, see: "Conference on Automatic Data Processing and Its Use by IRS," The Tax Executive, XIV, No. 2 (January, 1962), pp. 115—73. This conference was arranged kw'the then Commissioner, Mortimer M. Caplin, in order to acquaint interested persons with the plans of the IRS to umdernize its processing facilities; See also: "Uncle Sam's Electronic Tax Collector," Forbes, XCV, No. 4 (February, 1965), pp. 38—40. 2Lillian Doris (ed.), "Greatest Change in a Century cm Tax Collection--Automatic Data Processing (ADP)," in her jQggarican Way in Taxation: Internal Revenue, 1862-1963 Gmglewood Cliffs: Prentice-Hall, Incorporated, 1963T, pp. 74—82. 3Robert L. Jack, "ADP—-An Analysis of Its Operations and Results," 1966 Proceedings of New York University Twenty- j gflguth Annual Institute on FederaITTaxatIOn, p. 99. 22 23 phase-in the system, which became fully operational on a national basis in the year 1967. In this chapter an examination is made of the phil- osophy of the tax system of the United States, the need to have computers assist tax administrators, the organization and Operation of the IRS and its computer system, the com— puter equipment being used by the IRS, and expectations of the computer system. Taxpayer Self—Assessment Tax System The system of taxation in the United States is called a self—assessment system because each taxpayer has the responsibility to determine his tax liability and pay the amount due to the Government. Under such a self- assessment system, the taxpayer is responsible for becoming acquainted with those sections of tax laws, rules and reg— ulations necessary for him to prOperly fulfill his tax (fluigations. The IRS maintains a continuing program of taXpayer service to help the individual to understand his rights and responsibilities. In order to maximize effec- tiveness of this service to taxpayers, the Government pub- lishes regulations, rulings, and tax guides covering specific tax situations. It releases information through ness -¢.y.m -.o~.- nun.-..vu.-u nu. !.- a 30 .mscm>mm HmcuoucH mo HmcoflmmflEEoo mo manomom Hmocqm «wohflom Hmmw Hmomwh A3OHmm G30£m mummw Mo on «can OH Ham» HOHHm m0 H hdshv a c o s o 0 V mmmo-HQE HQ 0 m.ome.a e.aao.a H.eme.e o.eam.e m omm.a a see a a emm a He maneumm mo Hensez m c o o Hmuoa OD ~.mm H.mm e.Hm e.om muem m.mm w.wm Imqmwu movemeo eamae .e .. n m m "Ampcmmsonuv mmohonEm mmH .5 ooam we. m me. e we. w mm. m oe. m mm. a ma.am ma Hm meauomeaoo mo umoo .o . . AmumHaoe eoaaaasv m.aam H.5oe a.eme e.eam e.mem e.om~ e am e em mumoo meaumumao .m . . Ameoeaaesv scan a.eo~ m.maa m.eaa m.eme e.ome m.~ma e and m MNH umaeeoe emumsaumm .e . . AmeOaHHasv emeem e.eoa e.moa a.eoe m.~oe e.em m.am N as a m maneuom Hence .m Amumaaoe eoaeaani e.aa m.a m.e H.o m.m ~.~ no. a. ummemucH meaeeao ucH .mpcowmm mmonw .m mHm 0 GOA H m.mma e.mea m.m~e e.eae m.am o.am m.m o.m weoawwwwaoo.wwqmw .H meme home some meme owes emma oema omma .wme stOWGu ommH mummh Hmvmfim HON mGOHumhmmo WMH m0 £U30Hm m0 hhmEEdmll.HIN GHQMB I-‘~ a... .— iv»: v... Q’A “5 NA. h». '."!- - ..‘ n. N I. .P- MN“ 11:. N‘: .7. ‘s ‘1 31 and accounting for revenue during the past thirty-seven years has multiplied about 3.2 times as rapidly as the number of workers available to handle it. Meanwhile, the ratio representing the cost of collecting $100 of revenue declined from $1.13 to $.45. This is a drop of $.68. In other words, the gross collection of revenue multiplied about 2-1/2 times as rapidly as the operating costs of collecting it. The savings of $.68 per $100 of revenue collected is efficiency in its clearest form and is a tes- timonial to the economy and effectiveness of the IRS admin- istrators. Automation has made this increased efficiency of operations possible. Automation has made possible the handling of an increased workload at a decreasing cost. Pfill this progress be continued up to 1980 in which year it has been estimated 137 million tax returns will be filed?12 The 1960 figures on Table 2—1 appear to be out of line but they are not. Compared with 1950 figures, the 1960 cost of collecting $100 dropped from $.59 to $.40 due to the fact that gross collections went up 135% while op- euating costs went up only 58%. However, from 1960 to 1967, cmsts increased faster than the collections, causing the cmllection cost to go up from $.40 to $.45. During the 12Sheldon S. Cohen, "The Information Explosion: 'NueComputer in Society—-Government Services," The General Eflectric Forum; A Journal of Leadership Opinion, x, No.'4 (Winter, 1967-6'81, po 21. In. .lq in .14‘ ‘v on 44‘“ w... fit;- 5.. u‘. ‘5'; v.& -.A I.i 32 1950's the IRS began to use mechanical automation; elec- tronic automation came in after 1961. Also during the 1950's the IRS was able to centralize its returns processing into three service centers; just one center with a master file came in after 1961. Also, the number of IRS employees in 1960 was 5-1/2 thousand less than in 1950. Returns filed in 1960 increased over that of 1950 while the number of employees decreased. This opposite relationship in these two factors caused the high ratio of 1880.5 number of re- turns per employee for item eight on Table 2-1. The de- creased number of employees in 1960 was due to political, technical, and cyclical factors. The Republicans tradi- tionally cut government payrolls and 1960 represents the end of a Republican reign. Benefits of mechanical automa- tion in the 1950's were permitting payroll reductions. Also the economic situation in the form of cyclical reces- sions in 1958 and 1960 encouraged austerity in the govern- ment payrolls. The long-run trends show the workload of tax returns and refunds to be processed has steadily in- creased. With automation the long-range trend shows total operating costs have also gone up but less rapidly than the increase in workload. Also automation, phased-in over a five—year period, was completed in 1967. With the full benefits of complete automation in 1967 and thereafter, short-run fluctuations in costs and employment should sta- bilize and cause a tapering off of the long run trends for RA— 5"“ c.“ birv .n~ .- he! ion ‘I. . i Y. “.4 cl» u... ‘- b \ 33 the two ratios being discussed and analyzed here. The long- run trends show the directions of the general activity and are important. Short—run fluctuations reflect any one or a combination of political, cyclical, seasonal or abrupt technical changes. These fluctuations are less important than the long-run trends. The above analysis, it should be pointed out, ex— cludes from consideration the various types of information returns and other source documents handled. From 1959 to 1967, figures in the Annual Report of the Commissioner show that the volume of information returns has grown from about 300 million to nearly 350 million. In order to manage this progressively increasing vuukload and to process the mountains of paper accurately and economically, the IRS has followed two basic approaches in recent years. First, it concentrated on increasing the efficiency of work performance and, secondly, it sought to 13 While many procedural eliminate low priority operations. improvements have helped, only the substitution of machines fin:pe0ple has given promise of complete relief from the cnmerwise overwhelming workload problem. Automation in the cmficeS'was the logical solution to the problem of how to huuease the efficiency of work performance in the Internal Revenue Service. l3Sheldon S. Cohen, 1965 Annual Report, p. 14. v-c .A‘ buy 2. .l.. “I Ii‘n On I5. ‘Ic ‘v.. 4“ I. . a.‘ Q \‘Vv "‘ ‘ my. "‘.. Q 34 Punched card equipment in the largest district offices constituted the first authentic step toward mechan— ization for the IRS in the year 1948. Since large-scale operations are necessary in order to maximize the utiliza- tion of labor-saving machinery, the IRS began to centralize its returns processing Operations into three area Service Centers. The first Service Center was established on a test basis in 1955 at Kansas City, Missouri. A second one followed in 1956 in Lawrence, Massachusetts and a third in Ogden, Utah in 1957. By 1961, these three area Service Centers were responsible for processing the bulk of the Nation's 61.3 million individual income tax returns, the sorting and handling of over 330 million information re— turns, and the addressing and mailing Of about 140 carloads of tax return forms. Punch card equipment was installed gradually in the largest District Offices during the period beginning in 1948 and lasting through 1955. Centralization of equipment took place from 1955 to 1961. Then the equipment was up- dated. Punch card machinery was gradually replaced by contemporary high-speed computers which utilized magnetic tape. However, mechanical automation alone was insufficient to solve the long—run problem of efficiently processing the ever growing massive mountains of paper. It became evident that a whole new electronic system, with new concepts, would be required to meet the needs of the IRS "' ‘w—h .. 31c L-o \q. . 7.4. . .A- U». A! .\.e n,‘ 'v.. F. is v.. c_~ ‘9. o,' I u 11:.) ., (‘1) (I) 35 administrators who wished to utilize fully the latest com- puter technology in order to cope with the paper explosion. A feasibility study was instituted regarding a whole new electronic system. This study develOped into the ADP Plan, which has been characterized as a natural, but dramatic, step forward in tax administration. The new ADP Plan was dramatic in that it featured novel concepts in tax administration such as (l) a master file centralized in one location, (2) a taxpayer identifying number system, (3) consolidated tax accounts, and (4) increased centralization cm processing of tax returns, information returns, and refunds. Previous efforts to perfect a master file in the 1950's, when the IRS had first mechanized its Operations, resulted in failure because technological limitations of available equipment prohibited.consolidation of all infor- nmtion regarding taxpayers. Since then, effective planning and efficient organization on the part of the IRS, as well as vastly improved computer technology, have permitted the raster file concept to become an operational reality. Increased centralization resulting from the utili- zation of computers was confined to the returns processing mafivity. Other important IRS functions like taxpayer assistance, collection, and audit were continued on a local tmsis, decentralized to the fifty—eight District Offices. Iknmjor advantage of the use of computers for centralized ‘1 .7. up In. 'Vo ‘n ,- e._ n 1.,” 2,, U 3" 36 returns processing is that it frees the people in many of the District Offices from routine paper handling so that they can devote full time to these other important functions and duties. Important organizational changes in the National Office were made to recognize the growing contribution computers were making to the objectives of the IRS. The former Collection Division was divided into two new divi- sions effective January 1, 1961. The new ADP Division was delegated the responsibility for implementation of the ADP Plan and the installation of the new computerized system along with the management of the closely related returns processing, revenue accounting, and service center Opera- tions. The new Collection Division retained responsibility fOr enforcement activities.14 Organization of the IRS and Its Computer System The administrative organization of the IRS is designed in three layers, and the electronic data process- ing organization follows this same three-layered pattern.15 L l4Mortimer M. Caplin, 1961 Annual Report of Commis- §ipner of Internal Revenue, Internal Revenue Service, De- partment of the Treasury, Publication Number 55 (Washington: Government Printing Office, 1961), p. 64. Mr. Caplin was Commissioner from February 7, 1961 to July 10, 1964. 15Lancelot W. Armstrong, "The Development and Opera- tion of the Internal Revenue Service Network," The Com uter: flxfl.for Management (Business Equipment Manufacturers Assoc- iation, Elmhurst, Illinois: The Business Press, 1968), p. 67. Dan Armstrong is Director, Systems DevelOpment Division, IRS: Wash. , D.C. ’9. '. on .u v. ‘- u -2 . v« ‘v- u.‘ ‘u ‘1 . c.» 37 National, regional, and district Offices constitute the three layers in the administrative organization. The Na- tional Computer Center at Martinsburg and the National Data Center at Detroit, the seven regional service centers, and the fifty-eight district Offices constitute the three layers of the computer network. In order to understand the present IRS ADP system as a whole, it is imperative that the component parts of the entire system are viewed in proper perspective and related to the whole in a meaningful fashion. This calls for a clear understanding of the role of the IRS, its or- ganization and main functions, both at the National Office level in Washington, D. C. and at the decentralized field organization level of regions and districts because super- imposed upon this vast network is a complex computer system. The Office of Assistant Commissioner for Data Processing in the National Office has been charged with the organizational responsibility for the design, installation, and the Opera- tion of the computer system and is the focal point of this technical configuration as it directs the decentralized service centers. Behind the Operation of this vast and cxmplicated system is a new tax administration concept, the 16 concept of the computerized master file of all taxpayer h 16Robert L. Jack, "ADP-—An Analysis of Its Opera- tfions and Result," 1966 Proceedingsof New York Universit Twenty-Fourth Annual—Institute on Federalmm Duh Jack‘is Assistant Commissioner for Data Processing in the National Office of the IRS. -v V; -.I- III . ... 'v. 0“ ‘A. l u D'- 1. “I .e 4. '\ 38 entities, an understanding of which makes the system easier to comprehend. Mussion of the IRS The clear and simple mission of the Internal Revenue Service, as stated in all recent issues of the Annual Re- ports Of the Commissioner, is to achieve the highest pos— sible degree of voluntary compliance on the part Of taxpayers with the tax laws and regulations, and to achieve as well as maintain the highest degree of public confidence in the integrity and efficiency of the Internal Revenue Service. Included with the concept of efficiency would be the col- lection of the most revenue due the Government at the least cost. The mission also includes communicating the require- ments of the law to the public, determining the extent of compliance and the causes of noncompliance, and doing that vmich is required to prOperly enforce the law. IRS career officials in the National Office point cum.two important events that have helped achieve this Hussion. Pay-as-you-go, instituted in the early days of the Roosevelt Era, was the first significant event that mnfimibuted greatly to the achievement of this objective. Automatic data processing of returns, achieved on a nation- vdde basis by the IRS in 1967, has been the second big event tolfacilitate greatly the achievement of this mission. What influences this second event has been having on the mission CE the IRS is a major part of the objective of this study. u. :1- p. u. n.‘ "1 ‘1 u ’0 t... a \ ‘ 39 First, it is necessary to understand the vast organization and intricate functions of the IRS, how responsibility for the computerized Operations is distributed, and what equip- ment is being used. National Office and Decentralized Field Offices The IRS is organized as an integral part of the Treasury Department and.is headed by the Commissioner of Internal Revenue, who serves under the direction of the Secretary of the Treasury. The Commissioner of Internal Revenue presides Over the administration of the two main component parts of the Service: (1) the National Office in Washington, D. C. and (2) the field organization. Fig- ures 2-1 and 2-2 depict these two component parts. The National Office is charged with the responsi- bility for the development of broad nationwide policies and programs for the administration Of the tax laws and manage- ment of the activities, Operations, and endeavors Of the Service. The organizational components which comprise the bhtional Headquarters are (l) the Office of the Commissioner, vmich includes a Deputy Commissioner, The Assistant to The Commissioner, and the Foreign.Tax:Assistance Staff; (2) the CEfice of the Chief Counsel and (3) six Assistant Commis- sioner‘Offices, one each for the major functions of Inspec- tion, Administration, Compliance, Data Processing, Planning and Research, and Technical. This study will be concerned 501‘! .“ “run. . \ W... \ 40 Figure 2-1.’ Internal Revenue Service Organization U.S. TREA SURY DEPARTMENT :I GENERAL COUNSEL INTERNAL REVENUE SERVICE —I_ F g: COMM'SS'ONER —--- ---- - - - CH'E chNSEL Deputy Commissioner 0'9"" cm" Counsel —L‘ I I I l l Astrrto'cm‘oi Comm I I‘. I” ASSISTANT ASSISTANT ASSISTANT ASSISTANT ASSISTANT ASSISTANT i- COMMISSIONER COMMISSIONER COMMISSIONER COMMISSIONER COMMISSIONER COMMISSIONER mwsrous (“MO") (Administration) (Compliance) (Data Processing) i Planning and (Technical) “$.13: 1mm Research) I- [nimmont * Gononl hunt-on I Mund Llll'lhOfl 7 In Court DIVISIONS 7 DIVISION: DIVISIONS DIVISIONS owISIONs DIVISIONS 'w M ' I‘ ‘ ono cmon lflnm noon. on IW Sci." “In“. ”6:33.004"! M Intzrmoh'fll ' ”:22! t ‘ LIscellorioous ":“m' :u‘m"... ODOIIIIOM H - fluent: :rilgvligafllu "tunnel " Snlom Stamina lechmcai Publru '"nuth' Dwmon Mac Colloctoon 5 Iron: and Illfmllion lnIollIgmu “limiooment Semen Fromm. oni'rcll.orciiltronoi Owarcom LogISIotIon and Ruuiotlons Damon K Our-tion; and Pllnmng FOREIGN TAX NAIIONAL IRS Dm °"‘”°“ ASSISTANCE STAFF COMPUTER CENTER Clnier l Li: REGIONAL INS PECTORS -- --- REGIONAL COMMISSIONERS - -- - - - REGIONAL COUNSELS a. a) (n m DIVISIOKS ASSISTANT REGIONAL DIV S 0N5 ,w M" cOMMISSIONCRS . “C.;”: m mm.“ DIVISIONS 1’03““ 50‘0"" “Mihlflnbm In Alcohol and [Mammal TODIouI Tu Gonom Appoint. LItIuIIon Audit Tu Cum COIIICIIM Dot- Procmmg Ifltflli‘me District Directors ' sumo: CENTERS (58) R , ‘ (7) DIVISIONS | °"'"'°"‘ i Mninntntum ' ' ' Autumn; Audit and Mlmtmi Collection Minimum- , A IMOIIIIOM' Dob my“ a... —soho Imu um! duvet IIno wumm authority. New Inn (ummchon ' "9","; “mm or sun" Motionship. Tum Sm . I.“ I. It: 1 I. .UIII‘WI Iii l I II- Iktuorl ‘ ‘1,ng- IIIII > Ill1ii OUIIlIOINVIIIVI R It!!! hir‘v‘ . \ 41 95.2 is... it: 5:... as a o 3.3; 0(m ,I; .- diam-=83 5.8 3.8-8 :8...- O «to: 5.: 3:3 I wig 3.8.... 6......- o (358 3...... rs..- sis-.3 .3... i 38 00.x! a: 9.53.! 88..- ...81 3 ii @ 5.252 :83.- .338 Iii. 2820.— i .82...- N 22°“ DZ UQHJ 22.258 acofiEsE s 8:5 .38.. c982 I if #2:: N Fa I.II>I\,.../i , o I 519:6...- I O .— im u >fir E.) H. 3 U m.” (6.33; .1 o , III‘l a... 3:... _ O _ I, >5 3.3.1.3 5.28:0 zqu fiI I l I I, I} INHIOI I II a I II I I) [III-II, 7 0 22:3 _ 3:33” yeti: 3 I i 535.3 :5 8...: I 7. III . r Ma 312...“: . INC, .I a r ,. a o .1285 85.5. 3:31 So 4.: 7/ I'M-ggt‘ I. c), I. w l muofiuumwfl vac wCmeOm Oow>umm O320>Om HMQHOUGH A...... :5... .. 211. no mo: .NIN masses 140-033 0 ' 69 - 6 42 primarily with the Office of the Assistant Commissioner for Data Processing. The field organization consists of seven Internal Revenue Regions, each directed by a Regional Commissioner who reports to the Deputy Commissioner; fifty-eight Internal Revenue Districts, each administered by a District Director; seven service centers, each headed by a Director who reports to a Regional Commissioner; and a computer center and a data center, both of which are directed by the Assistant Commissioner for Data Processing of the National Office. The computer center is the National Computer Center (NCC) situated at Martinsburg, West Virginia and the Data Center is located at Detroit, Michigan. The field organization also includes seven Regional InSpectors who report to the Assistant Commissioner for Inspection in the National Cfifice, and seven Regional Counsels who report to the Cfifice of the Chief Counsel in the National Office. Office of the Assistant Commissioner for Data Processing_ The Assistant Commissioner for Data Processing is the principal assistant responsible to the Commissioner‘s CEfice for (1) all matters pertaining to the development of Eflograms, systems, procedures, and methods for the imple- nentation and operation of the IRS ADP Plan; (2) the receipt mfiiintegrated data processing tax returns and payments; (3) the accounting for the internal revenue; and (4) the review n- : u 0. on I but H "u- «I: . i.- “N - ‘ ‘ I (I) ‘r._ u“: 1 ‘b '2 .2 u o. 43 and coordination of all reports. He exercises responsibil- ity for direct line supervision over (1) the activities performed in his own Administrative Office, the Systems Division, Operations Division, and the Reports Division in the National Office; (2) the National Computer Center at Martinsburg, and (3) the Data.Center at Detroit. He exer- cises functional, or staff, responsibility for the ADP activities in the seven Regional Service Centers, and the 58 District Offices. He often confers and collaborates with Officials from other government agencies, private industry, and business to assure compatibility of relevant data which will be integrated into the ADP system of each. Figure 2-3 depicts the organization of the Office of the Assistant Commissioner for Data Processing. Attention is directed to the computer system which pmocesses tax returns and is now being used to check up on the taxpayers of the nation to make sure they comply with the Federal tax laws. Five main characteristics of this cxmputer system can be identified. These characteristics concern (1) organization, (2) taxpayer identifying numbers, (3) goals, (4) operational flow of information, and (5) general implementation and phasing in. Organization of the computer system follows the three layers found in the administrative organization. The (xmputer systemIis composed Of a centralized master file of consolidated tax accounts for tax accounting and data 44 Figure 2-3 Internal Revenue Service Organization of the Office of Assistant Commissioner (Data Processing) ASSISTANT COMMISSIONER (Data Processing) Administrative Office sllstems Division Operations Division B . . ~§§£EE§- Branches. 'Planning and -Program Applications Development 'Procedures - Resources “Service Centers Utilization Programs -Field Coordination 'Master Files PrOgrams Supervises: -IRS Data Center °National Computer Center (Management Information) Branches: Reports Divisionfi\ ~Data Processing Analysis :Reports Management and Systems -Reports Processing 45 reconciliation by taxpayer identification numbers at the National Computer Center (NCC) and decentralized data col- lection by seven Regional Service Computers and the 58 District Offices. Each attribute in this computer system is discussed in detail later under the topics of the Na- tional Computer Center, the master file concept, consol— idated tax accounts, and tax account numbers. The seven regional Service Centers, which are feeders into the Na- tional Computer Center, tape all tax returns on their com— puters and forward the tapes to the National Computer Center. The 58 District Offices, under the Old, manual method and during the phasing-in period for computers, collected the millions of individual and corporate returns and forwarded them to the seven regional Service Centers. Since the new system.became fully operational on a national basis in 1967, the filing of returns by all taxpayers has been directly with the regional Service Centers, thus freeing the District Offices for auditing and other impor- tant duties. The second main characteristic of the new computer system is the single identifying number for each taxpayer entity which is the key feature, perhaps, of the entire 17 sYstem. The Social Security number is used by —‘ 17Mortimer M. Caplin, "The Taxpayer-Identification lumber System: The Key to Modern Tax Administration," Imerican Bar Association Journal, XLIX, No. 12 (December, Ippo 6-50 46 individuals; the existing employer identification number system has been adOpted for use by business entities. These tax account numbers are discussed in detail later. The goals which constitute the third main feature of the system have been identified clearly and have been defined adequately.18 Under the American tax system of voluntary self-assessment, the government relies upon the individual taxpayer to apply the tax laws to his own situa- tion and to report and pay what is rightfully due. Under this concept, the IRS will seek to carry out four main obligations or goals with its new computer installations as fOllows: (l) to assure that taxpayers file all required returns, (2) to assure that taxpayers report all their income, (3) to collect all taxes due, and (4) to assure that overpaid taxes are returned.19 Operational flow of information begins with the filing of returns with the Regional Service Centers. In- formation returns are filed by businesses and others who pay taxpayer recipients their incomes from salaries, wages, 18See page 188 of Chapter II. 19Robert L. Jack, "The IRS Automatic Data Processing SYstem," Remarks delivered at First Annual Conference on Ems Impact of Computers on the Tax Practice, Co-sponsored ky'the AmeriEan andifiederal Bar Associations and the Na- tuonal Law Center of the George Washington University, Washington, D. C., June, 1966; Also, see: Sheldon S. Cohen “LS. Commissioner of Internal Revenue), "New Tax Collector Tells His Goals," Nation's Business, LIII, No. 4 (April, 1963). pp. 31, 68—73. .o on n, 'vn ‘A- 'v» ‘I- N. ‘- \_‘~ h 3. 'o 47 interest, and dividends. Self-assessed tax returns are filed by taxpayers with the Regional Service Centers. At the Service Centers, all returns are mathematically ver- ified, taped, and forwarded to the National Computer Center; there they are posted to taxpayer accounts. The information is examined by audit criteria.20 Income reported by tax- payers on tax returns is correlated and reconciled with that reported on information returns by means of the tax— payer's identifying number. All discrepancies are inves- tigated. Many returns are selected for audit. General implementation and phasing-in of the IRS' computer system began in 1962. Installation of the present computer system was initiatedeith the construction of the National Computer Center, the establishment of the Master File, and the selection of a pilot Regional Service Center in Chamblee, Georgia, in the Southeast Region. The first year of pilot experience with the Business Master File segment supported the hope that a venture of this magnitude would be successful and live up to expectations. The many pmoblems which developed were solved. After the first year CE pilot experience, the other six Regional Service Centers Mere phased in gradually on a carefully chosen schedule. Iflans for implementation and nation-wide phasing-in to full capacity operation in all seven Regional Service Centers 20See page in Chapter IV. 48 called for 1967 to be a crucial year. The Assistant As- sistant Commissioner for Automatic Data Processing said, Nationwide implementation of ADP is being accomplished on a gradual, phasing—in basis because of the problems of logistics--housing, equipment and staffing and ser- vice centers required by the System--and also because an abrupt change would disrupt and cripple our Operations. The complete, five-year schedule for phasing-in the com- puterized system on a gradual basis until nationwide coverage cm'computer Operations could be finally achieved is shown in Figure 2—4. The Chamblee, Georgia, Service Center, which is located in the northern suburbs of Atlanta has been the pulot center which began Operations for the Business Master File (BMF) in 1962 and the Individual Master File (IMF) in 1963. This center has been serving the District Offices of the states of Alabama, Mississippi, Florida, Georgia, Ten- nessee, North Carolina, and South Carolina. These states comprise the Southeastern Region which is the smallest of the seven regions as far as number of returns and volume Of dollars collected are concerned. Trial runs of new programs and tests of new facets of the system as it develOped and expanded were conducted and perfected in this pilot center before their use and operation in other regions. The pilot 21Robert L. Jack, "ADP--An Analysis of Its Opera- tions and Results," 1966 Proceedings of New York Universit Plenty-Fourth Annual Institute on Federal Taxation, p. I63. 49 .oasoocom afiIommcm mod oofl>uom osco>om accumucH .va whomam .moa .m .s0wumxm9 Hmuocom so musuwum ”NH Hanged cumsomImuco3B Muflmuo>HCD xuow 3oz mo mmcaomoooum coma e pasmom cam chflumHomo muH mo mammamcm chImode .xoon .A uuooom "oouoom .hmIHIH cw ucmsouo .mwcuomwaoo umooxmn .noIHIH ca ucmsoun .cmmflcmflz uaooxmm omzH mzm cops .coomo snoumog mzH mzm muummsnommmoz .OOGOHBMA Owucmaumrcuuoz mzH mzm .oz .mueo momcox umosoflz mzH mzm mmxoa .cfiumom cuoumozcusom mmzH mzm .MM .Aflumccfiocflov soumcfl>oo Houucoo mzH mam .mm .maemaoomaaem osuemauauoaz msH mam .mo .Amuamausv moansmeo ammoeusom hmma mmaa mmmd vmma mmma Nmmd kudOU OOH>HOm GOflmOm 'A an UV ' I on ‘u \ '5 O a“ .5." u‘. I 50 region has been used for system innovation tryouts before positive adoption and extension to other centers. Carefully selected administrative personnel were assigned to staff this center, which became a training ground from which key men were obtained when other centers opened. Chamblee began to build up its work force for processing tax returns and more specifically for processing business tax returns in January, 1962. Significant highlights for the installation of ADP during the 1961 fiscal year included the following: 1. Creation of the new ADP Division at the National Office by splitting it off from the Collection Division, 2. Selection and training of systems analysts and programmers, Systems design for business returns processing, 3. 4. Planning for personnel redeployment, 5. Establishment of the pilot service center in Chamblee, 6. Initiation of construction of the Natignal Computer Center at Martinsburg, West Virginia. The Old Collection Division in the National Office was split into two divisions: the ADP Division and the Col— lection Division. Over 100 Service employees such as in- ternal revenue agents, revenue Officers, tax examiners, and others‘were carefully selected and trained to become the pdoneer digital computer systems analysts and programmers 22Mortimer M. Caplin, 1961 Annual Report of Commis- sioner of Internal Revenue, Internal Revenue Service, U. S. Ikeasury Department, Publication Number 55 (Government Euinting Office: Washington, D. C., 1961), P. 23. ‘5' an Val S v- 4.. ‘4‘ (I) h I A. .‘. I; a- ‘~ ~." g “h 51 in the newly develOping system. These key employees were chosen on the basis of nationwide competition and were intensively trained ten to twenty-one weeks in systems analysis and programming. After this training, these key peOple began system design for the processing of business returns, which was scheduled tO begin in 1962 in the pilot center at Chamblee. Internal Revenue Service Programming The design of the present IRS ADP system was achieved in three major phases: development of the pro- cedures, the programming, and the Systems Acceptability Test (SAT). The first phase involved the preparation Of a synopsis or outline of the new or revised step-by-step sequence of instructions to accomplish the objectives. The origin, expected results, and proposed implementation was included. After it was decided what was to be accomplished, instructions had to be communicated to the computers. The guocedural instructions develOped in the first phase had to be converted into machine language through programming. The computers were programmed by first writing the English equivalent of machine codes or absolute machine language. Then this was translated into machine language by means of arcompiler program. All Federal government programming of computers is required to be done in CObOl. - v- .0! q | d I I I y. A. '5 w .O 1., .u. h,_ “m, I“ ..‘ - .. - "~ ‘1 52 The programming required in the IRS ADP system was centralized in the office of Assistant Commissioner for Data Processing in Washington, D. C., at the Pension Build- ing. The job of programming the present IRS ADP systemeas a huge technical undertaking. For example, the programming required over 2,000 pages of handbook issuances, 34 Honey— well H-200 computer programs, 89 IBM 7074 programs and 21 other programs. This total Of 144 programs involved ap- proximately 300,000 symbolic or English language instruc— tions and required the testing of over 500,000 machine instructions.23 Inefficiency of computer prOgrams is a luxury that cannot be tolerated with the volume of data handled. The average execution time of a programmed instruction in the HOneywell H-200 model found in all the service centers is 40 microseconds, or 40 millionths of a second. While this seems infintesimal, it could be costly with faulty program- nung. For example, if there were ten excess instructions which need to be multiplied by the execution time which is applied to about 60 odd million documents that a single wm msAhomH .mH umnEmumwmv mmm .oz .HH>Ax .Ho> smmcHSOh u H HoucH mo HOGOHmmHEEOU mo usomom Hmsccm mmmH ecocoo .m cooHocmb .oz H>Hx .Ho> HOGHOOH umouum HHOSm 0 g 0 m Hoo H a .iomae. mm easel use .osco >om HOGMOHGH mo HOGOHmmHEEOU mo muuomom Hcsccd ooupm HHmmo uncusuom Homcm How oouoom o.em omo.e e.mem some Oo.m~ omm OHanHm>< uoz emmH noise op .OHanHs>a uoz some m>.H 0H o.oem mmmH 0.0mm o.m o.HHH o.wHN «mmH o.e~m o.m o.moH o.mHm mama NmmH 0.0mm o.m 0.0HH o.vHN HmmH o.va o.m 0.0HH o.mom oomH m.Hom m.m 0.0m o.oom mmmH mama OHumcmmz Echwoum mama ocu HMHOB hmOH Show mmoH SHOE NIS EHOh cH mcHummHOHpuom OOHccmEoo mo nonfisz so emeam museums coHumEHOmcH mo umbasz mcusuom some OHuocmoz mZOHHHHZ 2H ZMDBmm ZOHB HmomHm Mom OOH>Hom ooco>om ill! Assamese seas omaam ma mausuom momma dszhZH m0 mmwfi .momH cmsoucu mmmH munch .NIN OHQMB usumu :oHumEHomcH mo HOQSSZII ‘s. t.‘ t... q 0"}. 70 Computerized tape filing of tax information returns grows more commonplace. Last year, for the first time some 1.7 million taped information returns reporting payments of salaries, interest, and dividends were filed experimentally with the IRS by ten companies that made the disbursements; the companies also were required to send along printed returns. For 1966, some 800 pay- ing companies have responded to an IRS invitation to submit tapes, and are expected to file as many as 50 million computerized information returns. This year the companies won't have to forward any paperwork, although the computers will print out copies of infor- mation forms that payers must forward to the individuals concerned. The Service estimates eventually some 250 million informati 3n returns will be filed to it on tape annually. 8 The processing of information document data at the IRS on magnetic tape from payers has proven feasible. Pilot project testing was conducted during 1966. This test confirmed the practicability of receiving from employers and payers their magnetic tape records of Form W-2 wage and tax data as well as Forms 1099 and 1087 information returns. . . . The pilot test involved receipt, from 70 partic- ipants, of about 18 million data records on 599 reels of magnetic tape, of which 44 reels required transla- tion to a rec 3rding code compatible with Service requirements. 9 A fresh IRS procedure designating acceptable tape formats and other specifications for filing information 38Wall Street Journal, XLVI, No. 177 (June 22, 1966). p. 1, c‘Eiumn ‘5. 39Sheldon S. Cohen, 1966 Annual Report Of Commis- floner of Internal Revenue, InternaTRevenue Service, lhuied StatesTreasury Department, Publication No. 55 (Washington: Government Printing Office, 1966) , p. 64. (I) .— —o— "s. .I 'I ”A La .1: “I ‘d 't 71 documents has been issued in response to over 900 inquiries during 1966. This procedure has resulted in substantial savings for both the Government and payers of wages, in- terest and dividends. The Government saves the cost of transcribing data from millions of paper documents to punched cards and subsequent conversion of the data to magnetic tape. The payers filing tapes no longer need to file the previously required paper COpy of the information return although they are required to continue furnishing the payee his copy. The IRS will accept a combination of unduplicated magnetic tape and paper returns. Approximately seven per cent of the information documents filed with the IRS during 1967 were tape records. In 1968 the figure increased to ten per cent. In regard to the second question raised earlier, the most satisfactory way to use information returns is to correlate the information contained thereon with the self- assessed tax returns of taxpayers. One of the major uses cm tapes is in the wage and information documents matching program. The Optimum.uti1ization of information returns, including those taped, remains under research by the IRS. Substantial progress has been achieved toward the attain- ment of a cardinal Objective of ADP--information document validation. . These documents have been of rather limited use to the Service in the past because of their sheer volume and the time it takes to make a manual match Of F‘.’ (I) ' I on \A ‘-~ I‘v- v.- H,‘ :- Hu- . 'Qo ! I (,-. r‘c ‘s v.“ 72 data appearing on them with the figures reported by taxpayers on their returns. Introduction of computers, coupled with the tax account number and master file operation, offers processing capabilities not previously available.40 Experimental tests were conducted in the pilot Southeastern Region to obtain information and experience in order to derive maximum value from these documents. These tests involved the matching of interest, dividend, and wage pay- ments reported on information documents with those reported on the individual returns of the recipients. Research to explore new potentials for information reporting has con- tinued and this activity has included 1. Analysis of different methods of matching informa- tion returns with the corresponding data on tax returns; 2. Methods of obtaining better identification of in- come recipients; and 3. Possibilities of extending the use of magnetic tape instead of paper information returns.4 The IRS Data Center at Detroit In 1965, the IRS Data Center at Detroit became operational. It is known as an Off-line center, that is, it is not connected with the main processor at the National Computer Center, and is responsible for the performance of all nonsmaster file data processing operations for the IRS. It was activated to handle, in a central location, such 40Sheldon S. Cohen, 1965 Annual Report, p. 18, 41Sheldon S. Cohen, 1967 Annual Report, p. 55. qt J- l 1.. ..V,h Rut P I. ri‘» For: .. D:V¢o V“ H a IN «g 'z‘ ‘u I v:‘ . I H“ g k 73 Revenue Service programs and activities as the preparation of Treasury Department payrolls, fiscal reports, Statistics of Income, taxpayer compliance measurement, tax forms dis- tributions, returns of non-taxable organizations, management information reports, special tax research, and special tabulations and comparisons for states and other Federal agencies. This center frees the ADP system from any and all work except that of processing taxpayer returns and related documents and data. The Regions of the IRS There are seven IRS regions which divide the United States. See Figure 2-2 on page 41 for a map of these I regions. Each region comprises several states. Taxpayers from each region file their tax returns with their regional service center. Table 2-3 shows the number of tax returns and total dollars collected by each region for 1968. It also shows the various states of each region and its service center location. IA ranking of the regions on the basis of total dollars collected in 1968 would show the following order: UJ North-Atlantic, (2) Central, (3) Midwest, (4) Mid- Atlantic, (5) western, (6) Southwest, and (7) Southeast. Arranking of the regions on the basis of the total number cm'tax returns processed in 1968 would show the following order: (1) North-Atlantic, (2) Western. (3) Midwest, II, ., l' ~I Ll ... M. , ., “I s .c c. a, I. "J I. .9 r 744 Tabh:2-3.--1967-68 regional returns and dollars collected — Internal Revenue Service. 1967 1968 1967 1968 1967 1968 I537 1968 ITS? 1968 1967 1968 TOE? 1968 Number of Returns (Millions) 17.64 17.80 15.44 15.70 13.14* 13.50 14.58 14.90 16.03 16.30 12.12 12.40 15.98 16.50 Source: Dollars Collected (Billions) $ 34.90 $ 39.70 20(92 24.10 11.18 13.20 25.19 29.70 22.36 26.20 11.72 13.80 17.86 21.40 $148.38 Region 1. North Atlantic: ‘2. Mid-Atlantic: 3. Southeast: 4. Central} 5. Midwest: 6. SoutHWest: 7. Western: Totals Totals States Maine Vermont New Hampshire Massachusetts Rhode Island Connecticut New York Pennsylvania New Jersey Maryland and Wash. D.C. Delaware Virginia North Carolina South Carolina Tennessee Mississippi Alabama Georgia Florida Michigan Ohio Indiana West Virginia Kentucky, Wisconsin Illinois Minnesota Iowa Missouri North Dakota South Dakota Nebraska wyoming . Colorado Kansas New Mexico Taxes Arkansas Louisiana Oklahoma Washington . Oregon Montana Idaho California Nevada Utah Arizona Alaska Hawaii Regional Service Center Location (Lawrence) (Philadelphia) (Chamblee) (Covington) (Kansas City) (Austin) (Ogden) 1967 Annual Report of Commissioner of Internal Revenue 1968 Annual Report of Commissioner of Internal Revenue .\ ‘fl HUI ‘no nu. ‘u‘. My. Eh“? ‘\ 75 (4) Mid—Atlantic, (5) Central, (6) Southeast, and (7) Southwest. The North-Atlantic region is first in both categories because it includes New York. Each region is directed by a Regional Commissioner who is responsible to the Deputy Commissioner in the Na— tional Office for the execution of the broad nationwide policies and programs and for the administration of the internal revenue laws as well as the direction and coord- ination of the functions and activities of the many district offices within his region. Figure 2—5 depicts the organization of the Office of Regional Commissioner. Among the various divisions of this office, each of which is headed by an Assistant Re- gional Commissioner, is that for data processing. The Assistant Regional Commissioner for Data Processing is responsible to the Regional Commissioner for planning, coordinating, and evaluating the tax returns processing, data processing, and revenue accounting activities of the region. He exercises line responsibility for supervision cwer those activities at the regional office, and functional cu'staff responsibility over those activities at the serv- ice center and the various district offices within his region. nanoamflssoo H2882“ we «came an» no :oflmfinmmuo .m-~ 933m nuun~ho NSF—nun anhzmo m3>¢mm x025: guzzowaum roan 76 5km Noam—5:209 n2< 3”: ~52 mm~H~4~uYthe Office of the Assistant Commissioner for Data Proc- essing in the National Office in washington with the Assis- tant Director of the Service Center in the Central Region at Covington, Kentucky, through the Assistant Regional Commissioner's Office in Cincinnati. 79 xxocucmx .coumcfl>oo .coflmwm Hmuucmu .uwucmo oofl>uom um Hauumuflo mo oofiwmo mo cowumecmwuo .fina u.§3!fl.u§£3ca «Ba 84.500 Egg. .wlm mucmwm «one I “goof-.3 32: g neg I g.» 9x 5.?3m 8233 Bang ~36 u jig-II- gfiug g ~38 u 3:780 .m 33a 82 aged ~03 I 9.890300” 0? toned an: 823 Eng: ~36 a 5:3. .m in 42380 Egan—a «HHS—.855 ~36 - ind; g 32.5 .35 cab-4 I only. 0& flaaaaa? 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By Revenue Law, IRS must inform tax— payers of the status of their returns no later than 45 ggyi3following the April 15 filing period--or by June Figure 2—7 depicts the work flow sequence of steps through which tax returns pass as they are processed through the service centers. All tax returns, remittances, correspondence, and other documents are received in the Receipts and Control Branches of the Examination Division. Classification of items and routing then follows. In this Branch as mail is received from taxpayers all letters are logged, opened, contents stapled together, and sorted. The tax returns are sorted by hand according to geographic location. Next they are separated according to the final result of the return; that is, whether or not they call for refunds, end in a zero balance with nothing owed and nothing to be re- funded, or have a check enclosed for balance due the Gov- ernment over and above the amount withheld by employers. Those returns with refunds due taxpayers are processed first before all others because interest is required to be said on the refund amount after a period specified by the law. 43Dean J. Barron, "Why Computers," National Public Agpountant, XI, No. 5 (May, 1965), p. 11. Figure 2-7. 81 noun m “*cmnor men Q n.c.c. \ i l @ mutton macs cmummru BEMNH 13AMM3IHHDN INUNMHES Work Flow of Central Service Center at Covington, Kentucky / A£Omflfl1MSAND Annunuswrlnuncmui ISNUUEMINMNCH (F1100) 8 N N h M 8 N ‘K \ Tfi—fi IRNMICONNKHION IHMNCH Revised 3/68 I an. ‘ u .OL‘ n... It“ FI. ‘A ‘1‘. I .55. Iv. 82 The Receipt and Control Branch also verifies tax returns and all supporting documents with remittances and determines their acceptability for deposit. It not only classifies all the various documents and initially accounts for all remittances by class of tax but also performs all teller Operations in the service center. This branch also establishes physical control over all paper documents, and maintains integrity of processing categories through pre— liminary steps such as counting and blocking, batching, numbering, and the preparation of production control documents. In the classification process, returns of a similar nature are gathered together and "batched" in lots of 100. For each batch a control card is prepared which designates each function that is to be performed on the batch as it is processed. {After batch control is established over the documents, they are released according to work schedules. From the Receipts and Control Branch, the batches begin their routing through the Service Center by being passed next to the Examination Branch. In the Examination Branch, all tax documents are edited for accuracy and com- ;fleteness. This branch examines, perfects, and codes all tax.documents in preparation for conversion to punch card foam. The trained personnel in this branch examine each tax form to verify that all essential information has been recorded and to see if there are any errors in fact. ‘n a. .II ‘r i In“. 83 Sometimes it is necessary to do research to interpret cor- rectly unintelligibly written numbers or to contact tax- payers for additional information to complete the return. After the editors are satisfied that the returns are complete and correct, each document is coded with a thirteen-digit locator number. The first two digits rep- resent the particular district, the next two represent the type of tax such as individual or business, the next two represent the type of document being processed such as a 1040 form or a 1040A form, the next three digits represent the Julian date of the year, the next three digits represent the block number, and the last two digits represent the serial number in the block which could go from 00 to 99. All returns, after having these thirteen-digit document location numbers stamped on them, are blocked with 100 returns per block. The Examination Branch also edits, codes, and ex- tracts information from tax returns for audit and statis- tical programs before the documents are forwarded to the Transcription Branches of the Data Conversion Division. The largest single Operation found in any service center is the Transcription Branch. This branch, using electric key punch and key verifier machines, transcribes and verifies tax data and coded information from tax returns and source documents to punch cards. It also processes documents which have been previously transcribed and for 84 which error conditions have been detected in subsequent processing. In the Transcription Branch of a typical service center, more than 500 keypunch machines are in operation on a two-shift of eight hours each or a three— shift, round the clock, 24 hours-a-day schedule, during peak periods of operations. Each keypunch operator tran- scribes pertinent information from about eighteen 1040 forms or thirty-three 1040A forms in about one hour. As nmny as ten cards may be required for the information from one 1040 form. Other functions performed by the Transcription Branch include transcription of data to process feedback information, documents, correspondence, and forms to Dis- trict Offices and taxpayers; transcription of data for accounting purposes; transcription of production and cost records used for tabulation and compilation of management reports; transcription of data for use in programs in ad- nunistration, audit, statistics, fiscal reports, intelli- gence and others. Some of this work is in the process of being transferred to the Detroit Data Center. After the information on the punched cards is verified, the tax returns and verified cards are forwarded to the proving and balancing sections. This is where the "block balancing" operation, one of the many controls to insure that all returns are accounted for, takes place. All cards in each block of documents are sorted, arranged 85 in numerical sequence and balanced against summary data information. When "block balancing" is completed the punched cards are forwarded to the Computer Branch where they are used as input to the computers. The returns them- selves are sent to and retained in the Errors Correction Branch for about nine days, which is the cycle period for processing returns, to be available for any possible future action during the processing. After the returns are re- tained in the Service Centers for about one year, they are sent to Government storage depots. Microfilming of returns is not necessary as all pertinent information from each return is transcribed, verified and posted to the consol- idated tax account in the National Computer Center and transcripts of these records back as far as 27 months are available to tax administrators. The Computer Branch of each Regional Service Center utilizes peripheral equipment and digital computer systems in the daily processing and conversion of punch card data to magnetic tape records. This process includes the compu- tation and validation of tax liabilities of all taxpayers within each respective region. Tapes are forwarded to the National Computer Center for processing and updating the Master Tape File of all taxpayers records. Each Computer Branch also maintains and controls hundreds of different programs to process and print various reqisters, notices, mail labels and other types of documents ‘1- U) “I ‘ II .0. R. F V‘. )0 1- f r» 'v Li»- M I 86 as a result of the processing performed at the National Computer Center and internally at the Service Centers. Each Computer Branch also maintains and controls several thousand reels of magnetic tape containing various types of information regarding the taxpayers in the particular region. Regarding the processing of tax returns in the Computer Branch of a Service Center, the pertinent tax information is transferred from the punched and verified cards to magnetic tape for processing further by Honeywell 200 model computers. On this high-speed printer tax infor- mation processed on magnetic tape is converted into read- able form. A typical Computer Branch processes returns on a.ten-hours-a—day, seven-days-a-week cycle. During the processing cycle when information on the punched cards is transferred to magnetic tape and mathematically verified, any errors discovered by the computer are listed on error registers which are forwarded to the Error Correction Branch. In the Error Correction Branch, mathematical or cmher mistakes detected by machine processing are corrected. Since the original returns and documents have been for- warded to this Branch, the personnel of this branch compare, annually, the original returns and documents with the nachine print-out of error conditions. The personnel per- fcrm research, perfect and resolve both the processing and f\| 1'»: . ‘( O! VII u. H In. ‘u: . \ ‘w 87 taxpayer errors that have been detected during the work cycles within the Service Center. Proper action codes are assigned to correct the errors on the error register which when corrected is forwarded, along with source documents, back to the Transcription Branch which punches up new cards. After the data in the corrected punch cards is verified, the cards are returned to the Computer Branch where the information is converted to magnetic tape and then it joins the normal flow of work. In this manner the transcription tapes are corrected when errors are found. Magnetic tape output of the Computer Branch con— taining pertinent tax information from individual and business returns is made ready for mailing to the National Computer Center. At the National Computer Center the in- formation is posted to the accounts in the Master File. The Receipt and Control Branch packages and releases the reels of magnetic tapes to the National Computer Center. They are air mailed to Washington, D. C., and then taken by motor to Martinsburg, west Virginia. They are air mailed because of the time element and the need to arrive <31time to make the six p.m. start of the processing cycle Saturday nights at Martinsburg and the Washington airport is the closest big facility. Each 2,400-foot reel of out- Emt tape contains an average of 15,000 taxpayer records. (Mleach record is the taxpayer's name, identifying account rumber and all pertinent data from.his return. The Receipts f)- “ . I. (I) ‘ .. (I) ' 1 ) o~ ( ‘I. 88 and Control Branch also sends source documents from which output tapes are prepared to prOper file series. This branch also packages and ships documents, tapes, and print- outs to Social Security Administration, Federal Reserve Banks, state employment security agencies, District Offices, and elsewhere. At the National Computer Center, the magnetic transaction output tapes from the seven service centers become input tapes. The data on them is used to update the Master File each week. Transaction tapes are returned to the various service centers showing changes to the Master File in the form of accounting and adjustment output tapes. Other output tapes have become known as action tapes. When print-outs are prepared from them, they dig- close (1) who failed to file a return, (2) who owes taxes for previous years, (3) who filed duplicate claims for refunds, (4) who is entitled to a refund. These output tapes reveal also any discrepancies or unusual character- istics regarding any particular return. The smallest peculiarity is logical grounds for closer examination and audit. Tax refund tapes listing amounts owed taxpayers are prepared and forwarded directly to the U. S. Treasury Department disbursing offices where refund checks are :uinted and mailed to taxpayers. Other output action tapes are forwarded to the regional service centers where they 89 are used to prepare tax bills, delinquent notices, and other types of data to be sent to taxpayers. Output tapes also identify those returns which, according to the audit criteria, are to be considered for audit. Back in the service centers, the output tapes from the National Computer Center are printed out in the Computer Branch and forwarded to the Accounting and Adjustment Branches. The Accounting Branch controls accounting out- puts from the National Computer Center, like settlement registers, and performs required journalization and general ledger posting. It initiates or processes such action as tax account transfers, tax account adjustments, debit or credit transfers, statutory clearances, and other actions, all related to Master File accounts of taxpayers. The Accounting Branch also performs the functions of balancing Master File accounts with the general ledger maintained in the Service Center. It reconciles accounts with regional disbursing offices, prepares periodic trial balances, pre- pares statements of accountability for the Service Center IHrector's Office and the Statement of Classified Collec- tions. The Accounting Branch controls accounting documen- tary data received from.District Offices for entry to Master File and processes outeof-region Master File accounting transactions. It also prepares periodic and Special financial reports covering deposits and collection data for transmittal to the National, Regional, and District Offices. 90 The Adjustment Branch receives adjustment requests and determines appropriate action to be taken, including any adjustment to tax due, penalties and interest due, and to the entity section of a module. This branch classifies, numbers, controls, and routes incoming adjustments and claims, and makes adjustments to both Master File and Non- Master File taxpayer accounts. It also controls and processes statutory case adjustments. The Research Branch establishes, maintains, and controls permanent and temporary tax return files. It retires returns and documents in accordance with prescribed procedures, which call for returns to eventually be stored in Government depots. District Offices There are 58 district offices, each headed by a District Director, who is charged with the responsibility of administering the internal revenue laws within the jurisdiction of his district in conformance with estab- lished IRS policies and programs of the National and Re- gional Offices. Figure 2-8 shows the typical chart of the organiza- tion of the office of District Director. It includes four Rain divisions, which are Audit, Collection, Administration, and Intelligence. , ~ euv'~,~d A1- 00 . .3 d. h UnhaA— in A. muvn‘v.i.l.h z¥ A v III. 6 ‘AU QNAJ 1‘ J. IIB‘. in uh l.-\.v Int ~II~V I .c! mmuummo 4(004 macammo mZON mmunmuo me ezmsozaama enmam =ozewm meaumume oz< mu_>mmm eros< muaeaa~oao zoaeampmazsza< zoam~>ao zoaeomaaou zosma>uo Haos< zoam~>ao mozmouaameze mOHUMMHo humth~o Houooufio uoauumwa Mo OOHMNO map No :OwumNflcmmHO .mIN ouflmwh 92 Some filing of returns by taxpayers is still going on in district offices. Direct filing with regional service centers is being phased-in gradually up to the year 1970. Until that time some district offices must devote part of their effort to the work load of receiving tax returns, processing them manually and getting them ready for the computers, and then forwarding them to the service centers. Computer Equipment Beinngsed by the IRS The IRS is using modern, high-speed, electronic equipment of the third generation in its nation-wide net- work of computer systems. The major items of equipment employed by the IRS in this configuration consist of three IBM BEG/Systems, five IBM 7074/Systems, nine Honeywell H-ZOO Main Processor Systems, nine Honeywell H-200 Input/ Output Processors, and two Stromberg Carlson Microfilm Printers. Table 2-4 shows the IRS computers and their locations. Computers are located in the National Computer Center, the seven Service Centers, the Detroit Data Center, and in the old pension Building (headquarters of the Assis- tant Commissioner for Data Processing) of the Washington, 1% C. National Offices. Most of the equipment is owned but some is leased. The IRS had followed the policy of leasing computers at the inception of the installation and application of its ADP Plan but shifted to a policy of purchasing computers in 1964. Vw N... Iiyu ‘3‘ 1.4., "31‘ 93 Table 2-4.-—Internal Revenue Service computer equipment. Type of Configuration and . Model Description Quantity Location IBM System/360 3 National Computer Center Model 65 IBM System/7074 2 National Computer Center (30K) Honeywell H-200 7 One at each Service Center Main Processor 1 IRS Data Center at Detroit (24K) 1 National Office in Washington (Pension Building) Honeywell H—ZOO 7 One at each Service Center Input/Output Processor 2 IRS Data Center at Detroit (12K) IBM System/7074 3 IRS Data Center at Detroit (20K) Stromberg Carlson 2 National Computer Center Microfilm Printers ou‘ “I: I! c.‘\ I); tn 94 Advantages to the Government in purchasing computer equipment were demonstrated by the Lease—Purchase Study of November, 1963. Accordingly, the three computers at the North-Atlantic, Midwest, and Western Service Centers and the two large—scale computers and support equipment at the National Computer Center were purchased in 1964. Depreciated purchase cost was equal to approximately two years' rental. Bids were requested from manufacturers for equip- ment to replace leased equipment (scheduled for pur— chase) to do the ADP service centers' processing job. The proposal which was accepted provides nonrecurring savings estimated at $1 million over the next three years. Because the multiprocessing capabilities of the selected computer require fewer computer systems to meet Operating needs, it now seems likely that $700,000 additional savings will be realized by 1967. All, or part of, the presently installed computer equipment, it should be recognized, may be subject to change in the future for two reasons. First, the contin- uing review and analysis of IRS requirements as the ADP system is refined and expanded may cause changes in equip- ment utilization. Second, technological changes caused by research and development by the many manufacturers in the dynamic electronic industry may make some of the present equipment obsolete. Changes in the IRS equipment have already been induced by the second reason--rapid technological advances. The IRS computer system originally had two IBM 7074 Systems and one IBM 1401 System, the latter being used primarily as a supporting configuration for the larger 7074's. When IBM 44Sheldon S. Cohen, 1965 Annual Report, p. 61. A4 UI “u l.) ‘ I . A“ ‘5 if (I, ' ll) 5‘- . .. .‘l ’I 'Q A" . . “h A u I 'N. 5‘. . . ~ . f 95 came out with their latest advancement in computer system technology in the form of the 360/System with a whole family of models, the IRS shifted at the National Computer Center to the 360/System, Model 65. However, "In the case of the service centers, a decision was made to replace IBM 1401 computers with Honeywell H-200's."45 IBM System/360 in the IRS Network Of Computers The computer configuration utilized by the National Computer Center at Martinsburg, West Virginia consists of three IBM 360/Systems, Model 65 and two IBM 7074/Systems (30K). Another IBM 360/System has been planned for purchase 46 The IBM in 1969 and still another sometime after that. Systems/360 are Model 65 with 14 Hypertapes and disk storage drive units attached. Four dual reel-type (1/2") tape units are included. The system.is also equipped with a console typewriter which serves as a communication link between the Operator and the system. Pertinent operational facts would include maximum storage capacity and Operating speeds of the component units such as memory, disks, hypertapes, reel-type tapes. The 45Sheldon S. Cohen, 1965 Annual Report, p. 58. 46William H. Smith, in his keynote address before the Computers and Taxes Conference held June 18-19, 1968 in Washington, D. C. at Statler—Hilton Hotel, Sponsored by the George Washington University. Mr. Smith is Deputy Commis- sioner Of the IRS. (A) xx: (1: ' . (I) "P. "V ‘- ‘N I O 96 nemory component has a maximum storage capacity of 262,144 alphabetic characters or 524,288 numeric digits. Rapid Operating Speeds permit the central processor to add two nine-digit numbers yielding a ten-digit result 153,845 times a second. Maximum disk storage capacity (one disk pack) is 7,250,000 alphabetic characters or 14,500,000 numeric digits. The third IBM 360/System installed in February, 1968 is equipped with three disk storage units. Regarding Operating speeds, the disk storage can transfer data between the disk storage unit and the central processor at the rapid rate of 156,000 alphabetic characters or 312,000 numeric digits per second. Access time to locate starting point is 85 milliseconds. One cartridge of hypertape can contain, as maximum storage capacity, 65,275,200 alphabetic characters or 13,550,400 numeric digits. This is equivalent to 24,176 taxpayer accounts containing a full three-year record. It is also equivalent to 1,613,880 fully punched numeric 80- column cards. Regarding operating speed, hypertape reads and writes 340,000 alphabetic characters or 680,000 numeric digits per second. This is equivalent to reading or writing 125 taXpayer accounts containing a full three—year record in one second. Regarding maximum storage capacity of reel-type tape, one tape reel can contain 23,040,000 alphabetic ] :7! Y~ ac Q‘b '4 A. "e 97 characters or numeric digits. Operating speeds of reel- type tape units permit the reading and writing of 90,000 alphabetic characters or numeric digits per second. IBM 7074/Systems There are two IBM 7074/Systems with 30K at the National Computer Center and three IBM 7074/Systems with 20K at the Data Center in Detroit. The 30K Systems have ten Hypertape and seven reel-type tape units attached. They are also equipped with a console typewriter which serves as a communication link between Operator and system. The memory component has a maximum storage capacity Of 30,000 ten-position words which can contain 150,000 alphabetic characters or 300,000 numeric digits. Regarding Operating speeds, the central processor can add two nine- digit numbers yielding a ten-digit result 125,000 times a second. Maximum storage capacity of one cartridge of Hyper- tape is 32,637,600 alphabetic characters or 65,275,200 numeric digits which is equivalent to 12,088 taxpayer ac- counts containing a full three—year record. Regarding Operating speeds, Hypertape reads and writes 170,000 alpha- betic characters or 340,000 numeric digits per second. This is equivalent to reading or writing 63 taxpayer ac- counts, containing a full three-year record, per second. 5‘ “H i...‘ is 98 The maximum storage capacity of one reel Of reel- type tape and Operating speed Of reel-type tape units are the same as that cited above under the IBM 360/Systems. The IRS Data Center at Detroit has three IBM 7074/ Systems of 20K, with ten tape units attached. They are also equipped with a console typewriter which serves as a communication link between the operator and the system. The maximum storage capacity of the memory in this 20K system consists of 20,000 ten—position words. It can hold 100,000 alphabetic characters or 200,000 numeric digits. The Operating Speed of the central processor per- nuts the addition of nine-digit numbers yielding a ten-digit result at the rate of 125,000 times per second. The maximum storage capacity Of the tape units (one tape reel) is 23,040,000 alphabetic characters or numeric digits. Operating speeds of the tape units permit reading and writing at the rate of 60,000 alphabetic char- acters or numeric digits per second. Honeywell H-200 Systems Each one of the seven Service Centers as well as the IRS Data Center at Detroit and the IRS National Office at the Pension Building in Washington, D. C. have a Honey- well H—200 Main Processor System (24K), with five tape Innis, one printer and one card read/punch unit attached. The maximum storage capacity of the memory component in S. b a: 5|. w' v. c“ 99 this system is 24,000 alphabetic characters or numeric digits. Regarding Operating speed, the central processor in this system can add two nine-digit numbers yielding a ten-digit result 14,705 times per second. The maximum storage capacity of the magnetic tape units, for a one tape reel, is 23,040,000 alphabetic char- acters or numeric digits, which is equivalent to 288,000 fully punched 80-column cards. Operating speed of the magnetic tape units permit reading and writing of 64,000 alphabetic characters or numeric digits per second. Input cards are read at the rate Of 800 cards per minute or 48,000 per hour. Cards are punched at the rate of 250 cards per minute or 15,000 per hour. Printing is at the rate of 900 lines a minute, with 132 characters per line, or 118,800 characters per minute. Each of the seven Service Centers has one, while the IRS Data Center at Detroit has two Honeywell H-200 Input/Output Processor Systems with 20K, which have two magnetic tape units, one printer and one card read/punch unit attached. One of the 12K systems in the IRS Data Center at Detroit is equipped with two printers. The maximum storage capacity of the memory in this system is 12,000 alphabetic characters or numeric digits. The Operating speed of the central processor permits the addition of nine-digit numbers yielding a ten-digit result at the rate of 14,705 times per second. AU .«ka. A" Vs 100 The maximum storage capacity of the magnetic tape units (one tape reel) is 23,040,000 alphabetic characters or numeric digits, which is equivalent to 288,000 fully punched 80-column cards. Operating Speeds of the magnetic tape units permit reading and writing of 28,800 alphabetic characters or numeric digits per second. Input cards read at the rate Of 800 cards per minute or 48,000 per hour. Cards are printed at the rate of 900 lines a minute, with 132 characters per line, or at the rate of 118,000 char- acters per minute. Microfilm Printers The National Computer Center at Martinsburg, West Virginia has two Stromberg Carlson Microfilm Printers. This is a system composed of a magnetic tape unit, a high- speed camera, and a cathode ray tube. A polaroid camera is also attached to photograph test frames. Pertinent operational facts concern capacity of frames and reference lists. Capacity of each frame fully recorded is 76 lines Of information, each line consisting of 135 characters and control symbols. Capacity of total characters on one frame is 10,260. A frame measures 1/2" x 1/2" which means that one frame is equivalent to 135 fully punched 80-column cards or 13.5 inches of reel-type magnetic tape. 101 When fully operational in 1967 the entire year's reference lists will be printed by microfilm system in about 1,777 hours on 600,000 feet, or 114 miles, of film. TO print the same data on hard copy (paper) would require 26,666 hours and 14.6 million feet (2,777 miles) of paper. To record the equivalent amount of information (155,520,000,000 characters) on reel-type magnetic tape, would require 6,750 reels or 3,069 miles of tape. Expectations of the Automated FederaI_Tax System Certain broad objectives were anticipated from the planned application of automatic data processing techniques to taxes which featured a National Computer Center and utilized the novel master file concept, taxpayer-identifi- cation number System, consolidated taxpayer accounts, and centralized processing. The following is the original list Of objectives that were expected to be achieved in the enforcement and revenue—producing Operations of the Internal Revenue Service: 1. Systematic check on failure of individuals and business entities to file returns. 2. Verification of mathematical accuracy of returns filed and computation Of tax or refunds due. 3. Determination Of taxpayer indebtedness for prior year taxes of all types prior to issuance of a current refund, and identification of duplicate refunds. ' 102 4. Provision for a consolidated tax account for each taxpayer that will reflect current tax status at any given point in time. 5. Matching of data reported on information documents with corresponding data on taxpayer returns. 6. Classification of returns for audit purposes. 7. Preparation of management, operating and statistical reports.47 These Objectives cite advantages of the system to the Government. They are expected to plug tax loopholes and solve some of the pressing problems that have plagued the IRS. Direct benefits of the automated Federal tax system to taXpayers are expected. They can be cited as follows: 1. Refunds processed quicker. 2. Mobile taxpayers who move without leaving a for- warding address can have their tax return refund checks forwarded properly through number identity in updated master file. 3. Identifying numbers assure authentic credit to prOper accounts and not to taxpayers Wlth same or similar names. 4. Repetitive requests for same information from tax- payers eliminated by updating of accounts. 47Dana Latham, 1960 Annual Report of Commissioner 0f Internal Revenue, Internal Revenue Service, Department C> the Treasury, Publication Number 55 (Washington: Gov- ernment Printing Office, 1960), pp. 31-32. Mr. Latham was Commissioner of the Internal Revenue Service from November 5, 1958 to January 20, 1961. The dramatic ADP Plan was Emomulgated during this period. 103 5. Conscientious taxpayers assured that total tax burden is fairly distributed by the system which identifies those who seek to evade their lawful Obligations. These objectives, which are benefits to both the Government and taxpayers, can be used as criteria by which to judge the effectiveness of the operations of the entire system after it has had a year or two of nationwide exper- ience with all facets completely developed and fully opera- tional. Theoretically, it appears to be a Significantly improved system for efficient tax administration and for inspiring voluntary compliance with and confidence in Federal tax laws. Results of operations and anticipations for the future regarding the automated Federal tax system are taken Up in the next chapter. 48Sheldon S. Cohen, 1965 Annual Report 0: the Com- Hussioner of Internal Revenue, Internal Revenue ervice, [L S. Treasury Department, Publication No. 55 (Washington: Government Printing Office, 1965) , P- 15- CHAPTER III THE EFFECTS OF THE APPLICATION OF COMPUTERS IN THE TAX-COLLECTING ACTIVITY OF THE INTERNAL REVENUE SERVICE This chapter considers the effects of the appli- cation Of computers in the tax-collecting activity of the IRS. The impact of computers on the results of operations is traced by fiscal years through (1) the phase—in period (1962 through 1966) of computer installations at the re- gional service centers and (2) the first two years (1967 and 1968) of the four-year phase-in period for direct filing Of returns with the service centers. An evaluation Of the system is included along with future plans. Results of Operationsby Fiscal Years Which End June 30 1252 Results The year 1962 was a memorable year for the IRS in at least two important respects: (1) it was the year nmrking a century of Operations--its 100th birthday, and (2) it was the first year modern high-speed computers be- gan on a limited basis to process tax returns. 104 105 The first year of a five-year phase-in period for the installation of a nation-wide network of computer systems began in 1962. Some of the significant high- lights of this first year of the implementation of the ADP Plan were, as follows: 1. Establishment of the Office of Assistant Commis- sioner, Data Processing, 2. Completion of systems design and programs for processing business returns, 3. Completion of the National Computer Center at Martinsburg, West Virginia,_and the new Atlanta Regional Service Center building, 4. Activation of the Philadelphia Regional Service Center, 5. Processing of business returns in the Atlanta Regional Service Center and the National Computer Center, 6. Initiation of systems design for processing in- dividual returns, 7. Selection of sites for the Dallas, Cincinnati, and Omaha regional service centers, and 8. Continuation and improvement of the plan for personnel redeployment. The Master File had its inception in 1962 when the pilot Southeastern Region's Service Center began pro- cessing corporation income tax returns along with certain . 1Mortimer M. Caplin, 1262 Annual Report of Com- nussioner of Internal Revenue, Internal Revenue Service, 0} S. Treasury fiepartment, Publication Number 55 (Wash- lngton: Government Printing Office, 1962), p. 25. a; rm (1 106 employer and excise tax returns. The Business Master File (BMF) was the first segment of the Master File to be acti- vated. "This major effort required the completion of sys— tems development, computer programming, and necessary testing to assure proper systems performance and involved the combined team work of over 100 digital computer sys- tems analysts and programmers.2 Systems development progressed on schedule for the activation of the Individual Master File (IMF) seg- ment of the Master File next year, 1963, in the pilot Southeastern Region's Service Center. 1963 Results A new high of 105.9 billion dollars was collected in the fiscal year of 1963. This new record was an in- crease Of 6.5 billion dollars over the previous year and represented the first time United States revenue collec- tions exceeded 100 billion dollars. There are definite indications that substantial improvements in voluntary compliance contributed to the sharp rise in internal revenue collections . . . the conversion to Automatic Data Processing had a salutary effect on taxpayers who had not been measur- ing up to their tax responsibilities. During the year many taxpayers came into district and local Offices to voluntarily disclose unreported income, pay prior years taxes, and state that they wanted 2Mortimer M. Caplin, 1963 Annual Report, p. 15. .ulu IE NU. kw n... S .. I \ ., . I4 .\.\I I O‘NIK 107 to get their taxes current before ADP was fully implemented.3 In 1963 the Master File at the NCC contained the accounts of business entities in the BMF for only the Southeastern and the Mid-Atlantic regions and the ac- counts of individual taxpayers in the IMF for only the Southeastern Region. The Southeastern Region, the pilot region, became fully automated with both the BMF and the IMF for its area activated. In the Spring of 1963 a computer took its first look at the magnetic tape record of seven million indi- vidual tax returns from the seven states comprising the Southeastern Region. The sensors Of this giant computer immediately detected a case where a taxpayer had filed seventeen different tax returns on which he claimed a refund from each.4 This was the first big fraudulent refund returns case that develOped from the use of com- puters. The taxpayer involved was sentenced to the Fed- eral peniteniary at Atlanta for fraud. Under the Old, nmnual methods, such duplicate refund cases were diffi- cult to detect, but with the computer system's Master 3Mortimer M. Caplin, 1963 Annual Report, p. 8. 4Mortimer M. Caplin, "The Taxpayer-Identifying Number System: The Key To Modern Tax Administration," American Bar Association Journal, XLIX, No. 12 (December, IPO 0 108 File, the duplicate returns problem was on the way to being solved. Even in the short span of its Operation, and with its limited application, the system has demonstrated its capabilities and worth in the way of protecting the revenue and insuring fairer distribution of the tax burden. This has been accomplished by detecting failures to file required tax returns, detecting in- stances Of multiple filing of overpayment returns by the same taxpayer, and mechanically applying overpay- ments, otherwise refundable, against outstanding taxes due from the claimants. 6 1964 Results Eight million individual returns and declarations of estimated tax from the Southeastern Region were pro- cessed through the computers, which picked up five million dollars in collections by detecting mathematical errors and other mistakes. Computers detected mathematical errors at the rate of one out of every eight returns they checked, which was three times as many as human beings were finding. 5Mortimer M. Caplin, 1963 Annual Report, p. 15. 6Sources of 1964 results were the following: Shel- don S. Cohen, "New Tax Collector Tells His Goals," Nation's Business, LIII, No. 4 (April, 1965), p. 78; "When Machines ec on Taxes," U.S. News and WOrld Report, LVIII, NO. 16 (April 19, 1965), pp. 103-04?:“When The Machines Get Your Tax Return," U.S. News and World Report, LVIII, NO. 16 (April 26, 1965), p. 110; Bertrand M. Harding, 1964 Annual Eeport of Commissioner of Internal Revenge, Internal Reve- nue Service, U. S. Treasury Department, Publication Number 55 (Washington: Government Printing Office, 1964), p. 12, Thu Harding was Acting Commissioner from July 11, 1964 to January 24, 1965. 109 Serious errors and evasions were detected by the computers which permitted the imposition of additional tax assessments. These extra assessments in the South- eastern Region, where the computers were in full Opera— tion for both the IMF and the BMF, increased 25% in 1964 compared with a 9% rise in the rest of the country. Three hundred thousand tax evaders who failed to file returns were uncovered. $2.6 million in duplicate refunds were avoided in 1964. Three fraud cases involv— ing multiple refunds resulted in convictions. Cross- checking by taxpayer number of current returns showing refund claims with back taxes owed for earlier years re- sulted in the offset of $16.7 million and saved the IRS from paying refunds and then recollecting back taxes from those to whom refunds were made. On returns filed in 1964, individual taxpayers reported two billion dollars more interest income than in 1963, an increase of twenty-eight percent over the previous year. Also, the number of taxpayer returns showing inter- est income increased 45 per cent. The number of taxpayer returns reporting dividend income increased twenty per cent in 1964 over 1963. There was also a sharp increase in the dollars amount of dividend income reported in 1964 compared to 1963 for individuals. Many taXpayers came forth and volunteered, in anticipation of being detected by the new computer system, 110 to report some of their earlier income that they had neglected to report. $4.8 million of back taxes came in from 1962 through 1964 from such people. Business returns from the Southeastern, Middle— Atlantic, Central, and Southwestern Regions, representing half the nation, were processed. From the eight million business returns filed and run through the BMF, the com- puters turned up 185,000 delinquency leads which resulted in $30 million additional taxes. Other developments regarding the computer system in 1964 were reported by Mortimer M. Caplin, the Commis— sioner Of Internal Revenue, as follows: . . . Significant savings in computer processing time were realized by Splitting the IMF into active and inactive accounts for each weekly posting cycle. The necessary systems redesign and computer repro- gramming is being completed so that this principle can be applied to the BMF in 1965. Preparations are nearing completion for a test to be conducted involv- ing the use of government telephone lines for the transmission of master file input and output data between NCC at Martinsburg, West Virginia and the seven service centers. If this test proves success- ful, when installed, this process will eliminate numerous shipments of magnetic tape. 12§5 Results8 A record 114.4 billion dollars were collected in 1965, despite tax rate deductions made effective during n—‘; 71964 Annual Report, p. 12. 8Sources of 1965 Results are as follows: "Com- Puters Get Results on Taxes," U. S. News and WOrld Report, LX, No. 6 (February 7, 1966), p. 82; "Computers Spotting 111 the years. An all-time high Of 102.5 million tax returns were filed. Three hundred and forty million information returns were received. An important milestone in the ADP Plan was reached on January 1, 1965. In 1965 all business returns from every part of the nation were processed by computers for the first time and recorded in the Business Master File at the National Computer Center. One of the big features of the ADP System is that it identifies taxpayers who do not file their returns. Under ADP, the delinquency check is performed by comparing the recorded returns filed against the filing requirements in each taxpayer's account in the master file . . . . Results of the BMF check for 1965 are as follows: Number of notices of nonreceipt issued... 1,011,366 Number of delinquent return investiga- tion notices issued.................... 583,749 Number of delinquent returns secured..... 396,915 Dollar value of returns secured..........$83,289,000 9 After the computers identify nonfilers and delinquents and they do not respond to notices, their cases are turned over to the enforcement personnel, who use legal procedures to keep the inventory Of delinquent accounts at a minimum. A delinquency check by computers in the South- eastern region detected fourteen thousand individual tax ——k False Tax Returns," U. S. News and WOrld Report, LX, No. 14 (April 4, 1966), p. 99. Sheldon S. Cohen, 1965 Annual Egmort of Commissioner of Internal Revenue, pp. - . 9Sheldon S. Cohen, 1965 Annual Report, p. 15. 112 evaders who failed to file returns and revealed the need to investigate 80,000 additional cases. In the Southeastern and the Middle-Atlantic Re— gions, the only two regions processing individual returns by computers through the IMF in 1965, 75,000 cases of multiple refund claims by individuals were detected. The Middle-Atlantic region, with service center headquarters in the city of Philadelphia, was phased into the IMF in 1965. That year a duplicate returns case involving three people who had filed twenty-five returns claiming refunds totaling thousands Of dollars led to indictments against the trio in California. The point being made here is that, with the Master File, mobility of taxpayers among regions is no longer a problem in detecting duplicate filers and then finding them to impose sanctions of the law on them for their violations. IRS Officials cited other cases as examples of tax fraud uncovered by computers. An accountant tax evader with annual income ranging from $25,000 to $35,000 had not filed any returns since 1957. Another taxpayer had been reporting earnings of $3,000 to $4,000 on his returns, but when his returns were matched with informa- tion returns filed by corporations, additional unreported dividends income of $20,000 was revealed. A businessman earning a salary of $10,000 and holding a stock paying dividends of $10,000 evaded taxes by not filing a return, VFL .‘IU 113 but cross-matching by the computers revealed his viola- tion. Mathematical errors detected and corrected in 1965 benefited both taxpayers and the Government. On this point Commissioner Cohen said, The mathematical verification of 62.9 million tax returns disclosed 3.9 million errors in computa- tion of tax, an increase of 49 per cent over last year. The tax increase resulting from mathematical verification was $194 million, while the tax decrease was $94 million--a net recovery of $100 million. This net yield was less than eight per cent above the 1964 yield principally because 75 per cent of the additional errors detected involved returns in which the taxpayer overstated his tax liability. In de- tecting and correcting these errors it was found that the primary cause for the overstatement of tax lia- bility was that taxpayers were not taking advantage Of their right to use the standard deduction provid- ing them the greatest tax advantage. This was probably due to the minimum standard deduction being availablf for the first time with respect to 1964 returns. 0 Important benefits Of mass document processing through the medium of ADP with high-speed computers began to appear and be crystalized in the Service Centers where computerization took place. These were as follows: (1) rapid identification Of nonfilers, (2) prevention of duplicate refunds, (3) complete verification of estimated tax credits, and (4) identification of taxpayers who underpaid their estimated taxes. 101965 Annual Report, p. xiii. . flu 114 Major management improvements by the IRS contri- buted substantially to cost reduction, which added up to $17.1 million in fiscal 1965. Some examples of ADP sys— tem changes made were, as follows: 1. A new system which transfers data directly from magnetic tape to microfilm has been adopted for production of final printed computer outputs such as indexes and settlement registers for use in district Offices and service centers. The small volume of microfilm contrasts sharply with the great volume of paper outputs previously neces- sary. Savings in manpower (four man-years), space, paper, and computer printout time are esti- mated at $298,700 annually beginning in 1966. A computerized tape library system was devised which enabled the Service to defer additional tape purchases estimated at $303,000. Simplified key punching procedures resulted in first year savings of 136 man-years and $542,800 during fiscal 1965. Purchasing rather than leasing computers and certain other ADP equipment was found to be to the Government's advantage. Nonrecurring savings to be realized through this change are estimated at $1 million over the next three years. Issuance by service centers of follow-up notices on individual income tax accounts completes the mechanization of all major collection notices to the taxpayer. This change-over will result in savings of 128 man-years and $587,000 in fiscal 1966 and ensuing years. Consolidation of New York and Northeast Regions into the North-Atlantic Region.11 The 3.5 million returns examined (audited) in fis- cal 1965 represents a four per cent decrease from 1964 g; 11Henry H. Fowler, 1965 Annual Report of the Secre- tary of the Treasury, Treasury‘fiepartment, Document No. 3236 was ington: Government Printing Office, 1966), pp. 115-16. 115 which was caused by a continuation of the "cutback planned in fiscal 1963 to provide a more balanced program by shift- ing emphasis from the examination of low income nonbusiness returns to that of higher income nonbusiness returns and small business returns."12 The exempt organizations audit program has been expanded in recent years. Specialized training programs and special studies have been developed in this area. A master file of exempt organizations has been established and ADP processing techniques are being applied to this . . . 13 area in order to improve compliance. 1966 Results The fiscal year 1966 reflected a pattern of con- tinued growth in the national economy, tax returns pro- cessed, and dollars of revenue collected. A record number Of 104.1 million tax returns was filed and processed. Gross internal revenue collected jumped sharply to a new record of 128.9 billion dollars. Refunds, including in- terest, increased to a new record of 7.3 billion dollars. The gradual conversion of IRS to automatic data Processing of individual income tax returns remained on schedule. The Southwest, Central (except Michigan), and 12Ibid., p. 122. lBIbid. C.; 116 Western (except California) Regions were successfully in- troduced into the individual master file operation in the year 1966. Remaining regions to be phased into the IMF Operation next year were the Mid-West and North-Atlantic Regions and the States of Michigan and California. On January 1, 1965 the BMF had become operational nationwide, with all regions phased-in. The planned schedule called for the ADP system to be completely Operational by January 1, 1967. The master file continued its healthy growth in 1966. The BMF went from 5 million accounts at the close 14 Of 1966. Operations in 1966 increased the IMF accounts from 17.8 to 36.9 million.15 Employee redeployment in the district offices re- sulting from implementation of the ADP plan was handled smoothly. The Civil Service Commission helped minimize the impact on employees in this extensive conversion Program. . . . Permanent staffing in the district office re— turns processing function was reduced from apprOXi- mately 12,000 in 1960 to 4,300 in June, 1966, a net reduction of some 7,700 positions. This has been accomplished without once resorting to involuntary . l4Sheldon S. Cohen, 1966 Annual Report 0: Com- mlSSioner of Internal Revenue, Internal Revenue erVice, ETTE—TEEasury Department, Publication Number 55 (Wash- 1ngton: Government printing Office, 1966), p. 15. 15Ibid. 117 separation or transfer. All placements were on a voluntary basis, and the majority were made within the employees' own district Offices. Present plans call for about 1,800 employees to remain at the end of conversion. The IRS Data Center at Detroit opened as planned on January 1, 1966. Its purpose was to relieve Regional Service Centers of certain activities. All data process- ing activities in the Service Centers not directly related to the ADP master file began shifting to this Data Center in Detroit. There were many improvements in tax administration due to the ADP system. Programmed delinquency check—ups were designed to collect past-due taxes and identify non- filers. Delinquency checks performed in 1966 involved the mechanical comparison of data in the taxpayer accounts located in the master file at the NCC. Recorded returns that were filed were compared with the filing requirements in each consolidated taxpayer account in the BMF only, as the IMF was not yet fully Operational. . . . Results are shown below for the BMF check in 1966, when all seven regions were included, com- pared to 1965, when only four regions had been under the BMF for sufficient time to permit this check: 1965 1966 Number of notices of non- receipt issued 1,011,366 1,981,872 . l6Sheldon S. Cohen, 1966 Annual Report of Commis- EAQner of Internal Revenue, Internal Service, U:_§: Treasury Department, Publication Number 55 (Washington: Government Printing Office, 1966) , p. 16. “UL 118 1965 1966 Number of delinquent return investigation notices issues 583,749 1,005,723 Number of delinquent returns secured 396,915 777,624 Dollar value of returns 17 secured $83,289,000 $171,077,000 A computerized delinquency check of individuals was performed for the Southeastern Region in 1965. This examination uncovered thousands of cases in which tax- payers had been depriving themselves of millions of dol- lars in legitimate refunds by failing to file tax returns. Mathematical verification by computers was applied to all the high-volume business returns filed in the nation. The mathematical verification process was also applied to individual returns filed in the five regions having all or part of such returns processed by computers. The computers performed a more comprehensive mathematical verification of Form 1040 than manual methods. All esti- mated tax credits claimed by individuals were verified by computers in the Southeast and Middle-Atlantic Regions. These verifications were estimated to have yielded about 19.1 million dollars18 in additional tax revenue that would not have been produced without computers. Computers were used to calculate net refunds; that is, to check on outstanding accounts before making l7ibid. 119 any refunds. Figures Show that the ADP system has been effective in identifying old unpaid taxes before permit- ting current refunding of overpayments to taxpayers. "In fiscal year 1966, overpayments numbering 291,863 and amounting to $58.7 million were offset against tax lia- bilities for the same taxpayer."19 ADP ended the problem of duplicate refunds. Many taxpayers with honest intentions had filed during one year more than one refundable income tax return, because they had worked at more than one place. Under the old manual system, there was a considerable lag between the time the refunds were made and the duplication "errors" were detected. Recovery of the money at a later date was Often very difficult and eXpensive. Under the new ADP system, duplicate returns requesting refunds can be detected before refund checks are issued. “This system resulted in over $6 million in additional revenue in the calendar year 1965 in the two regions using ADP procedures for processing individual returns."20 Research continued on the optimum use of informa- tion returns. Tests conducted on the matching of infor- mation documents with self-assessed tax returns were fruitful. They revealed the following: __¥ 19Sheldon s. Cohen, 1966 Annual Report, p. 17. zoIbid. 120 Apparent Law Violators in Additional Taxes the Southeastern Region Number and Penalties21 1963 Nonfilers............ 1,699 $150,000 1963 Underreporters....... 1,513 193,000 1962 Delinquents.......... 372 72,000 1963 Frauds............... 3 132,000 1963 Frauds............... 3 Under Investigation In Southwestern and Mid- Atlantic Region 1964 Delinquents.......... 11,000 478,000 ADP scrutinized all tax returns in making audit selections. Computers enabled a systematic and rapid screening of tax returns for selection of those with characteristics of tax error. . . . For this purpose audit selection criteria are programmed into the computers at the service cen— ters and the National Computer Center. The computers are also programmed to pass over the returns Of tax- payers where seemingly questionable issues have been examined for the immediately preceding year and found to be acceptable. This means that generally a tax- payer will not be contacted from year to year for the same reason, a consideration of no small consequence in reducing annoyance to the public. It means also that audit can be extended to cover other taxpayers whose returns may not have been selected for audit because of manpower limitations. The classification and selection of returns for examination was only the starting point. Manual screen- ing was required after computer selections in order to achieve a manageable audit workload. Using both manual 21Ibid. 22Sheldon S. Cohen, 1966 Annual Report, p. 17. In. S! A—b ‘L£.$KI 121 and machine methods, 18.2 million returns were classified as audit candidates and 2.9 million of that number were selected for examination.23 Optional filing of returns with Regional Service Centers was popular in the Southeastern and Mid-Atlantic Regions. This centralization saved costs for sorting, packing, and shipping functions at the district offices 24 estimated at $50,000 for 1965 and $113,000 for 1966. ADP resulted in increased voluntary compliance, according to the Commissioner. Because of the difficulty of determining motiva- tion, no accurate measurement can be made of the amount of revenue realized from taxpayers who have filed delinquent or amended returns because of a fear of being caught through ADP. There are good reasons to believe, however, that many millions of dollars in previously unreported taxes have been realized from taxpayers who have specifically indi- cated that they were filing delinquent or amended returns because of fear of detection by the ADP system. Tangible results of the ADP system as it shifted into second gear began to crystalize in 1966. Definite points of improvement in tax administration continued to appear. The list of improvements showed that l. ADP identified nonfilers, 23ibid., p. 22. 24Ibid., p. 17. 1966 Annual Report, p. 20. 25Sheldon S. Cohen, 122 ADP verified arithmetic on returns, ADP calculated net amounts before refunding, ADP stopped duplicate refunds, ADP matched information documents with returns on a limited basis to reveal apparent a. nonfilers, b. underreporters, c. delinquents, d. frauds, ADP scrutinized all returns in making audit selec— tions, ADP saved costs by centralization of filing in service centers, ADP resulted in increased voluntary compliance. Major management improvements by the IRS contri- buted toward the efficiency of programs and operations to the extent of tangible savings amounting to $14.4 million in fiscal 1966. Some examples of changes made which related to.ADP were as follows: 1. 2. Automated data processing programs are used to identify income tax returns having characteris- tics that indicate audit potential. identification of returns saved approximately 13 technical man-years or $102,000, in fiscal 1966, and further savings are expected in fiscal 1967 when the program is scheduled to become opera- tional nationwide. The computer A two-part "piggyback" mailing label was distri- buted with form 1040 individual income tax returns and form 1120 corporate income tax returns this year. Experience this year in two regions W. “6 IL\ ~\v nu. . \III .. ,... \ EV. 123 indicates a 51 percent usage of the label, which contributed to faster and more accurate proces- sing of returns and substantial manpower savings. 3. The option Of filing returns claiming refunds direct with the service center, which was tried in the Southeast region in fiscal 1965, was ex- tended to the Mid-Atlantic Region in fiscal 1966. Over 80 percent of the overpayment returns in each region were directed by taxpayers to the service center, eliminating the need for the Service to sort, pack, and ship these returns from district Offices, to service centers. Sav- ings to the Government in fiscal 1966 were esti- mated at $113,000. The Option will be extended to additional regions in fiscal 1967. 1967 Results Tax returns, collections, and refunds were pro- cessed faster and more accurately than ever before in 1967. This progress was due to the fact that the com— puter system became fully installed in all regions of the nation. Commissioner Cohen said, Culminating 6 years of intensive effort, a major event in the annals of tax administration occurred when the automated Federal tax system became a national network on January 1, 1967. By bringing computers with all their capability and versatility into our administrative structure, the Service is equipping itself to cope with a workload that is constantly growing and tax laws that are ever chang— ing and increasing in complexity. 26Henry H. Fowler, 1966 Annual Report of the Secretar of the Treasur , Treasury Department (Govern- ment Printing Office: Washington, 1966), p. 120. 27Sheldon S. Cohen, 1967 Annual Report of Com- udssioner of IpEernal Revenue, Internal Revenue ServiEe, [L S. Treasury Department, Publication No. 55 (Government Printing Office: washington, 1967), p. v. “H“ “in.“ IAN“ “U C wilt. 124 Highlights of IRS operations for the fiscal year 1967 were as follows: 1967 Operations Highlights28 2 MILLIONS Percent 1966 1967 Change Item Gross Collections $128,880.0 $148,374.8 15.1 Refunds: Number 45.1 49.0 8.6 Amount $ 7,314.6 $ 9,630.9 31.7 Returns Filed 104.1 105.4 1.3 Returns Examined 3.5 3.1 -10.7 Additional Tax From En- forcement $ 2,862.8 $ 2,729.4 - 4.7 Delinquent Taxes Collected, Total $ 1,309.7 $ 1,550.0 18.3 The first high point in the phase-in period for computers was reached January 1, 1965 when the first seg- ment of the master file became fully operational. The Business Master File (BMF) became nationwide in scope. The second milestone was achieved January 1, 1967 when the other (IMF) larger segment of the master file was completed. In 1967 the Individual Master File (IMF) coverage became nationwide by the phasing in of the Mid- west and North-Atlantic Regions, Detroit, Los Angeles, and San Francisco Districts. Individual income tax re- turns and accounts from the Office of International Opera- tions (OIO) were scheduled to enter the system in 1968 to achieve complete coverage. The computer system made a new deposit procedure Possible in 1967 for direct payment of corporation #— 28Ibid., p. 1. H1 0—3 rr 3‘ '(1 (.3 In 125 estimated income tax payments. Plans call for this new method to be extended to other business tax payments in 1968. Payment is required to be made directly to Federal Reserve Banks or member banks. As part of the procedure, taxpayers are provided with preaddressed punch cards which are completed and submitted with payments when due. Federal Reserve Bank deposits remittances to the Treasurer's account and forwards the punch cards to the Office of the Treasurer, where the data are transcribed to magnetic tapes which are forwarded to the National Computer Center. At the NCC the data on these tapes showing taxpayers' de— posits are reconciled with amounts claimed as prepayments on returns. This type of procedure may conceivably be applied to individuals in the future. Advantages of this method are: l. accelerated deposit to Treasury's account in Federal Reserve Banks, 2. taxpayer relieved of requirement to attach vali— dated receipts to tax returns, 3. new deposit form simplifies bank processing, and 4. procedure eliminates several processing Opera- tions (like tel§er) in service centers and thus saves manpower. 9 Transfer of necessary data to the ADP system was achieved. Complete transfers of non-master file data and Programs formerly asigned to regional service centers were 29Ibid., p. 63. .{3 "1 126 made to the Data Center at Detroit. Everything in the nature of taxpayer correspondence and adjustments rela- tive to both segments of the master file accounts and tax returns were processed in the Regional Service Cen— ters. Tax returns were selected for audit examination by computers on a nationwide basis using ADP programmed criteria. "To reduce manual processing of prior-year delinquent accounts all business taxpayer Open accounts from 1962 and individual accounts from 1963, are incor— porated on the master files and processed under ADP procedures."30 To sum up, the step-by-step phasing in of the installation of the ADP Plan was completed in 1967 on schedule and without major interruptions or uncon- querable difficulties. Enabling legislation to achieve direct filing of returns with the service centers was passed but optional direct filing of refund returns for individuals was ex- tended in 1967. Public Law 89-713, enacted on November 2, 1966, authorized the Internal Revenue Service to require taxpayers to file their returns directly with ser- vice centers. Prior to this, such filing was Optional. The change in filing requirements will be introduced gradually with total installation scheduled for 1970.31 30Ibid., p. 20. 31Ibid., p. 20. 127 Optional direct filing of refund returns was planned to be extended in 1968 to all regions. However, mandatory direct filing of Forms 1040 and 1040A were planned to be- gin for 1968 in the pilot Southeastern Region. Direct filing of selected business returns, such as Forms 941, 720, CT-l, CT-Z, was made mandatory in the pilot Service Center at Chamblee, Georgia. Direct filing will continue to be extended to other regions and other tax return forms gradually up to 1970 when complete nationwide direct filing of all returns in all regions will be mandatory. Computerized Operations on a nationwide basis in 1967 greatly facilitated efficiency in the collection and the enforcement activities of the IRS as follows: 1. ADP verified taxpayer arithmetic, 2, ADP verified estimated tax payments, 3. system helped identify nonfilers, 4. enabled unpaid liabilities to be deducted from refunds due, 5. caught refund duplicated before issuance of check, 6. information document matching extended to detect delinquents, 7. selections for audit facilitated by ADP.32 The IRS continued to make significant changes which contributed to progress in cost reduction and ¥ 321bid., p. 20. management improvements. Of $16.5 million were reported by the Service. 128 During fiscal 1967 record savings Some examples Of changes made that involved ADP were as follows: 1. Many refund checks mailed to taxpayers are unde- liverable because the taxpayer moved and did not notify the Post Office or the Internal Revenue Service of his change of address. These checks are returned to the Service. Prior to fiscal 1967, undeliverable checks were redeposited to the taxpayer's account pending receipt of a change of address. In March 1967 a new procedure was begun which delays the redeposit of undeliverable checks. This results in savings for the Govern- ment by avoiding the costly process of reissuing checks and improves service to the taxpayers by making checks immediately available for issuance upon receipt of a change of address. The two-part "piggy-back" mailing label, used in two regions for the tax year 1965, was extended to three additional regions for the 1966 tax year. Use of the preaddressed label helps prevent errors, speeds up processing, and contributes materially to keypunch savings. Before the Service authorizes a refund for an overpayment of tax, the taxpayer's account is searched, by computer, for any unpaid liabilities. If any are found, the overpayment is appropriately applied and any remainder refunded. This capabil- ity, which could not be applied economically under manual methods, has permitted the Service to amend some of its procedures for collecting past-due accounts. The minimum dollar value of a past-due account which is required before manpower is as- signed to its collection has accordingly been raised, reducing the number of small accounts which require expensive collection action. It should be noted that past—due accounts will be accumulated from year to year, and once the minimum dollar value is exceeded, manpower will be asgigned to the collection of taxes and interest owed. 3 3Henry H. Fowler, 1967 Annual Report of the Secre- .EE§L£ELEEE_$£§E§E%X, Treasury Department (Government ffice: ashington, 1967), pp. 100-101. Printing 0 129 Tax audit activity was expanded on the larger and more complex returns. Revised demands on tax administra- tion, due to the fact that the complex to simple returns ratio has been rising, caused this shift. "Continued high-quality audits plus shifts in audit concentration to larger cases resulted in additional tax recommendations Of $3.3 in fiscal 1967."34 A 22 percent reduction in the inventory of individual and corporation Older year returns awaiting field audit was achieved during the past two "This more current inventory helps reduce the years. number of requests to extend the statute of limitations, enables taXpayers to know the status of their Federal tax accounts earlier, and reduces the accumulation of interest due on both assessments Of additional taxes and on refunds of overassessments."35 The application of team audit techniques has helped reduce the backlog of Older returns in the In view of the large corporate tax return area. tremendous growth in the size, number, and complex- ity of large corporations since WOrld War I the assignment of one man per case was no longer realis- The new large case audit program applies the tic. concept of a carefully planned, highly coordinated audit using a team approach, with each agent given specific assignments according to a formal overall Since its inception in July 1966, examination plan. this program has been successful in improving the quality of large case audits, obtaining better uni- gglution, fbrmity of issues raised as well as their re and shortening the time span of examination. 34Ibid. , p. 105. 351bid. 351nm. , p. .106. .1: >s r\ «\s ~-¢ an» 130 A new policy was established for retaining master file data. Data was retained in the master file for three years under the Old policy. Under this new policy, brought about as a result of a cost-benefit study, 1. tax settlement data will be retained for 27 months beyond the posting date of the transaction that brings the tax account to a zero balance or re- leases it from any prior hold placed on the ac- count, and 2. tax base data will be removed from master files annually after completion of scheduled computer runs for Service programs. 1968 Results The workload of the IRS in terms Of volume during the fiscal year of 1968 reflected the expanding economy Of the nation. The following highlights Of 1968's opera— tions show that last year's records were exceeded in several areas: 1968 Operations Highlights38 Millions Percent Item I967 1968 Change Gross Collections $148,374.8 $153,535-3 3-5 Refunds: Number 49.0 51.9 5.9 Amount $ 9,630.9 $ ll,420.6 18.6 Returns Filed 105.4 107.6 2.1 Returns Examined . 3-1 2-9 '5-6 Additional Tax From Enforcement rs 2,833.0 s 2,929.8 3.4 Delinquent Taxes Collected, Total rs 1,552.3 s 1,521.9 -2.0 rRevised 37 Ibid., p. 110. 38 , Sheldon S. Cohen, 1968 Annual Report of Commis- suoner of Internal Revenue, Internal Revenue Service, U. 5. Treasury Department, Publication No. 55 (Washington: Gov- ernment Printing Office, 1968), p. v. 131 Dollars of receipts and refunds, number of returns filed and refunds reached new record levels during 1968. Re- funds covered tax overpayments of $11.3 billion to which was added interest of $121 million. TO keep the amount of interest paid on refunds at a minimum, the IRS pro- cesses first through the computer system all tax returns involving refunds. In his 1968 Annual Report to the Secretary Of the Treasury, Sheldon S. Cohen, Commissioner of Internal Revenue, said, The unprecedented build-up of the Service's workload in recent years underscores the wisdom of automating our returns processing Operations. Yet the completion Of a nationwide ADP network last year did not make it possible to cape fully with the massive and evergrowing document handling operations confronting us.3 The biggest bottleneck with the present data in- put system is the transcription (keypunching) Operation, the transference of data from the return into cards. To alleviate this difficulty, a direct entry system has been researched, field tested, and installed during 1968 in the Southwest Service Center only. Installations of this direct entry system.to improve computer input efficiency in three more centers are planned for 1969, and in the re- maining three service centers in 1970. When these in- stallations are completed, the punching and processing of 391bido’ p0 i0 132 approximately 400 million cards a year will be eliminated. This improvement in technology will speed up data input to the computers and save several million dollars each year. During 1968 the major aspects of the computer pro- gram were brought to fruition even though complete direct filing in all seven service centers has not been realized. Progress was achieved during 1968 in the program of phas— ing—in direct filing of returns with service centers rather than with district offices; complete phasing-in will be achieved in 1970. The hundreds of millions Of tax transactions con- nected with the receiving and accounting of the unprecented $153.6 billion in collections for fiscal 1968 were pro- cessed through the 88 million accounts in the master file at the National Computer Center. The new deposit system instituted in 1967 only for corporation estimated income tax payments was extended to other areas in 1968. Additionally covered by this sys- tem, effective January 1, 1968, are payments of withholding and F.I.C.A. taxes by employers and withholding agents (railroad retirement tax), regular corporation income tax, and tax on unrelated business income of exempt corporations. This new Federal tax deposit system, providing for payment 0f taxes directly to designated banks, was established to accelerate the flow of tax money through the banking system. i’. r'f‘ '(3 «j (I) 133 It was developed in coordination with the fiscal services Of the Treasury Department and replaced the depositary re- ceipt procedure that had been operating for the past twenty years. This new system speeds up the deposit of taxes to the credit of the Treasurer Of the United States and also helps reduce the teller workload of the IRS by eliminating the deposit functions of the service centers and district offices. Filing requirements were further streamlined for corporation estimated taxes in 1968, in addition to the improvements induced by the new Federal tax deposit sys- tem described in the above paragraph. The requirement to file Form 1120ES, Declaration of Estimated Income was discontinued. Form 1120W, a worksheet not to be filed, is now provided to corporations for computing their periodic estimated tax payments. The new computer system made this change possible. The new deposit system, des- cribed above, coordinated with the master file processing at the National Computer Center provides for an automatic validation of tax credits claimed on tax returns. Some accounts Of results in the second year of full-scale, nationwide computerized operations in the IRS appeared in the pOpular public prints. They are worth scrutiny. One report highlights the huge amount Of re- funds being made in 1968 on 1967 returns filed by taxpay- ers. "This is the year of the big payoff at the IRS. 134 Never before have so many taxpayers been eligible for so 40 much in income tax refunds." One reason cited is that taxpayers still do not claim enough exemptions. The re- port goes on to say that, By the day before the April 15 filing deadline, about 39 million returns had been processed. About 32.5 million of these involved refunds. Last year, about 36.8 million returns had been received Of which 27 million involved refunds . . . SO far, re- funds have totaled $5.8 billion, up from $4.4 billion last year. Early results of returns, of course, reflect the lucky taxpayers eager to get back some of their withholdings. They file early and the IRS follows a policy of proces- sing "refund returns" first before all other types to keep interest costs at a minimum. The final figures for refunds in 1968 show substantial increases of 1967 and they set new records for number Of refunds and dollar volume. The sharp increase in refunds is due primarily to the new graduated system of withholding taxes, first adOpted in May, 1966, and now in full Opera- tion. The new system did.away with collecting a flat 14% of all taxpayers' incomes. Instead, the withholding is graduated upward in six steps, from 14% to 30%, depending on the size of a taxpayer's income. Under the system formerly in use, it was common for a taxpayer to claim fewer exemptions than he . 40..Now IRS starts paying Out," Business Week, April 27, 1968, p. 39- 41Ibid. 135 was entitled to, in the hope Of avoiding a big pay- ment at filing time. This tactic was presumably made less attractive under the graduated system. But many taxpayers evidently kept to the old system Of claim- ing fewer exemptions, and now they are getting refunds. There is also the rising cost of living. IRS officials point out that mortgage payments are larger, more taxpayers are itemizing deductions, and state taxes have gone up. All reduce taxable income.42 Despite widespread taxpayer awareness of the use Of computers and greater taxpayer sophistication in fil- ing returns, mistakes are still legion. . . . Of the 39 million returns already processed, about 3.4 million had some mistake that threw off IRS's totally computerized tax collection system. The system is geared to the use of Social Security numbers, and to date about 551,000 returns have contained the wrong number. Carelessness abounds. More than 1.2 million re- turns were figured on the wrong tax table, or data were filed on the wrong lines. More than 500,000 re- turns were filed with one or more forms missing. And 228,000 over-eager filers forgot to sign their returns. While the most mistakes were made by individuals, businesses are not immune. In fact, business mistakes had reached about 395,000 by mid-April, up from 370,000 last year. The most frequent mistake is failure to include the employers identification number-- about 127,000 so far. And 106,000 business returns had mathematical errors. Another report made in April, 1968 close to the April 15 deadline for the filing of individual tax returns hold that income tax returns computations show a mixed pattern. It said, M 42Ibid. 43Ibid. 136 IRS computers, in their second year of full Opera- tion, detect that out Of 31.9 million individual re— turns filed by the end of March, 607,000 contained mathematical errors, down from 842,000 last year. But while the individual taXpayer took more pains with his addition and subtraction, businesses became sloppier. Out of 5.8 million business returns processed, mathe- matical mistakes occurred in 95,000, up from 72,000 a year earlier. Past "austerity" programs within the Government have hit the IRS. Not long ago the following announce- ment was made: . . . The House Appropriations Committee lops $7.8 million off fiscal 1967 appropriations for IRS compliance activities. It expresses concern over rapid growth in the compliance area and advocates a moderation until the full impact of the ADP progiam on voluntary compliance can be determined. . . . 5 Another report made public on this all-important topic Of appropriations said, A bigger budget for the IRS is sought partly to reverse a decline in audits. President Johnson's budget that went to Congress Monday slates $760 million spending for the Revenue Service in the fiscal year starting next July 1, up $73 million from the current period despite the bud- get's general "austerity" emphasis. The increase is needed, Officials argue, partly to "prevent a de- terioration in the level of taxpayer compliance." The number of tax returns of all sorts is expected to rise some 3.3 million in the current fiscal year and another 2.8 million in the next to a total 111.5 million by mid-1969. 4"Income Tax Return Computations Show a Mixed Pattern," Wall Street Journal, Wed., April 10, 1968, p. 1, column 5. 3 45Journal of Accountancy, CXXI NO. 5 (May, 1966), ta *Ih «a 137 Yet the actual number of returns audited has been falling, the budget shows, to 2,925,000 in the current fiscal year from 3,108,000 in the period ended last June 30. The aim is to step up the number of audits to 3,196,000 in the coming period. In addition, IRS Chief Sheldon Cohen wants to spend an added $1.5 mil- lion, or a total Of $12.5 million, to keep closer tabs on tax agents themselves through "internal audit and security" measures. The IRS seeks a 2,700 increase in its staff in the new budget, the lion's share of a planned expan- sion Of 3,500 jobs in the Treasury as a whole. Sylvia Porter's nationally syndicated column con- tained some very interesting information recently on the topic Of the IRS's computerized tax system. Her column said, Now that you've filed your 1967 Federal income tax return, what are the chances that the Internal Revenue Service's mechanical brains will pick up even your slightest error? Not as great as you have been led to think. In the past couple of weeks, a flurry of scare stories have appeared in newspapers and magazines reporting that the IRS's computers are relentlessly whirling 24 hours a day, seven days a week and giv- ing the impression that the computers will select millions of our just-filed returns for questioning—- among them, Of course, yours. The implication is that tons of returns are being automatically fed into the giant system and that never before has an audit 0f your return been so likely. Well. This being the season for stories such as this, I've done my own investigating. And the facts are quite different from what these stories seem to suggest. 6"A Bigger Budget for the IRS is Sought Partly To Reverse a Decline in Audits," Wall Street Journal, Wed., January 31, 1968, p. 1, column 5. 138 Despite the use of advanced data processing equip- ment, the IRS is "almost sinking in an ocean of paper- work," says the Research Institute of America in a report privately circulated to its subscribers. The Research Institute adds: "The Computer system itself is in trouble. Be- cause the demand for computer usage far exceeds the present IRS computer capability, individual returns with underpayments and overpayments of tax get pro- cessing priority. So-called "full-paid" individual returns received by the IRS in 1967 may not get prop- erly entered in the IRS computer setup until 1969." (Bold face mine.) The heart of the problem is that an overwhelming 105,000,000 returns were received and 49,000,000 re- funds were made last year--a volume of paper the IRS didn't anticipate until 1970. This reflects the spectacular expansion of business and the upgrading of millions of workers to taxpaying levels. On tOp of this, the IRS has been receiving tens of millions of information returns on dividends and interest——and also a soaring number of complex indi- vidual returns. Then on top of all this in turn, the IRS computers have been uncovering more errors than ever before and thus its employees have been doing more corresponding with taxpayers than ever before. This hardly adds up to the publicized picture of an efficient mechanical brain quickly ferreting out your new return and pouncing on your "little errors." Hardly. In fact, the IRS itself has calculated that your chances of an audit are as follows: If you're filing as an individual about one in 25; If you're filing as a corporation, about one in eight; If you're filing as individual estate return, about one in four and a gift tax return, about one in 14. But, cautions Leon Gold, chief tax expert of the Research Institute, your Odds of an audit are‘much ' greater if your adjusted gross income is $25,000 or more; if you are in a trade or profession in which 139 payment in cash is widespread practice; if you claim any deductions which appear abnormally big against average deductions for your income bracket; if you have substantial unreimbursed entertainment expense. And expect your arithmetic to be checked. Clincher: So scarce has IRS manpower become that the Service has "temporarily suspended" its Taxpayer Compliance Measurement Program. These TCMP audits were exhaustive, time-consuming examinations of a small cross-section Of returns designed to help the Treasury improve its audit-collection procedures. The IRS no longer has manpower for these A to Z audits; it needs all its personnel just to keep up with regular exams. Taxpayer errors were not the only kind of trouble that prevents the newly computerized Federal tax system from working smoothly. IRS errors, computer errors, or more correctly, human errors of individuals Operating the computers, have come to the fore. One such public report said, Computer errors in processing tax returns abound. Many corporations in the New York area have been getting bills for taxes already paid or statements that they have overpaid their tax. One smaller firm says it recently received in a single day's mail a notice it had overpaid by about $1,000 and a bill for taxes due of almost $4,000. The company says its tax payments at the time actually were right up to snuff. J. O. Tuescher, assistant regional commissioner of the Internal Revenue Service for data processing in the Northeast region, figures there are currently some 35,000 "adjustments" of this kind kicking around, but that this is down from a high of 55,000 a few months ago. He says a major cause of the foulups is 47Sylvia Porter, "Tax Auditing Still Lagging," The State Journal, (April 22, 1968) Lansing, Michigan, Po - , co umn . 140 that taxpayers frequently use incorrect identifica— tion numbers when estimating or paying taxes, with the result that the computer doesn't credit a pay- ment to the right account. Inexperienced people feeding wrong information into IRS computers are another source of the problem, he concedes. IRS officials in Washington maintain that SSmpu- ter errors of any magnitude aren't widespread. Another report, originating with the Associated Press, with a New York dateline said, . . . Not only is the computer working faster and more smoothly now, but its human attendants, a very large number of them part-timers, are much bet— ter trained. Human errors, nevertheless, slow it down. The problem with computers is people. When peo— ple make errors, the computer, contrary to reports about its ruthless efficiency, cannot always detect the inaccuracy. Mistaking error for fact, it Often puts in motion events that humans can barely halt. This, for example, is the sequence of events that followed the transposing of one digit in a Social Security number: The numerical error caused the estimated tax pay- ments made by Mr. Smith—-only the names in this story are fictiona1--to be applied to the account of Mr. Jones. Jones was expecting a refund of $215.04. He didn't receive it by last June, so he called up a local Office of the IRS. The answer rocked him. "All refunds of more than $5,000 are delayed," he was told. "I thought it was extremely laughable," Jones said at the time. It be- came even funnier. Computer Errors in Processing Tax Returns Abound," WaLlStreet Journal, Wednesday: December 20: 1967' P' 1' cobmmxs. 141 Last November Jones received a check for $5,813.40. Brief elation turned to frustration, and Jones sent back the check along with a signed statement that he sought only $215.04. Early this year Jones finally thought he had it straightened out. His refund for the smaller amount came. In fact, 6 per cent interest was added because the government was late in payment. Shortly thereafter another envelope came from the Treasury. It contained a check for $1,646.90. This too was sent back to the government for the informa- tion of its computer, which can add billions of fig— ures in the flash of an eye but cannot always spot an incorrect one. The moral, so far as the IRS is concerned is to be nice to the computer. Whether taking money from you or trying to hand it out to you, the computer can give you a hard time. Don't confuse it. Be accurate. You'll get your4§efund faster. And your patience won't be taxed. Another report found in the public prints discus- sing the Internal Revenue Service and its computerized system said, One way of checking on tax errors made by the IRS is to look over the "case file" Of any Congressman. In large numbers of cases, it is the congressmen to whom a citizen complains when he feels he is get- ting a raw deal from the IRS or other federal agencies. The congressional district served by Rep. Garry Brown, R—Michigan, is an average midwestern district-— partly urban, partly rural. Brown's Office receives a half-dozen or more complaints about IRS activities each month. Most concern the slowness of paying re- funds--which is generally the biggest problem citizens have with IRS. 49John Cunniff, "IRS 'Monster' Speeds Good News to Eerly Filers of Tax Returns," The State Journal, Lansing, Michigan, Thursday, April 4, 1968, p. H-6, column 6. Author is Business Analyst for Associated Press. 142 Brown says that his Office receives generally satisfactory cooperation from IRS in working out prob- lems for constituents. But he also feels that IRS relations with citizens leave much to be desired. Many peOple, Brown says, complain to him that IRS takes months to acknowledge correspondence, or does not acknowledge it at all. In the past several months, Brown estimates that about 10 per cent of the cases handled by his office concern complaints that returns of given individuals are audited in successive years, for questions that have already been settled. An example would be a taxpayer who claims a non-related person as a depen- dent. Having once established the 1egitmacy of the claim for a dependent's deduction, the taxpayer's return is audited in successive years for the same reason--and the proof must be filed each year. The IRS, in this case, admits it has had problems like this in the past. Insufficient data available at district Offices from past returns have been re- sponsible for this type of complaint, according to a spokesman. But, the IRS says, the new computers have "memory banks" which in the future will stOp this kind of practice. The computer will "remember" that the questionable deduction has been verified in past years as valid. In other cases, Brown says, about 40 per cent in- volve simply "slow handling" of refunds . . . . In general, Brown says, "our problems with the Internal Revenue Sgfivice are not out of proportion with other cases." Evaluation Of the System Evaluation of the ADP system in the IRS is possi- ble, using three criteria. They are (1) results of 50Cleve Corlett, "Computers Tightening Income Tax Collections, Increasing Revenues," The State Journal, February 14, 1968, Lansing, Michigan, p. B-l, Column 1. DN 5515. P. ... u Oi I‘li Q.“ 143 operations after a five-year installation period of phasing- in and two years of full Operation on a national scale with computers, (2) effects of results on functional requirements for information, and (3) effects Of results of Operations on original Objectives. In other words, attention is di- rected to Operations, functional requirements for informa- tion, and objectives of the system. The Officials Of the IRS have done this, and what follows is largely an inte- gration of their considered Opinion and expert judgment plus some outside amplification and illustration. Results Of Operations: Improvements in the Form of Efficiency Factors that have Contributed Toward Success Results of Operations is a criterion by which to evaluate the ADP system. Have Operations over a period Of time achieved optimum utilization of resources, both human and material? Optimum utilization of resources is achieved through constant improvements in organization structure, systems, procedures, programs, and policies, and through the development and implementation of adequate machinery for efficient and effective Operations. In- creased efficiency is possible through improved methods, Programs, techniques, and judgment criteria so that Opera- tions result in tangible savings and cost reductions wherever possible. "fi '1") (I) h! 144 Efficiency factors considered here include the criteria of (1) man-years saved by adOption of ADP, (2) Operating costs and volume factors including the "cost of collecting $100," and (3) other factors such as changes in the form of new programs, procedures, systems, and technical advances that have resulted in progressive im- provements in Operations. Man Years Saved Through Automation.—-Table 3—1 shows tax return processing and revenue accounting direct man years, costs, and related information covering the period of IRS automation which runs from 1954 to the pre- sent time. From 1954 to 1962, the automaticity of the ADP system was characterized as "mechanical." Centrali- zation Of the processing of returns was achieved to the extent that three centers were processing the nation's returns but there was no master file. From 1962 forward, the automaticity Of the ADP system has been characterized as "electronic." Centralization of the processing of re- turns data has been achieved by the establishment of one center, the National Computer Center, where there is a master file. Therefore, there are two periods of IRS automation that are being considered here, (1) 1954 through 1961 and (2) 1962 through 1968. This table of figures, covering both these periods of automation, is the Official IRS document submitted and used before a Subcommittee of the Committee on Appropriations—-House of Representatives, I din flxV 1' A“ flufibhfllUU ~J~ I.» IN. Ab M VA Vlu. 1H “toll“ mmvnfi .16 I11 Fh a. I! kit.>0er| 1. PROV #1 Ha Ono-u...‘ a .U i a N. ‘ ”Unlilu Fri h nut)“. kmvfl! Ihv EU. .4 n...NaVL.v' 1| 0 1‘: 1 51 AU § .J‘. ...- .cmumsaummn owHQMHHM>M U02m 145 . H.Hom . 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MOOMIcOE mmmo new» new» mmonw mcudumm Hmuos mummw Ocumeumm noun on new: mom new: mom 1cm: Oouwsvmm mumflooom commoooum whom» mmouw mcusumm law: 00 lumSflumm .coaumfiousm MO OOHHOQ wsu mcHHm>OOIIGOflOOEHOMSH Umumawu can mumOUII.HIm OHQMB 146 90th Congress, 1st Session, which considered ApprOpriations for Fiscal Year 1968. This table uses direct man years realized for the work performed in tax returns processing and revenue ac- counting functions as a criterion and basis for analysis and evaluation of the worth of the ADP system. Prior to 1962, returns were processed in three area (West, South, and East) service centers with auto- matic equipment of the mechanical variety, but with no central master file or taXpayer identifying numbers. The IRS ADP Plan became effective in 1962 with the Opening of the first of seven regional computerized service centers, the pilot center at Chamblee, Georgia, and the activation Of the National Computer Center. These regional service centers tied in with the NCC and became feeders for it. The NCC Operated under the new master file concept with all its implications. Analysis of the figures in Table 3-1 show, first of all, that there has been a steady increase over the years in the volume of gross receipts, number of returns processed, total costs of returns processing and revenue accounting, and man years realized which reflects time of employees working on the job. The growth of all these four factors reflects the steady growth of the economy 0f the nation. 147 Returns processed per man year realized steadily increased from 5,400 in 1954 to 6,300 in 1962 and then de- clined back down to 5,400 again in 1968. After 1962, it steadily decreased during this period of "electronic" automation. This trend reflects the increased productiv- ity of the returns processing Operation due to automation with high-speed computers under the ADP Plan and is the reason for the decrease. Closer examination reveals gross receipts have gone up approximately two and one-half times during this period of automation. However, returns pro- cessed per man year has remained the same with automation-— being 5,400 in 1954 and 5,400 in 1968. But, to keep it there, the automated system had to be improved and up-dated from mechanical to electronic automation during this period in order to handle the increasing workload. This conclu- sion results from the increasing trend of figures from 5,400 in 1954 to 6,300 in 1963 during the mechanical period and then the decreasing trend from 6,300 in 1963 to 5,400 in 1968 during the electronic period of automation. Ef- ficiency at the IRS would not be what it is today without this shift from mechanical to electronic automation. Had this volume of returns, which increased from.88 to 109 nullion, been processed manually, it would have required twice as many peOple or man years to do the same job as the machines; this conclusion results from a comparison 0f the third column of figures on Table 3-1 entitled 148 "returns processed" with the next to last column of figures entitled "estimated man years to process manually"--which practically doubled from 16.3 to 31.5 during the total automated period. Gross receipts per man year steadily increased. With full coverage of the nation by computers on January 1, 1967, the increase is the greatest in 1967 and thereafter. The figures in the next to last column, estimated man-years required to process manually, have steadily in- creased over the years to a total of 301.1 thousands from 1954 to 1968, while actual man-years realized with automa- tion totals 253.0 thousands, over the same period of time. These figures show that there has been an estimated man- year savings Of 48.1 thousands by using the computerized systems over the period of time. Almost half, or 22,300 estimated man-years, of the 48,100 man years estimated to be saved by automation during this period of time, occurred in 1967 and 1968, the only two years during which there has been nation—wide coverage of computer systems. Operating Costs and Volume Factors.--Tab1e 3-2 Highlights of IRS Operations from 1958 to 1967 shows some major items for consideration and analysis in the evalua- tion of the ADP system. At the moment attention is di- rected to cost and volume factors. During this ten-year Period, from 1958 to 1967, the volume of the major lines 149 .mscm>om encumuce mo uchemmeEEoo on» NO monomwm emsccd "wuusom .m Honfisc umwoxw muteeoo mo mCOeeeeE Ge mousmwu Hem e emeeeuo> meemoeumenumz . . . . . e.me m.~e m.oe e.ee message «.me e me ~ om e me e me e am xme esoo use emcee>eece .ee Omeem manna . . . . .eo m.mw m.ve o.ee m.we m.em Iwm xma mEOO e oe o oe e oe m ee m nae emsee>eeCe .oe . . . . mm. me. me. m ooem one ee. ee. ov. me me ee me -uumeeoo eo umoo .m e.amm e.eem m.mem e.mee e.oev e.oee m.mee e.mme m.e~e e.mee e mumoo mceumumao .m eeuoe m.eeo.e m.emm e.eem m.emo.e «.me~.e m.oe~.e m.e~e.e m.~em.e m.mom.e o.oee.e e .cmuomeeoo mwxmu ucwovceewa .n UCQE m.mee.e m.oee.e m.~eo.m m.m~e.~ e.emm.e e.mem.~ e.eoe.~ m.m~e.~ e.~ee.~ e.m~m.~ e -wonOecm gone xme emcoeueeee .e m.~ m.m o.m m.m m.m m.m e.m m.m m.m e.m Omcefimxm mce3ucm .m e.mm m.Nm e.em e.mm e.em e.am e.ooe e.moe e.eoe e.eoe emeem mcuzhmm .e e.eee.e m.eee.e e.em~.e e.emo.e o.mom.e «.moe.e e.mom.m e.eeo.e e.eem.m m.ome.m e ucsoeaumecseom .e e.em e.mm o.mm m.oe e.oe m.oe m.~e m.mm e.ee e.me umnssZumpcsemm .m . a . s . a . e . s . e . s . a . a . a mea.“ m mam mee m mmm mme e «an eme e eoe eme e oee mme e mem eoee m oem meee o emv veee o oee emee e eem eeee nomeewo mmOuO .e meme meme oeme eeme meme meme veme meme eeme meme smue .meme 0» mmme munmeenme: .mCOeumuomo :0 uuomou mooe>uom Onco>mm emcuoucHll.~lm ments 150 Of activity have all gone up. This activity includes gross collections, refunds, and returns filed. All three volumes have increased at a steady pace. It is only logi- cal that operating costs should also increase at a steady pace, and they have. However, operating costs have in- creased at a slower rate than gross collections. This relationship between Operating costs and gross collections can be eXpressed as a ratio, called "cost of collecting $100." This ratio increased from .41 to .45 during the first period of automation which ran from 1958 to 1962 through 1964, if a time lag is al- lowed; this was the "mechanical" automation period which was permitting this ratio to increase. It took "elec- tronic" automation to turn this trend down after 1964. This trend began to level out in 1968 at .45 which means the completely phased-in computer system was reaching its maximum "electronic" efficiency. The "cost of collecting $100" from 1962 to 1967 has an interesting pattern or trend as depicted on Table 3-2. During this period of gradual installation of the new computer network, this ratio continued to rise from .46 in 1963 to .59 in 1964. After 1964, this ratio started to decline while the workload of returns filed and refunds processed continued to go up. The influence 0f the "electronically“ automated system began tO take effect. By 1967, which was the first year Of full ,..u a|/\ \‘ I P‘s 151 nation-wide automation with "electronic" high-speed com- puters processing returns through a master file at the NCC, the "cost of collecting $100" went down to .45. This drop is attributed to efficiencies achieved in Op- erating costs primarily through electronic data proces- sing. Constant improvements were made each year in the Operations as the system was phased-in to full national coverage. IRS Officials say that the dollar savings result- ing from the system are more than enough to pay for the installation and Operation of that system. Each year's savings are enough to pay for the EDP operation of that year. For instance, one official said, "We estimate that a net additional revenue yield of over $5 million was realized from the expanded mathematical verification of these returns in the Southeast Region alone. We believe that the yield from this single Operation will pay for 51 the increased cost of ADP. The Commissioner Of Inter- nal Revenue said, "I recently stated to the Appropriations Committee that if we were to try to do the job we are doing today, without our present system, it would take . 51Robert L. Jack, "ADP--An Analysis of Its Opera- tion and Results," 1966 Proceedings of New York University 23th Annual Institute on Federal Taxation, p. 109. Mr. Jack is Assistant Commissioner for Data Processing in the National Office of the IRS. IINQI hilh II. C in! pth ;~ 152 12,000 additional people."52 A report said, Roughly $5 billion of taxes collected in 1966 will be the result of what IRS, somewhat euphemisti- cally, calls its "service activities"--the collection of taxes from individuals and businessmen who have understated their obligations or ignored them com- pletely. IRS officials don't know precisely how much of this $5 billion will be attributed to the new hard- ware. But it's likely, judging from recent history that the equipment investment-~which totals about $17 million so far—-wi11 pay a handsome dividend. A consideration of cost factors shows that automation is a labor-saving device. On this point a report said, Since 1960 when IRS began phasing-in the new system, about 6,200 of its employees have become redundant. By next year (1967), when the phase-in is complete, the workforce engaged in returns pro— cessing and tax collection will be down to 1,800. In 1960, it amounted to 12,000. An IRS Official "guesstimate" that this reduction in force represents a saving of something like $50 million a year. Still another report said, . . . It was estimated that in past years the taxpayers neglected to report more than $20 million in income which resulted in a $5 billion loss to the Government. Some Officials believe that the revenue yield from just one of the automatic Operations, 52Sheldon S. Cohen, Proceedipgs Of the 1967 Second Apnual Conference on Computers and Taxes, "Current DeveIOp- ments in ADP and Tax Administration,fi_Sponsored by the Com- puters-in—Law Institute, George washington University in cooperation with the American Bar Association and the Federal Bar Association, held in Statler-Hilton Hotel, June 6-7, 1967, p. 2. . 53F. Hirsh, "Computers and Tax Collection," Data- TEElSE. x11, NO. 3 (March, 1966), p. 30. 54Ibid. 153 that of mathematical verification, will eventually pay for the $50 million cost of the system. In the official IRS News Release IR-924 dated May 8, 1968, Commissioner of Internal Revenue Cohen, said, Additional revenues from computer operations more than tripled last year as the Internal Revenue Service completed its first full year of Automatic Data Processing (ADP) operations on a nationwide basis. The expanded capabilities of the ADP system pro- duced additional tax revenues of $86 million in 1967, compared to $27 million in 1966. Since 1962 when IRS began the transition to ADP, operations, a total of $166 million has been realized from the system. Other Factors.--Many changes, technical improve- ments, new programs, and procedures made possible with computers can be identified. These improvements help mobilize the resources and capabilities of EDP in the IRS for increased efficiency and optimum utilization of re- sources. Many Of these items are good examples Of the direct impact computers are having on the administration of Federal income taxation. A survey of IRS Operations as recorded in the Annual Reports of the Commissioner of 55 Joe Alex Morris, "Meet The 'Monster' That Checks Your Taxes," Readers Digest, XC, NO. 537 (January, 1967), p. 177. Condensed from Kiwanis Magazine, December 1966- January 1967 issue. 56 Sheldon S. Cohen, "Automatic Data Processing: Progress for 1967,“ IRS News Release IR-924, May 8, 1968, reprinted in Standard Federal Tax Reporter, Commerce Clearing House, Incorporated, Volume 7, Paragraph 8750, p. 74,503. 154 Internal Revenue and the Annual Reports of the Secretary of the Treasury revealed some Of the more important items in this category. A rejuvenation of the Taxpayer Assistance Program has taken place since the computers have been installed. Many people became much more concerned about their taxes when they realized how much more efficient the tax col- lecting and tax enforcement activities of the IRS became with computers. They rushed for help to the offices of the IRS and to tax practitioners. As a result, the Tax- payer Assistance Program has been streamlined, revitalized, expanded, upgraded, innovated, and extended on a year-round basis to keep taxpayers better informed and supplied with technical assistance and to foster voluntary compliance. Changes in this area have been emphasized and some exam- ples are upgrading of facilities, error reduction programs, increased use of television and radio to reach the Ameri- can public, extended use of question-and-answer columns in newspapers, establishment of public reading rooms in each Of the seven regions and in Washington, D. C. in order to carry out the Freedom.of Information Act, Public Law 89-487, telephone assistance from central points known as Centiphone, improved forms and publications, published rulings, and letter rulings by National Office in response to the many inquires. 155 Other improvements in Old programs or developments Of new programs have been identified under the topics of (l) the taxpayer compliance measurement program (TCMP), (2) the master file Of exempt organizations, (3) the sta— tistics of income and tax models, (4) audit criteria de- velopment, and (5) the Federal—state COOperation program. All these programs have been influenced by or originated as a result of the new computer system. They are taken up in the next chapter. Many technical changes have resulted in efficiency, cost reduction, and improvements in operations, as fol- lows: (1) optical character recognition pilot study for computer input, (2) magnetic tape reporting for informa- tion returns, (3) direct entry for computer input, (4) pilot study to determine feasibility of transmitting data between service centers and National Computer Center through Federal Telecommunications System (voice network), (5) retention period for master file data reduced from three years to maximum of 27 months, (6) direct filing of returns with service centers legalized but being phased- in up to 1970, (7) purchase of equipment (computers) in- stead Of lease policy now followed, (8) merger of New York and Northeast Regions into North-Atlantic Region, (9) a seven percent reduction in number of forms and let- ters, (10) revised procedures for collection of delinquent accounts, (11) use of microfilm to replace paper, (12) 156 magnetic tape replacement by hypertape, which was replaced in turn by superhypertape, (13) equipment changes such as H-200's replace IBM 1401's at service centers and installa- tions of IBM Systems/360 Model 65 at National Computer Center, (14) preaddressed labels to expedite the process- ing of returns, (15) improved library to cut tape inventory at NCC and rehabilitation process for magnetic tape to save over $5 per reel, (16) simplified key punching of whole dollars only on certain forms to save time, manpower, and money, (17) computer generated follow-up notices of tax accounts, and (18) the new deposit system, instituted in 1967, which reduces teller workload Of IRS, accelerates flow of money to the U. S. Treasurer, and permitted elimi- nation of Form llZOES. Results of Operations: Difficulties Impeding the QperatiOns of the System Taxpayer Errors.—-Taxpayer errors which computers are helping to catch can be classified into several cate- gories. Among the 75.7 million tax returns on hand through November, 1967, IRS officials gave the following statistics on errors: 1. 2.1 million returns had incorrect or missing social security numbers; 300,000 were filed with missing signatures; 200,000 did not contain necessary W-2 forms; 300,000 were missing necessary supporting state- ments of one form or another; 1.1 million contained arithmetic errors; 400,000 took wrong deductions; 2 3 4 mm 0 O 157 7. 1 million used wrong tax tables; 8. 12,000 made errors in claiming exemptions; 9. 400,000 filed incomplete entries. TaXpayers are usually notified promptly and asked to make needed corrections by the IRS when such errors are detected. Accurate taxpayer information encourages accurate returns filing. A self-assessment system like the Ameri- can taxation system needs well-informed taxpayers the same as a democracy needs well-informed voters. The Tax- payer Assistance Program of the IRS has been extended to a year-round basis and has been upgraded and emphasized in recent years as the result of computer efficiency in detecting errors. An error reduction program was empha- sized by the IRS in 1967. It was built around the tabu- lation, by regional service centers, of weekly totals in six major error categories for individuals and four for businesses as follows: Individual ErrorsSB Business Errors 1. arithmetic l. employer identification 2. tax table number 3. social security number 2. business code 4. signature 3. depositary receipts 5. Form W—2 4. arithmetic 6. schedules 57 Cleve Corlett, "Computers Tightening Income Tax Collections, Increasing Revenues," The State Journal, East Lansing, Michigan, Wednesday, February 14, 1968, p. B-l. Mr. Corlett is the Washington Bureau correspondent for the State Journal. 58Sheldon S. Cohen, 1967 Annual Report, p. 4. 158 Widespread publication of this information for taxpayer consumption took place through mass communications media with the advice that refunds were needlessly being de- layed because of such mistakes. Increased use Of tele— vision and radio became a part of the expanded and stream- lined information program by the IRS to better inform and assist the public. This error prevention campaign was greatly ex- panded in 1968 by the IRS. Included in the publicity about the types of errors was the theme that errors on returns inevitably delay refunds. A secondary message warned taXpayers that the error frequency rate increases toward the close of the filing period, so early filing was advised as advantageous to both taxpayers and the IRS. IRS Problems with the System.--The first full year Of nationwide computerized operations in the IRS resulted in success and a relatively smooth Operation. Two major reasons have been cited for the successful Operations as follows: (1) the gradual installation approach and (2) the redeployment program for personnel whose jobs were affected. Computerized Operations were first installed in the pilot Southeastern Region at Chamblee, Georgia. Each major phase Of the system was pilot—tested in Chamblee before being adOpted in the other six regions. This step- by-step approach made the shift from manual methods to automation a smoothly Operating transition. Contributing 159 to this successful change was the training program and the redeployment of 9,000 employees. The system has been successfully launched and has been Operating smoothly for over two years now under the guiding influence of Mr. Robert L. Jack, Assistant Com- missioner for Data Processing. Two major problems stood out in the first year's nationwide operation with compu- ters, as follows: (1) incorrect or missing Social Security numbers and (2) billings for unprocessed payments. On these two points, Commissioner Cohen said, Some problems in the smooth Operation of the system were traceable to incorrect or missing Social Secur- ity numbers. For example, the IRS encounters diffi- culty in crediting the prOper account when a taxpayer's check does not show his Social Security number and becomes separated from the return. Also, there are still some instances of bills being sent out when payments have been received by the IRS but have not yet cleared through the system. The IRS is making every effort to design measures to prevent this problem.5 Other problems encountered in the ADP program have been discussed in more detail by the Deputy Commis- 60 sioner of IRS. Before getting into a detailed account 59Sheldon S. Cohen, "Automatic Data Processing: Progress for 1967," IRS News Release IR—924, May 8, 1968, §§andard Federal Tax Reporter, Commerce Clearing House, Inc., Volume 7, 1968, Paragraph 8750, p. 74,503. 60William H. Smith, "Problems Encountered in the Automatic Data Processing Program in the Internal Revenue Service," Remarks by the Deputy Commissioner before the Section on Taxation 1968 Midyear Meeting in Phoenix, 160 Of the kinds of problems the IRS has encountered in its transition from manual methods to automatic data pro- cessing with modern high-speed computers, the Deputy Commissioner pointed out three important impacts the system is having. They are (l) the magnitude Of central- ized Operations, 42) increased Opportunities for errors, and (3) increased taxpayer contacts. Deputy Commissioner William H. Smith is held in great regard and speaks with unimpeachable authority on the IRS's computerized tax sys- tem as he was, perhaps, its chief designer and interpreter at its inception and during many of the crucial years fol— lowing its application in the first pilot center. He was Assistant Commissioner for Planning and Research in the National Office in Washington when the ADP Plan was con- ceived. In his present assignment as Deputy Commissioner, he has the Opportunity to oversee its Operation which has been under the expert guidance and stabilizing influence of Mr. Robert L. Jack, Assistant Commissioner for Data Processing. There are no better authorities to quote in this area Of electronic data processing in the IRS than the two top veteran IRS career men, Mr. Smith and Mr. Jack. Mr. Smith is quoted extensively below. Arizona, Standard Federal Tax Reporte£,Commerce Clearing House, Incorporated, Volume 7, 1953: Paragraph 3751: PP- 74,503—74,507. 161 Regarding magnitude of Operations, Mr. Smith said, First, in a nutshell, what do we mean by automa- tic data processing in the Internal Revenue Service? The heart of the system is the Master File concept where every taxpayer in the nation has his own indi- vidual tax account. These tape records are main- tained in our National Computer Center in Martinsburg. Actually, this is not a particularly glamorous place to see. It is simply a low—slung modern building housing a number of large scale computers and several hundred technicians. The transaction tapes and the great bulk of our processing Operations take place in our seven Service Centers. These have rather limited computer capabil- ity, relatively speaking, but employ thousands Of peOple during peak operations. Every year, nation- wide, we have to recruit and train about 13,000 tem- porary employees--mostly housewives--for work in these centers during the filing period. The Internal Revenue Service receives about 110 million returns every year and about 350 million in- formation documents. Nor is this volume of paper staggered throughout the year. It tends to arrive in peaks and valleys. For example, two out of five American taxpayers file between April 1 and April 15th. About two out of every three people who file in— dividual income tax returns get refunds. This year, we will probably issue around 52 million of them. Under the law, we have only 45 days after the due date of the return to schedule a refund. If we miss this deadline, we have to pay interest, so we have every incentive to move fast. Obviously, this peak load problem is without parallel anywhere else in the world--in government or in industry.61 Regarding Opportunities for error, Mr. Smith said, A key fact to be grasped early is that ADP has not "caused problems" in the sense which this phrase 611bid., p. 74,504. 162 is usually understood. Many of the problems we are facing now were with us before computers were even invented. What has happened is that the cold-blooded efficiency of the computer and the system places prob- lems in bold relief; they simply cannot be overlooked or brushed under the rug. The new system is infinitely more comprehensive than its predecessors and has the ability to identi- fy all sorts Of errors and omissions that in the days of manual processing would have passed unacted upon. It has also increased the Opportunity for error on the part of both the taxpayer and the Government. Perhaps the largest cause of error is traceable to our reliance on the social security number, or the employer identification number. We cannot administer the system without this common numerical denominator, and yet it is ironic that many problems arise when the number is not furnished or written incorrectly. In regard to increased taXpayer contacts, Mr. Smith said, To put it simply, the system is filling many gaps in tax administration and is generating many more pub- lic contacts than ever before. Taxpayers who do not appear to have filed all re- quired returns are now receiving letters requesting explanations. For the first time in 25 years, taxpayers who do not appear to have made required payments of estimated tax receive an inquiry from us--without exception. Taxpayers who do not appear to have met the re- quirements for depositing withheld Federal taxes are being asked for explanations. Liabilities for back taxes are being Offset by refunds which would otherwise be due these taxpayers. These are but a few examples of the additional contacts with the public which are growing out of the expanded capability the system gives us. 62lbid. 163 These additional contacts are part Of the over- all problem.53 Deputy Commissioner Smith has commented publically on the major problems encountered in the ADP processing program. These problems concerned full-paid returns, estimated tax returns, misapplication of payments--busi- ness returns, misapplication of payments--individual re- turns, computer notices and correspondence, split remittances, amended returns, and undelivered refunds. His comments on these problems are quoted here. Full-Paid Returns. The first problem I want to talk about concerns full-paid returns. Here we are faced with a dilemma that follows from our attempt to balance workload and work on first priority mat- ters first. As I have suggested, our top priority is to issue refunds. Next comes the issuance of bills. All other returns-~by definition, those that appear to be paid in full—-are put on the shelf for processing later in the year. There are some 17 million Of these. The problem arises when a taxpayer writes to us after filing one of these returns. Let's say he wants to file an amended return or wants to change something. Estimated tax returns create a problem Of identity because taxpayers often do not use the same information on the declarations as on returns filed later. PrOper appli— cation of credits is often difficult, especially so in community property states where taxpayers often file joint declarations and separate returns. __ 63Ibid. 164 Complaints of misapplication ofppeyments on busi- ness returns have been numerous. Many times the trouble arises from the separation Of the depositary receipt from The new Federal Tax Deposit System should the return. Issuance of notices that apply eliminate this problem. a penalty for failure to make timely deposits has caused some problems in that some notices were issued that should not have been issued. Consolidated business re- turns have caused problems of correlation Of the parent corporation with the accounts of each of its subsidiaries. Each entity has its own identification number which com- Many erroneous bills to parents and pounds the problem. improper refunds to subsidiaries have been issued "be- cause Of the time sequences in which these multiple, but related, transactions have been posted to the master file."64 To solve this problem, consolidated returns and those of their subsidiaries are removed from the work flow and There- manually correlated before further processing. fore, estimated tax credits on consolidated returns are allocated among the parent and subsidiaries before post- ing takes place in the master file. Misapplications of payments to individual returns Two reasons can be cited. Trouble with very Often occur. 641bid. 165 numbers is the first reason. wrong numbers are Often supplied by taxpayers and also transcription errors in the form of misinterpretations Of names or numbers on the The second reason part of IRS employees take place. This gets into the sec- arises from a time lag element. ond major problem cited earlier by Commissioner Cohen-- billings for unprocessed payments. Deputy Commissioner Smith elaborated further on this sticky problem. Another problem occurs because of the time lag in recording payments on a bill on the master file before issuance of a followup notice. It takes us three weeks to cycle a payment from input to issuance of We are taking a close look at the the credit advice. possibility of lengthening our billing time table to see whether we can improve matters without unduly de- laying receipt of revenue due the Government. Sometimes an individual taxpayer account will get so snarled up that the problem feeds on itself and error compounds error. We are seriously thinking of developing a procedure that would freeze problem ac- counts as soon as they are detected and until they are resolved. We are also considering placing communications between the Service and taxpayers under computer con- This would facilitate our access to taxpayer trol. accounts and enable us to more easily dip into un- settled accounts and pull the information needed. You can appreciate that this would substantially improve our ability to answer inquiries and take prompt corrective action. But the cost would be sub- stantial and in the interim we will have to rely on shorter term solutions. There have been taxpayer complaints of the cold, Deputy impersonal computer notices and correspondence. __ 65Ibid., p. 74,505. ,_._..«—.- 166 Commissioner Smith gives a forthright evaluation Of this problem. Perhaps the most vehement complaints we receive have to do with the unintelligibility and cold, im- personal nature of some of the notices generated from Happily this is something that the computer system. can be attacked and worked on, and we are making steady progress. Commissioner Cohen and I have an extensive program under way to instill in our written messages to taXpayers the same clarity and considera- tion that we expect Service employees to exhibit in their face-to-face contacts with taxpayers. we have brought in an outside consulting firm to help and have already improved several hundred notices and form letters. we are also sensitive to the fact that we have not been able to answer correspondence nearly as This is most frustrating to promptly as we should. the taXpayer, particularly when he has written re- peatedly and still doesn't get an answer. Many peOple write in during the filing period asking when they will be getting their refund. Here, in fairness to the 50—Odd million taxpayers who are due refunds, we do not interrupt our processing to We know that we get try to answer these inquiries. the overwhelming majority of refunds out within five or six weeks, so we consciously lay these inquiries aside and don't work on them unless 10 weeks have gone by from the time the taxpayer filed. The volume of corre5pondence in Service Centers is staggering. We receive about four million pieces Of mail a year from taxpayers. Taking into account the mail received in response to our own letters and notices, the figure runs three times that, or about 12 millions. Frankly, we haven't yet found the one best way to control correspondence Of this magnitude. The Archivist of the United States recently told us that the Internal Revenue return files are unique, They are both in terms of size and frequency of use. three times as large as those of the Social Security Administration, four times the size of the enlisted men's files for the Army, Navy, and Air Force, 167 altogether, almost six times as large as the Veterans Administration's claims files, and over nine times as large as the Selective Service files. You can appreciate that it is no simple matter to keep our files current during the filing period. We are studying the problem, however, and are installing a number of changes which should help us to be more responsive to taxpayer inquiries.66 Split remittances from taxpayers cause the IRS many headaches and they constitute a big problem. Practices that taxpayers followed in the days when returns were processed by hand have proved to be troublesome under automatic data processing. Something as simple as a taxpayer sending a single check in payment of more than one liability causes This is because mass-process workflows headaches. for different kinds Of returns take different direc- tions, and there is always the danger of error when payments are split and applied to different liabili- It is a great help of course when taxpayers ties. send a separate check in payment of each class Of tax. Taxpayers have always sent in remittances of one kind or another without telling us what they are for. Our necessary reliance nowadays on temporary and in- experienced employees makes it even harder to get unidentified remittances matched up with the right account. It is also a great help to us when taxpayers re- cord their social security numbers on all their If the check should become detached from the checks. return it can be processed as a separate document and a credit can be posted to the account. This means a 67 bill will not be issued when the return is processed. Amended returns always were troublesome under the Old system of manual techniques. 661bid., p. 74,506. 671bid. 168 Now with the swiftness of ADP, an amended return sometimes gets processed before the original return (particularly if it is a full paid return), and you can imagine the errors this causes. We are consider— ing the introduction of a distinctive, abreviated form for use in making amended returns. This should simplify things for taxpayers and enable us to pro- cess amended returns much more expeditiously.68 Undelivered refunds constitute a problem because of the mobility of the population. Strange as it may seem, large numbers Of people entitled to refunds move without notifying the Post Office or Internal Revenue of their new address. Not surprisingly then, we have large numbers of undeliver- able refund checks. Occasionally our employees may misread the taxpayer's address or make some other error which results in misdirection of the check but for the most part checks are sent to the best address we have. Despite the capability of the ADP system there are still about a quarter Of a million undelivered refund checks each year. Only in about 50 per cent Of the cases are we successful in getting the checks remailed to the prOper address. A summary of the more prevalent problems, then, as indicated by Deputy Commissioner Smith and Commissioner Cohen can be listed as follows: (1) wrong or missing num- bers, (2) retrieval of full—paid returns when needed, (3) correlation of estimated tax declaration with returns filed later, (4) misapplication of payments concerning business returns, (5) misapplication of payments concerning 68Ibid. Form 1040X Amended U.S. Individual In- come Tax Return was issued in 1968. 691bid. 169 individual returns, (6) complaints of the cold, impersonal computer notices and correSpondence, (7) split remittances from taxpayers, (8) amended returns often get processed before original, and (9) undelivered refund checks. Ape Functionel Requirements for InformatiOn Being Met? Any data network is required to meet the informa- tion needs of its user. While each of these five functions has its own particular demand, the information requirements of the group have been similar. The five functional in- formation requirements Of the IRS are as follows: 1. Returns processing and revenue accounting. This function includes determinations Of correct amounts of tax liability, taxable balances, re— funds, billings, tax credits, accounting adjust- ments, and other items involved in maintaining taxpayer accounts on a current basis. 2. Taxpayer assistance and services. The Service has an Obligation to make it as simple as possi- ble for taxpayers to fulfill their obligations under the taxing statutes. This function covers a broad range of activities, such as direct as- sistance to taxpayers in completing returns, simplification and clarification Of forms and correspondence, response to inquiries, prepara- tion of publicity information for mass communi— cations media about filing and reporting require— ments, and so on. 3. Compliance. This involves the collection function, dealing principally with delinquent returns and accounts, and the audit function, checking the correctness and completeness of the items of in— come and deductions reported on returns. The compliance function also includes the intelli- gence investigation of cases involving tax fraud. 4. Taxpayer appeals. Taxpayers have right to inde- pendent review Of proposed determinations of tax 170 liability resulting from audit examination. The appeals function of the Service operates at two levels--the district and the region. If a tax- payer disagrees with the findings Of an examining officer, he may request an informal conference at the district level; if no agreement is reached there, he may request that the Appellate Division consider his case at the regional level. The Ob- jective is to resolve tax controversies, without litigation, on a basis which is fair and impartial to both the Government and the taxpayer. 5. Technical. This is the interpretation of the tax- ing statutes. Many thousands of requests for technical information are received annually which require the issuance and publication of rulings, advisory statements, and other tax guide materials 70 for the benefit of the public and Revenue Officials. The ADP Plan which features the Master File System and the National Computer Center was designed primarily to serve only the first three of the above mentioned functional requirements for information. These three im- portant functions are the returns processing and revenue accounting, taXpayer assistance and services, and compli- ance. "The Master File System was not structured to pro- vide direct support to the other two important areas of taxpayer appeals, and the issuance of technical informa- 71 tion." In addition to these work-function requirements 70Lancelot W. Armstrong, "The Development and Operation of the Internal Revenue Service Network,“ The 99mputer: Tool for Management, Business Equipment M5334 facturers Association/BEMA (Elmhurst, Illinois: The Business Press, 1968), p. 68. Mr. Armstrong is Director of Systems Development Division in the Washington Office of the.Assistant Commissioner for Planning and Research. 7lIbid., p. 71. 171 for information in the IRS, there is also the vitally im- portant administrative, or managerial, requirement for information. The administrative requirement for informa— tion would include the many management information reports. Among these management information reports would be those regarding financial status and Operations and research reports. The Detroit Data Center was constructed to serve these needs for data not filled by the National Com- puter Center. The next chapter considers the application of computers to several important aspects in this area Of management information systems. Age the Original Objectives of the §ystem and the Mission Of the IRS Being Met? One method of evaluation of the ADP system is through analysis of the effects of results of Operations on original objectives. A system is worthwhile, has validity, and can be justified if it is meeting its Ob- jectives. The ADP system, according to a summary of its original objectives discussed in Chapter II was expected to (l) systematically check on failures to file returns, (2) mathematically verify the accuracy of returns filed, (3) Offset tax liabilities against refunds, (4) detect duplicate filing for refunds, (5) provide a consolidated tax account for each taxpayer to reflect current status at any given point in time, (6) match data reported on .1 172 information returns (W-2, 1099, 1065, etc.) with corres- ponding data on tax returns (7) classify returns for audit, and (8) prepare management, Operating, and statistical re- ports which includes research reports. From the results of operations reported and dis- cussed above, the conclusion can clearly be reached that all but the last Objective is being met by the ADP sys— tem. On this point, an IRS administrator said, The first seven Objectives are being met, either fully or in part. The eighth Objective, considered less urgent than the others, has not been achieved in the ADP Master File System. Instead, a separate facility, the National Data Center, was established in Detroit to process the bulk of the management, Operating, and statistical reports, as well as other "non-master file" Operations. On the basis of achievement of Objectives to date, it is fair to say that the present system was origi- nally well conceived and that its Operation has con- tributed significantly to the Service's ability to carry out its primary mission of strengthening the principle of voluntary compliance and achieving a more equitable distribution of the Federal tax burden. Granted, taxpayers have made mistakes; granted, the IRS has also made mistakes and has some real chal- lenging problems with its new system; looking at the whole Operation, it has been successful and smooth. Any new system has "bugs" to iron out. The IRS system is no exception to this point but the magnitude of its Opera- tions is exceptional. 721bid., p. 73. 173 The system is meeting three of the five functional requirements for information; the other two are being met at the Detroit Data Center. The system is meeting all Objectives but one and this is being taken care of in the Detroit Data Center. The system was well conceived and its vast Operations are contributing toward a realization Of the IRS mission. On these three points then, which have been used as criteria to evaluate the system, it can be concluded that the system is responding favorably in spite of its inherent limitations. There are certain inherent limita- tions to the system, however, which have been recognized and are discussed next. Limitations of the System There are certain limitations inherent within the present ADP system. Two weaknesses in the network have been detected. One concerns technology Of the hardware; the other concerns locations and communication. On the technology side, "batch" processing or sequential pro- cessing as it is also called is a limitation. There are "time lags" due to the communications problems resulting from the separate locations of the National Computer Cen- ter and the seven service centers. A closer examination of these two weaknesses is in order. 174 "Batch" processing or sequential processing as it is sometimes called, is a technological limitation. On this point, the IRS Director of Systems Development Divi- sion said, . . . One of the serious limitations of our pres- ent ADP System results from the use Of sequential or "batch" processing. By this is meant that transac— tions--these may be receipts of returns, payments, or claims, for example--are accumulated and run against the master files on a weekly cycle. These transactions, often running to several million each week, must be sorted into taxpayer identifying number sequence prior to this run in order to "match" them with master file accounts which are also maintained in sequence by identifying numbers. This means, of course, that the computer must process the entire file of master file tapes each week. It also means that it is necessary to anticipate, well in advance, the types of information likely to be needed to deal with day—to—day problems of tax administration and limit the output Of data from the master file to those73 bodies of information having high priority and volume. "Time lags" are another limitation of the system. This weakness results from the locations Of the seven Regional Service Centers in Atlanta (Chamblee), Philadel- phia, Covington (Cincinnati), Austin, Kansas City, Law- rence, and Ogden—-all in different states--whi1e the National Computer Center is located in Martinsburg, West Virginia. On this point Lancelot W. Armstrong said, . . . Time delays also become an important factor, since the regional service centers, where input and output Operations are located, are varying distances from our computer center where master file updating runs take place. 731bido ’ pp. 73-740 74Ibid., p. 74. 175 This limitation manifests itself also in another way. The Director or Assistant Director of a Regional Service Center, or any other qualified personnel out in the field, must often wait ten days to two weeks before his request for a transcript of a taxpayer's account at cur- rent status is answered from the National Computer Center. What Does the Future Hold for the IRS ADP System? It is possible to visualize a completely revised ADP system so that it is substantially modernized from a technology point of view. Imagine, for example, an IRS ADP system similar to the New York Stock Exchange computer system. This stock system is not nearly so massive as the IRS system as far as volume Of data to be processed is concerned. Data for only a few thousand stocks is proc- essed in that computer system while data for over 107 million taxpayer returns in about 88 million accounts needs to be processed in the IRS computer system so that the cost of the IRS system would be much more. In any event, go into any large stock broker's Office in any large city and press a few buttons on the computer termi- nal to request from the computer located in New York City the current price data of a particular firm's stock. Be- fore your eyes within a few seconds appears the required data on a terminal screen. The answer is almost instan- tenous. This is the modern technology of "random access" 176 with display terminals which the present IRS ADP system lacks due to cost factors. On this point Lancelot W. Armstrong said, . . . Visualize, for example, massive direct ac- cess files for all taXpayer accounts which can be tapped for information on an "as needed" basis, or from which cumulative reports to management at all levels can be generated as frequently as desired. Also, it is not unreasonable to look forward to an ability to respond within seconds or minutes to ur— gent inquiries from field offices through display terminals located strategically across the country. Also within reach is a communications network linking all key points of the Service's organizational struc- ture and capable of handling all types of transmis- sion——voice, message, and data. The Office of the Assistant Commissioner for Planning and Research in the IRS National Office at wash- ington is busy working on a more modern system. Future system development is not being neglected. Lancelot W. Armstrong, who directs the IRS systems develOpment divi- sion, said, The Service's present major planning effort in the data processing area--the design of a conceptually new ADP system--will consume a large portion of the Service's systems planning resources over the next few years. There appears to be no alternative to com- _plete replacement of our ppesent system with a much gpre versatile and responsiVe one. (underscore, mine) This observation should not be construed as an indict- ment Of the present ADP system. Indeed, it is produc- ing very well and is satisfying most of the objectives which it was originally designed to achieve. It can continue to do so for several more years. However, while the system deals quite well with the conventional returns processing aspects of tax administration the 751bid. 177 Opportunities to improve on these processes and to introduce highly desirable system innovations are severely limited by the system itself. This is a roundabout way of saying that while the job is get- tingédone, it is not being done as well as it should be. The Systems Development Division of the Office of the Assistant Commissioner for Planning and Research at the National Office in Washington is presently at work developing objectives for a new, modern system as the first step. These Objectives can be classified into the following two categories: (1) technological task Objec— tives which the new equipment should have the capability to perform and (2) program objectives which would include the original objectives of the present ADP Plan, plus additional ones. In short, these Objectives amount to hardware objectives and software objectives. The IRS National Director of Systems Development has delineated very clearly what these objectives are. They are quoted below. The Service would expect our new system equipment to be capable of performing the following tasks: 1. Accelerate the introduction of data into the sys- tem and thereby improve the currency of informa- tion available to users. Improved input devices and techniques now being tested will help here, but other factors, such as high-speed communica- tions networks, are also involved. 2. Provide direct and easy access by the end users to basic data stored in the master files. This 76Ibid., pp. 72-73. 178 provision is intended to suggest an inquiry capa- bility and then only on a need-to-know basis. The user, say a Revenue Office or Agent, would generally have access only to the status of a particular account at a particular point in time. Hopefully, this Objective, if realized, will re- duce the time required to extract data from basic files from weeks or months to a matter of minutes. Provide the facility to compile data from the basic file on a selective basis and in the final form desired. This implies an ability to provide promptly such summary information (on certain classes of accounts, for example) as management may require on a demand basis. Provide an effective identification system which will make possible linkage and association of re- lated data regardless of source. The present device for associating data is the social security or employer identification number. This objective suggests the development of an identification sys- tem which would permit ready association of infor- mation outside the tax system with information in the files. Any such system will, Of course, have to use existing Social Security numbers. Provide firm control and rapid retrieval Of source documents or images thereof. In tax administra- tion, trying to get one's hands on a particular return or other tax document in a hurry can be a frustrating experience. The new system would be expected to improve substantially the control over documents and access to them. The program objectives for the new ADP System in- clude those originally set forth for the present sys- tem, as well as some extremely desirable additional ones. Some of the more important of these are: 1. Integration into the tax account files additional indicators to show the current status of delin- quent accounts, accounts under audit, appeal, investigation, or litigation, and accounts on which technical rulings have been issued. Access to information is now available only after a con- siderable time lag. Consequently, it is possible that a transaction may be posted to an account and an action taken even though the account theo- retically is in a suspense status due to pending enforcement action of some kind. Situations like 179 this will be avoided if this objective can be in- corporated into the new system. Provision for prompt access to master file data as needed to carry out taxpayer service functions. At present only limited information about indi- vidual accounts is available in district and branch offices. As a result, there is often a delay in answering a written or personal inquiry by a taxpayer about the status of his account. The new system should eliminate, or at the very least, reduce such delay. Application of the system to the problem of ac- counting reporting, and distribution of revenue receipts. This is a broad subject and one which will require a great deal of study and evaluation of the legal and Operating requirements involved. It should be possible, however, to integrate many of the applications involved into the new system. Development of a workable and efficient procedure to facilitate Federal-state data interchange pro- grams. At present, the Internal Revenue Service has entered into agreements with more than 40 states under this program. We want to design a system which will provide for carrying out the Service's obligations under these programs as efficiently and completely as possible. Provision, to the extent practicable, for "by- product" applications such as economic statistics and management information. This is regarded as a gray area which will be carefully studied with- out any prejudgment as to its ultimate inclusion or exclusion in the final system. Development of plans for the future ADP system, in the form Of definition and scope of the project, was started in 1965.78 Work on the project began in 1966. 1968 was the target date for a comprehensive report with 77Ibid., pp. 74—76. 78Sheldon S. Cohen, 1965 Annual Report, p. 59. ': I. try 180 recommendations for a conceptually new fourth generation ADP system.79 Progress was made in designing the new system for installation early in the 1970 decade, perhaps in 1972 or 1973. Plans were well into the first study phase--the definition of information requirements--in 1967. "Potential users (Collection, Audit, Intelligence, Data Processing, etc.) are defining and cataloguing their re- quirements with respect to such characteristics as sig- nificance, urgency, volumes, frequency of occurrences, and frequency of demand."80 Such a catalogue will provide re- liable information regarding total processing and storage requirements of the system. The final product of this phase of the plan will represent a statement of the major programs expected to be in effect in the period 1970-1975. For each program, Objectives will be specifically defined and supporting information requirements develOped in terms of detailed descriptions of inputs and outputs to be included in the system. These requirements will then be interrelated so that duplicetive and conflicting elements may be reconciled.8 After this phase has been established, the Service will consider equipment, file maintenance, processing equip- ment requirements,content and frequency of output and 79The 1968 Annual Report of the Commissioner Of Internal Revenue gave no additional information about the development of, or progress being made with, the new com- Puter system, except to say that the planning work continues. 80Sheldon S. Cohen, 1967 Annual Repert, p. 56. 8 M lLancelot W. Armstrong, The Computer: Tool for S§E%¥EEEEL(E1mhurst, Illinois: The Business Press,71968), 181 other matters of actual design of the computer system. include 1. 2. Major benefits anticipated in the future system faster entry Of new information into master files; direct access to information on file by revenue Officers, agents and other Service technicians in the field; inclusion of more comprehensive data on file in terms of both historical and current information; rapid, selective, and prOperly formatted retrieval Of information, and better management through improved allocation of resources.8 Plans at the present time indicate the new system will be installed within five years. "In the meantime, everything that can possibly be done to improve the Opera- tion of the present system will be done. "83 82Sheldon S. Cohen, 1967 Annual Report, p. 56. 83Armstrong, The Computer: Tool for Management, CHAPTER IV THE APPLICATION OF COMPUTERS TO TAX RESEARCH Orientation The areas of tax research under consideration re- late to IRS operations such as the functions of returns processing and compliance, and to the legal and technical functions. Two major programs pertaining to the functions Of returns processing and compliance are (l) the Taxpayer Compliance Measurement Program (TCMP) and (2) the "Dis- criminant Function" Selection of Returns for Audit by Computer (DIF). Other important programs which pertain to the legal and technical functions of the IRS are (1) Tax Exempt Organizations Computerized Master File, (2) Statistics of Income and Computerized Tax Models, and (3) Reports and Information Retrieval Activity (RIRA). The ADP Master File System at Martinsburg, West Virginia was not structured to provide support to the preparation of Henagement information reports or research reports; it has been taxed to capacity with returns processing. There- fore, the research programs considered here deal primarily with the computer configurations in the Detroit Data Center. 182 183 Taxpayer Compliance Measurement Program (TCMP) The IRS inaugurated in 1962 a long-range research study on its Operations which was called the Taxpayer Compliance Measurement Program (TCMP). This program was designed to provide administrators with scientifically collected data from which new knowledge would emerge con- cerning compliance levels, enforcement needs, and alloca- tion of enforcement resources. It has developed into a reliable data base for use in other special studies which are an integral part of the Planning—Programming-Budgeting System (PPBS) of the IRS.1 TCMP involves the use of computers to measure the levels of compliance by taxpayers classed as individuals and as businesses. It also provides IRS policy-making Officials with an objective yardstick for evaluating the adequacy of its Operations and the effectiveness of its planning. This program was conceived as a long-range planning, coordinating, and control device. It has been develOping over a period of years on a phase by phase basis in order to obtain valuable information presently lacking in several problem areas as follows: 11968 Annual Report of Commissioner of Internal Revenue, IRS Document NO. 55, Treasury Department, Super- intendent of Documents, U. S. Government Printing Office, washington, D. C., pp. 51-52. 184 l. the size and nature of the total tax administra- tion workload; 2. the portion of the total tax administration job that is accounted for by current operations; 3. the portion of the total tax administration job that is left undone; or the gross tax administra- tion gap; 4. the level of taxpayer compliance; 5. changes in the level of taxpayer compliance and whether compliance is increasing or decreasing under existing programs; 6. the effectiveness with which current Operations are being conducted; 7. the net tax administration gap, or that portion of the gross tax administration gap that is worth closing.2 The highest ranking IRS career official said: The purpose of TCMP is to find answers to such ques- tions as the following: How many and what kind of tax returns did we fail to get and why? What is the size, nature and tax significance of errors on tax returns? How much of the total taxes due did we fail to col- lect and why? Is the level of taxpayer compliance better or worse than in previous years? By how much? What seems to be the underlying causes Of the change in the level of compliance? Group effort by computer experts, mathematicians, administrative specialists and statisticians characterizes 21964 Annual Report of Commissioner of Internal Revenue, p. 36. 3William H. Smith, "Impact of Automation Upon En- forcement of the Federal Tax Laws," 1965 Proceedings Of , Efie Seventeenth Tax Institute of University of California §Ehool Of Law, p. 46. 185 the TCMP. It is really a management science or Operations research project by a team of technical expects who have joined their specialized efforts to develop a bold admini- strative measurement program in the field of taxation. TCMP research began with the gathering of data in three separate phases--delinquent accounts, delinquent returns, and errors in returns filed. Later, in 1967, the third phase, "errors in returns filed," was divided into two groups, those Of individuals and those of businesses. Since then the TCMP has been identified as composed of four parts or administrative areas as follows: Deliquent Accounts Deliquent Returns Individual Returns File Corporate Returns Filed tthl-J O O The delinquent accounts part of TCMP was designed to alleviate tax collection problems Of unpaid accounts. Past experience indicated that nearly half of the 6.5 million bills and notices issued became delinquent, and they involved about 1.5 billion dollars in revenue. The delinquent returns part Of TCMP was designed to detect nonfilers, taxpayers who were required, but failed, to file tax returns. Since the delinquency poten- tial among salary and wage earners has been rendered nomi— nal through the operation of the payroll withholding 41967 Annual Report of Commissioner of Internal Revenue, p. 60. 186 system, the TCMP was designed to stress business and farm returns examination. It was also set up to focus atten— tion on nonfilers of dividend and interest income. The program was designed to detect failure to file income, excise, and employment tax returns by individual pro- prietors, partnerships, and corporate taxpayer. The returns-filed part of TCMP was designed to deal with the audit phase activity, especially with tax returns containing errors. First, returns filed by-in- dividuals were considered and then returns filed by cor- porations were added. "A computer analysis of audited results covering a random sample of the 64 million indi- vidual income tax returns filed in 1964 and subsequent years"5 was made. These sample returns were representa- tive of all Forms 1040 and 1040A filed in the nation. From them the IRS was able to Obtain a statistical des— cription Of the behavior of the entire universe of tax- payers. These studies enabled the IRS to determine the number of returns with errors and the tax significance of the errors. The data also revealed the characteristics Of the taxpayers who made errors. It also indicated the nature of the errors classified not only by types but also by sizes of tax and by the designated issues involved. The data became very valuable in helping to establish 5William H. Smith, 1965 Proceedings of the Seventeenth E3; Institute of University of California School offiiaw, p.746. 187 audit criteria for electronic computer programming. Uni- formity in selection Of returns for audit was made possible. Budget reductions in Fiscal Year 1968 curtailed TCMP develOpment that year. A Delinquent Accounts survey had to be cancelled along with a Delinquent Returns Farm Business survey. Scheduled surveys of Individual and Corporation Returns filed were postponed. "However, dur- ing 1968, results of the initial Individual Returns Filed survey of 1963 individual returns filed in 1964 were used to develOp a new computerized audit selection technique."6 The audit criteria developed were based on rigorous mathe- matical analyses of audited results obtained by these representative and unbiased TCMP surveys. What became known as the "discriminant function" technique of select- ing returns by computer for audit was developed from this TCMP research. This technique is discussed later in this chapter. The primary uses of data from the TCMP have been 1. To develop cost-yield relationships (average and marginal) in delinquent accounts and returns and examination Operationsfor Planning-Programming- Budgeting System inputs and requirements; 2. To measure the levels of compliance and tax ad- ministration gaps for determining the Service's long-term enforcement policies; 3. TO determine changes in compliance levels over a period of time for prOper direction of enforce- ment programs; 61968 Annual Report of Commissioner of Internal Revenue, p. 51. 188 4. To develop better selection procedures to improve the effectiveness of enforcement operations; and 5. To identify alternative methods of operations to achieve greater operating economies. The anticipated short-run benefits to be derived from TCMP from an operations point of view have been sum- marized as follows: 1. Establishing the extent of potential cost reduc- tion from revised collection programs based on greater use of data processing procedures and lesser use of enforcement manpower; 2. Determining the Adequacy of the Business Master File as a delinquent returns check; 3. Disclosing pockets of delinquent returns and non- compliance for systematic follow-up by enforce- ment personnel, educational programs and other indicated tax administration methods; and 4. DevelOping an effective ADP selection procedure for more than 7 million individual returns filed annually. It is contemplated that TCMP will show, over the long range, trends of compliance. It will indicate whether the methods of tax administration are associated with in- creasing, decreasing, or constant levels of taxpayer compliance. Discriminan§_Function Selection by Computer of Returns for IRS Audit From the 75 million tax returns filed annually, in recent years, about three million, or four per cent, 71967 Annual Report of Commissioner Of Internal Revenue, p. 60. 8Ibid. 189 are selected for detailed examination or audit. In 1967, of the 3,100,000 examined, 52 per cent were found to have misinterpreted the law and were required to pay an additional $3.3 billion in tax. But of the total examined, 40 per cent were able to substantiate all entries and were notified of "no change." Another 7.6 per cent or 200,000 were found to have overpaid and were refunded $362,000,000-- which they had neither expected nor requested. In 1968 a reduced number of examinations were made because of the desire to have quality audits and to take into account the rising complexity Of returns being filed. Interview audits were stressed as the primary means to achieve quality audits, and they have been ef- fective in difficult office audit type returns. From the 2.9 million returns examined in 1968, $2.95 billion in additional taxes were recommended by auditors. TaXpayers in 1968 overassessed themselves $177.9 million, which was refunded.lo Before the use of electronic computers in 1962, individual income tax returns were classified for audit by the IRS exclusively on a manual basis. Experienced revenue agents, using guidelines established by the National Office, looked at the returns and then used 9Joseph S. Rosapepe, "How To Collect $155-Billion," Public Relations Journal, XXIV, NO. 4 (April, 1968), pp. - . T e auEhor is director Of information for IRS, washington, D. C. 101968 Annual Report of Commissioner of Internal Revenue, pp. 20-21} 190 their individual judgment to screen and select returns for audit. .This was known as the eyeball method. A centralized machine selection method was intro- duced with the inception of the computerized system of returns processing in 1963. Both the old manual method in some regions and the new machine method in other regions were used until the computerized system was com- pletely phased in and made Operational on a national basis in 1967. Corporation and individual tax returns for all seven IRS regions are currently screened by audit selection criteria11 programmed into the National Computer Center at Martinsburg. From tax returns selected by these criteria, audit selection tapes are prepared by Martins- burg computers and sent out to the seven service centers where lists are printed out and then sent to the 58 dis- trict Offices. There in the districts further eyeball screening takes place by experienced agents who may remove returns from the audit stream if they judge them not worthy of audit. The number of returns selected centrally llSee Joel Foster and James Nolan, "IRS Computer Centers Are Concerned About PeOple TOO," Journal of Ac- countancy, CXXV, NO. 5 (May. 1968). PP- 25'233 A Warning to TaxPayers: Exclusive Interview With The Former Com- missioner of Internal Revenue," U. S. News and World Report, LXVI, No. 5 (February 3, 1969), pp. 36r39; William H. Smith, "DevelOping a New Technique in Selecting Returns for Audit," figurnal of Accountangy, CXXIII, NO- 6 (June, 1967): PP. 22- 23; William H. Smith, "What The IRS Is Now Doing TO Improve Various Aspects of Tax Administration," The Journal Of Taxation, XXV, No. 1 (January, 1967), pp. 56-58. 191 by the programmed audit criteria generally exceeds the audit capacity of the IRS. Therefore, the second stage of manual screening at the district level by experienced personnel cuts the number of computer selected returns to a managable audit workload. The level of the audit workload has settled to about three million returns in recent years. A consideration of some of the audit criteria presently programmed into the National Computer Center is appropriate at this point. The present computer selec— 12 different classifi- tion system uses a range of 36 to 50 cation criteria. Different criteria are used for various types of returns. Any return selected by these programmed criteria is identified as a potential candidate for audit. In the past, IRS officials have refused to talk about or discuss how its computer system was programmed to catch the more common areas or types of error. Only recently has the IRS indicated broad areas Of taxpayer error. Now it will identify at least a few of the more common areas of error but it still keeps exact figures and percentages secret. During the 1968 tax season, the IRS publicized four critical audit issues: dependency exemptions, in- terest payments, contributions, and medical expenses. On . 12William H. Smith, "Developing a New Technique in Selecting Returns for Audit," Journal of Accountancy, CXXIII, NO. 6 (June, 1967): PP. 2§;§§_ 192 each issue information packages were prepared and distri- buted to regional offices for local release. By directing public attention on these issues of most frequent taxpayer error, misunderstanding, and uncertainty, the number Of returns selected for audit had the greatest chance to be reduced. Some audit criteria as determined by the editors Of Business Week have been identified as concerning (1) size of income, (2) multiple sources Of income, (3) se- lected occupations, (4) deductions and contributions that exceed certain norms, and (5) any out-Of-pattern personal or financial transaction.13 High income alone will cause a return to be selected for audit. Size of income is constantly watched by the computers on the theory that higher incomes have higher chance Of error. The IRS computer system at the NCC is programmed to be alert to all possibilities of error. All returns above a certain figure of income are selected for audit. The IRS will not state what that figure is. Some tax Specialists outside the IRS believe the "certain fig- ure" is $30,000. Some say it is $20,000. Others say $25,000. The computer system is programmed to select for audit tax returns with multiple sources of income. 3"Unhappy Returns From The IRS' Computers," Egsiness Week, February 25, 1967, pp. 73-74. 193 Multiple sources of income are a prime source of tax error among individual taxpayers. Examples of income recipients whose income may come from several sources are manufacturers' representatives, some salesmen, the self-employed, those with large investments in stock and bond holdings or real estate holdings, and those whose incomes are derived largely from oil or gas royalties. Tax on some Ofthese incomes are calculated by different tax rates, such as those found in short-term vs long-term capital gains. All these alternatives create possibili- ties for inadvertent errors. Selected occupations are carefully watched by the computer system. Many professional or skilled peOple ob— tain most of their incomes from a wide base of clients, patients, or customers; many receive practically all of their income in cash. Examples of these taxpayers are lawyers, freelance writers, accountants, architects; doc- tors, waitresses, and cab drivers, to cite a few. The returns of the taxpayers in these occupations are pro- grammed to be selected for audit. Deductions and contributions that exceed certain norms are marked for audit. There are norms for certain deductions and contributions within each income bracket. These norms are expressed as percentages of adjusted gross income, and the IRS keeps these percentages secret. The norms are difficult to pinpoint as they differ sharply 194 from one region of the United States to another. Any sharp deviation in a return should be fully eXplained. Chances are the first agent who reviews a fully explained unusual deviation will approve it. Bunching items of contributions under "miscellaneous" is a positive way to attract audit examination. Property donations such as a painting or shares of stock should be explained as to how the value was determined. "If it's over $200, state clearly that there are no conditions attached to the gift, and clip to the 1040 a signed copy of any appraisals. 14 A large interest Ignoring this will get you an audit." deduction will be questioned unless an explanation is at- tached to the return indicating the cause, such as a sizeable house mortgage. Above normal deductions for state and local taxes need explanation. While it is pos- sible to deduct more than amounts shown on the sales tax table in the 1040 instructions, clear explanations of excesses deducted will help avoid a call from the IRS. Purchases of large items like a car or a boat should be explained with details where sales tax is applicable. For businessmen, heavy travel and entertainment deduc- tions, especially for mixed business-pleasure travel, get special attention. Form 2106 should be used to cover all "T & E" items to reduce the chances Of audit. _— l4"Personal Business-Taxes," Business Week, NO. 2012 (March 23, 1968), p. 141. 195 Any out-Of-pattern personal or financial trans— action on a return will cause the computer to select it for audit. For example, if a return suddenly drops divi- dend income, it should be explained that the stock had been sold or otherwise disposed of, so that the first agent who reviews it will approve. If a son were dis- charged from the military service during the year being filed and returned to college or school, the taxpayer can count him as a tax deduction. The computer is programmed to reject for audit a sudden deduction for a new child for a middle-aged man. If the new deduction is adequately explained, the agent who reviews the return will probably approve it. Other big abnormal items to report and ex- plain properly are sizeable sales of securities or real estate and the use of income averaging. Casualty loss claims will bring an audit if they are not itemized and clearly explained; theft and vandalism losses should show dates and details of the police report. Claims for house- hold accident losses, like drOpping a ring into the gar- bage disposal unit,will bring an audit. Deductions of losses for termite damage will guarantee an audit. To reduce chances of a tax audit under the new computer system, IRS men and tax practitioners have one major, pertinent piece of advice for all taxpayers; be more complete and accurate and EEEE.With the information you file. Complete means brief and concise but to the 196 point. Long, detached, rambling explanations will cause your return to be tossed on the audit pile. Following this simple advice will help avoid inspection and ses- sions of questions with a revenue agent. When an agent finds these three elements present--completeness, accuracy, and neatness--he will be inclined to have more confidence in the return and pass it by. The combined machine-manual method of selecting returns for audit had been successful and satisfactory but it lacked optimum efficiency desired by the IRS Of- ficials. To increase the efficiency Of the machine selec- tion method and to reduce, perhaps eliminate, the manual selection part, the IRS instituted a new research project that entertains the use of mathematical techniques along with the computer. It hoped this new research would pro- duce the desired results of increased efficiency Of ,machine selection of returns for audit. From this re- search, the new technique called "Discriminant Function" has emerged to identify returns for audit exclusively by computer. What is meant by "Discriminant Function" and how does it work? Discriminant Function15 is a process by which re— turns are scored and ranked by computer on the basis of l55ee "Returns for Audit Chosen by ADP,“ Journal of Taxation, XXIV, No. 5 (May, 1966). p. 310: WilIiam H. Smit , Developing a New Technique in Selecting Returns 197 likelihood of error. Highest scores indicate returns that are greatest candidates for audit. Essentially every line or entry on the individual tax return is given a ”score." The score represents that line's or that en- try's relative importance. The relative importance has been determined by the IRS through research and mathema- tical analysis. The formula to Obtain the score is called the "discriminant function." The total score shows the comparative need for audit. Since details of this new method have not been revealed by the IRS, not much is known about the technique and the formula used is highly secret. The words of two IRS Officials can be quoted to help describe this vaguely known technique. On this tOpic, the Deputy Commissioner of the IRS said, . . . The essence of this technique is to deter- mine mathematically the weights (Or relative impor- tance) Of various significant return characteristics. 'The capacity of the computer is then used to scruti- nize all returns in the same uniform way by applying For Audit," Journal of Accountancy, CXXIII, NO. 6 (June, 1967), pp. 22-23; William H. Smith, "What The IRS Is Now Doing To Improve Various Aspects Of Tax Administration," The Journal of Taxation, XXV, No. 1 (January, 1967), pp. 56-58; I'Selection crater Returns For Examination," Journal of Accountancy, CXXVI, No. 4 (October. 1968). pp. 72-74: "IRS Testing Machine Which Selects Returns for Audit," Taxation For Accountants, 1, NO. 4 (September-October, 1966), 57—2I97—“Computer Spotting of Income Tax Returns Gets Under Way," The Wall street Journal, XLIX, NO. 70 (wed., January 22, 1969), p. 1, Col. 5;#“COmputer Selects Returns for Audit," 1968 Annual Report of CommiSSioner of Internal Revenue, p. 20. 198 these weighted criteria to any applicable character- istics that appear on the documents. In this con- nection, these weights are so determined as to maxi- mize the separation of returns with potentially large errors from those with few or no errors of little consequence. Then each return is automatically classified and assigned or not assigned for audit examination according to these scores. If our present expectations are realized, the computerized mathematical selection method will in- crease the effectiveness Of a given level of audit manpower by (l) reducing the prOportion of examined cases resulting in little or no tax change, (2) in— creasing the average tax change resulting from audit and (3) further reducing the manpower heretofore re— quired in the classification process--manpower that can be more profitably engaged in examination work. In addition, all individual returns filed will be uniformly screened for audit by the same selection standards and with the same degree of intensity ir- respective of the filing or examination district.l6 On this Discriminant Function System, the Assistant District Director, Internal Revenue Service, Boston Dis- trict, said, . . . Basically, this is a system which uses a mathematical technique designed to select returns with a high probability of tax change. The technique is performed as the returns go through the data proc- essing machines on tape. While I'm not a mathemati- cian, its principle, I believe, works this way-- relative importance (weights) of various selection criteria (both positive and negative) are determined mathematically. Each line of the tax return is given a weight and the values are added. The higher the score, the more likely the return will be audited further for error or deception. What's the formula? Actually, the formula, as Singleton Wolfe, Director of our National Audit Division, indicated at a recent Providence, Rhode Island meeting is "so closely 16William H. Smith, "Developing a New Technique In Selecting Returns For Audit," The Journal of Accountancy, CXXIII, NO. 6 (June, 1967): PP- 23'25- 199 guarded that even he does not know it." We are hope- ful that this further extension of the use of computer technology will enable us to reaiize further gains from the same relative manpower. Test to validate this technique were completed in 1968. The Discriminant Function method has proved more effective than the present machine criteria selection method and it compares more than favorably in cost and value with ordinary visual screening methods. The Discriminant Function technique is presently being used in the Fiscal 1969 tax season on 1968 income tax returns filed on 1040 and 1040A forms showing less than $10,000 adjusted gross incomes. In Fiscal 1970, it will be used to classify higher income returns for audit-- those with over $10,000 of adjusted gross income. This Discriminant Function technique is now being referred to in the public prints by the acronyn "DIF" or the "DIF" System.18 The Discriminant Function System will provide uniform screening of individual tax returns and reduce __ l7Elmer H. Klinsman, "Some Recent Trends In Fed- eral Tax Administration," Massachusetts CPA Review, XXXXII, No. 5 (February-March, 1969), pp. l69-70T_ 18See the column by Sylvia Porter, "Save On Taxes-- II," $9? Sag}naw News, Tuesday, February 18, 1969, Section B: Page 5, COlumn 5} "Computer Spotting of Income Tax Re- turns Gets Under Way," The Wall Street Journal, XLIX, No. 70 (Wednesday, January 227 1969?) p. 1, Column 5; "New Formula Classifies Returns For Audit," Journal of Taxa- tion, XXX, No. 3 (March, 1969): P- 150- 200 both machine and manual selection costs. Simulation tests indicate that the DIF System will produce the following favorable results: 1. Higher tax change yields from returns examined, 2. Lower audit classification and related data processing costs, 3. Fewer tax returns audited with little or no tax change.19 Computerized Research in the Legal and Technical Areas The ADP Master File System at Martinsburg, West Virginia was not fully structured to provide support to taxpayer appeals and the issuance Of technical informa- tion. Consideration is now directed to the application of computers to these two functional areas--legal and technical--and to the computer configurations in the Detroit Data Center where these research programs are handled. An IRS official has given the following perti- nent statistics in these two areas: Tax practitioners are keenly aware, I am sure, of the tremendous magnitude of our legal and techni- cal workload. In a tax system encompassing almost 100 million tax returns each year, it is an unavoid- able fact of life that differences of Opinion or questions of interpretation in need of resolution will frequently arise. Although the overwhelming majority of tax returns fall into the non-controver- sial category, it is not surprising that every year we process 35,000 to 40,000 requests for rulings or 191968 Annual Repert of Commissioner of Internal Revenue, p. 51. 201 technical advice, that each year 50,000 cases reach the informal conference level, that our Appellate Division considers 15,000 cases annually, and that approximately 5,000 cases are docketed in the Tax Court each year. In addition, several thousand tax cases are tried by the District Courts, the Circuit Courts 8prpeal, the Court Of Claims, and the Supreme Court.2 The legal area of work primarily involves tax- payer appeals. Each taxpayer has the right to an inde- pendent review Of a proposed determination of his tax liability resulting from an Official audit examination. The Service provides each taxpayer with two informal levels of appeal before going into the formal level of the Tax Court. He may appeal his case when in disagree- ment with an examining Officer by requesting a district level conference. If he disagrees with the findings at that level, he may request that his case be heard in the Appellate Division at the regional level. The objectives of these appeal procedures is to resolve tax controversies with taxpayers without litigation on a basis that is con- sidered mutually fair and impartial to both taxpayer and government. In the event an agreement is not reached at the Appellate Division, the taxpayer may file an appeal with the Tax Court of the United States. Taxpayers with unresolved cases at the district level or at the regional 20William H. Smith, "Impact of Automation Upon Enforcement of the Federal Tax Laws," 1965 Proceedings 9: the Seventeenth Tax Institute of University of Southern Salifornia Schooliof Law, p.56? 202 appellate level can avoid litigation before the Tax Court by directing their cases into Options other than the Tax Court that are Open to them. These Options can be exer- cised on the part of the taxpayer by paying the deficiency and within two years from the date payment, filing a claim for refund of the amount in dispute. The taxpayer can file suit in either the U. S. district court or the U. S. Court of Claims when the claim is disallowed by the Ser- vice or within six months after the claim is filed if no action is taken. The technical area of work involves primarily the interpretation of the taxing statutes. Published rulings play a vital role in tax administration. The compliance capability of the nation's taxpayers depends upon the timely development and dissemination of technical inter- pretations Of the revenue statutes and regulations. Pub- lication of administrative interpretations Of tax law provides guidance to taxpayers and tax practitioners both in planning transactions and in preparing returns; they promote uniform treatment of issues in the examination Of returns because they provide precedents to be cited and relied upon in the disposition Of other cases. Many thousands of requests for this kind of technical infor- mation are received annually by the IRS, which necessi- tates the issuance and publication of numerous rulings, advisory statements, and other tax guide materials for 203 the benefit Of both the public and IRS Officials. An ex- cellent example is the many tax determination letters issued by the district directors in recent years on pen- sion plans and tax exempt organizations. The Deputy Commissioner of Internal Revenue spelled out clearly the difficult problem of achieving coordination and control of legal and technical information in order to achieve uniformity and consistency in the Service's enforcement, appellate, technical, and litigating positions. He said, The dimensions of this caseload have made it difficult to supply fingertip coordination among the hundreds of offices and thousands of individuals charged with the handling of these cases through conventional reporting and indexing techniques. Con— sequently, our conferees, technical advisors, and attorneys are frequently at a great disadvantage, since they often are unable to benefit from past precedents of an unpublished nature or to exchange views with technicians working in other offices on cases involving identical issues. Also, in many cases, lack of coordination produces a duplication of research effort, causing an unnecessary waste of skilled manpower. For the tax administrator, lack of coordination means absence of control, and for the tax practi- tioner it means uncertainty in the face of inconsis- tent positions being taken by the Government in the settlement and litigation Of cases. Invariably, it also means delay in the identification of technical trouble Treas, with correSponding delay in remedial action.2 Plans were begun in fiscal 1964 tO establish an improved management information system with particular 21William H. Smith, 1965 Proceedinge of the Seven- teenth Tax Institute of Universityof Southern California §ghool of Law, pp. 56—57. 204 emphasis on these two areas of work--legal and technical.22 An IRS information, storage and retrieval system, based on the usage of computers, was sought to improve effi- ciency in the management Of these areas and to be more readily responsive to Treasury Department and Congressional information needs. However, computer utilization progress and systems development in these areas has lagged behind that in the tax collecting areas. The problem in the legal and technical areas is one of storage and retrieval Of pertinent legal documents and abstracts which are so voluminous and challenging for classification. Computer software technology (programming) needs further develop- ment in this area, particularly with reSpect to the in— dexing of material. In spite of the limited tools at hand, some progress has been made. It is traced and re- ported below under the tOpics of Reports and Information Retrieval Activity (RIRA), Computerized Master File of Tax Exempt Organizations and Pension Trust Funds, Statis- tics Of Income and Computerized Tax Models, and Federal- State Cooperation in Exchange of Tax Information Program. Re orts and Information Retrieval AptiVity (RIRA) Accountants and other tax practitioners taking cases to court, or contemplating such action, should __ 22ig§4 Annual Report of the Commissioner of In- ternal Revenue, p. 39} 205 understand how the IRS handles litigation today. RIRA is a new computerized system that strengthens the IRS' hands and sharply improves the vigor of its tax collection. RIRA is a new development in the National Office of the IRS. RIRA is a legal information retrieval system that Operates for the benefit of Service attorneys in the Chief Counsel offices. More specifically, RIRA is a "mag- netic tape computer-based system combined with microfilm and high speed microfilm reader-printers."23 In short, computers are used to store, retrieve, process, and dis- seminate legal information for the following purposes: 1. To assist IRS attorneys in taking positions in litigation that are consistent with established IRS policy. 2. To help create uniformity of treatment of tax- payers throughout the country. 3. TO provide accurate and complete statistics of pending technical and litigation matters. 4. To enable the IRS to perceive more quickly problem areas in the tax law.24 Objectives to be served by the Reports and In- formation Retrieval Activity (RIRA) System are concen- trated primarily in the legal area of the Service's work and can be separated into two broad categories. In the first category are those Objectives directed toward the , 23David T. Link, "Micro Forum," The National Pub- llc Accountant, X, NO. 5 (May, 1965), p. IS. 25R. P. Hertzog, "RIRA--The IRS' New Electronic Weapon in Litigating Tax Cases; How It WOrks," Texation fer Accountants, I} No. 6 (January-February, 1967), p. 363. 206 achievement of maximum consistency of positions taken by the IRS attorneys on legal issues. The second category consists Of Objectives directed toward improving the capacity of professional personnel to research case files, court decisions, administrative rulings and interpreta- tions, technical memoranda and special studies. Since 1913, when the first Federal income tax law passed,the proliferation of statutes, administrative rulings and regulations, case law, and learned articles has caused an information explosion which now only the computer can manipulate effectively. In the past, decided cases have been reported and have been fairly well indexed by the published tax services and other books available to tax practitioners, but numerous matters processed by the Chief Counsel's Office have not been and may never be published. The Associate Chief Counsel said, In the last fiscal year, the Chief Counsel's Office handled over 26,000 civil litigation matters of all kinds, as well as over 1,200 criminal cases. At the end of that year, there were over 11,000 cases pend- ing in the Tax Court and over 3,300 refund suits in the Federal courts. Since cases are handled by some 650 Chief Counsel attorneys in 34 cities, there exists a serious physical problem of keeping all these attorneys in all these 25R. P. Hertzog, "How The Chief Counsel's Office Uses ADP in Litigation of Cases," The Journal Of Taxation, XXIV, NO. 5 (May, 1966), p. 309. 207 cities fully informed and up-to-date on the particular subject matter and issues of pending cases as well as with that in the closed internal file. In the past, be- fore RIRA became effective, it was not unusual for an IRS attorney in New York or Washington to take a firm posi- tion on a particular issue which was exactly Opposite of the position assumed by another IRS attorney on the same issue in, letlussay, Texas or California. It is possible that both lawyers could have either won or lost. RIRA is a welcome change that is designed to overcome this weak- ness. It is necessary and desirable that positions taken in litigation in various parts of the country be consis- tent with established IRS positions. A four-man Office of the Chief Counsel out in the field in a place like Buffalo, when equipped with RIRA service, has available to it the same information resources as does the 250-man 26 RIRA will permit the IRS to provide National Office. equal application of tax laws throughout the entire United States faster, more consistently, and much more efficiently. How does RIRA work? The main features of the operation of RIRA are (1) the Uniform Issue List (UIL), (2) Microfilm, and (3) Counsel Legal Information Centers (CLIC). —__.._. 26Mitchell Rogovin, "Impact of Computers on Tax Practice Today: What They Can Do For The IRS and Tax Men," The Journal of Taxation, XXV, NO. 2 (August, 1966), p. 112. 208 For many years in the past, the big obstacle to legal communication for the IRS has been a lack of com- mon language in taxation. For attorneys to research and coordinate properly their cases and issues, some kind Of indexing system which uses uniform language is essential. Such an index was develOped in 1962. It was called the Uniform Issue List (UIL) and was originated for imple- mentation and installation into RIRA. "Keyed to the In- ternal Revenue Code, UIL is, basically, an index--an in- dex in which a limited number Of terms are used to desig- nate apprOpriate legal issues.27 An eight-digit number is assigned to each section of the Code. Within each section there are major classifications. A major classi- fication often has sub-classifications. For example, under Section 162 of the Code, which concerns business expense deductions, 24 major classifications and 52 sub- classifications appear. The number 0162.00-00 describes an issue concerning trade or business expense. The number 0162.02—00 is used if the business expense involves the question of whether the expense is an ordinary and neces- sary business expense. If the question concerns that of providing the amount deducted, the number 0162.03-00 is used, and so on. This list provides a uniform legal . 27David T. Link, "Micro Forum," The National Pub- 139 Accountant, X, No. 5 (May, 1965), pp. 14-15. 209 language in the field of taxation. It permits both the classifier and the researcher to use identical terms when referring to the same type Of issue. It contains legal concepts or descriptors rather than broad issues. Descriptors are intended to portray the various problems within issues. Therefore, several indices might be neces- sary to describe some issues. Both pending and closed cases are tied into the index, along with abstracts giving exact positions taken by both the Commissioner and the taxpayer. The 2,000 page index, which is issued monthly along with micro- filmed abstracts, is forwarded to the 40 Counsel Legal Information Centers (CLIC) which are equipped with micro- film reader printers. By examining the one- or two-page abstracts, IRS attorneys can determine the exact position taken by both the taxpayer and the Commissioner. The index shows such things as the number of cases in a Speci- fic classification and geographic location. It also in- dicates docket number and status of each case, dates of most recent change in each case, name Of each taxpayer involved, and the particular attorney handling each case. Government attorneys are able to classify issues in the cases assigned to them with UIL. The procedure followed by attorneys in each new case is to (l) classify the issues involved and assign a UIL number on a computer— printed form, (2) prepare an abstract of pertinent facts 210 in the case which should be about one or two pages long, (3) forward abstract and computer-printed form to the RIRA computer processing center which is now centralized at the Detroit Data Center. At the Detroit Data Center the case abstracts are microfilmed and periodically distributed to field offices. The computer-printed form is processed through transcrip— tion (keypunching) to computers which produce two types Of monthly printouts showing an inventory of cases pend- ing with the Chief Counsel's Office. These printouts become guides for all government tax lawyers to locate other pending cases in the office concerned with issues similar to their cases. The first monthly printout lists all cases in sequence by UIL number and shows pertinent information about each case. The second printout from the centralized computer lists inventories of cases ac- cording to the office handling them. A copy of the first monthly printout is distributed to all field offices where microfilm reader-printers permit full utilization of the information. Focal points of the RIRA system are the Counsel Legal Information Centers (CLIC). There are 40 IRS Counsel Centers. The problem of circulating the ab- stracts to some 650 IRS attorneys spread throughout the United States in the 40 Counsel General Centers waS~ solved by using microfilm on which to transfer the data. Ha— _._.- __-,.-..’— n— ., _ -—- . A—-- 211 These abstracts became somewhat equivalent to law books. The Filmac 400 reader-printer, developed by the Minnesota Manufacturing and Mining Company, supplied the required viewing equipment and rapid printer capability. Under the new system, an attorney simply checks the index, requests the cartridge containing the in- formation he needs, inserts it in the reader-printer machine, then advances the microfilm to the desired image. By pressing a button, he can Obtain--in five seconds--a print of the document appearing on the screen. What about the availability of the computerized RIRA index to private tax practitioners? Some insight into the government's position on this matter can be Ob- tained from the following quote: As Chief Counsel, it was my h0pe to make the RIRA index available to private tax men insofar as possible without revealing confidential information. Privi- leged material exists within the system since ruling and technical advice requests handled by the Inter- pretative Division of the Chief Counsel's Office are also indexed and abstracted . . . . While it would not be realistic to expect the Government to make this information available to the public, this does not mean that a modified index could not be worked out in time . . . .29 A chief difficulty since RIRA's inception in 1964 has been the inability of the Chief Counsel's Office to keep this legal information system current. Primary __ 28David T. Link, "Micro Forum" The National Public égcountant, X, NO. 5 (May, 1965), p. 15. 29Mitchell Rogovin, "Impact of Computers on Tax Practice Today; What They Can Do For The IRS and Tax Men," figurnal of Taxation, XXV, NO. 2 (August 1966), P. 113. 212 cause Of this difficulty was lack Of a prOper computer facility. Computer time and key punch Operator time had to be purchased; microfilming facilities of other govern- ment agencies had to be used. This arrangement caused many delays and prevented the production Of a list of pending cases with any degree of regularity. The prob- lem was solved in July, 1967 when the IRS Data Center at Detroit began doing all RIRA processing. The computer facilities made available to RIRA at Detroit has permitted this legal information system to remain current. Up-to- date monthly listings are now produced of all civil cases, except collection suits, pending in the Tax Courts, Dis- trict Courts, and Courts of Appeal. Recently, the Assistant Commissioner for the Technical Division Of the IRS stated that the IRS Chief Counsel pointed out that his office hoped to have very soon on 16mm microfilm a complete listing of all pending cases available for sale to practitioners on an annual subscription basis.30 Details of this announcement and the microfilm listing of tax cases that have been made available appeared in the January, 1969 issue of the Journal of Taxation as follows: Microfilm listing of tax cases available--A monthly listing on 16mm microfilm of all tax cases, other 30Tax Analysis--Key Government Officials Give In- formal Views on Timely Topics," Journal of Accountancy, CXXVI, NO. 4 (October, 1968): P- 72- 213 than collection suits is now available on a subscrip- tion basis. The listing contains all the tax cases pending in the Tax Court, district courts, Court of Claims, and the Appellate Courts. Subscribers to the service, which costs $78 a year, will receive a uniform Issue List (IRM 1275). This is an index used to make broad identification of case issues. It consists of an eight-digit issue number and brief titles keyed to Code sections. Each case is listed by court docket number under the apprOpriate issue number. The listing contains the taxpayer's name, the court, city in which the case is docketed, the assigned Chief Counsel field Office or division, the filing date Of the petition. Practitioners should not expect this service to pro- vide more than a broad directional indication of the issue or issues involved. For example, under issue number 0061 15-00 which related to interest income under Section 61, the list might contain some 75 cases. The Uniform Issue List (IRM 1275) furnished the practitioner lists some 12 subdivisions under the 0061-15-00 category (accrued-01, principal v. interest- 02, bond-03, capital recovery-04, etc.) but these finer shadings do not appear to have been made. The listing is available from the Clearinghouse for Federal Scientific and Technical Information, U. S. Commerce Department. TIR 993, 10/7/68, contains a sample application. Ap- plications or requests for applications should be sent to Clearinghouse, Springfield, Va. 22151. Pay- ment must accompany the application. The initial reel was mailed in November and contained docketed cases which were pending as of September 25, 1968. Tax Exempt Organizations and Pension Egust Fund—Master File Plans were initiated in the fiscal year of 1964 to construct and develop a computerized master file system u‘ 31"Microfilm Listing of Tax Cases Available," The gpurnal of Taxation,XXX, NO. 1 (January, 1969), p. 56. 214 of tax exempt organizations in order that administration of the legal work might be improved and to be more readily responsive to Treasury Department and Congressional infor- 32 mation needs. The file was established in fiscal year 1965. There has been a persistent rise in the number of organizations and pension trusts seeking tax exemption. The organizations, in addition to private foundations, which may be granted exemption from income tax have been classified into six broad groups as follows: 1. Charitable or religious . Public (educational or scientific) . Business and professional (chambers of commerce, trade associations, etc.) Civic (townships and cities) Employee associations (labor units, pension trusts and insurance companies) Private (social clubs, fggternal organizations and cemetery companies.) U'lob LON C 0‘ o Closer examination of all these organizations was planned to make sure the activities of these organizations were confined to those for which they received tax exempt status. In 1964 there were "well over a half million organizations exempt from tax under various provisions *_ 321964 Annual Report of the Commissioner of In- ternal Revenue, IRS Document No. 55, Treasury Department, Superintendent of Documents, U. S. Government Printing Office, washington, D. C., p. 39. 33Norman H. Ginstling, "Permissable Activities of Exempt Organizations (Other Than Foundations)," 1965 Proceedin s of the New York University 24th Annual lfi:_' EEEtute on Federal Taxation, p. 115. 215 Of the Internal Revenue Code."34 Information from these questionnaires regarding name, address, employer identi- fication number, purpose of organization, and nature of activity was transcribed to magnetic tape and constituted the foundation for a consolidated file of exempt organi— zations. All transactions pertaining to their status are now posted to this file from returns submitted by these organizations. Pertinent information posted to these records include (1) the granting, denial, termina- tion or revocation of exemption status; (2) compliance or non-compliance with annual filing requirements; (3) audit results; (4) recommendations for future audits. This file provides a central and accurate listing Of all tax exempt organizations. From this file is pro- vided a directory of organizations to which contributions by taxpayers are deductible. A national roster Of organ- izations whose exemptions have been denied or terminated is also provided. Together these lists make it more feasible for the IRS to determine those contributions which are deductible and to detect those contributions which do not qualify for deductibility. Periodic screening of the Exempt Organizations File permits delinquency checks to be made in order to ~— 34William H. Smith, "Impact of Automation Upon En- forcement of the Federal Tax Laws," 1965 Proceedings of the Seventeenth Tax Institute of University of Southern Cali- §9rnia School Of Law, p. 53. 216 identify those organizations which are required to but did not file the annual information returns or the "un- related business" income tax returns. It permits selec- tion of returns for audit. In general, the relatively new Exempt Organizations Master File permits national supervision and administrative control over the universe of exempt organizations for the first time. Just as the Individual Master File (IMF) and the Business Master File (BMF) at the NCC permit closer control over the nation's taxpayers, this master file of exempt organizations en- ables the IRS to make sure that the classification Of tax exemption attaches purely to those organizations which legally operate within the framework of the appli- cable exemption statutes. The Tax Exempt Organizations Master File System is maintained on tape by the computers in the Detroit Data Center. The file was expanded in 1966 to include trusts established under pension plans. The number of individual organizations included in the master file went up during the 1968 fiscal year from 309,000 to 358,000. Exempt pension trusts included in the file increased from 35 89,000 to 106,000. The system was upgraded in the 351968 Annual Report of theggmmissioner of In- gernal Revenue, IRS—Document NO. 55, Treasury Department, Superintendent of Documents, U. S. Government Printing Office, washington, D. C., p. 9. 217 fiscal year of 1968 by redesigning many elements and re- defining its objectives, as follows: 1. To use computers to generate mailing labels for returns, 2. Retrieve and provide information quickly by type, size and other significant characteristics Of all tax exempt organizations, 3. Create a capacity for determining compliance with the filing requirements Of the law, 4. Establish a more effective system for processing returns, 5. essist in selectigg exempt organization returns or examination. A proportionate share of the IRS' audit examina- tion program is allocated to exempt organization returns. The main objective of this examination program is to verify the tax exempt status of organizations by attest- ing to the fact that these organizations confine their activities to those permitted by the exemption provisions of the law. In 1965 over 12,400 returns were examined in the program to detect and prevent tax abuses in this area. Examination of tax exempt organization returns increased in 1966 to 13,331. Almost $38 million in addi- tional taxes and penalties resulted from these examinations. Recommendations to revoke the tax exempt status of 232 organizations were made by examining Officers in 1966. From the 11,746 returns examined in 1967, 260 revocations were recommended. All the 12,128 returns examined in fiscal year 1968 were found to be operating as required 36Ibid. 218 by law, except 182 organizations. Examining Officers recommended revocation of the tax exempt status of these organizations.37 The tax exempt organizations, eSpecially private foundations, are now being watched very closely. Closer scrutiny has been made possible by the computerized mas- ter file. The Treasury Department has recommended to Congress a number Of new rules to close loopholes, along with a report that there has been some abuses of the tax exempt privileges of private foundations.38 Congressmen now are being prodded by tax-paying businessmen and their Spokesmen to deal with the problem of tax exempt organizations that engage in activities which compete with taxpaying businesses. A former Inter- nal Revenue Commissioner, Mortimer M. Caplin, who now represents the National Tax Equity Association, cited many examples of unfair competition from churches, pri- vate foundations, trade associations, fraternal benefi- 39 ciary societies and cooperative associations. Private 371968 Annual Report of Commissioner of Internal Revenuez p. 22. ‘ 38"Tax-Free Foundations: Study Starts in Congress," U. S. News and World Report, LXVI, NO. 6 (February 10, ' pp. 81-82. 39"Tax-Free Groups Studied Again,“ U. 8. News 32d World Report, LXVI, NO. 10 (March 10, 1969), p. 100. 219 foundations have been growing at the rapid rate Of about 2,000 a year. They now control $20.5 billion in assets. "The Foundation Center, an association of philanthropical organizations, estimates there were 22,000 at latest count. The IRS by its broader definition lists 30,262 foundations."40 The "big ten" among foundations are" * Assets (Millions) Ford Foundation . . . . . . . . 3,580 Rockefeller Foundation . . . . 804 Duke Endowment . . . . . . . . 615 Mott Foundation . . . . . . . . 424 Lilly Endowment . . . . . . . . 390 Kellogg Foundation . . . . . . 375 Carnegie Corporation . . . . . 336 Sloan Foundation . . . . . . . 327 Pew Memorial Trust . . . . . . 303 Hartford Foundation . . . . . . 270 *At end of 1967, latest available. Source: Foundation Center.41 Complaints are being made that a large number of foundations abuse their tax-exempt status. Many con- gressmen are determined to force broad changes in the way private foundations Operate. Some want to tax all foundations.42 —_ 4O"Tax-Free Funds Come Under Fire," U. S. News ‘ epd World Report, LXVI, NO. 9 (March 3, 19697, pp. 84¥85. 41Ibid., p. 84. 42"Many in Congress Ready to Tax All Foundations, Curb Their Operations," The Wall Street Journal, XLIX, N9. 97 (Friday, February 28, 1969), p. 1, Col 6; "Founda- tions Feel Heat of Tax Reform," Business Week, No. 2062 (March 8, 1969), pp. 72-76. 220 Statistics of Income and Computerized Tax Models At the present time, the series is required by Section 6108 of the Internal Revenue Code of 1954. The first volume of Statistics of Income issued was for 1916; however, it contained tax data for individuals back to 1913 and for corporations back to 1909, the very first years of income taxation. The next fifty years saw the Statistics of Income program develop from the initial small report used for tax administration purposes to a set of volumes containing numerous complex analyses which provide important data needed for economic and financial research as well as for tax administration. The IRS has been accelerating its use of Statis- tics of Income and tax models for tax research. The Statistics of Income Program has become a feature of the computers at the Detroit Data Center. Great improvements have been made in the type and quality of the data in the series. Computer technology has vastly contributed to improved data processing methods and speedier publication of the volumes. The Statistics of Income provide very valuable information about the operation of our tax system. New compilations made possible by centralized computeri- zation of the data at the Detroit Data Center are now providing more SOphisticated information for use in con- nection with Federal tax administration and tax research 221 of various kinds. The information is used (1) to analyze the tax or economic effects of specific provisions of the Code and (2) to measure taxpayer responses to the admini- stration of the Federal tax system. It also supplies a financial profile of taxpayers. The Statistics of Income series published in Fis- ' cal 1967 included the following seven major reports: 1. Individual Income Tax Returns, 1964 (192 pp. $1.25); 2. Individual Income Tax Returns, 1965, Preliminary (25 pp., 20¢); 3. U. S. Business Tax Returns, 1963 (237 pp., $150); . U. S. Business Tax Returns, 1964, Preliminary (25 Pp°l 20¢); 5. Sale of Capital Assets Reported on Individual Incomeflax Returns for 1962 (153 pp., $1.00); 6. Farmers' Cooperative Income Tax Returns for 1963 (58 pp. 40¢); 7. Foreign Tax Credit Claimed on Coiporation Income Tax Returns, 1961 (73 pp., 50¢). The first four reports are examples of regular reports and the last three are supplemental reports. The list of reports issued in the Statistics of Income series during the fiscal year of 1968 is as follows: 1. Individual Income Tax Returns, 1965 (224 pp., $2.00); 2. Individual Income Tax Returns, 1966 Preliminary (26 pp., 20¢); 3. U. S. Business Tax Returns, 1964 (213 pp., $1.25); 431967 Annual Repprt 9f Commissioner of Internal Revenue, IRS—fidcument No. 55, Treasury Department, Super- intendent of Documents, U. S. Government Printing Office, Washington, D. C., p. 104. These publications in the Sta- tistics of Income series can be ordered from the Superin- Eendent of Documents, Government Printing Office, washington, . C. 20402. 222 4. U. S. Business Tax Returns, 1965, Preliminary (25 pp., 20¢); S. Corporation Income Tax Returns, 1963, (429 pp. $2.25); 6. Corporation Income Tax Returns, 1964, Preliminary (41 pp., 25¢); 7. Corporation Income Tax Returns, 1965, Preliminary (31 pp., 25¢); 8. Fiduciary, Gift, 22d Estate Tax Returns, 1965 (114 pp., $1.25). The computerized information and statistical data included on the reports Of the Statistics of Income series are very useful for 1. Revenue estimating; 2. Tax and financial research conducted by Govern- ment agencies, businesses, private research organizations, and universities; and for 3. Supplying financial and economic data used in the preparation of the National Income and Product Accounts which show all contributions to the Gross National Product.45 The IRS has develOped and is making increased use of tax models for use in tax research to evaluate proposed 46 The IRS tax model consists of changes in the tax law. a statistical sample of approximately 100,000 individual income tax returns, which is weighted to represent the entire universe of taxpayers on Forms 1040 and 1040A filed 441968 Annual Repert of Commissioner Of Internal Revenue, p. 93. A 451967 Annual Report Of Commissioner of Internal Revenue, p. 57. . 46E. J. Engquist, Jr., "Improved Statistics Result- ing From the ADP System," Taxes, XXXX, NO. 1 (January, 1963), pp. 39-44. The author is director of Statistics Division, RS. 223 throughout the nation. The tax model was constructed by transcribing data from a selected sample of tax returns to magnetic tape and then manipulating the data by com- puter to simulate changes in the rules governing the computation of income tax due. A tax model using 1960 individual income tax returns was used to simulate the effects of reduced rates and a minimum standard deduction that were features incorporated in the provisions Of the Revenue Act of 1964. A new updated model based on a sample composed of 100,000 individual income tax returns for 1962 was constructed to provide fast and reliable forecasts of the revenue effect of changes in tax laws and their ad- ministration. This 1962 model consisted Of a magnetic tape file of the selected sample of individual returns along with a computer program capable Of simulating the results Of a wide variety Of possible changes in the tax law. This 1962 model was used extensively in predicting revenue that would be received under various proposals for graduated withholding rates on salaries and wages. The research based on this 1962 model laid the foundation for the Code changes legislated by the Tax Adjustment Act Of 1966 (Public Law 89-368). A revised 1964 model was designed to provide more up-to-date base data and more flexible computer manipula- tion and tabulation possibilities. This 1964 model Of 224 individual returns was constructed with a sample of 95,000 Forms 1040 and 1040A tax returns, stratified by size of adjusted gross income. It was selected from the popula- tion of 66 million individual income tax returns filed for 1964 income. The 1964 model has been used extensively, for example, to evaluate proposed tax legislation in the area of taxpayers aged 65 or over and for the deduction for state income taxes that the Treasury Department was considering. Three tax models were being used in l967--the individual, the sole proprietorship and the corporation models. These computerized model files were maintained on magnetic tape at the Detroit Data Center. In addition to the 1964 individual tax model described above, the 1964 sole proprietorship tax model and the 1964 corpora- tion tax model were used for tax research on contemplated legislative changes. The sole proprietorship model was used to indicate profiles of individuals with large busi- ness deductions and losses. It was based on receipt and disbursement amounts for a sample of 147,000 Schedules C and F of Form 1040 for 1964. The corporation model file contained the complete 1964 income statement, the balance sheet and other schedules for a sample of 51,000 returns in the Form 1120 series for accounting periods running from July, 1964 to June 30, 1965. 225 During the fiscal year 1968, three simulation models were develOped--the 1966 individual tax model, the 1966 sole prOprietorship model and the 1966 corporation tax model. The 1966 individual tax model contained about 80 income, deduction, and tax related items from each of 86,610 Form 1040 and 1040A tax returns. The other two models will contain the same number of data items for samples of about 130,000 tax returns concerning sole pro- prietorships and 49,000 tax returns concerning corpora- tions. Duringl968, the IRS used the 1964 individual tax model to predict how various groups would be affected by the surcharge that became law that year. The tax models are not only predicting devices but they are also used to provide information regarding the characteristics, or profile, of groups Of taxpayers. For example, the 1966 individual tax model is currently being used in the 1969 tax year to isolate the characteristics Of the increasing number of taxpayers that are receiving large refunds. The number of individual income tax returns with refunds increased 26 per cent from 1964 to 1966 and an even sharper increase of 46 per cent in the dollar amount of refunds resulted for the same period. The information to be derived from the tax model will enable the Service to determine the reasons for these sharp increases in re- funds and permit the develOpment of appropriate Operating Plans to correct this developing trend. 226 Under the terms of Sections 7515 and 7809 of the Internal Revenue Code as amended by Public Law 87-870 (87th Congress, 2d session), the IRS has undertaken special tax research studies on a reimbursable basis. Under the provisions of the law, the IRS may receive pay- ments for special studies and compilations furnished to private organizations and non-Federal government agencies. The IRS is permitted to use the payments to reimburse the Congressional apprOpriation which bears the cost of such work. The legal power to make these special tax studies and tabulations is clear evidence Of Congressional recog- nition of the wealth of statistical information available on tax returns and related documents. Requests for data on a reimbursable basis fall into two categories, as fol- lows: (1) copies of material from the Source Book of Statistics of Income and (2) special studies. Major users have been universities, private individuals, state and local government agencies, companies, research organiza- tions, and other Federal Government agencies. During 1965 the IRS opened its tax model tape files for the first time and made available for sale copies of its magnetic tape files. The tape file, for example, which shows the construction Of the 1962 indivi- dual income tax return model can be purchased for about $300 by researchers in other Government agencies and non- government organizations. About sixty items of information 227 are included on each individual record in the file. From this data users can compute the tax liability and most of the income, deduction, exemption, and tax credit details for each individual taxpayer included in the file although all identifying data for each taxpayer entity has been deleted. In this manner the IRS makes available valuable data for statistical purposes while at the same time pro- tecting the confidentiality of tax returns. The announcement was made in the October, 1968 issue of the Journal of Accountanqy,48 that the 1966 IRS tax model is now available to researchers at cost. This model is a miniature of the entire U. S. taxpaying popula- tion. It is on magnetic tape and represents a random selection file of 86,000 returns with taxpayer names and other identification details deleted. The file can be fed into computers to measure the impact of any prOposed changes in the tax Code. Any prOposal tested with this 1966 Tax Model is calculated on each one of the 86,000 re— turns in the sample.49 48"IRS Tax Model Available To Researchers At Cost," figurnal of Accountancy, CXXVI: NO- 4 (October, 1963): PP- 14’16 0 49Tax researchers desiring further details on the use Of this model or others may write to Assistant Commis- sioner, Planning and Research, Internal Revenue Service, washington, D. C. 20224. 228 Programs of Federal-State Cooperation in Exchange Of Tax Information5U The Federal-state Cooperation in Exchange of Tax Information Program is still in the process of develop- ment. In at least one area Of activity--the exchange of audit information--reports indicate the program has pro- duced very valuable results for both the IRS and some states. For example, the IRS was able in 1964 to make $7 million in additional assessments of taxes, interest, and penalties due to the audit information received from the states in the program. For the same year 18 states and the District Of Columbia made deficiency assessments totaling $25 million due to audit information received from the IRS. The Federal-state cooperation program has been expanded through the use Of computers. TO develOp leads to identify nonfilers and delinquents, the states tape file of income taxpayers was matched with the tape of the IRS to produce two separate files. The first file, 50Annual Reports of Commissioner of Internal Revenue: 1965, p. 36; I966, p. 36; 1967: p. 35;l1968, p. 33-34. See also: "Tax Pitfalls to Avoid,“ Nation's Busi- ness, April, 1968, p. 16; James S. Currie, "Effects of Federal ADP on Federal-State Coordination Programs," 1963 Egoceedings of 16th Annual Conference, National Tax Asso- ciation, pp. 120-27; Henry B. Jordan, "Taxpayer Identify- N ers," Lybrand Journal, XXXXIV, No. l (1963), p. 31; "For This Year's Tax Returns: The Closest Check Yet,“ U. S. News and WOrld Report, LXIV, NO. 10 (March 4, 1968), pp. - o 229 for use by the states, listed taxpayers who filed a Federal return but not a state return. The second file, for use by the IRS, listed taxpayers who filed state re- turns but no Federal return. The IRS presently has in effect "Tax Information Agreements" with 45 states and the District of Columbia. The six states which have not entered mutual formal ex— change agreements with the IRS are Alabama, Connecticut, Louisiana, Nevada, Rhode Island, and Texas. The IRS prepared and forwarded to the states 339,000 audit abstracts during the calendar year 1965. WOrking with the National Association of Tax Administra- tors, the IRS Obtained a consensus from state tax admini- strators pertaining to a uniform set of data elements in tape mode from the Individual Master File (IMF) to be furnished routinely to COOperating states. At the end Of 1967, a total of 25 states had indicated willingness to participate in a pilot tape program that covered individual income tax returns for the tax year 1966. By the end Of Fiscal Year 1968 there were 28 states and the District Of Columbia with computer systems signed up to exchange IMF tax information in tape mode with the Federal Government. Exchange of Business Master File (BMF) information in tape mode has not yet been develOped. The IRS continues its longtime practice of exchanging audit abstracts on a manual basis and honors requests from states for BMF data on a case-by-case basis. 230 Computer—generated magnetic tape files are now being used. Magnetic tapes were made available to the states by the IRS in accordance with 5 U. S. C. 140 and sections 7515 and 7809 of the Federal tax laws, which permit the IRS to make a user charge for such service. Computerized magnetic tapes enable the Federal and state governments to provide each other tax returns information much more efficiently and economically than manual methods used in past years. Confidentiality of information exchanged on tax returns is protected by law which makes unauthorized disclosures subject to prosecution. Congress has enacted laws authorizing the availability of Federal tax informa- tion to state tax Officials. Since 1909 with the first excise tax on corporations, Congress permitted state tax Officials legal access to corporation tax returns. This inspection right was extended in 1935 to individual in- come tax returns. The Federal law requires the informa- tion to be made available on a confidential basis to state tax officials, and state laws reciprocate by per- mitting the IRS to inspect tax returns on a confidential basis. Confidentiality of Federal tax returns is pro- tected by section 7213 of the Internal Revenue Code by imposing a fine of $1,000 or imprisonment of not more than one year, or both, for unauthorized disclosures by any officer, employee, or agent of any state or political 231 subdivision. The confidential nature of income tax returns is not deemed to be changed by making the information available to the states and through them to political subdivisions, like cities. A joint IRS-state review of controls over the exchange of information program to in- sure confidentiality has resulted in the preparation Of guidelines for states to follow. These guidelines are now included in all IRS-state contracts and revisions to update exchange agreements. CHAPTER V THE APPLICATION OF COMPUTERS TO THE PREPARATION OF TAX RETURNS Orientation The computerized efficiency of the tax collecting activity of the Internal Revenue Service was delineated in an earlier chapter. All individual and corporate in- come tax returns filed with the IRS have been processed through an elaborate electronic data processing network Of computers on a nationwide basis since 1967. The taxpayers of the nation can prepare them- selves for the computerized efficiency of government computers by using computers to develop greater efficiency of their own. At least nine tax return preparation ser- vice companies have been identified as harnessing the speed and accuracy of the computer to prepare tax returns. They are Computax, Datatax, Autotax, Fast—Tax, Unitax, Computer Tax Service (CTS), Programmed Tax System (PTS), Systems and Taxes (SAT), and Digitax.l These services make available their systems to taxpayers through local E 1For details of each company, see Appendix A. 232 233 tax practitioners such as certified public accountants, pub- lic accountants, lawyers, bankers, and tax specialists. One man in the computerized tax return business estimated that half a million 1965 tax returns would be prepared by computers in 1966 and that one million 1966 tax returns would be prepared by computers in 1967.2 By 1970, Computer Science Corporation estimates that over 10% of all individual returns filed each year will be processed by Computax and that in the fore- seeable future income tax forms will be replaced by direct tape-to-tape tax return transmission from com- puter centers to Internal Revenue Service automatic data processing locations.3 Table 5-1, Selected Types of Tax Returns Filed with the Internal Revenue Service 1965 through 1968, shows that individual income tax returns filed on Form 1040 have been going up at the rate of two million each year during the period 1965 through 1968. The number of 1040 Forms filed in 1968's tax season was 54 million. This figure as well as all the other figures in Table 5—1 presents the trend of the potential demand for computerized tax return preparation services. At the Federal level there is a strong potential demand for computerized tax return preparation service in k 2"Electronic Ally For The Taxpayer," Business Wefi. March 26, 1966, p. 167. ——" 3"Tax Returns By The Computer," The National Pub- 139 Accountant, X, No. 1 (January, 1965), p. 7. 234 Table 5-l.--Selected types of tax returns filed with the Internal Revenue Service in 1965 through 1968. Individual Federal Income Tax Returns: Form 1040 Form 1040A Other 1040 Formsa Form 1040 Fiduciaryb Declaration of Estimated Tax Partnership Income Tax Returns Corporation Income Tax Returns Estate Tax Returns Gift Tax Returns 1965 1966 1967 1968 (Figures in Thousands) 48,158 17,774 110 910 6,166 977 1,420 94 122 50,054 18,578 115 977 6,322 962 1,502 103 134 52,000 19,080 114 1,030 6,202 956 1,526 113 137 54,062 18,617 114 1,045 6,450 1,002 1,623 119 139 aThis category includes Forms 10403, NB, NBA, PR which represent U. S. non-resident alien income tax returns and self-employed taxpayers in Puerto Rico. bForm 104l--U. S. Fiduciary Income Tax Return for Estates and Trusts. Source: Internal Revenue. Annual Reports of the Commissioner of 235 the areas of individual, fiduciary, partnership, and corporation income tax returns as well as estate and gift tax returns. Figures representing this latent demand are shown in Table 5—1. Thirty-three of the fifty states now require in- come tax returns to be filed, and an ever growing number of cities in the United States are joining the list. Rec- ords show that 171 cities in eight states had a city income tax as of the end of 1967.4 Some of the computer returns services do only the Federal individual income tax return; some do the Federal and a few of the state returns; a few do Federal, some of the states.and the city of New York; at least one does Federal individual, corporate, and partnership income re- turns as well as some Of the state individual income tax returns; some of the services are presently doing research on and later hope to process fiduciary, partnership, and corporate income tax returns and estate and gift tax re- turns also. The point stressed here is that latent demand exists for computerized returns service for many types Of returns at the Federal, state, and local levels. 4Avon M. Dreyer, "City Income Taxation in Michi— gan," The Michigan State Economic Record, X, NO. 6 (June, 1953), p. 1, East Lansing; Bureau of Business and Economic Research, Graduate School of Business Administration, Michigan State University. 236 Major factors creating the demand for mechanized returns preparation have been the following: (1) in- creased complexity of tax regulations has forced tax- payers to seek professional help from tax consultants in such large numbers that tax practitioners have become inundated with work,5 (2) the government's shift to a computerized tax collecting system. This system puts each tax return under a microscope which Often boosts chances for a full-scale government audit when errors, 5The problem became so severe that the American Institute of Certified Public Accountants requested the Internal Revenue Service to grant time extensions for in- dividual returns being prepared by overburdened tax con- sultants. See the following references: "Dangers in- herent in Some Extensions," Journal 9; Accountancy, CXXI, No. 2 (February, 1966), p. 63; "What Factors Are Being Looked For In Extensions Requests," Journal of Taxation, XXIV, No. 4,(April, 1966), p. 246; "AICPA Urges IRS To Modify Extension Policy Based on Practitioners WOrkload," Journal Of Accountanqy, CXXI, No. 4 (April, 1966), pp. 18-20; "AICPA Pleads For Filing Extensions Based Solely On WOrkload of Practitioners," Journal of Taxation, XXIV, No. 5 (May, 1966), p. 316; "Practitioners Complaifi About Service's Increasingly Stricter Extension Policy," Journal of Taxation, XXV, NO. 1 (July, 1966), p. 36; Irving AIten, "It Is Getting Quite Apparent That Some Relief Is Needed On The Federal Individual Income Tax Preparation WOrk Load," Journal of Accountangy, CXXIII, NO. 1 (January, 1967), p. 23; "Favorable 1967 Extensions Experiences Can Be Continued," Journal Of Accountancy, CXXV, No. 1 (January, 1968), p. 65; Commissioner S e on S. Cohen's Views On Filing Time Ex— tensions," Journal of Accountancy, CXXV, NO. 1 (January," 1953), p. 66; 1'The Practical Approach to IRS ExtenSions, The National Public Accountant, XIII, NO. 1 (January, 1968), P- IO; "Report On The NSPA Survey Of IRS ExtenSion Prac- tices," The National Public Accountant, XIII, NO. 1 (Jan- uarYI 1968;: PP' 6—9' 237 omissions, or abnormal items are found. The computerized tax return preparation service industry is growing rapidly. Usually a company first ap- pears on the local scene, then serves a limited region before going national. Of the major companies identified in the field, most all of them are marketing their pro- fessional services on a national basis. The initial investment required to enter the in- dustry is quite large. One to two million dollars are required according to Mr. Hubert Hall, president of Tax Computer Associates, a Washington, D. C. service company. The setup cost of a computerized returns preparation ser- vice includes the programming and market develOpment. Tax Computer Associates originally marketed the Autotax service which was originated by Mr. Hall. Attention is invited in the remainder of this chapter to a consideration Of the computer programming and processing of income tax returns in general. This con— sideration includes discussion and analysis of the follow- ing topics: (1) services presently offered, (2) definition Of a computer-processing tax return service, (3) input forms, (4) processing Operations which include steps in the process, classification of the services into completely computerized and partially computerized, turn—around time, equipment used, owners and managers, experience in the in- dustry, (5) output of printed returns and other services, 238 (6) errors, (7) confidential nature of the information. Then price structure, problems Of the industry that af- fect all firms, reaction and Opinions of users, and ef- fects or results of computerized returns are considered. The_Firms: Computer Processed Income Tax Return Services in General Services Presently Offered Nine firms have been identified as offering com- puterized tax return preparation services on a local, regional, and national basis. They are Computax, Autotax, Fast-Tax, Datatax, Unitax, Computer Tax Service (CTS), Programmed Tax System (PTS), Systems and Tax (SAT) and Digitax. Computax has emerged the leader in this rapidly growing industry. These firms and the services they Of- fer are summarized on Table 5-2 Services Provided By Computer Processed Tax Return Firms. One firm, Systems and Taxes (SAT), went bankrupt so that only eight firms remain in Operation today. One of these eight, Datatax, suspended Operations in the 1968 tax season to update its equipment and forms. It resumed Operations on a limited basis in the Manhattan area in the 1969 tax season and plans to make a comeback in 1970. The historical de- velOpment of each firm along with other related details can be found in Appendix A. 23S) m: UTTSm 0060 Mt .Qfidw 0502 000? o Mud? OH wmcvmxm USO GEOUCH EHdh uh Odfiflflfiow m: umorm memo me .ddsm OCOZ 0mm» a they m EH08 Ono; 0:0 EH09 UHOfiwllwuuwfloum MO 00GM£UXM HO THMW EOHN mmmoeH cam MGHMU «a ”chvnow OGOZ OGOZ 0:02 mww F can m no» He U OCH 0 .Hflom HOw GOHMMHOOHQOQ mo Teacmnom me uwozm tuna me .QQSm 0:02 mow v no» ocoz U n0\0:m m .eoom MOM GOeumemoa mo masconom m* ummcm mama m* .mmfim 0:02 mm» o mm» m use b ch UGOEMOHQEMIweOm hueudocm emeoom mo sceumusmfiou "mlo oedoonom ma umonm mumo me .mmsm mcoz who» n and» m can m scemmowoem no mmocemsm Eouu Ammoev newoum no oeopcnom me uoonm coco me .Qmom mcoz meow m once we .HU .OcH pcoEwueumm new OEOOCH “m oesvmnom . 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The various types of firms offer a completely computerized service or a partially computerized service; the distinc- tion between the two is discussed later. The various kinds of computer-prepared tax returns include individual income tax returns on basic Form 1040, corporate income tax returns on basic Form 1120, partnership information income tax returns on basic Form 1065. At least one firm, Fast-Tax Of Dallas, Offers service on the corporate and partnership returns in addition to the individual returns. Research for computerization is being conducted by some firms on fiduciary income tax returns, Form 1041, of estates and trusts. Some firms in the young industry which do not Offer service on the corporate and partner- ship returns are studying the possibility of extending their services to these areas.. Some firms are research- ing estate tax returns (basic Form 706) and gift tax re- turns (basic Form 709). Vertically, the computer services are offered at three levels—-Federal, state, and city income tax returns. All firms in the rapidly developing industry process the Federal income tax return, Form 1040. Some process com- plicated returns including basic Form 1040 with all possible supplemental schedules and supporting forms. 242 Others hold to the simplicity Of the basic form, primarily, without any supplements. Most of the firms process some of the state income tax returns. New York and California are-the two state returns most often served by the com- puter firms because of their large populations. Compu- terized state return service is now Offered by one or an- other of the firms for the following states: California, Georgia, Indiana, Louisiana, Massachusetts, New York, North Carolina, South Carolina, Maryland, Virginia, Wash- ington, D. C., Colorado, Kansas, MisSouri, New Mexico, Utah, Oklahoma, Michigan. Programming of additional state returns is now in process by several of the firms. Thirty— three of the fifty states now require income tax returns to be filed. At least three of the services--Computax, PTS, and Digitax—-have programmed the city of New York income tax return and now offer that service in their package. There were 171 city income taxes in eight states at the end of 1967 and this list continues to grow longer each year. gefinition of a Computer-Processing Tex Return Service Computerized processing of tax returns can be de- fined as a sophisticated automated service Offered by firms that (1) receive raw information on questionnaire- interview input sheets from their customers, who are practitioners; (2) compute final tax liability Of each 243 client that is supported by calculations on basic forms, supplementary schedules and supporting forms; and (3) print out the return, including the basic forms supple- mentary schedules and supporting forms, and collate and assemble the returns for packing and shipping back to customers. The finished product is the printed out re— turns on the official forms or facsimilies thereof, ready for signature and filing with the government agencies. Comparative operating data are shown on Table 5-3 for the various services regarding especially (1) input of tax data--interview forms; (2) processing of the tax data—~steps in process, equipment used, years of experience, manager-owners, processing centers, turn- around time; and (3) output Of finished product—-printed tax returns and supplementary schedules and forms for Federal, state and city levels. Input of Tax Data: Forms The input forms are specially designed and vary greatly among the seven services. They have been labeled interview forms, comprehensive questionnaire, input forms, tax interview answer sheet, worksheets and schedules, questionnaire sheets and interview sheets. The number of input sheets required to be filled out varies among the services from one, to two, to three, to 11, to 19 to 27. Complexity of the return determines whether or not all .m.D usonmsounu xeo» 3oz Meow 3oz xeow Bmz mmeueo oomoenu ommoenu .U.Q ommoeno .moemEmo eonmE Ne mmemmcm woe mmemmcd woe mmeemo .c0umcenmm3 mmemmad woe mewucmu mcwmmoooum .m mhmo mo Anxmomv h emnEdcllmcemmmooum N N m m N m Aemfihocv m how OEeB UCSOHCICHSB .m noose memo e umeexomno e N m m mama e ee nN me mummzm uo HmnEdz mummnm nummnmxuoz ummnm um3mcd mummnm wuemc tem mEuOh 30e>nwuce mEuom mnemGCOeumOso mEnOm pmeemo ne 3me>ecuce neceummno cesumm xme usmcH o>emcmnwumeoo 3me>emucH mEHOE usmcH .h A. 2 me can on eoooz moee owns oem ZmH oem EmH Hove Eme ammo ZmH com EmH own ZmH om>eca ucmfimemvm mo make .e meme ce meeocoeooz umuem Ocoomm mcoomm nuesom Ocoowm nunsom gamma useumnmmo GOmmmm xmB .m Omunmum meme meme meme meme eeme meme meme maceumnmoo new» .e moe>emm mmeeumspce noemmnmm moenwad smoom uuezoeo: memcso xme couuee mo mcmcmcme mo ououeumce oceumoHU umc3o .Om mum>eem cmmsoxm .>eo memos HouomEOo noummmmm monmEEOU mo acmmsoo usmumm .m Nue3ouo: cememmou eemuuom peondm sees unmadex GOmmz .m .Q moe>umm no Hocmsmz .mm .3 .d .uz xcmum .3 neocmum monomo mo Ewen mo unopenmum .N xuo» 3oz mecHOMeemU mecH0meemU usoeuomccoo nmxoa xuow 3oz mecHOuwemU moemfimn memOCOHU umeuuwnz sow3cmou0 ameema xeo» 302 oucsmmm em ammunom mumuumswmmmm .e man who xmueca xmumumo xmBIHOMh xmuousd xmunmeou meuoueuo .mooe>emm cumumu xmu mnennoooumluousmsoo mo meumumuo mswumummo m>eumnmmEOU:I.mnm Oenma 245 the many sheets are used. All the necessary data that go into the completed tax return are recorded by the preparer- practitioner on these specially prescribed input sheets. Each practitioner, after signing a contract, receives a set of input sheets on which to record his client's in- come tax information. At that time, he usually is required to estimate the number of returns to be filed monthly or seasonally, make a depOSit which is applied against cost of first returns processed or pay a registration fee. An instruction book, manual, or letter is usually provided by the various services to subscribers to assist them with proper usage of input forms. Some of the larger services Offer instructions at meetings they hold for practitioners and their staffs.. Negative experience with and negative Opinions of computer—processed tax returns is Often caused by improper use of input forms. Therefore, correct usage of these forms is stressed by all services. Proper usage of input forms is required and stressed over and over in order to prevent a result that will be "GIGO"-- garbage in, garbage out--as computer vernacular puts it. Success of the whole computer-processed Operation and printed out return depends upon prOper usage of input sheets which contain the crucial data. Erpcessing of Tax Data: Operations The input forms, when completed by preparer, after an interview with his client, are forwarded to a processing 246 center where the information is computerized and a finished tax return printed out. At the processing center, the in- formation from the input forms is keypunched on cards and verified. Then the information is transcribed by computer from cards to magnetic tape and stored in the memory com- ponent of the hardware equipment which is equipped with "random.or direct access," which easily permits rapid up— dating Of information in the memory component. The com- puter begins its analytical Operations by reviewing the information received and making calculations according to programmed instructions. These programmed instructions direct the computer (1) to calculate the tax.liability several times using the various alternatives permitted and (2) to select the computed alternative which gives the taxpayer the lowest legally obtained tax liability. There is considerable variety in the processing Operations among the services. Some services have ela- borate input forms that number eleven pages or even as high as 27 pages on which tax details are recorded for the computer to make all calculations. These calcula- tions made by the computer would include the tax liability and summary figures on all the supporting schedules and forms. The tax practitioner makes no calculations. Computax, Autotax, and Fast-Tax fit this category. Other services require fewer input forms--one, two, or three Sheets--and require the preparerrpractitioner to do some 247 of the calculating. The input forms Of these services contain some summary figures representing supporting schedules and forms that the preparer—practitioner must compute. Datatax, Unitax, CTS, and PTS fit this cate- gory. Some input forms require the practitioner-preparer to make all necessary calculations except the computation of the liability for tax. Unitax has this packaged offering. The conclusion to be derived from the first two types of operations is that the first category of services can be characterized as completely computerized and the second category can be characterized as partially computerized. This classification of services has an influence on turn-around time, output, costs, manager- owners, experience in the field. Turn—around time involves the number of days re- quired for processing the data through the computer center and getting the completed printed out return back in the hands of the preparer-practitioner. The completely computerized systems usually commit themselves to a five- day turn-around period, except one-~Fast-Tax, which has a two-day turn-around commitment. The partially computer- ized systems usually commit themselves to a two-day turn- around period, except one--Unitax, which has a five-day turn-around. Computax admits the turn-around time ex- tends itself from a five—day to a seven-day period during the peak season period, March 20 to April 17. 248 Equipment used is mostly IBM. All the services use IBM 360/Systems, except Unitax which uses the IBM 1401 8K Model, Datatax which had been using the IBM 7330 Model, and Computax which uses Univac. Datatax suspended Operations during the 1968 tax season in order to update its computer equipment and expects to be back in opera- tion for the 1969 tax season. All the completely computerized services are sub- sidiaries or divisions of a parent company. They origi- nated primarily through the promotion skills of private Operators-practitioners or other technicians and grew in Operating expertese to the point where adequate financing and marketing of their systems was lacking without further backing. Backing was obtained from parent companies through acquisitions, mergers and combinations. These parent companies now supply necessary financing and pro- vide their own previously established market outlets for distribution of the service to the national market. The partially computerized services are primarily privately owned, managed, and Operated by individual outlets but seek to serve their customers on a national basis through franchises. They do not have powerful financial backing 0f parent companies but must depend on other private fi- nancial means. The completely computerized services are Older and more experienced than the partially computerized 249 firms. These Older firms began Operations in the early or mid-1960's in a local area like California, Washington, D.C., Dallas, or Albuquerque. They then grew in strength and served the region Of their neighboring states before going to national market coverage. The partially com— puterized services are younger. They began Operations in the mid and latter 1960's. These firms are strong in their local and regional areas like California and New York. They have been Offering their services on a limited national basis for only one or two years and cater to the smaller, less complicated returns. They charge less, have simpler input forms, and shorter turn-around times than the fully computerized services. Programming Computer-Prepared Tax Returns Programming of the computer-prepared tax returns gets into the technical operations of computers. Inquiries made to firms about their programs were answered in vague generalities or were marked "confidential." The programs are regarded as secret information that is to be kept confidential from competitors. However, two firms, Com- putax and Autotax, did give some information regarding their programs. All programming for Computax Corporation is done at the headquarters office in El Segundo, California. The actual computation of the tax return is done on Univac 250 1108 computer models which are rented in New York, Chicago, El Segundo, washington, D. C., and San Francisco. The Univac 1108 program is written in Cobol at Computax and originally was develOped by Computer Science Corporation in 1964. The program was enlarged in 1966 to include 75,000 instructions, including some 23,000 CObol state- ments, which permitted the processing Of a return in an average of six seconds. Today, the main 1108 program consists of about 100,000 Cobol statements, which when compiled, generate about 500,000 machine language instruc- tions. In the course of computer-preparing an average Federal tax return, it has been estimated by the President Of Computax Corporation that about 750,000 machine lan- guage instructions are executed. The programming for Autotax, where the IBM System 360 Model 30 is used, is done entirely in 360 Assembler Language develOped by IBM. The same programs and sub- routines are involved in producing a simple return as a complex return. The programs are selectively executed, as needed, according to the data submitted to the computer. EVen a very simple tax return would involve a number of Programs. The present Autotax system represents over 3:000 pages of programming and nearly 400 separate programs, 6Letter from Daniel R. Mason, President, Computax Corporation, December 20, 1968. 251 any or all of which may be automatically applied to a single batch of returns being processed through the com— puter. Federal returns and the five state returns (California, New York, North Carolina, Georgia and Michi- gan) processed may be randomly intermixed within the same batch.7 Output: Printed Tax Returns Output of the computer systems consists primarily Of neatly printed and accurately calculated tax returns in triplicate ready for signatures and filing with the government tax agencies. This printed output of tax re- turns includes the Federal, state, and city returns if all three levels are included in the package of service rendered. The services print out a completed Federal Form 1040 with just about all possible variations con- ceivable and furnish extra sets Of schedules to enclose with state and city of New York returns. Variations de- pend upon the degree of complexity Of the returns. Some outputs include only the basic Form 1040 pages one and two with no supplements. Other outputs would include the basic Form 1040 and practically all the possible supple- mentary schedules and forms. Variations in the complexity . 7Letter from Maitland K. Flood, Chief Systems Engineer, Office of General Manager-Autotax, Tax Computer AssOCiates, Falls Church, Virginia, December 10, 1968. 252 of forms are found in the spectrum between these two ex- tremes. Illustrative examples of both simple and complex returns at all three levels of Federal, state, and city, are furnished by the firms upon request. Complete returns with supporting schedules are furnished for some states like California and New York, and for the City of New York. The completely computerized services tend to cater to the more complex returns which are more readily accomodated by their complex and elaborate input forms, their usually longer turn-around times, and their longer experience in the industry. Other output items of service in addition to the printed returns which most all the firms supply especially if they are completely computerized, are as follows: (1) extra c0pies of the Federal return for filing with a state or city return if the state and city returns are not in- cluded in the package of service; (2) a letter of filing instructions for the taxpayer-client; (3) a special audit report or "diagnostic report" for the customer-practitioner which points out possible problem areas on the computerized return; (4) pro forma worksheets for next year containing repetitive data needed for next year's return processing. Brice Structure Cost was cited as the major deterrent to wider acceptance of computerized returns in the 1966 tax season. 253 . . . Many accountants indicated that the cost made computers practical for only the more complex 'returns. For the simpler returns (for example, itemized deductions plus a Schedule D), the account- ant could not pass on the cost of the computer to the client, and absorbing the cost would wipe out most, if not all, of his profit.8 Higher prices were a predominant feature of the 1967 tax season.9 Substantial losses sustained by several firms in 1966 operations and the bankruptcy of one firm in 1966 induced higher prices in 1967. The price structure varies among the services. Price determination for a tax return by computer is simi- lar to the price determination of a new automobile. The price of a new car includes the cost of the basic model plus the charge for the various options that accompany it. The price of a computerized tax return includes the cost of the basic form 1040, which includes the determi- nation of the tax liability on pages one and two, plus the charges for the supplementary schedules or forms, like Schedules B, C, C-3, D, F, G, etc. The charges for the supplementary schedules may be on a flat-rate basis; that is, a flat amount for each 8"Computer-Prepared Tax Return Service Is Generally Satisfactory; Survey Outlines Pros, Cons, Problems," Taxa- tion For Accountants, I, No. 5 (November-December, 1933); p. 279. 9"Computer Tax-Return Preparation: How The Several Services Shape Up This Year," Taxation For Accountants, I, NC. 6 (January-February, 1967), p. 322. 254 supplementary schedule whether the schedule has many or few items thereon. Or the charges for a supplementary schedule may be on a per-item basis; that is, a fixed amount for each item appearing on a supplementary sche- dule or form. Sometimes a combination of a flat-rate charge and a per-item charge is found in the price struc- ture for the supplementary forms and schedules. The computer figures and prints the invoice. In addition to the basic charge and the supple- mentary charges, some firms have what might be called cover or minimum charges such as (l) a required deposit when the order is placed, or (2) a minimum fee, or (3) a down payment at time contract is signed, or (4) an of- fice registration fee when service begins. These cover charges and minimum fees are offset against the cost of the returns; unused portions are not refunded. The basic rate of a return sometimes has an additional charge added to it for input cards, or for an excess amount of cards over and above a normal number. The price structure for each individual service showing the breakdown of the basic charge, the supple- mentary fees, and any initial cover charge or minimum, is shown in Table 5—4 Price Structure. The fees for average returns and complex returns in 1967 were estimated as follows: 255 om.H waflowsom madam ucmfiaamumCH oo.H wadflmfiom mmuoz oamm Euom 0? mo. co; co; ox: 84 $33 suom omae EHom oo.a mm. oo.a oo.a xmmm. oo.a ween Euom oo.a mafia Snow uxma on wucmEumsncd oo.a momm Show ommm Euom oo.a ovvm Euom O\c om.H om.m moan Euom "mEoocH o» mucmEumdhpd oo.H 0 co mcoaumadoamu om.m mo. om.H om.m 0\c om.N U OHDponom 0\c mo. oo.H Him manpwnom om.m mo. om.m m madpwnom Eoo.m Eoo.a OH. mm. «mm. om.m «mam. om.m Q manponom 0\c mo. oo.a oo.a «mam. oo.a muu waspmcom om.m mo. oo.m om.m «mmm. om.m U masmmnom Dapwuu mEoocH usmEmHHuwm xom. umsuh .mumumm .mflcmumCDHMQ «om. xuflscca HO coflmcmm «OH. soHumHomumoa x0min mmwuamxom Ucm mucwm 0\2 mo. oo.m xmmm. oo.m m waspwcom O\c U«mo. «mam. 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M och oo.mw no menus oflmmn men «can oofium mounu mm: xmuflsam wuss moflum xmeuummmu .c0mmwm m woflum 0:9 .mmwmwmwn powwoooum mcuduwu mo nomads Hmuou com: mewocmmmv .mmu mm mauSumu xuow 3oz mo xufiu new .mDMum .Hmumpmm ma Hm . mums» SUHzB uOM susumu mumum xuow 3oz unmoxo madnuaum>m mooDH .mofl>uwm m>wusomxm can .mofl>umm cumpcmum .mofl>umm ummcsm "moadposom .ommm poucwum nod owe pcm pumo Hod oma moan mcoflumusmsoo new oo.aw wot: u Romy mafia com :0 mmmum>o than .Aufiomuo xmu c wwo m:a>oav .m massmnom co m can a moms .Ammmmmsa . mam mopsHosfl mmumno Show canon an» 9 m . mum o .oa mo mmooxm :H u mo 0 : Euom .AcoH .mcuoumu mumummmm new Homo .uospwp wumo Uaflcov avvm Each .Awocwpflmmu mo macmv mHHN Show moan Euo a m Acoswssoxm sma xoflmv ossm Enos .mmoqoa .osoa no N new H mm pumo umn NH m xmuomfioo Hadn m we mum a» mvumo Hmcofiuwopm :ufi3 mausuwu Mom .mpumo nonsmhox 0H How umoo wpsausfl scams mmowu .mmuw m .noma .mm mumSunmm xn couuaensm am we ucsoomflp web a .mw wo mmmoxm as Undo mom oa.m mo mmumso HMGOHuappm c . um xmusmsou adds swan 03» pmuflmu mau0m usage uom pm3oH ma mumcu ucsoem menu um>o mcfluflsku magnumu uom .mcumo nocsmxmx mm HOu umoo opsaocd 30Hmn move r0 mmumno on I 0\: “ESEHCHE n E “Emufl Mom: R. Llllllllllu “4 mm. m owz Enos , 0\c mo. mom uwz Euom _ oo.m mom.mom.ao~ osz sues oflmmm . mszBmm xmow ZMZ ho VBHU ’ C M 00 m oo.~ oo.m mausumm moumum umnuo . oo.v mflmuoww ~ oo.v MCHHOHMU :uuoz ,. .cmm mom mumum l oofixoz 3oz , . o l comm mo o.m.o.o.m mmasemnom M coaum wofium _ oo.v oo.m . cusuwu cusses .tmm mom ovm snow osmmm " pom mom cusumm mumum MHGHOMflHmo mm. mm. wOflHQ moHN BH ”WWW snouwu moaum mom Hm m _ 0\c oo.~ .pmm mom . . . mom HO mom ; oo.mw cusumu com mom mom .Hom 9H Euom owmmm oo.mw cusnmm mumum xuo» 3mz o o . H u mZMDBmm WB4Bm oo.am mummnmxuoz mason cum moaum mmmm mom moflum HMfluwcH wow Amcuzumu NV ya a 0\c moaum HmauacH wow m .H m om\om om.rw moi“. HmiuicH . as..m mlnmmmumgu . . . ow cusumm .wmh XQOU muuxm "mwofl>umm ascofluflppd .MgWA—w— ,- ,7 _ 257 Average Return Complex Return Estimated Fee Estimated Fee 1967 1967 Fully Computerized Firms: 1. Autotax $16 to $18 $25 to $30 2. Computax $12 $25 to $30 3. Datatax $ 8.33 $25 to $30 4. Fast-Tax $ 8 to $10 $26 Partially Computerized Firms: 5. Unitax $ 4.30 $ 6 to $ 8 For the practitioner's returns which contain many supplementary schedules-—and few items on each schedule, the per-item price structure would give the lowest cost. On the other hand, a practitioner's return which contains few schedules, but with numerous entries on each schedule, would obtain the lowest cost with the flat-rate price structure. To minimize cost in a large—volume office, multiple contracts could be entertained. Tax returns could be separated into groups according to degree of complexity. Each group would be placed under contract with the service firm that offers the lowest price struc- ture for that type. 10 The services lowered prices in the 1968 tax season. For the fully computerized firms like Computax and Autotax, lo"Computerized Tax Returns Still Have Growing Pains But Continue To Improve," Taxation For Accountants, II, No. 5 (November—December, 1967), p. 272. ,—....- r—~—n _. w'—"— 258 the cost of an average return was about $15. Autotax shifted its price structure from per-item rates on the supplementary schedules in 1967 to flat rates per schedule in 1968. Datatax did not operate in 1968, but operations were partially11 resumed in the 1969 tax season. The 1968 fee for Fast—Tax was about $9 an average return. Fast-Tax shifted its price structure from flat rates per schedule in 1967 to $3.00 per basic form compu- tation plus twelve cents per card punched plus fifty cents per page printed in 1968. For the 1969 tax season, Fast-Tax will charge $1.00 for basic form computations plus twelve cents per punched card plus sixty-six cents per printed page. The Form 1065 partnership return and the Form 1120 corporate return charges are the same as Form 1040 charges except for an additional computation charge of $2.00 per return. There is no registration fee for the Fast-Tax service. Fast-Tax added the computeriza- tion of the tax returns for the states of Nebraska, New York, and Minnesota in the 1969 tax season, in addition to the eight state returns already programmed in 1968. Processing of New York City income tax returns was in- cluded in the 1969 Fast-Tax System. The fee in 1968 for a partially computerized system ranged from $2 to $6. This latter category of A 11In Manhattan only. 259 partially computerized firms included Unitax, Computer Tax Service (CTS), and Programmed Tax Service (PTS). Unitax, in 1968, had three basic price cptions--the bud— get service, the standard service, and the executive service. CTS had one basic charge of $3 that included everything except New York State returns for which there was an additional $1.00 fee but this was refunded if over 200 returns were processed by a practitioner. The PTS fee ranged from $3.50 to $5.00 per client depending upon the total number of returns processed through the system during the tax season. This fee included a package of three returns per c1ient—-Federa1, state, and city of New York. Difficulties That Retard Progress The application of electronic high-speed computers to the preparation of income tax returns has been diffi- cult primarily because of the complexity of the Federal return and because of many clients‘ needs for service at the state level and the city level. Thirty-three of the fifty states now require income tax returns to be filed, and an ever growing number of cities in the United States are joining the list. There were 171 cities in eight states levying a city income tax at the end of 1967. The young computerized tax returns industry has been plagued with many problems and the emerging computer processing 260 systems have been busy getting rid of the "bugs" in their Operations. The problems of the industry and the "bugs" in the systems of the firms have culminated in negative experiences for many practitioners. Most new industries have been faced with similar trouble. Eventually, the industry will solve its problems and the "bugs" will be eradicated so that computerized returns preparation ser- vices can flourish unhampered by technological and admini- strative deficiencies. First, the problems and “bugs" must be identified. Then solutions and fumigation can be applied. What are some of the major "bugs" in the systems of the firms that are preventing growth? What problems are retarding develOpment of the industry? These questions are considered next. fléipr "Bugs" in the Systems Impeding Growth Three major deficiencies of the systems reported in the 1966 tax season that have prevented more wide- spread acceptance of the services have been (1) high cost, (2) excessive input forms, and (3) processing delays.12 12"Computer—Prepared Tax Return Service Is Gen- erally Satisfactory; Survey Outlines Pros, Cons, Problems.“ Taxation For Accountants, I, 5 (November-December, 1966), p. 278. MM...“ .- V“- .. 261 In the 1967 tax season, turn-around time for fully computerized services continued to be a "bug."13 The promised five-day turn-around was often not kept but a seven to thirteen-day turn-around time was experienced. The seasonal industry-wide April rush was a big problem here. It is during this rush that the turn—around time gets pushed higher. Solutions prOposed have been the building of increased capacity and cyclical filing. Key- punching has been the biggest production bottleneck in computer-processed tax returns firms. This "bug" contri- butes to extended turn-around times. The technological solution to this transcription problem appears to be "optical scanning." Research on this improvement of technology is being carried on. Transcription errors are a "bug" in the systems of the service firms. These errors are caused by human beings and not machines. Causes of these errors can be traced to two types of human beings--the preparer of in- put sheets and the keypunch Operators. In many cases the Quality of the handwriting of the preparer of the input sheets is low, and the data appear on the sheets in garbled and illegible form which makes accurate transcription . 13Dominic A. Tarantino, "Computerized Tax Returns Still Have Growing Pains But Continue To Improve." Taxa- Egon For Accountants, II, No. 5 (November. December, 1967). p. 274; 262 difficult and time-consuming. In other cases, even though the handwriting on the input sheets is clear and legible, the preparer omits some important tax data, or "forgets" it. This is the preparer's side of the coin. On the other side is the keypunch operator. The trans- criber sometimes punches wrong keys, misinterprets the reading of data, neglects to include some important data that appears on the input forms, or has some other dif- ficulty. These keypunching errors result in errors on the final printed return. Reruns of the tax return due to errors become a necessity. Non-chargeable reruns are caused by errors on the part of the keypunch operators within the service firm, while the chargeable reruns are caused by errors on the part of the preparer. Reduced rates--about 60% of the original--are common for charge- able reruns. The solution to this problem of errors appears to be training of a higher quality for both pre- parer and keypunch operator and selection of the personnel to do the work with greater care and higher qualifications. Another "bug" in some systems is the inability to process, along with the Federal return, the applicable state return and, in some cases, the city return, as a Package. Services whichmhmnot do the particular state return prepare an extra Federal return to be filed with the state return which is prepared by hand. Manual prep- aration of the state return often cancels out the time 263 saved preparing the Federal return by computer in those cases where both are required. City returns carry this problem deeper. Additional programming and financing is needed to solve this problem. Think of the money it would take to finance the software in a particular ser- vice to program not only the Federal tax return but also the 33 state returns, and the 171 City returns known to be in existence. Perhaps a tax programming service would help. High prices constitute a "bug." Although some services reduced their prices in 1967 to a level below that of 1966, prices were still high in 1968. Many practitioners who still operate under the manual method consider the cost prohibitive for them to enter into con- tracts for the service. They feel that the high cost makes computer services practical for the more complex returns only. Solution here appears to be increased efficiency and increased volume on the part of the ser- vices to permit them to decrease costs per unit of out- put. Resistance to change also enters into the picture here so that a selling effort is often needed on the part of the services to induce practitioners into trial runs of their service and to encourage several smaller operators to join with several other practitioners with the same price problem and submit all their returns as one subscriber. There appears to be no Opposition on -- 9““: _.._ -- ...-. ,. — __a. . 264 ethical grounds to combining returns of several small operators into one order.14 Excessive input forms seems to be a perennial "bug" in the systems. "By the time that I fill in the 15 . IS a com- input form, I could do the return itself," ment that is heard over and over every tax season. It is a major criticism. Points of dissatisfaction with and criticism of the input forms are as follows: trouble filling out some forms due to their questionable design, the length of some forms, small spaces allowed on many forms in which to record data, too many forms to fill out and keep inventory of. The completely computerized services do have long input forms because they completely eliminate calculations on the part of the preparer. Many forms are required in order to contain all the necessary tax data without making any summaries while recording. The partially computerized firms have shorter and fewer input forms but then calculations of summaries by the pre— parer are required which endangers accuracy. Complex returns require long and numerous input forms. Computer l4"Computer Tax-Return Preparation: How The Ser- vices Shape Up This Year," Taxation For Accountants, I, NO. 6 (January—February, 1967), p. 325. 15"Computer-Prepared Tax Return Service Is Gener- ally Satisfactory," Taxation For Accountants, I, No. 5 (November-December, I§66), p. 279. F flHJ—AA. .——..— _. ._. 265 calculations of all summaries and sub-totals are desired to support the overall calculation of the tax liability, all of which generates accuracy in the calculations and permits the services to make guarantees for it. The com- pletely computerized firms, therefore, cannot eliminate the long and numerous forms that are required to do the job. The solution here appears to be training in the use of forms, increased experience in the use of the forms, and the additional service of pro forma input forms to contain repetitive data for next year. Many firms began offering the pro forma service in the 1968 tax season and found it helpful. There is a communications problem between practi- tioner and the computer service. What services do the tax practitioner expect the computer firms to render? Are the computer firms expected to be the tax man's tax man or do the tax practitioners reserve this function for themselves? Can the computer firms afford to return to the tax practitioners "garbage" when what the practitioner- preparer submits is "garbage"? Can the practice of "GIGO"-- garbage in, garbate out--be allowed in the young industry? Frank Hubert of Datatax discussed these points in an ad- dress before many practitioners in a 1967 Computers and Taxes Conference. He develOped this communications prob- lem further and said: 266 . . . Are you ready for the overview that is in— dicated by the demands you place on us to send you back a perfect product, even though you have over— looked a valuable ingredient? Let me explain what I mean: A friend of mine sent in the data for a return without indicating the salvage value for an asset. The return was later questioned by IRS and the client incurred an addi- tional liability. My former friend feels that our review staff should have called to determine if he'd entered the asset net. To me this would have been an insult to his intelligence, yet he expected it. We can plan in finite detail to handle some ob- vious oversights. However, there is no way to deter- mine what is going on in the minds of our subscribers. A good example of our inability to read minds is our trying to decide what you mean when you indicate that you plan to send us 100 tax returns. Does this mean that you have 100 regular clients whose informa- tion you will collect and submit? Or does it mean that you have 10 but h0pe to increase by 1000%. You play hell with our forecasting every year. We don't dare not prepare for the maximum, especially gince we dOHTE have adequate history to draw upon.1 Major Industry-Wide Problems Affecting All Firms There are several industry-wide problems that can be classified into four groups characterized as legal, seasonal, technical, and ethical. There are two legal problems which confront the industry and retard its growth 16Frank Hubert, "Remarks on Computerized Tax Re- turns,“ Proceedings of the 1967 Secondennual Conference 9§_Computers and Taxes, Sponsored by The Computers-In- Law Institute of:The George Washington University in co- Operation with The American Bar Association and The Federal Bar Association, Held June 6—7, 1967, in Statler Hilton Hotel, Washington, D. C., p. 28. Frank Hubert is General Manager of Datatax. 267 and development toward maturity. The first legal problem is the differences in Federal, state, and city statutes for individual income taxes. These differences constitute a major deterrent to the industry. The complexities involved in programming for the differences between Federal and the 33 state income tax statutes will be a major obstacle to the success- ful marketingWOfcomputer processed tax returns on a truly national basis.17 One service reports, "We are breaking our backs to pro- gram all the state returns."18 Very little attention yet has been devoted to the City income tax returns by the computer services, except for a few firms that program the New York City income tax. What about the other 170 City income tax returns known to be in existence at January 1, 1968? The City tax complicates this legal problem of differences in statutes and carries the problem deeper for the industry. Solution appears to be both in- creased programming effort and additional financing on the part of the services. Perhaps closer cooperation among the agencies of the three governments levels and the industry could be induced by working with the IRS, tax associations and other interested groups. Dominic A. Tarantino, "Computerized Tax Returns Still Have Growing‘Pains But Continue to Improve," Taxa- tipn For Accountants, II, No. 5 (November-December, 1537), p. 273. 18Frank Hubert, p. 29. ‘ H.:-A’~-u--,.»n.-u~_. ..~ 5 268 The second legal problem concerns new tax laws containing retroactive features which require changes in tax returns filing requirements. These changes without notice cause programming and workload problems for the industry. The solution appears to be the promotion of enabling legislation permitting a moratorium before new law becomes effective. The seasonal industry-wide March 1 to April 15 rush to file returns creates the annual spring workload problems and processing bottleneck. About 85% of the 68 million individual returns in 1966 were filed between March 1 and April 15. The tax practitioners offer their service much like the manufacturers offer their products to the American consumers. Both groups are influenced by consumer preferences. In the case of the tax practi- tioners, consumer preferences cause two peak periods in each tax season. Taxpayers can be classified into two groups, as the Internal Revenue Service discovered in its computer setup, the early filers and the late filers. The early filers have been assembling data needed and have it all ready to file when the earliest time possible arrives. This time is January. So, tax practitioners. and the IRS both have the first bottleneck in their Operations, first peak of the new season, in the form of an avalanche of returns to deal with in January. The late filers let things go until they are forced by time 269 to act by the approaching deadline, April 15. So, tax practitioners and the IRS both have the second bottle— neck or "rush" period to deal with—-the April rush. Tax practitioners and the IRS have both found the April rush to be the greater. The April rush in recent years has plunged both groups into a sea of work that almost inun- dates them. The computer is the answer to processing these mountains of tax returns that suddenly appear in April but the transcription problem is the bottleneck at this peak period for both groups. This bottleneck, this April "rush" has not yet been solved. The solution appears to be cyclical filing as suggested by Mr. Frank Hubert of Datatax. This would spread the filing of re- turns out over the year. However, enabling legislation and help from the IRS to get the legislation approved is needed before this solution becomes effective. On this problem, Frank Hubert said: The final unresolved question in my mind is: How do you level the workload? I have two sugges- tions that have proven beneficial elsewhere in industry. 1. Enabling legislation which would permit cycli- cal filing throughout the year based on the taxpayer's last name. 2. Enabling legislation which would permit a moratorium before a new tax law would become effective. These proposals are not as far-fetched as they sound. Most charge accounts are set up for alphabeti- cal billing, and we have recently passed legislation which permit auto manufacturers a breathing spell 270 before they have to meet all the safety standards. The Tax Law is certainly more dynamic, and warrants equal consideration. Internal Revenue may prove an ally because they have the same problems except that they have three years to uncover any ambiguities. However, they haven't been checking 68 million tax returns in the past. The groundwork needs to be laid over the next two years so that hopefully by 1970 we can realize this goal. In this connection it seems advisable that an ADP Advisory Committee should be appointed to assist IRS in build ing a case. Then perhaps we can all breath easier. 9 The technical problems of the industry concern programming, research, errors, and standardization of filing requirements. Programming of the State returns constitute a technical problem and a financial hardship for the services. Most practitioners prefer not to use a particular computer service if it does not provide the state tax return as well. In the 1968 season about half the 33 states with income tax requirements had their re- turns programmed by one service or another. Some ser- vices planned to have all 33 states programmed in the 1969 tax season. At least three services--Digitax, Com- putax and PTS--have programmed the City of New York tax return. There are at least 170 other cities with income tax requirements. How many of these will the services program? 19Frank Hubert, p. 29. wq— a... .4- 271 Research to achieve computerization of corporate, fiduciary, and partnership information income tax returns is under way in several firms. One firm--Fast-Tax--al- ready offers service on the corporation tax and the part- nership information returns. Computax is investigating the fiduciary returns possibility. Can research be insti- tuted for the computerization of employment tax returns, estate and gift tax returns? Lack of standardization in filing requirements is a problem. Some firms process only the basic Form 1040 and no supplementary schedules. Other firms process basic Form.1040 and some of the supporting schedules. A few process everything possible. Sometimes official IRS forms are used, sometimes facsimilies are used, other times unofficial supporting schedules are used. Frank Hubert, on this problem, says . Where do we draw the line? I think we can start by at least standardizing the filing re- quirements of the Computer Services while the in- dustry is still young and while there are only a few such services available. In order to do this, though, greater COOperation must exist between government and industry. . . . 0 Another industry problem, related to forms, con- cerns the lateness each year in the release of tax forms by the state and Federal agencies. Daniel R. Mason, 20Frank Hubert, p. 28. 272 President of Computax Corporation, has pointed out this problem. He said: One of the problems that we have to look to the State and Federal Agencies for solution is the late- ness each year in release of forms. For example, the Massachusetts return is not only complicated but I think it was the 16th day of February, the current year (1967), that the State of Massachusetts released forms. The State of New York, I think, it was around the 19th of December when they released their forms. We must get earlier release of forms. There is a problem here in our redesigning the forms and order- ing them in continuous form paper. The forms paper people have 30 to 45 days lead time on this and it's kind of hard to do a State of Massachusetts return on the 3rd of January when we don't kngw what the hell the forms look like until February. 1 ii a 5 Errors perpetrated by the services and by the preparers have been a technical "bug" of the systems. Errors by both tax practitioners and computer services have caused negative experiences for both groups. Chief source of errors on the tax returns has been traced to input sheets and transcription of data from these input sheets to cards and tape for the computers to use. Dif- ficulty at this crucial point has been traced to both sides-~practitioner-preparer's illegible handwriting and omission of data, on the one side, and key punching errors of transcription operations employed by the services 21Daniel R. Mason, "Remarks on Computerized Tax Returns," Proceedings of the 1967 Second Annual Conference 9§¥Computers and Taxes, Sponsored by The Computerséln-Law Institute of The George Washington University in coopera- tion with The American and Federal Bar Associations, Held June 6-7, 1967 in Statler-Hilton Hotel, Washington, D. C., p. 32. 273 on the other side. The services, therefore, have charge— able reruns of the tax return when errors are found due to the preparer's fault, and non—chargeable reruns when their key punch operators make the errors. Chargeable reruns have averaged, prior to the 1968 tax season, a fee of 60% of the initial price of the return, exclusive of any charge for extra cards. In the 1968 tax season, Computax began charging 100% of the initial price, exclu- sive of any charge for extra cards, for chargeable reruns per Change Request Form initiated by preparers. "Autotax requires that incorrect returns be resubmitted within two weeks of date of delivery to the accountant. If not, charge is 100% of initial cost."22 The computerized preparation of a tax return by a third party does not excuse the professional practi- tioner, accountant, or the client from legal responsibility for errors. The professional practitioner should ade— quately check the computer—prepared return when it comes back from the third party. He should examine it carefully in order to satisfy his professional responsibility that it is accurate. Most of the services have a limiting clause in their contracts restricting their liability to $100 in case of negligence or for misplacing as well as 22"Computer Tax—Return Preparation: How The Several Services Shape Up This Year," Taxation for Ac- ggpntants, I, No. 6 (January-February, 1967), P. 324. 274 losing any data. Since final responsibility rests with the client and his professional adviser, the professional tax practitioner would do well to examine his liability insurance contract to make sure that it covers tax returns computer processed by a third party. Other errors of the services that have disenchanted practitioners are collating errors resulting in mix-ups of forms and schedules in packages of returns sent back to preparers.23 Practitioners received returns back that belonged to someone else. Some practitioners received back returns that belonged to them but some of the sup- porting schedules attached did not. Practitioners have bothered the services with their sometimes unreliable predictions of when returns would be submitted to processing centers, causing bad forecasts, operating problems, and workload pileups.24 The concept of privileged information found in relationships between professional practitioners and their clients have been threatened by computerized tax returns. Third parties have been injected into the con- fidential relationship. Some professional tax practi- tioners reject computerized tax services on the basis of 23Daniel R. Mason, Proceedings of the 1967 Second Annual Conference on Computers and Taxes, p. 32. ..._1.I -4 PVC)?“ ~34.” 6' 1 3)“!H33 .1 4 275 ethical considerations. They object to the transfer of confidential tax information outside their offices and question the ethics of signing a return prepared by a third party outside their control. All the computerized tax return systems permit input sheets to be sent to their processing centers with- out taxpayer names. Social Security numbers are used to identify taxpayers and their returns. The services will send back printed returns without the names. The practi- tioners can add the names by having them typed in. The audit sheet or "diagnostic" report will remind the prac- titioner to add the client's name. The services call attention to the fact that their employees are conditioned to work with confidential information just as office employees of practitioners are. Also the services claim that their keypunch operators rarely see every item on a return because of the mass pro— duction techniques utilized such as speedy assembly-line production and division of labor. The processing of a return takes place to rapidly and the operators do only part of a return so that each return is fragmented. On the other hand, the computer services point out, the manual method of preparing a return in the practitioner's office permits the typists and clerks to see the whole return . FM7fi 1411'“ MW“. 1‘ \‘ 1 -h . 4‘ M n. 276 The computerized firms sell a professional service-- a computer printed tax return. Professional accountants would not think of submitting a long-hand prepared certi- fied financial statement to the bank. Professional lawyers would not think of submitting a long-hand prepared brief to the judge. Why should the professional accountant or lawyer be willing to submit a hand-written tax return? The rules laid down by codes of ethical conduct can be quoted to the professional accountant who objects to the computerized tax return on ethical grounds that he cannot have someone outside his organization handle a client's confidential data. The committee on professional ethics of the American Institute of Certified Public Accountants has considered this problem and has sought the answer to the question, "Does use of computer services pose a ques- tion of ethics?" In answer to this question as to whether or not it is ethical for an accountant who is a member of the Institute to utilize outside services to process con- fidential tax returns or other confidential information of Clients, the official committee has issued the following statement: If a member utilizes outside services to process tax returns or other confidential client information, he may not in the opinion of the committee on profes- sional ethics, delegate his responSibility to insure the confidentiality of such information. He must take all necessary precautions to be sure that the use of outside services does not result in the release 0f confidential information. He should also conSider 277 the desirability of putting the client on notice when outSide services are to be used. Some experience on this topic was brought to light vice. Many accountants asked about the need to notify clients that an outside firm like Computax was being used to process their tax returns. The comments from two pane members are quoted below: We were concerned about the confidential nature of the data with which we were working. We felt the burden was upon us to know something about Computer Sciences Corporation. We learned that the input forms were split up among various key punch operators so that no one key punch operator would have full in- formation as to what existed in a return. We had verbal assurances that the material would be treated in as confidential a nature as possible. We felt that it would not be advisable to contact our clients about this as there seemed to be little interest on the client's part as to whether his return was sent out of the office or not. When we dealt with people in the public eye, we processed our returns in our office. In one such instance we sent the input forms to Computax but we deleted the client's name from the input forms. When the return came back to our office we type in the name. We reached a somewhat different conclusion on thi subject. We found that if we just told the clients we d nate were running their returns through Computax, it elimi 25"Tax Returns--By Computer," The Journal of Ac- EQpntancy, CIX, No. 2 (February, 1965), p. 24. 26"C.P.A.'s Critique of Computerized Tax Returns, 239 Journal of Accountancy, CXXI N0. 2 (August, 1953, P- 1965 I p. 160 in a dialogue between members of the New York State Society of CPA's and Computax in 1965 at the end of the tax season when Computax asked accountants for a critique of its ser- 1 I 16. 278 a lot of questions. There were a few instances, how- ever, wherezthe client wanted his return to remain in the office. In answer to a question as to how Computax pre- serves the confidential nature of returns when they engage ! outside service bureaus for the key punching job, Mr. Alan 1 A. Stern, project manager at Computax, said: i We are dealing with a number of key punch opera- tors rather than just one. One key punch operator sees a very small portion of each return. This is a very high-speed operation and the key punch operators are mainly interested in pushing the work through as quickly as possible and as accurately as possible. In all probability, you have some nonprofessional peo- ple on your clerical staff working on returns and these peOple see the entire return. At Computax, their Operating people see only one form of the return. 8 Development of the Industry and Opinion of the Service by Users 1965 Tax Season Computax processed approximately 43,000 individual tax returns in 1964 which was the first season of use of computer-processed returns.29 In the 1965 tax season, Computax was used by over one thousand accounting firms to process approximately 100,000 tax returns. Reaction 27Ibid. 28Ibid. 29"Tax Returns - By Computers," Journal of Ac- EQDntancy, CIX, No. 2 (February, 1965), p. 23. 279 to the use of computerized tax returns was sought by Com- putax at the end of the tax season in 1965. A panel dis- cussion with several accounting firms that used Computax to process returns was held by the New York State Society ( of C.P.A.'s on May 27, 1965. The dialogue which took K place at that meeting was published in the Journal of Ac- 30 countancy. The overall evaluation of Computax by users was favorable. Most of the accountants who used the ser— vice found it valuable. Some of the major problems en- countered by accountants in the initial use of computerized returns in their offices was staff resistance to change, Computax slowness during peak rush periods, and lack of additional schedules by Computax service. Other services were starting up in 1965 but had not yet received national recognition. They were Autotax, Datatax, Unitax, and Com- puter Tax Service (CTS), all of which began by serving regional areas. 1966 Tax Season The use ofcnmputer—processed tax returns on a nationwide scale began in the 1966 tax season. Demand for the service was strong. 1966 was the year in which the national market developed in the new industry of 30"C.P.A.'s Critique of Computerized Tax Returns," figurnal of Accountancy, CXX, No. 2 (August, 1965), p. 15. 280 computerized tax returns. Heavy demand was anticipated in the 1967 tax season. The 1966 tax season can be described as a "Shakedown" year. It was the year the computer companies really began doing returns on a large scale, using extensive promotion campaigns to sign up accountants to use their services. I—h——-v._._A _______#___________ As is usual in any new industry, many changes took place. Some of the companies sustained sub- stantial losses; there were some changes in ownership; and one company was adjudicated a bankrupt and ter- minated its services.3 At least seven firms were in operation processing tax returns by computers in 1966. Most but not all were operating on a national basis. The list included Compu- tax, Fast-Tax, Datatax, Unitax, Systems and Taxes (SAT), and Computer Tax Service (CTS). Computax emerged the 3 leader in the field with three-fourths of the market. 2 Autotax and Datatax each had about 10 per cent of the market and the balance of 5 per cent was distributed over the remaining firms of Fast-Tax, Unitax, SAT, and CTS. Computax and Datatax were acquired in 1965 by parent com- panies with national distribution outlets already estab- lished. Autotax was purchased by a parent company with 31"Computer Tax-Return Preparation:. How The Several Services Shape Up This Year," Taxation For Ac- EQPntants, I, No. 6 (January-February,7l967), p. 322. 32"Computer Prepared Tax Return Service Is Gen- " erally Satisfactory; Survey Outlines Pros, Cons, Problems, :Eggation For Accountants, I, No. 5 (November-December, 1966). p. 278. «ah I 281 national market outlets in 1966. SAT went bankrupt and its services were terminated in 1966. Fast-Tax and CTS were newcomers to the field in 1966. Users of the new service were generally satisfied in 1966 and about three quarters of them indicated they intended to use the service again in 1967 at least as 33 The overall much and perhaps to a greater extent. favorable impressions of users with the service firms and their declared intentions to use the services again next year came in spite of the year's Operations being plagued by "bugs" in the systems of the processing firms and problems of the newly developing industry. 1967 Tax Season The use of computer services to prepare tax re- turns expanded in the 1967 tax season. The service firms increased their volumes. Not only did the services them- selves improve but they were used more effectively by accountants and practitioners as they became more experi- enced. Two features dominated the 1967 tax season--higher ’ c 0 34 prices and improved serVices. 33Ibid. 4"Computer Tax—Return Preparation: How The Sev- eral Services shape Up This Year," Taxation For Accountants, 1: No. 6 (January-February, 1967), p. 322. ”an... \_‘ I .l n. r 282 A survey of sixty-six CPA firms in Oklahoma was made in 1967 to determine the reaction of accountants to 35 the use of computer-prepared returns. In that state, client reaction was favorable, and the vast majority of firms using the services that year planned to use them 5} again in 1967. The experiences of attorneys with computerized income tax returns have been very similar to the ac- countants.36 Greatest advantage of computer-processed tax returns to attorneys was found to be relief from repetitive chores--typing and proof-reading, and mathe- matical accuracy. The chief complaint concerned process- ing delays--time lags. Seven to ten days was the turn— around time experienced whereas five days or less was promised. Adverse comment also was made on the failure of the computerized services to provide state returns-- especially the state of Massachusetts, which has an un- usually complex return. Robert P. Bigelow, a member of the Electronic-Data Retrieval Committee of the American Bar Association and a member of a Boston law firm, conducted an informal 35Nora Marie Vinyard, "Computerized Tax Returns," The Oklahoma CPA,VI, No. 3 (October. 1967). p. 18-26. 36"How Do Attorneys Like Computerized Returns?" Taxation For Accountants, III, No. l (March-April, 1968), P0 EI- 283 survey of attorneys to obtain their reaction to the use of computer assisted tax return preparation.37 He sent questionnaires to 130 law firms in Boston in the Fall of 1966. Sixty-three answers were received from small and ; large law firms. Some of these law firms did not handle tax returns while others had several hundred tax clients. a'a‘\{r- my ".ws Bigelow updated the survey in the Spring of 1967 by ques- -_h"' f.. tioning the 1966 respondents--1aw firms--plus some ac- I my I countants ontheir 1967 experiences with computer assisted tax returns. Most law respondents rated the Services a about the same as the previous year. Three law firms de- cided against using the services in 1968 for the following reasons: (1) lack of a state return, (2) manual system was faster, and (3) employee resistance. The major com- plaints of the 1967 respondents was the lack of a state of Massachusetts return and key punching errors at the input stage by service transcribers. A significant find— ing of Bigelow's survey was that every firm which made extensive use of the computer services-~that is, processed over 50 returns or computerized more than 35% of their 37Robert P. Bigelow, "Remarks on Computer Assisted Tax Return Preparation," 1967 Proceedings of The Second Apnual Conference On Comppters and Taxes, Sponsored by the Computer-In-Law Institute Of the George Washington University in COOperation with the American Bar Associa- tion and the Federal Bar Association, held in Statler— Hilton Hotel, Washington, D. C., June 6-7, 1967, p. 17. volume-~planned to use the services again in the future. 284 "Bugs" in the systems of the computer services found in the 1967 tax season were time delays, key punching in— accuracy, and lack of state returns. More compatability between city, state and Federal returns is necessary. A f? summary of the comments from Bigelow's survey is as fol- E lows: E COMMENTS FROM LAW FIRMS SURVEYED38 E 1, Y \ Favorable 1. Less proofreading: relief from typing; mathemati- cal accuracy. 2. Time saved; easier computations; legibility and good copies for client. 3. Corrections and changes did not require recompu— tation. 4. Inexpensive; elimination of preparation of de- tailed schedules; pro forma schedules for next year; consistent technical review. Unfavorable 1. Delay in processing and machine breakdown. 2. No individual state return (Massachusetts). 3. Proofreading required, especially when service misinterpreted handwriting. 4. Cumbersome format. 5. Insufficient space for items; too many subsidiary schedules. 6. Difficulty of correcting data when additional in- formation was received from taxpayer; time required to fit into present system; difficulty of reading print out; weak mailing envelopes. How The Service Can Be Imppoved 1. Make format closer to Federal return format. 2. More consolidated schedules. 38"How Do Attorneys Like Computerized Returns?" Taxation for Accountants, III, No. l (March-April, 1968), P. 6].. 285 3. There should be more space on the forms for the preparer's information. 4. Simplification of information forms. Increase speed of processing. 1968 Tax Season In 1968 the computerized tax return service con- tinued to improve but continued to have growing pains. The computer service firms lowered prices, simplified input forms, and worked hard to lower turn-around time.39 Autotax, Computax, and Fast-tax were the three fully com- puterized firms operating in 1968. Datatax shut down completely to update its equipment and planned to resume operations in the 1969 tax season. Programmed Tax Systems was a newcomer to the field in 1968, joining CTS and Uni- tax as the group representing the partially computerized firms of the industry. PTS marketed a package including Federal, state, and city of New York returns, at a max- imum price of $5 per package. These partially computerized firms are the industry's answer to the original criticisms of computerized services-—high prices, excessive input forms, and processing delays. The partially computerized services offered lower prices, shorter input forms, and shorter turn around times. 39Dominic A. Tarantino, "Computerized Tax Returns Still Have Growing Pains But Continue To Improve, Taxation g9; Accountants, II, No. 5 (November-December, 1967), p. 72. --.~a--.—. r 286 1969 Tax Season The editor of "Practitioners Forum" in the Journal of Accountancy reports that the introduction of the topic of computer-prepared tax returns in a conversation group of accounting practitioners practically always stirs up a controversy with enthusiastic supporters on the one side and reluctant users and disappointed, critical users on 40 the other side. This controversy continued in 1969. Computax and most other firms held prices for the 1 1969 season much the same as in 1968. The number of com- panies has increased to nine with the appearance of a new firm, Digitax.41 Datatax, a division of Litton Industries, Incorporated, suspended service in the 1968 tax season in order to update its equipment and forms for input. Data- tax attempted a come back this past season by Operating in the Manhattan area only. If this pilot re-entry attempt is considered successful, Datatax plans to revive their services throughout the country on a gradually increasing basis over the next several years. The 1969 season saw additional programming of more state returns. Computax added five more state returns to its package of service-- 40Richard C. Rea, "Computer—Prepared Tax Returns," Mrnal of Accountangx, CXXVII, NO. 3 (March, 1969), pp. 82-83. 41See details of Digitax in Appendix A. 287 Michigan, Arizona, Colorado, Maryland, and Wisconsin. Pro forma input forms became pOpular and more widely used by most of the firms. These pro forma input forms are worksheets for next year's returns and they eliminate much of the routine copying of information which is re— peated on returns from one year to the next. Turn around time continued to be a problem. The line up of the nine known services breaks down into two classifications, the fully computerized services and the partially computerized services. Compu- tax, Datatax, Fast-Tax, Autotax and Systems.and Taxes constitute the fully computerized service classification but SAT went bankrupt and Datatax is faltering. CTS, Digitax, PTS, and Unitax constitute the partially com- puterized services. The completely computerized services print out Form 1040 and all the supporting schedules by computer. The partially computerized services print out by computer only pages one and two of Form 1040 with summary figures only but attach copies of input sheets or other manually prepared or typewritten supporting schedules when the return is filed. Some partially computerized services will print out by computer one or two of the sup- porting schedules such as the Income Averaging Schedule or the Retirement Income Credit Schedule. All the ser— vices continue to limit their services to professional tax practitioners; none deal directly with the public. 288 All the services guarantee confidentiality of returns and accuracy of their work; they all offer to pay any interest and penalties due to an error on their part but Computax negotiates the amount. Computax now prints out forms 1116, 2210, 3468, 4136.42 It computes installment sales calcu- lations; determines state sales tax deductions by using guidelines or amount submitted by preparer and has computer select the more advantageous if requested. Computer Tax Service (CTS) raised its basic price from $3 to $4 a return, but this includes any applicable state return. Where no state return is required, the price is $3.50 for the Federal return. CTS charged these single fixed prices for returns regardless of the complexity of the return or quantity of schedules. A registration fee of $20 was required to provide all supplies needed during the tax season. The CTS now includes completely computer 42Form 1116 Statement in Support of Credit For Taxes Paid or Accrued to a Foreign Country or a Possession of the United States, used to support the amount of foreign tax credit claimed on individual, partnership or fiduci- ary income tax return; Foorm 2210 Statement Relating to Underpayment of Estimated Income Tax by Individuals, ex- planation of underpayment to avoid penalty on estimated tax; Form 3468 Computation of Investment Credit, used by individuals, estates, and trusts and corporations claim- ing an investment credit; Form 4136 Computation of Credit ‘for Federal Tax on Gasoline and Lubricating Oil, used by individuals, estates, trusts or corporations, including small business corporations, claiming credit for Federal excise tax on the number of gallons of gasoline and lub- ricating oil used. 289 printed Income Averaging, Schedule G; Retirement Income Credit, Schedule B; Federal and State 1969 Estimated Taxes; calculations of all limitations, exclusions, and alternatives; comparison of all deductions to national averages. Computer-printed state returns for 31 of the r? an," 33 states with income tax laws were offered by CTS in the 1969 tax season. Four more CTS computer centers for proc- E essing returns were added to the sixteen already open. Processing of returns in the 1969 tax season for the state of Michigan was done in Detroit, within 12 to 24 hours after receipt of input forms. It was originally reported that "CTS offers its 43 This services to the general public at a higher cost.“ original intention did not work out. CTS, like all the other services, sells its service to tax practitioners only. At least one of the "big eight" CPA firms is presently considering setting up its own tax return prep- aration computerization. Studies are now under way in our firm to deter- mine how and to what extent our Spectra 70 (RCA com- puter) system can be used not only for return prep- aration but in various aspects of tax planning as well. I have no doubt that we will be reading about 43Dominic A. Tarantino, "Computerized Tax Returns Still Have Growing Pains But Continue to Improve," Taxa- tion for Accountants, II, No. 5 (November-December, 1967), p. 273. 290 the results of these studies in some future issue of this journal. The consensus of tax accountants is that it takes about twenty-five returns that should be processed before an accountant can adequately judge whether he should use a computer service.45 Mr. R. C. Rea of Rea and Associates CPA firm of New Philadelphia, Ohio, believes a tax practi- tioner should try at least twenty-five before deciding against computer-prepared returns. This conclusion and recommendation agrees with the results of a survey made in 1967 by the New Jersey Society of CPA's of firms and practitioners who used computer—prepared returns for 1966.46 George H. Webb, Jr., partner of Webb & Webb, CPA firm of San Francisco said that his firm has used Compu- tax service since its inception in 1964 and has found it satisfactory. They used it again in 1969 and found the service muchjmproved-—fewer errors in preparation of the return and in collating, computer printed return is cleaner than the duplicated copies of pencil drafts, additional information submitted by clients or their errors can be 44Ira S. Sheinfeld, "Computers and Taxes," The ggthur Young Journal, (Winter, 1968), p. 21. 45"Should You Use a Computer Service to Prepare Tax Returns? If So, What Kind?" Taxation for Accountants, 111, No. 5 (November-December), 1968, p. 277. 46Richard C. Rea, Journal of Accountangy, p. 83. 291 corrected by a phone call to Computax and computer program makes all corrections automatically, pro forma sheets save preparation time, and recap sheet is helpful. His firm believes the costs are an expensive overhead item but that they are warranted under the circumstances, as they permit more efficient use of the professional staff in the prep- aration of returns by enabling them to use their time making professional decisions rather than Spending it on detailed clerical work. Webb and Webb reported their costs for computer-prepared returns varied from $7.00 to $65.00 with the average at $17.50 per return. Rea and Associates reported their costs ranged from $5.20 to $27.62 with an average of $12.05.47 These costs were reported for the 1968 tax season and prices in 1969 changed little or none at all. Effects of Computer Application pp_Tax Returns The greatest effect of the application of compu- ters to the preparation of income tax returns is the im- pact on tax practitioners. It takes the drudgery out of the practitioner's tax season (January through April) by providing relief from costly, burdensome, repetitive, nondiscretionary duties that are connected with tax returns preparation, such as recording, calculating, checking and 47Ibid., p. 86. 292 proof-reading, typing and reproducing. Recording involves the entry of repetitive data on tax forms and worksheets. Calculating involves the computing of summaries, subtotals on the various forms and worksheets as well as finally, lthe tax liability. Checking involves proof-reading data to make certain figures have been entered and calculated correctly. Typing involves transferring all the data from hand forms to printed pages. Reproducing involves duplicating original into required number of copies, usually three-~one for files of practitioner's office, one for client-taxpayer to keep and one for client-taxpayer to file with the government. Many times an additional copy or two may be required to file with state or city returns. Accountants, lawyers and other tax practitioners have found that the preparation of income tax returns is progressively becoming each year more complex, more dif- ficult, more time-consuming and, therefore, less profit- able. Tax practitioners agree that each tax season means enormous pressures. The tax season has always meant long hours--nights and weekends, extra help, interruptions of more important fiscal work, and heavy overtime costs. Utilizing the services of the new computerized tax returns preparation industry brings relief to the practitioner. It eliminates clerical duties and saves, therefore, time and the cost of that time. —— ———~————'~ A47 7 293 The lower cost of the return as prepared by the services in addition to the savings in operations realized makes profitable the use of computer prepared returns by practitioners. The time saved permits practitioners to accept more tax clients, more consulting work, or other Tax practitioners also have the income—producing work. complexity of tax returns preparation reduced to simplic- ity by the computer services. Speed and accuracy are achieved. All possibilities of options are considered mechanically by the computer if it is so programmed. Examples are itemized deductions vs. standard deduction, joint vs. separate returns, etc. Other possibilities in tax practice are opened by computers for tax practitioners such as preparation of corporate, estate, and partnership returns; determining tax advantages of corporate vs. partnership form of doing business; estate planning; year-end tax review. There is an effect on the client-taxpayer. The computerized efficiency of the services matches that of the IRS and constitutes a defense for the taxpayer against government computers. The completeness and the accuracy of computer-processed tax returns results in the filing of better returns by taxpayers. The Federal government's shift to a computerized tax collecting system has put each taxpayer's return under a microscope which often increases chances for a full-scale government audit when 294 errors, omissions, or abnormalities are found. The new services help taxpayers overcome errors, omissions, and abnormalities in their returns before they are filed. The diagnostic report to the practitioner is a valuable item in this respect. There is an effect on the government. Computer printed returns are more legible than those written by hand. The clearly printed returns will help IRS key- punch Operators to make fewer interpretative mistakes. Computerized returns filed by taxpayers will help govern- ment increase its accuracy and reduce the necessity of full scale auditing of many returns. A general impact of computer prepared returns is the creation of a new, highly technical, service-type industry which serves tax practitioners of all types. A general result of computer processed returns is the creation of the possibility of tax forms replace- ment by direct tape—to—tape tax return transmission from computer centers of the services like Computax to the Internal Revenue Service automatic data processing centers. CHAPTER VI SUMMARY, CONCLUSIONS AND IMPLICATIONS Summary The computer is having considerable influence on Federal income taxation. This influence is particularly noticeable in three activities which have become signif- icantly modified, as follows: (1) tax collecting which has improved in efficiency and has become more centralized, (2) tax research which has expanded into new areas, and (3) tax returns preparation which has developed into a newly emerg- ing industry of computerized tax returns preparation firms. Figure 6-1, Automated Federal Tax System-—Internal Revenue Service, is a flowchart which depicts a complete view of the vast computer network now Operating throughout the United States to collect taxes and process returns and related documents. Conclusions and Implications Conclusions and implications emerging from this study can be classified into three major categories which follow the organization of the study and are summarized 295 Figure 6-1. 296 Automated Federal Tax System--Internal Revenue fir TAXPAYERS Individuals, Corporations, etc. 8: Government Agencies. etc. PAYERS Of INCOME gig} Businesses 4 . . Banks 3' I ll d I \ “I I Tax lnforrnatiJJ Correspondence and Assistance Tax and lRetu rns Information Payments [Correspondence Payments [Errespondengl DepOSIts by Businesses Tax Returns Payment Information Tax Adjustments Actions DISTRICT OFFICES (58) * Tax payer Assistance * Enforcement Activities: Collection 74K ‘1 I Correspondence Bills Tax Notices Tax Forms and Instructions 1 Elia .W .\ j (1} EV REGIONAL SERVICE CENTERS (7) Audit Intelligence * Process Tax Returns: Transcribe data from tax ~ returns to magnetic tape / Check tax returns for mathematical accuracy 7?.“ * Issue Bills and Delinquency /L—- flue Notices \iisfi * Identify Returns for Audit )1 E31”! “‘-¢emi * Process Taxpayer Corre- W spondence and Account 6 Adjustments , ! ! Tax Dim #243501 F Tax Returns \ Enforcement Information Taxpayer Directories and Status of Accounts 297 ‘ Refund Checks Refund Check Data III NATIONAL COM PUTER CENTER / fl. * Maintain ADP Master Files 0‘ Taxpayers Accounts TREASURY REGIONAL * Produce Data for Collection D‘SBURS'NG OFFICES (6) of Delinquent Taxes (inlclusding Identification of Non- File * Produce Refund Checks and Duplicate Filers) Taxpayers Accou nts * Prepare Taxpayer Refund e u o o e o a o e o o a o . Dt f C Data OFFICE OF THE TREASURER a a of Deliggueflte‘f‘gggs) fir Produce Bills and Notices /‘______ OF THE US ',i .. \_// //) Data * . Pre are Business Bills. Tax Notices «Av Identify Returns for Audit \' TaxpDeposits Data . ‘ Mailing Lists and BUSINESS Tax -- Enf forcement * Prepare Taxpayer Directory Deposits Data 5" Information and R eturnrns—Docu ent I _j;’ Index Taxpayer Directories and Status of Accounts 3 n De posits Federal Reserve and Local 298 above. The first two categories, tax collecting and tax research, are combined and considered below. Regarding Tax Collectingpand Tax Research The conclusions and implications in this category can be divided into three sections: those concerning gov- ernmental tax administrators, those concerning taxpayers, and those related to professional tax services. Those concerning governmental tax administrators.-- Returns processing activity of the IRS has been centralized from the local level of 58 District Offices to the 7 Regional Offices which supply data to one centralized point, the National Computer Center. The vast magnitude of the cen- tralized operations at the NCC is almost incomprehensible—- data from approximately half a billion source documents converge into a Master File containing eighty-eight million accounts by a computer configuration which operates perpet— ually around the clock. The administrative control function of the IRS has been significantly improved as a result of this centralization. Efficient operations and efficient allocation of resources have resulted by keeping costs of collecting $100 of revenue below $.50 while the volume of returns (workload) has steadily increased. Also, 48,100 man-years have been saved by ADP from 1954 to 1968 and it would take an estimated 12,000 more people to do the present job without computers. Other non—quantitative improvements 299 and new programs have been made possible by centralized mechanization. Therefore, efficiency has increased. Im- proved control and increased efficiency has inspired con- fidence of the public in tax laws and integrity of the IRS to the extent that increased voluntary compliance has resulted. Therefore, the mission of the IRS has been achieved. Voluntary compliance has been maximized and tax evasion has been minimized to the extent that the objectives of the system have been achieved. The American computerized tax system has become a model for the other nations of the world to follow. The computer system has increased the opportunity for error on the part of both the Government and the tax- payers. Many of the present problems preViously overlooked under the cxhi manual methods are now identified and acted upon by the cold-blooded efficiency of the computer. In- correctly written numbers or numbers not furnished by tax- payers create many problems and render the system less operative. The new system has increased Government-taxpayer contacts by means of computer-generated notices. Omissions, errors, abnormalities found by the relentlessly searching computers are printed out for computer conversation with taxPayers who complain of the cold, impersonal nature of the contacts. Taxpayer errors need to be decreased, espe- cially wrong and missing numbers, and the Government's computer contacts need to be improved. 300 The IRS computer system has its limitations. The third generation hardware technology is growing old and its "batch-processing" is outdated. There are problems of communication among the district, regional, and national levels; time lags result. The computer can do only what it is told to do; the program instructs the computer and the program is created by human beings. The computer can not audit tax returns. A conceptually new computer system with modern technology of the fourth generation is being planned for installation early in the 1970's, as the present system is satisfactory for the short-run but inadequate for future long-run needs and growth. The application of computers to processing of tax data at the NCC and the Detroit Data Center has enhanced tax research; created many changes, technical improvements and new programs the major ones of which concern Taxpayer Compliance‘Measurement Program, Taxpayer Assistance Program, Master File of Exempt Organizations and Pension Trust Funds, Statistics of Income, Tax Models, Audit Criteria (DIF), and Federal-State COOperation. Many implications emerge, or can be detected, in the computer application to tax returns processing and tax research as follows: 1. Computer applications in business and industry will require Government auditors to audit "through“ 301 rather than "around" the computer as the audit trail disappears into the computer. With "discriminant function” selection of returns for audit, the Government may employ the CPA of the taxPayer business involved to do the auditing for the Government. The possibility exists that one combined tax return might be research and develOped and used for Federal, state, and local levels with the Federal government collecting and processing returns and then reimburs- ing lower levels. Closer cooperation has been emerging. While state income tax laws vary, many states do pattern the preparation, calculation, and filing of state returns after that of the Federal tax. The new Federal Reserve Bank deposit procedure instituted in 1967 for direct payment of corporate estimated income tax has potential for expansion and extension to all other levels, especially indi— viduals, thus eliminating teller operations of the IRS which would get them out of the banking business and reduce some of the paper handling. The computer system provides the capability to the Federal Government for calculating, preparing and sending its citizens their tax bills. With the Master File identifying all taxpayers whose incomes — ———~ .z—L w 7 302 are reported on information returns, with "normal" or "standard" deductions allowed, it is possible for the Federal Government to issue tax bills to the vast majority of individual taxpayers. This is conceivable for individuals but less so for busi- nesses. The chief barrier to bringing this possi- bility into reality is the American political philosophy of democratic self-government, which when applied to taxes means "taxpayer self-assess— ment." This tax philosophy of "self-assessment" flourishes strongly in the United States today, and modification of it would be difficult but necessary to realize this potential change. Those concernipgptaxpayers.--Taxpayers have become more concerned about their tax responsibilities as compu- terized review and examination of returns has become sharper and more comprehensive and taxpayer compliance measurement has been boosted by computer operations. Computers verify the taxpayer's arithmetic on the return and examine the contents, notably deductions for abnormalities, omissions, or inconsistencies according to scientifically determined audit criteria called “discriminant function" (DIF), and then send out notices to taxpayers for corrections when necessary, or if necessary classify a return for more de- tailed audit by the District Office. This microscOpic examination of each taxpayer‘s return by computers, along 303 with the complexity of the return, together with its tech- nical and legal nature, have caused taxpayers in large numbers to seek help and advice from the Federal Govern- ment's Taxpayer Assistance Offices or from professional tax practitioners. Increased individual taxpayer reliance on professional tax services has been the result. All U. S. taxpayers are now identified and listed in the Master File at the NCC with a consolidated account that contains considerable personal information to consti- tute a tax dossier. Taxpayer errors need to be minimized, especially wrong numbers and missing numbers, in order to improve the Operating efficiency of the system. Those concerning professional tax services.--The professional tax services have become inundated with clients. Both Federal Governmental Taxpayer Assistance Offices and the practitioners offices of CPA's, PA'S, lawyers, banks, and tax specialists have expanded their services to fulfill the increased need for help to taxpayers. To obtain relief from the increased workload, private tax practitioners seek, increasingly, help from the computerized tax return prep- aration services. A new industry has been emerging—-the computerized tax returns preparation industry. Certain accountants collaborated with computer specialists to program tax returns. They organized proprietorships or partnerships 304 to sell their service first on a local basis then regionally before being finally absorbed or merged with a parent cor- poration which provides national distribution. Eight firms now flourish and now constitute the computerized tax return preparation services industry, which is expected to grow rapidly in the future. The vast majority of tax returns in the future are expected to be computer calculated and printed by these emerging services. Regarding Computerized Tax Returns Preparation The greatest effect of the application of computers to the_preparation and_printing of tax returns is that on the tax_practitioner.--It takes the drudgery out of the practitioner's tax season. The computer eliminates the practitioner's need to perform simple clerical work and frees his time for more complex work. The computer helps increase the practitioner's income primarily by providing low cost service and releasing his time for other higher- level work. The computer will enhance the prestige of the tax practitioner by requiring his services on an advisory basis concerning tax implications involved in client com- puterized programs because computerization of programs mean they are difficult or impossible to change after getting data into the computer. Will the service firms deal directly with the public and thus eliminate the services required from tax 305 practitioners? Hardly. Computer Tax Service (CTS) tried it with a testing of the public market in Los Angeles and found it unsatisfactory and impractical. Tax returns are too technical, and the technical knowledge and service of the tax practitioner are required to facilitate efficiency in the usage of the input forms of the computerized services. __ - n.- - .‘R‘!1'. ‘e "w. _ There is an effect on the client—taxpayer.--The computerized efficiency of the services matches that of the IRS and constitutes a defense for the taxpayer against the efficiency of government computers. The completeness and accuracy of computer-processed returns results in the filing of better returns by taxpayers. The Federal Government's shift to a computerized tax-collecting system has put each taxpayer's return under a microscope which often increases chances for a full-scale audit by the government when errors, omissions, or abnormalities are found. The new services help taxpayers overcome errors, omissions, and abnormalities in their returns before they are filed. The diagnostic report to the practitioner is a valuable item in this respect. Effects concerning:government tax administrators.-- Computer printed returns are more legible than those written by hand which helps the Government reduce errors of tran- scription and interpretation and helps reduce the need for audits. 306 Computer printed returns create the possibility of tax forms replacement, for individual income tax returns, by direct tape-to-tape tax return transmission from computer centers of the services (like Computax) to the IRS automatic data processing service centers. The simplified input forms of the service firms would replace the complex Gov- ernment forms. Standardization of state tax return forms becomes possible through the computerized service firms. Computer Tax Service (CTS) has convinced the state of Massachusetts and others to simplify their complex forms which is a step in this direction. Perhaps the state and city forms will standardize into a form like the Federal. This possibility exists. Computers promote it. APPENDICES APPENDIX A THE COMPUTERIZED TAX RETURN SERVICES AVAILABLE Computax Computax Corporation, 910 North Sepulveda Boulevard, I, El Segundo, California 90245, is the leading computerized tax return preparation service in the United States. It was developed by Computer Sciences Corporation, a company widely known for the research and develOpment of programming systems for scientific, military, and commercial uses. The Federal income tax returns, state tax returns of California, Maryland, Michigan, Wisconsin, Colorado, Arizona, and New York, and the New York City tax returns are included in the Computax service. Computax was designed specifically to relieve the tax practitioner of the burden- some, repetitive, nondiscretionary duties connected with tax return preparation. Computax performs such functions as entering repetitive data, calculating, checking, typing, reproducing and assembling returns. Forms prepared and printed by this method carry the assurance that data has undergone numerous electronic checks to verify that the minimum allowable tax liability has been established. 307 308 While the Internal Revenue Service does not endorse any particular service or product, the reports and schedules prepared by Computax have been approved and accepted by the IRS for filing Federal returns. Computax has been the trail-blazer in the field of the new computerized tax return preparation services. It has maintained its leadership in the industry through six tax seasons. The concept of automatic preparation of income tax returns became a reality in 1963. Computer Science Corpor- ation of El Segundo, California, programmed in that year a Univac 1107 computer to prepare individual Federal income tax returns and individual California state income tax returns.1 The C.P.A.-scientist who was the designer-imple- menter of the original automated tax return preparation system was Alan A. Stern, employed since 1962 as a research and development scientist at Computer Science Corporation. On the conception of Computax, it has been reported that The idea for Computax originated with William Fahy, CSC data processing supervisor. In 1963 while preparing his Form 1040 just before the April 15th deadline, the thought occurred to him that data processing equipment might be Ehg_answer to tax preparation for everyone. When he sought the opinion of accountants, he received varying answers: from 'Impossible' and 'Couldn't pos- sibly work' to 'Very feasible' and 'Terrific.‘ At this point CSC agreed to begin research. 1Howard M. London, "Automation and Tax Practice,“ Igigg, XLIV, No. 1 (January, 1966), p. 22. 309 Sample computer-oriented tax returns were shown to several accountants. They expressed interest. A pilot program was initiated and, during 1964, 43,000 returns were prepared by Computax. According to CSC, the num- ber of returns that can b3 processed under the system is Virtually unlimited.' The Skousen Tax Service of Montrose, California supplied the original taxpayer interview forms around which Computer Science Corporation developed its first program for the automated preparation of tax returns. The pilot test run of 43,000 returns was processed the first year using this original program. New and greatly expanded interview forms and computer programs were then develOped by CSC computer analysts for their Univac 1107 in 1965. After local California accountants expressed much interest in the computer approach to income tax returns, Computer Science Corporation engaged the marketing division of Dun and Bradstreet to conduct a survey in order to de- termine the potential use of computer techniques in prepar- ing individual returns.3 Accounting firms of all sizes were surveyed in Los Angeles, San Francisco, Chicago, and New York. The majority of accountants interviewed expressed interest and concern mainly with input schedules, processing capabilities for tax problems, appearance of the final 2"Tax Returns By The Computer,“ The National Public Accountant, x, No. 1 (January, 1965), p. 7. 3"Tax Returns--By Computer," The Journal of Accoun- tangy, CXIX, No. 2 (February, 1965), p. 23. 310 printed return, and costs. Mr. Stern reported that the potential lower cost and time savings impressed them most but that their chief reservation was the complexity of the tax return for computerization. This reservation led to a consideration of what the computer can do for the accoun- tant and what it can't do. The computer can do many things to assist the ac- countant. Some of the areas in which this help has been manifested have been the following: 1. Performing all calculations for: a. F.I.C.A. tax overwithheld b. Dividends received exclusion c. Retirement income credit d. Foreign tax credit e. Investment tax credit f. Lowest tax, including alternative tax method for capital gains 9. Tax reduction due to income averaging 2. Checking returns for missing information--such as name, address, social security number, occupation-- and for any unanswered questions regarding travel reimbursement, previously filed returns, etc. 3. Checking for inconsistency of information. The computer will immediately catch such inconsistencies as a single taxpayer's return showing a social security number for a wife, or a rent schedule filed with no depreciation schedule attached, etc. 4. Revealing areas for potential tax reduction, such as retirement income eligibility, the comparative advantage of filing separate or joint returns, etc. 5. Relieving the accountant of many clerical procedures involved in preparing returns. Other areas for computer application have emerged. This type of programming treatment might be extended to such other tax activities as: 1. Preparation of corporate, estate, or partnership returns; . 2. Checking of dividend income and security transac- tions; 3. Year-end tax reView; “he“. 5 N _ “A“ N . 311 4. Determining tax advantages of corporate vs. part- nership form of doing business; 5. Estate planning;. . . 4 6. Information retrieval of tax court deClSions. What can the computer not do? The computer cannot make judgmental decisions. It can do only what it is told to do. Therefore, tax accounting Operations requiring judgmental decisions will remain for the accountant or tax practitioner. Most calculations should be performed by the computer, as this function is what it can do accurately and very rapidly. Mr. Stern studied this situation in collab- oration with tax Specialists of the C.P.A. firm of Touche, Ross, Bailey & Smart so that the Computax system would harness the speed and accuracy of the computer to the needs of tax practitioners. There are several by-product benefits of the com- puterized processing of Federal income tax returns as in the Computax system. Some of these benefits are the prep- aration of (l) a state or city return, (2) filing instruc- tions to the client, (3) time and cost data which the accountant normally keeps with each return, and (4) a pro forma work sheet for use as a checklist and to eliminate rewriting the same descriptions when preparing another year's tax return. 4Ibid. have been a major concern of accountants. Corporation's study of costs, based on from the Dun & Bradstreet survey about cific functions performed in preparing that reductions were possible with the When an average accountant prepares an tax return, he goes through the following functions which 312 Cost considerations of computerized tax returns take the following amounts of time:5 Function 1. Gathering and assembling all data on work sheets, exclud— in the actual preparation 0 the return itself Preparing return from all information available Reviewing for theory Reviewing calculations Preparing, reproducing and collating final returns Total Hours Per Average Return Computer Science figures obtained time spent in Spe- a return, computer approach. average individual revealed Time Spent, In Hours Accountant Clerk F1 I4 O O O LOUIE-4 \J 0 sq in o (a) O C O H P‘HHH H O 5.: U! Computax found that the computer program, on the average, makes it possible to eliminate steps (2), (4) and (5): which results in a savings of 2.1 hours of the accountant's time, and 1.3 hours of clerical time. A time study of a typical return of a dentist, included below, that was pre- pared by a typical C.P.A. firm illustrates by the following 5 Ibid., p. 24. 313 figures how Computax can save time for practitioners to do more returns or other profitable work during the busy tax season: COMPUTAX Manually E I Preparation 28 minutes 107 minutes 2 Checking 10 minutes 24 minutes 2 Review 7 minutes 12 minutes ' TOTAL Professional Time 45 minutes 143 minutes E These figures show that there is a saving of 98 minutes in E. professional time, or 1.6 more hours that is available for working on more 1040's or doing other profitable work. For the 1965 tax season, Computer Science Corporation estab- lished a price for its Computax system that averaged $7.25 for individual Federal returns and about $8.75 for the Federal plus the state return. Much time and consideration was devoted by Computer Science Corporation to the original design of the input forms which practitioners use on which to submit the neces- sary tax data of their clients. A tax partner of Touche, Ross, Bailey & Smart was consulted by Computer Science Corporation to insure that due consideration had been given to the many varied types of complex transactions that can arise on tax returns. There are twenty separate input pages that might be used in the Computax system for a com- plex Federal income tax return. About one-half of this total might be used on an average return. The input sheets 314 for the Computax system, which have been designed to accept only those data which are required on the tax return itself are as follows: Interview Interview Interview Interview Interview Interview Interview Interview Interview Interview Interview Interview Interview Interview Interview Interview Interview Interview Interview Interview Form Form Form Form Form Form Form Form Form Form Form Form Form Form Form Form Form Form Form Form NH U'IIDOJLU co ”HO .0 oo \10‘ com 11: 12: 13: 14: 15: 16: 17: 21: Taxpayer Identification Data Estimated Tax Information--Form 2210-~Wages and Salaries Dividend Income Interest Income Income from Rent and Royalties Gains and Losses from Sales or Exchanges of Property (This in- cludes Long-Term and Short-Term items) Gains and Losses from Sales or Exchanges of PrOperty (PrOperty other than capital assets, Sections 1245 (1231) assets, and Sections 1250 (1231) assets) Gain on Installment Sales Partnerships, Estates or Trusts, Other Sources, and Pension and Annuity Income Profit or Loss from Business or Profession and Schedule C-3 Information Profits or Loss from Business or Profession Farm Income and Expenses Depreciation Business Expense (Employee and Partnership) Itemized Deductions Itemized Deductions (Continued) Tax Credit Schedule and Additional Tax Due Income Averaging Footnote Schedule Recap (Optional) A growing number of practitioners have expressed a desire to learn the proper preparation of the many input forms in the Computax system of computerized returns. This interest was reflected in the fact that in December of 1967 over 1,000 practitioners accepted invitations to attend a 315 Staff Training Seminar held in New York on the use of Computax computerized returns.6 Instruction guides on the use of the input forms are furnished as a matter of policy by Computax to each practitioner. Review procedures of the input forms Should be developed by each tax practitioner to insure accuracy before the returns are forwarded to the processing centers. This is the purpose of the recapitulation sheets on which it is possible to summarize the taxable income figure. Most services have developed such a procedure or checklist of items to be covered properly. One practitioner Said, . . . We have learned from our own experience and from other users of Computax that a major safeguard is the calculation of taxable income for ourselves by filling in the recap sheet (Computax Form No. 21). This requires footing and recording totals in the input forms. The same review procedures covering correctness and completeness of the raw data used for hand—prepared returns apply to the Computax schedules. There is one big difference, however—-we do not verify footings. Computers handle that for us. The program was enlarged in 1966 to include 75,000 instructions, consisting of some 23,000 Cobol statements, . . . 8 which processed a return in an average of Six seconds. 6“Staff Training to Take Advantage of Computerized Tax Return Service," Taxation for Accountants, II, No. 6 (January-February, 19687, p. 376. 7Donald Chapman, "A Procedure For Review Of Compu— terized Returns," Taxation for Accountants, II, No. 2 (May- June, 1967), p. 125. 8Edward K. Yasaki, "Computing and Tax Accounting,“ Datamation, XII, No. 3 (March, 1966), p. 33. 316 And yet the turn-around time, from receipt of interview forms submitted by accountants and practitioners to the mailing of completed tax forms was and still is five days. Key-punching has been the bottleneck. In September of 1965, Computer Science Corporation sold a fifty-one per cent interest in the Computax Corpor- ation service to Commerce Clearing House, the huge Chicago based tax and law information dispensing firm. Together they formed a new venture, the Computax Corporation, to pioneer and to carry on the enterprise of automated tax returns with a policy of serving only tax practitioners such as certified public accountants, lawyers, public ac- countants, tax counselors, bankers. Then Computax Corpor- ation became a public corporation by offering 60,000 shares of the 1.2 million shares outstanding. On December 29, 1965, it was announced in the public prints that the Com- putax Corporation "registered with the Securities and Exchange Commission a secondary offering of 100,000 capital shares . . . to be offered for public sale by Computer Science Corporation."9 This secondary offering was subse- quently withdrawn in favor of the 60,000 share primary offering. 9 column 1. Wall Street Journal, December 29, 1965, p. 13, 317 At its inception, Computax service was available through the CSC in the states of New York, New Jersey, Connecticut, California, Texas, Oregon, Washington, Nevada, and Arizona. After CCH acquired control of Computax, Computax Corporation began marketing its service through the already established Commerce Clearing House sales or- ganization. A much wider distribution of the service through the Commerce Clearing House marketing force made Computax service available in 1966 in 34 states covering EA most of the country except part of the South and Midwest, Alaska, and Hawaii. More than 100,000 returns were processed by Computax during its first two years of operation--in 1964 and 1965.10 Competitors estimated in 1966 that Computax had about 2,000 clients throughout the nation with a volume of 200,000 11 returns. Another report said that Computax Corporation in 1966 was geared and set up to handle the computerized processing of 575,000 tax returns.12 This volume would amount to a sales income of $6.6 million considering the average charge per return by Computax was $11.50 in 1966. . 10Alan A. Stern, "Computer Tax Returns," The Na- Signal Public Accountant, X, No. 12 (December, 19655, p. 8. 11"Electronic Ally For The Taxpayerr" Engine“ week' March 26, 1966, p. 168. 12Edward K. Yasaki, "Computing and Tax Accounting,“ fitamation, x11, No. 3 (March, 1966), p. 33. 318 However, Computax remained silent about its business while its application to go public was pending before the Secu- rities and Exchange Commission. The president of Computax Corporation gave some statistics on 1967 Operations of his firm. He said: This past tax season we had processing centers in Los Angeles, Chicago and New York. We processed 170,000 Federal returns, 55,000 state of California returns, 21,000 state of New York returns, and 7,500 what we call chargeable reruns. Incidentally, the re-run rate is 4-1/2 per cent. In other words, 4-1/2 per cent of the returns sent to us nationally, had to be re-run because of either preparer error or omissions or error on the part of the taxpayer. Average prices for this past tax season were: our Los Angeles Center, the returns processed there averaged $16.50. Incidentally, these prices would include the applicable state returns, but do not include the chargeable re-runs. So, Los Angeles $16.50; Chicago $12.57; and New York $13.58 for a grand national average of $14.50 for the returns we prepared for 170,000 taxpayers.l3 Speed and accuracy are the two major criteria by which to evaluate computerized operations of tax return preparation. The factor of speed is often expressed in terms of "turn-around time." Accuracy is often indicated by chargeable and non-chargeable re-runs. Some statistics on these two points at Computax in the 1967 season are as follows: 13Daniel R. Mason, "Remarks on Computerized Tax Returns," 1967 Proceedings of the Second Annual Conference gp_Computers and Taxes, Sponsored by the Computers:IE:L§§— Institute of the George Washington University in cooperation with the American Bar Association and the Federal Bar Asso- ciation, Statler—Hilton Hotel, Washington, D. C., June 6-7, 1967, p. 30. 319 Timely enough, we've heard comments today about turn-around time, etc. I'll break my statistics into two pieces; First, from January 3rd to March 20th, by which time we had processed half our volume for the year. Up until March 20th, out of 85,000 returns proc- essed, just about 500 returns were in our hands longer than five working days or seven calendar days. March 20th to April 17, there's another story. I might back up for a moment and say that up until March 20th, we had received from 20 to 50 per cent of the number of returns that our customers had predicted and in the course of about three days following March 20th, we suddenly found ourselves at 200 per cent of what cus- tomers had predicted they would send us. But anyway, from March 20th to April 17th, 75 per cent of the re- turns were done within seven calendar days, 5 per cent --nine days, 3 per cent—~10 days, and one per cent--1l or more days. For Accuracy: Again, I'm talking about this tax season just finished. Preparer error, which I've already mentioned, ran 4-1/2 per cent. Computax error, and I break this into two categories: first, Computax error which was detected by our customers ran about 1.4 per cent; second, Computax error which was detected by us was about 5 per cent. Computax processed a total of 240,000 returns in the 1968 tax season and 400,000 in the 1969 tax season. Since its inception, it has processed over 1,000,000 returns and has about 80 per cent of the C.P.A. market. Lawyers, bankers and trust companies have been heavy users of the system. How The Computax System Works.15--The Tax practi- tioner records his clients' tax data on professionally 14Ibid., pp. 30-31. 15Alan A. Stern, “Computer Tax Returns," The Na- tipnal Public Accountant, X, No. 12 (December, 1965), pp. 8-9; 25. Also, see: *“Tax Returns By The Computer," The National Public Accountant, X, No. 1 (January, 1965), pp. 6-7: 230 320 designed "input" forms called Interview Forms. The tax practitioner then forwards the Interview Forms to one of the five Computax processing centers in Los Angeles, Chi- cago, New York, San Francisco, or Washington, D. C. Computax makes all calculations and computations 23 an" electronically from the Interview Forms. First, the infor— mation is keypunched and verified, then fed at the rate of 800 input cards a minute onto tape, using IBM 360 Model 20's; the tape is then fed into the Univac 1108 computer system. A portion of a single reel of magnetic tape can store enough basic taxpayer information needed for the preparation of 400 Federal and state tax returns. The computer begins its analytical operation by reviewing the information it has received, computing the tax liability several times by the various programmed methods, then se- lecting the most favorably computed alternative which gives the taxpayer his lowest legally obtained tax liability. Some examples of the alternative calculations and selections which the computer makes, in less than three seconds, are: (l) itemized deductions vs. 10% standard deduction vs. the minimum standard deduction, (2) short-term VS- long term capital gain calculation, (3) income averaging method, etc. Computax prints out on IRS-approved income tax forms three completed and fully verified copies of each return including required supporting detail schedules. These copies are returned to the tax practitioners, who 321 review and then forward them to their clients for their One copy is signatures and timely filing with the IRS. retained in the files of the practitioner and one copy in the files of the client-taxpayer. Computax also includes a filing letter of instruc- tions for the taxpayer-client and a special "diagnostic" The audit report or audit report for the tax practitioner. indicates any problem areas that the computer found which ‘1'“ marry. 5'3. WW need further consideration by the practitioner. The computer's diagnosis of the taxpayer's return The machine is based on a library of current tax laws. has over 45,000 programmed instructions stored in its memory, and, in preparing its report, checks the return against current law to determine whether or not there are any inconsistencies or omissions or if deductions exceed limitations. The computer can relay to the tax preparer over 400 different diagnostic checks. If, for example, a tax preparer indicates that a return should be calculated as joint income and the computer estimates a lower tax for separate returns, it will indicate this fact, together with the potential saving. Similarly, if the taxpayer is shown as being Single, yet a social security number is listed under the wife's name, such Another special an inconsistency will be reported. feature of Computax is the income averaging ability of the program. Computax caters to the more complex returns that often include the declaration of estimated tax and even the Computax farm schedule or the income averaging schedule. service has been programmed to handle practically any indi- Prices for vidual tax return regardless of its complexity. 16"Tax Returns By The Computer," The National Public 1 (January, 1965), p. 23. Accountant, X, No. 322 the service, therefore, vary accordingly. The price is correlated to the amount of information that must be sub— mitted to the computer. Autotax Autotax of Tax Computer Associates, Professional Building, 200 Little Falls Street, Falls Church, Virginia 22046 became operational in October, 1965 and is presently owned by Research Institute of America, 589 Fifth Avenue, New York, N. Y. 10017. The Autotax program that computes the Federal Form 1040 for individuals was originally developed in 1964 and is the result of the pooled knowledge of highly skilled technicians and qualified tax advisers. Over 10,000 man hours have been used to develOp the program. The program prepares tax returns in great detail and is very comprehensive. It can handle amounts up to $21,000,000 and turns out a return in exact dollars and cents. The Autotax program will prepare supporting schedules of any kind, which are printed on the official form in a format which is accepted by the government.17 Since the computer used at Autotax is the IBM System 360, Model 30, the prOgramming is done entirely in 360 Assembler Language. The same programs and sub—routines are involved in producing a simple tax return as a complex one. The programs are selectively executed, as needed, 17George Kinnard, "The Computer versus The Fifth Season," Law and Computer Technology, I, No. 3 (March, 1968), p. 15. George Kinnard Is the General Manager of Research Institute Autotax. Mr. Kinnard was formerly a Manager in the Marketing Staff of the Research Institute of America, and is a past President of the Ohio Consumer Loan Association. 323 depending on the data submitted to the computer. Even a very simple tax return would involve a number of programs. The current Autotax system, in total, represents over three thousand pages of programming and nearly 400 separate pro- grams, any or all of which may be automatically applied to a single batch of returns being processed through the com- puter. Furthermore, the Federal returns and the several state returns may be randomly inter-mixed within the same batch.18 V-“ ”may. -—_1 At its inception, Autotax was under the management of three CPA firms: Buchanan & Company; Bobys, Noble & Brothman, both of Washington, D. C.; and Garbelman, Winslow & Company of District Heights, Maryland.19 This system is marketed by Tax Computer Associates, which is owned by three certified public accounting firms, in the Washington, D. C. area. Built around an IBM 360-mode1 30 computer, Autotax currently (March, 1966) services about 200 tax consultants from 'almost every state.‘ Mr. Hubert Hall became President of Tax Computer Associates and directed the first year of operations at Autotax. During this first year of processing tax returns in the 18Maitland K. Flood, Chief Systems Engineer, Tax Computer Associates in a letter to the author dated December 10, 1968. 19HOpe Chamberlain, "Next Year Is Now," National Epplic Accountant, XI, No. 10 (October, 1965), p. 9. 20"Electronic Ally For The Taxpayer," Business lest. March 26, 1966, p. 168. _ 324 1966 tax season, Autotax service included the Federal return and the state returns of Maryland, Virginia, and the District of Columbia. Last July (1966) the controlling interest of Autotax was acquired by the Research Institute of America. The advantage to all concerned was the nationwide marketing staff of the Institute. As you all know, we have a I sales force that has been calling on the lawyers and 5 accountants of the nation since 1935. In presenting ? our Tax Coordinator we have been in close contact with the professionals who were involved in Federal taxation, so Autotax is a compatible product. E. Despite the fact that we did not start our sales effort until September of 1966, it was gratifying to find at the end of this tax filing season (1967) that we had processed returns from all but two of the fifty states, plus the District of Columbia. The sales and advertising promotion of Autotax stresses several points. Tax practitioners agree that the preparation of income tax returns is becoming each year more complex, more difficult, more time consuming, and less profitable. Tax practitioners find that each tax season means tremendous pressure, long hours--nights and week-ends, extra help, disrupting more important work, and heavy over- time costs. Autotax eliminates typing, duplicating, com- puting, math verifying, proofing, recording. These functions are performed automatically by Autotax computers. 21George Kinnard, "Remarks on Computerized Tax Returns," 1967 Proceedings of the Second Annual Copference on Computers and Taxes, Sponsored by the Computers-In-Law Institute of The George Washington University in COOperation with The American Bar Association and The Federal Bar Asso- ciation, Held in the Statler Hilton Hotel, Washington, D. C., June 6—7, 1967, p. 33. two steps: 325 How does Autotax work? The practitioner follows (1) he assembles information on a detailed set of 17 basic "tax control forms" according to the instruc- tions given for each firm, and (2) he mails the completed tax control forms to the Autotax processing center in the suburb of Washington, D. C. at Falls Church, Virginia. steps: 1. Autotax takes over from this point, following these Upon arrival at the processing center, the "tax control forms" are assigned a unique identification number. The information on the forms are reviewed by com- petent people who are trained for this job. All data inserted on the forms by the practitioner is keypunched on to cards. All alphabetic and numeric data keypunched on cards is key-verified to insure accurate transcription of information. The cards are then screened by Autotax's unique pre-edit program. (This separate program, designed by Autotax technicians, is designed to assure addi- tional accuracy by eliminating practitioner errors as well as keypunch errors. The cards are pro- grammed through a 360 computer to catch such errors as card omitted, card duplicated, various practi- tioner errors which do not conform to the program, numeric information appearing in an alphabetic field and vice versa, etc.) The cards are then processed by the tax program on a 360 computer which automatically selects the method of filing which produces the lowest lawful tax. Pertinent data concerning each return is stored on a disk under the taxpayer's social security number, and this information is directly accessible to the computer should a program seek it directly at random. Wren-m... ____._- fl 4 ~ ' J— 100 ll. 12. 13. putation. control forms. 326 The 1040 return and the four state returns that have been programmed with all accompanying schedules are printed in four copies along with a schedule of fees. Each Form 1040 and any programmed state return along with supporting schedules are collated and stapled. Detailed schedules for any unprogrammed state returns are produced in quadruplicate if needed. A diagnostic report accompanies each return to the practitioner and it indicates errors or omissions that the computer observed, the need to file a particular schedule or form, or any other pertinent data. The completed returns, with all necessary supporting schedules and the original "tax control forms" are returned to the practitioner within five days after being received by Autotax. The practitioner, after the first year, receives in the last quarter of each year a pre-printed input set of "pro forma" tax control forms for the coming year which contains repetitive information for the next tax season's return. (Updating this data on the pro forma makes the next season's tax return easier and quicker to prepare.)22 The tax practitioner need not perform a single com- All he is required to do is fill out the tax The same item is rarely entered twice be- cause the IBM 360 computer used by Autotax has "random access capability" (see step number seven, above). Autotax contains three built-in checks for accuracy. It includes a separate computer program called 'pre- edit.‘ The pre—edit searches out errors and omissions before tax computation starts. 23“Our Computer Is After Your Tax Jobs," The Journal 9£_Accountangy, CXXIV, No. 4 (October, 1967): Po 31- 327 From the time of its inception Autotax has provided a complete diagnostic audit report with each printed tax return. This report is a valuable aid to the practitioner in his final interview with his client, as it contains the following data pertinent to the return. 1. Losses on a Schedule C, D or F. 2. Comparison of tax liability with and without income averaging. 3. Explanation of certain assumptions made by the computer. 4. Errors or omissions that were observed by the computer. 5. Warning to the practitioner to attach a certain schedule when necessary. Future Autotax plans call for the writing of a master estate-tax program, and maintaining and updating it in accordance with pertinent court decisions or changes in tax law and regulations.25 With accountants and tax practitioners slowly accepting the computer as a new partner in their profession, the sticky problem of ethics has been raised. How to pre- serve the confidential nature of tax returns when using the computer as a new tool in its Operations has become a real challenge to the ethically minded practitioner. Tax 24George Kinnard, op. cit., p. 16. 25Hope Chamberlin, "Next Year Is Now," National prlic Accountant, XI, No. 10 (October, 1965), p. . 328 practitioners who use the computerized services must bear the responsibility of guaranteeing that client information will remain confidential. Autotax, conceived and developed by three CPA firms, made a special effort to incorporate safeguards in their system to protect accountant—client confidence. Some safeguards, or internal control devices, to preserve the confidential nature of tax returns when processed through Autotax are the following: 1. Identity of taxpayer by social security number rather than by name puts the return on an impersonal basis. 2. Speedy, mass-production-line techniques for key— punching operators and other processing personnel make highly unlikely the possibility of gleaning significant information from any one return even if the employee had the time or interest. 3. Only a professional reviewer of the input data at the beginning of the process and a professional reviewer at the end of the process have the oppor- tunity of taking an overview of any taxpayer's complete affairs. 4. Information passing through key punching and ver- ifying operations are maintained in a raw state. Typists, in the old non-computerized method, see far more significant and meaningful information on tax returns than keypunch operators under the new automated method. Autotax had its second national tax season in 1967.26 However, the 1967 tax season was the first year for Autotax to be operated by Research Institute of America. The 26"Computer Tax-Return Preparation: How The Several Services Shape Up This Year," Taxation for Accountants (January-February, 1967), p. 322. )- . 1‘ I P‘- ' _, 329 General Manager of Autotax under the new ownership said at the end of their first year: The results of our first nationwide season of processing returns have produced the following conclusions: 1. Since those who have used the system in large quan- tities have indicated a desire to continue and increase, we are convinced that there will be an F3 increasing acceptance of the system, and we are expanding our scope accordingly. 2. Many lawyers who have refrained from preparing tax . returns in the recent past are finding it econom- ically sound to give clients their thinking and knowledge of the law in this area. 3. The completeness of the computer processed return will result in the filing of better and more detailed returns. On the other side of the coin we still have some Operational problems, but they do not appear as for- midable as they did a year ago. . . . Our commitments to the future are many in the areas of more programming. We are making a number of changes in the Federal program, which will result in more simplified input forms. We have immediate plans to program several more of the state returns. Our long- range plans include both the corporate and fiduciary returns. A notable improvement in the Autotax service in the 1968 tax season was a reduction in the number of input forms and a change in the name--from a comprehensive ques- tionnaire input of 27 pages to 17 basic "tax control forms" with eight additional possible forms, if needed. The 17 basic "tax control forms" are as follows: 27George Kinnard, "Remarks on Computerized Tax Re— turns!" 1967 Second Annual Proceedings of the Conference on Computers and—Taxes, Sponsored by the Computers-In—Law In- stitute of George Washington University in cooperation With the American Bar Association and the Federal Bar ASSOOla— tion, Held in Statler-Hilton Hotel, Washington, D. C., June 6-7, 1967, pp. 33-34. 330 1. Identification Data, Dependents and Estimated Tax Information 2. Salaries, Wages, Tax Withheld and Sick Pay Exclusion 3. Dividend Income 4. Interest Income, Income From Estates and Trusts and Other Sources 5. Partnerships, Small Business Corps., Investment :3 Credit and Recapture of Investment Credit 5 6. Gain or Loss From Sale or Exchange of Non-Deprec- : iable Assets and Carry Forwards 7. Medical and Dental Expense 8. Contributions and Contribution Carry Forwards 9. Interest Expense and Taxes 10. Other Deductions and Sale of Property Other Than Capital Assets 11. Rental Income and Rental Expenses 12. Profit or Loss From Business or Profession l3. Expense Account and Additional Information 14. Pensions and Annuities, Payments by Self-Employed Persons to Retirement Plans and Retirement Income Credit 15. Income Averaging--Federal Return Only 16. Note Schedule 17. Depreciation Schedule and Gain or Loss on Sale or Exchange of Depreciable Property Other possible forms available if required are as follows: 18. Business Expenses (Incurred as an employee or in connection with partnership income) 19. Royalty Income and Expenses 20. Installment Sales 331 21. Schedule of Farm Income and Expenses 22. Farm Income for Taxable Year——Accrual Method 23. Sale or Exchange of Personal Residence . 24. Child Care Deduction 25. Net Operating Losses, Foreign Taxes and Investment Credit Carry Forwards Foreign Tax Credit and Other Credits The cost of an average return at Autotax amounts to approx- imately $15. A contract is required to be signed along with a minimum deposit of $250. A main disadvantage of Autotax is the fact that it does not print all schedules and forms on government facsimiles whereas the other two fully come puterized services do; that is Computax and Fast-Tax. In- stead, it prints the schedule on computer-paper lists, which are government approved and accepted, but they are not so neat as the government facsimiles. Fast-Tax Fast-Tax, Computer Language Research, 2501 Cedar Springs Road, Dallas, Texas 75201 is offered by Computer Language Research, Inc., a company founded to develop and market the Cleartran compiler for the IBM 1620 computer of the second generation. Some details of the first processing year (1966) were as follows: . . . The standard five-day turn-around time is offered (one-day service if punched cards are submit-" ted), but only individual Federal returns are handled, and the average charge is $8-10. Processing is by a 332 40K/1620 with disc pac. Anticipating 360-processing next year (196759 Fast—Tax is still in the throes of its first year. Fast-Tax has developed into America's most advanced computerized income tax program package as corporate and partnership information income tax returns as well as indi- vidual returns are now included in its service.29 None of the other firms in the young industry have yet offered service on the corporate and partnership returns. Fast-Tax, which can be classified as a completely computerized service as contrasted with the partially com- puterized services, prints items of a list directly on tax form facsimilies. All items of a list such as dividends, depreciation entries, and other items, are printed directly on the facsimilies rather than on attachments, space per- mitting. Up to 40 transactions can be shown on Schedule D. Returns can be computed in either whole dollars or with penny amounts. Eight digit accuracy is maintained for Form 1040 and related schedules. Ten digit accuracy is maintained for Forms 1120 (corporations) and 1065 (partner- ships). Generation of investment credit, carry of deprec- iation to schedule D, and recapture of investment credit is 28Edward K. Yasaki, "Computing and Tax Accounting," Datamation, XII, No. 3 (March, 1966), p. 34. 29"Fast-Tax," The Journal of Accountancy, CXXV, No. 6 (June, 1968), P ,75. 333 automatic. The turn—around time is 24 to 48 hours during the peak-load portion of the season, or even less if required. Eleven state tax returns were processed in the 1969 tax season for the 1968 returns as follows: California, Colorado, Kansas, Louisiana, Minnesota, Missouri, Nebraska, F? New Mexico, New York, Oklahoma, and Utah. The New York City flEI tax return was included in the 1969 season. Only Fast-Tax i has a completely integrated highly versatile cost depletion [I program for oil and gas properties. Fast-Tax does pro forma all the way on every item which is likely to be used the following year. This includes such items as dividends, interest, depletion, farm operations and schedules B, C, C-3, F—l, G, and others. Depreciation pro forma includes incrementing the depreciation reserve and indicating what the depreciation will be the following year. Retired prOp— erties do not Show on pro forma. Fast-Tax is available on a royalty basis; that is the program can be rented. Fast-Tax will also process tax practitioners cards. Or, Fast-Tax will do the entire job itself in 24 hours or less, if required. The Fast-Tax program is available to interested parties wishing to operate their own centers on a royalty basis of 10% of the base price. The computer configuration required is an IBM 1620/40K or IBM 360/32K with 1620 emulator. Computer clock time will average about one minute per return on the IBM 334 360 model. The number of cards per return will vary from an average of 65 for smaller accounting offices to 100 for large offices. Experienced operators can punch 200 cards per hour. For the 1968 tax season reporting 1967 income, Fast-Tax charged $3.00 per return for computation, 12 cents per card punched, and fifty cents per page printed. For the 1969 tax season reporting 1968 income, the base charge for Fast-Tax service was $1.00 for Federal Form 1040 or state computation, plus 12 cents per card punched and 66 cents per page printed. Extra sets were priced at fifty cents per page printed. There was no card charge for reruns and the rerun charge did not exceed 45% of the base price. Fast-Tax prints and collates returns from cards punched by others at 50% of the base price. The 1065 (partnership) and the 1120 (corporations) charges were the same as the Federal 1040 for individuals, except for an additional computation charge of $2.00 per return. There is no reg- istration fee for the Fast-Tax service. Fast-Tax has eleven input forms that were designed by Computer Language Research, Inc., for the individual income tax return 1040 and its related schedules. They are as follows: Fast-Tax Federal 1040 Form and Related Schedules Form or Forms Form 1 Page 1 of 1040 Form and Recapitulation of Return 335 Form 2 Page 2 of 1040 Form - Part II Income Other Than Wages Form 3 Page 2 of 1040 Form - Part IV Itemized Deductions Form 4 Depletion for Schedule B and/or C Form 5 Schedule B Income and Retirement Income Credit Form 6 Schedule F Farm Income Form 7 Schedule C Profit (or Loss) From Business or Profession Form 8 Page 2 of 1040 Form - Part III Adjustments Including: Form 2240 Sick Pay Form 3903 Travel Expenses Form 2106 Employee Business Expense Form 29SOSE Payments By Self Employed Persons to Retirement Plans Form 9 Schedule D Gains and Losses From Sales or Exchanges of Property Form 10 Schedule G Income Averaging and Credits, including: Form 3468 Computation of Investment Credit Form 4136 Credit for Federal Tax on Non-highway Gasoline, etc. Form 1116 Foreign Tax Credit Recapture of Investment Credit Form 11 Form 1040ES Declaration of Estimated Income Tax Form 2210 Statement Relating to Underpayment of Estimated Income Tax by Individuals Letter of Transmittal Footnotes Fast-Tax is set up, equipped, and programmed to process complex individual income tax returns on the 1040 Forms. It also processes corporate income tax returns on 336 Form 1120 and partnership information returns on Form 1065. Tax practitioners who elect to use the Fast-Tax service fill out the input forms and forward them to the Fast—Tax headquarters and processing center in Dallas, Texas. The input forms are processed, printed out returns are collated, and neatly printed out returns are mailed back to the prac- r1 . o. l v '. "I. titioner within one or two days. * Datatax Datatax30 was one of the major of several fully- computerized tax return preparation services available to tax practitioners during recent tax seasons. It is not offered to the general public. Datatax, a well-known pioneer in the field, began Operations in 1964 with a trial run on 2,000 1963 returns in Albuquerque, Nex Mexico. Frank Hubert & Associates of Albuquerque originated and developed Datatax service which was originally offered to practitioners in the Southwest, primarily in the states of New Mexico, Texas, Arizona, Utah, and Colorado.31 Mr. Frank Hubert, President of Datatax, indicated that the trial run in 1963 fulfilled their expectations. The steps in the operating procedure of the Datatax system were originally listed as follows: 30Address in McBee Systems, Litton Industries, Incorporated, 80 Greenwich Avenue, Greenwich, Connecticut 06830. 31"New Computer-Prepared Tax Service Announced in Five Western States," Management Services, II! No. 5 (Sep- tember-October, 1965), p. 9. 337 The tax return preparer interviews the client. The preparer sends the information to Datatax. Datatax keypunches and verifies each item, then Calculgges and prints the information on the printed forms. QNNH see. The fee charged for the service was $4 for a Federal tax return that used the standard deduction. An additional charge of $1.50 was made for itemizing deductions, for providing additional schedules, or for income tax averaging. The fee charged for state income tax returns was $1.50 additional. The cycle time for each return was 72 hours. This time included the span between the interview and the receipt of the tax return back in the hands of the preparer. Monroe Data Processing Division of Litton Indus- tries, Incorporated, acquired Datatax Corporation in Decem- ber, 1965.33 After this purchase, Datatax service, orig- inally offered in only five Southwestern states, became available nationwide. About 6,000 returns34 were prepared in 1965 by Datatax, when the service was Operating in the Southwest 32nTax Returns By Computers Is A Growing Business," qurnal of Accountancy, CXX, No. 3 (September: 1965): PP- 16-18. 33"ComputerS Play a Growing Role in Helping Accoun- tants Figure Their Clients Annual Tax Returns,“ Wall Street Journal, December 15, 1965, p. 1, column 5. 34"Monroe Will Offer Nationwide Computerized Tax Service," Journal of Accountancy, CXXL, No. 1 (January, 1966), p. 14; See also: Computer Tax Service," The Na- Eional Public Accountant, XL, No. 1 (January, 1966), p. 16. 338 only. At Litton's Monroe Division, Datatax tooled up for 175,000 returns in 1966 but expected to process less35—- 36 about 100,000 personal returns. At Litton Industries, Datatax was absorbed by McBee Systems, the division which handles all automated office procedures. McBee Systems, with its national distribution organization that had been calling on accountants across the United States for many years, was a perfect outlet for Datatax. Also, Datatax filled out the McBee product line. According to one of their advertisements, Datatax makes the following appeal to tax practitioners: Several thousand accounting practitioners came through the tax season this year without strain or overtime work. They used DATATAX, the computerized tax return preparation service offered by McBee Systems. Datatax solves the 'peak load' clerical problem during the tax season, eliminating the need for temporary help and/or overtime. It provides a uniform cycle time for tax return preparation at a predictably low unit cost. Most important-~you gain time--to enable you to accept more tax c1ients--provide more consulting and other year—round income—producing work. This is in addition to the clerical savings. Your clients benefit too, because of the speed, and accuracy and impressive appearance of computer-prepared DATATAX returns. And also because you are able to give them the full range of accounting and consulting serv- ices on a year-round basis. 35E. K. Yasaki, "Computing and Tax Accounting," Qstamation, XII, No. 3 (March, 1966), p. 34. 36n31ectronic Ally For The Taxpayer," Business Week, March 26, 1966, p. 168- 37"Were You A Relaxed Datatax User This Tax Season?“ IQ? Journal of Accountanpy, 123, No. 5 (May, 1967), p. 77. 339 In the 1967 tax season, the basic charge for the Datatax service was $5.00 with additional charges depending on the complexity of the return. Additional schedules and calculations resulted in additional costs. How the Datatax service worked in the 1967 season was spelled out in a step—by-step procedure as follows:. 1. You record data collected in the interview with your client on a simplified DATATAX Answer Sheet. One COpy is retained, and the other is sent to your nearest DATATAX Processing Center. Upon receipt of the Answer Sheet, we record the date; assign a processing number; and send it on to Review. Trained reviewers check your Answer Sheet for over- sights and, if none are found, forward it to the Data Processing Supervisor. Otherwise, you are contacted. Data contained on the Answer Sheet are converted to machine-language media and verified. It is then fed into an electronic computer, which has been especially programmed to handle virtually any tax computation. The computer accurately makes hundreds of arith- metical computations including a. ascertaining whether income averaging applies b. computing limitations on medical expenses, con- tributions, etc. c. determining income and self-employment taxes d. making all depreciation computations e. figuring the amount of capital gains and losses, determining short-term or long-term status, and computing the alternative tax f. determining reportable profit on installment sales (both ordinary and capital gain portions) g. computing retirement income credit and investment credit h. figuring Section 1245 and Section 1250 recap i. performing any or all of these steps a second time if a change in a completed return is required. 340 6. Finally, the return and related schedules are com- puter-printed on official forms and other forms acceptable to the government. 7. We forward completed returns in triplicate within five working days after they are received. Yog review, Sign, date and deliver to your client. 8 Datatax suspended operations in the 1968 tax season. Competitors say their troubles concerned old computer equipment that Datatax was using, inadequate input forms, and lack of acceptance by the certified public accountants. Datatax reentered the market and attempted to make a come- back in the 1969 tax season by operating in the Manhattan district of New York only. Unitax Unitax39 is a partially computerized tax return preparation service that was originally developed by the Skousen Tax Service, Montrose, California. It's service is aimed at the smaller taxpayers, the computer run being used only for pages one and two of the Federal 1040 Form, its California income tax equivalent, Form 540, and the Indiana income tax equivalent, Form IT-4O.4O Unitax expected to 38"McBee Systems, DATATAX, Data Processed Tax Re- turns," Brochure S-551, McBee Systems, Royal Typewriter Company, Inc., A Division of Litton Industries, Incorporat- ed, Greenwich, Connecticut, 1966; See also: "Don't Tax Yourself This Coming Tax Season," Taxation for Accountants, November-December, 1966, p. 318. 39Address is Unitax, Incorporated, 12222 East Philadelphia Street, Whittier, California 90601. 40Edward K. Yasaki, "Computing and Tax Accounting," Estamation, Xii, No. 3 (March, 1966), p. 33. 341 process 120,000 returns in 1966 on an IBM BR 1401 computer at a service bureau. The average charge to practitioners was $3.20 per return. The sales promotion effort made by Unitax to tax practitioners in a 1967 advertisement included the following elements: Computerized tax returns service is offered for $2. This service gives you beautiful, accurate computer printed pages 1 and 2 of Federal and state returns. 5 36 hours is the processing time. Additional services I. are available. If you want all supporting schedules E computed, checked, duplicated and assembled, the charge is only slightly more. As one of the Nation's oldest and largest computerized tax services, Unitax guarantees accuracy. Federal returns are processed from practi- tioners in all states. State returns are processed currently for California and Indiana. Processing cen- ters are located in Los Angeles and Chicago areas. Most of the computerized tax return preparation services key punch all information of a taxpayer into the computer. The computer makes all calculations. The com- puter then prints out a completed tax return ready for signature and filing with the Internal Revenue Service. Unitax operates quite differently Since it is only partially computerized. It manually performs the necessary calcula- tions from figures and information which the practitioner records on worksheets. Unitax checks all calculations if they have made by the practitioner. An audit of the return is made for completeness. Examples of the other key items 41"Computerized Tax Returns," Journal of Accoun- tancy, CXXIII, No. 2 (August, 1967), p. 75. 342 checked would be (1) posting of W—2's, (2) head of house- hold status, (3) F.I.C.A. overpayments, (4) over age 65 medical expenses and deductions, (5) retirement income, (6) investment credits. Summary figures such as subtotals of income and deductions are injected into the computer. The high speed F] computer calculates the tax independently, selects the proper method where there is a choice and then prints out page one and page two of the Federal and state returns. “if Worksheets of the practitioners are reproduced and are attached to Pages 1 and 2 to make up the return package. Unitax supplies its clients with three computer printed forms of the tax return--one original and two carbon copies and a limited pro forma for use in the following year. Turn-around time has been five days. Deadline for accepting returns is April 13th. Chief advantage of Unitax has been its low cost. Basic charge has been $2.8042 per return when practitioner does the calculations, $3.80 if Unitax does the calculations. There is an additional charge of twenty-five cents for each worksheet exceeding three. No deposit is required, nor is there a minimum number of returns to be under contract. An average return ran about $4.30, including computations. Complex returns 42"Computer Tax Return Preparation: How The Several Services Shape Up This Year," Taxation For Accountants, I, No. 6 (January-February, 1967), p. 327. 343 ran from $6 to $8 each. Reruns were charged at the rate of 50% of the original cost. These costs pertained to 1967 Operations. Unitax has three types of service available for each return and three corresponding price schedules. This arrangement was offered in the 1968 and 1969 tax seasons. The practitioner chooses the service desired for each return with no minimum number required. The three types of service extended to tax practitioners by Unitax include (1) Exec- utive Service ($4.30 and up), (2) Standard Service ($3.10 and up), (3) Budget Service ($2.25 flat). The prices quoted here are the 1969 tax season prices which are much the same as the 1968 prices. Executive Service No. l: The assumption made in the executive service is that the practitioner makes no computations except for depreciation, if any. Unitax per— forms all other computations, performs a complete math check of those computations and the depreciation, performs a tax review, makes photocopies. Computer prints out Pages 1 and 2 of the 1040 and California 540 (or Indiana IT 40), and Schedule G if applicable. Unitax assembles print-outs with supporting schedules. Returns are signature—ready when mailed back to the tax practitioner. The Basic Proc- essing Fee (three input worksheets) is $4.30; additional worksheets have a charge of $.40 each; more than five items on Capital Gains Schedule D cost $.10 per item over five. 344 Standard Service No. 2: The assumption made in the standard service is that the practitioner lists information and performs all computations on three input worksheets. Unitax performs complete math check, tax review, makes photocopies. Computer prints out Pages 1 and 2 of the 1040 V and 540 (or IT—40), and Schedule G if applicable. Unitax FE assembles print-outs with supporting schedules. Returns I“ are signature-ready when mailed back to practitioners. The Basic Processing Fee (three input worksheets) is $3.10; I7 additional worksheets have a charge of $.30 each; more than five items on Capital Gains Schedule D have an extra fee of $.05 per item. The error fee is $.40 per return. Additional charges for Services 1 (Executive) and 2 (Standard) are as follows: Schedule G (Income Averaging) has an extra charge, in addition to worksheet charges, of $.50; W-2'S over five total cost $.05 each; extra procedure fee (pennies on worksheets, if desired, instead of rounding off to whole dollars) costs $.30; Schedule not submitted thus requiring Unitax to write it up costs a fee of $.75; SDI Refund (California only)--Unitax prepares claim form and furnishes envelope, $.25; extra copies of returns requested at time of processing, $.50. Budget Service No. 3: The assumption made in the budget service is that the subtotals submitted by tax prac- titioner are accepted on the worksheets. Unitax verifies totals on worksheets. Computer prints out Pages 1 and 2 345 of the Federal and state returns and Schedule G; there is no tax review, no photOOOpieS, no collating or assembling. The Basic Processing Fee is $2.25 flat; Schedule G costs $.90, if photocopies of worksheets are desired they cost $.08 each copy; extra procedure fee such as pennies on worksheets instead of rounded dollars, etc., costs $.30; r? SID Refund (California only)——Unitax prepares claim form in and furnishes envelope, $.25. There is a registration fee which applies to all E" three types of services of $18.00. This fee includes enough forms for 50 tax returns, the $5.00 Reference Guide, special stamp and other supplies. Reruns are charged at the rate of 60% of original fee if all changes are made by the practitioner; if all changes are not made by practi— tioner, full fee. The following steps illustrate how Unitax works: 1. Practitioner interviews client and records all pertinent data in pencil on Special time-saving Unitax worksheets which are available at a nominal cost. These forms are so complete and streamlined that many long form tax returns can be handled on a total of only three work- sheets. 2. Worksheets are mailed to Unitax in the large enve- lopes furnished free for practitioner's convenience. 346 3. At Unitax, skilled tax technicians complete and review worksheets and accompanying schedules for accuracy and completeness according to the service selected. 4. Summary figures are keypunched into our Specially programmed electronic computer. 5. The computer automatically tests for allowable E1 limitations on contributions and makes other tests, cor- II recting practitioner's figures if necessary. 6. The computer selects the proper filing method, I computes the lowest possible tax and prints out pages one and two of both Federal and state returns, and Schedule G if applicable. 7. Worksheets are reproduced on tOp quality Xerox equipment to provide supporting schedules (for services 1 and 2 only). 8. All schedules and printouts are collated in proper order, stapled and rushed back to practitioner ready for signature (for services 1 and 2 only). Systems and Taxes (SAT) Systems and Taxes43 was originated by Robert Philipson and Company, a Certified Public Accounting firm in Washington, D. C. It claimed to have been the first to send computer-prepared tax returns to the Internal Revenue 43Former address was Systems and Taxes, Division of Computers for Industry and Business, 25 West 43rd Street, New York, N. Y. 10036. 347 Service--these being the 1962 tax returns prepared in 1963.44 Philipson sold the service in 1966 to Computers 45 CIB expected for Industry and Business, a New York firm. to process 25,000 returns in 1966 and 100,000 in 1967. Computers for Industry and Business failed to make a profit and went bankrupt so that the service is no longer [E II _ offered.46 i a Computer Tax Service E Computer Tax Service (CTS)47 was founded in 1965 I I by an accountant, a computer systems engineer, and a com- puter programmer. The purpose of this organized venture was to develOp a computerized tax return preparation system. The intent was to market the program along with a small in-office computer as a package for professional accoun- tants, tax Specialists and lawyers at the price of about $26,500. This computerized tax return preparation system was thoroughly tested and in operation in the 1965 tax 44E. K. Yasaki, "Computing and Tax Accounting," Datamation, XII, No. 3 (March, 1966), p. 34. 45"Electronic Ally For The Taxpayer," Business Week (March 26, 1966), p. 168. 46“Computer Tax-Return Preparation: How The Several Services Shape Up This Year," Taxation for Accountants, I, No. 6 (January—February, 1967), p. 322. 47Address is Computer Tax Service, Incorporated, 3535 North Verduga Road, Glendale, California 91208. Mr. A. W. COpland became its first President. 348 season. It was used by hundreds of professionals in many states during the 1966 tax season. Service became nation- wide in the 1967 tax season and advertisements began to appear in the national professional journals like the Journal of Accountancy.48 CTS is offered by local tax professionals in local IBM 360 computer centers where the $1 powerful specifically programmed IBM 360 model 30 is used. The computer language used at CTS for the program is the IBM Autocoder. I CTS concentrated on the elimination of the drawbacks of the older, fully computerized tax return preparation services in the development of its system. The three main drawbacks which formerly made computer tax returns services prohibitive were cost, turn-around time, and complicated 49 CTS charged only $3.00 per client for both input forms. 1967 Federal and most state returns. It Operates on a two day turn-around which is fast service. A simple three-page income tax questionnaire is used for computer input. Low cost, fast service, and simplicity are the three keynotes emphasized by CTS in marketing their system. Accuracy is, of course, assumed with a computer. CTS goes a step 48"The Most Revolutionary Tax Return Ever Offered Is Now Available To You,“ The Journal of Accountancy, CXXIV, No. 3 (September, 1967), p. 11. 49"Computer Processed Income Tax Forms," Data §ystem News (February 26, 1968), p. 7. 349 further by guaranteeing accuracy or they will pay any IRS penalty and interest. Mr. Abner W. Copeland, President of Computer Tax Services, Inc., spoke at the 1967 Second Annual Conference on Computers and Taxes held in Washington, D. C. In that speech he gave a short history of his firm as follows: Computer Tax Service, Inc. was organized in 1965 by a team which encompassed the disciplines of accounting, data processing systems and computer programming. The purpose of the venture was to develOp a data processing system to market as a package with a small in—office ’“ computer for professional accountants. Successful programs were developed for operation on Control Data LPG-21 computer. Five systems were installed. One of the programs developed for the LPG-21 was the preparation of Federal and State income tax returns. The success of this program stimulated a survey of tax practitioners. The survey revealed basic requirements that could be realized only on a larger system. After two years of effort, the system was successfully devel- Oped on an IBM 360 computer. The breakthrough that was accomplished has had extremely enthusiastic response. CTS has introduced a new Bhase to computer-prepared tax returns--SIMPLICITY.5 Points stressed by Mr. Copeland about the CTS con- cerned simple input, easy adaptation to practitioners' existing procedures, rapid processing turn-around, flexi- bility, and economical cost with a simple structure. All tax returns are prepared at CTS with a maximum of only 50Abner W. Copeland, "Remarks on Computerized Tax Returns," 1967 Second Annual Conference on Computers and Taxes Proceedings, Sponsored by Computers-In-Law Institute of the George Washington University in cooperation with The American Bar Association and The Federal Bar Association, Held at Statler—Hilton Hotel, Washington, D. C., June 6-7, 1967, p. 34. 350 three 8-1/2 x 11 input sheets which are completed at the time of the client interview. The first sheet shows data on earned income. The second sheet gives data on deduc- tions. The third sheet gives supplemental data on addi- tional income from Schedules B, C, D, F, partnerships, estate; final schedule totals for adjustments to income from moving or travel expense, sick pay and retirement plan; final totals for adjustments to tax form, investment credit, etc. In 1967's tax season during which 1966 returns were processed, CTS handled Federal returns from every state in the Union and also state income tax returns in eight states as follows: California, Georgia, Indiana, Louisiana, Massachusetts, New York, North Carolina, and South Carolina. The processing of ten more state income tax returns was added to the service in 1968 as follows: District of Columbia, Hawaii, Iowa, Kansas, Maryland, Michigan, Minne- sota, Missouri, Virginia, and Wisconsin. A total of 31 51 City returns of states were included in the 1969 season. New York and Detroit were added to the package of service at CTS. The price structure was changed and expanded. The $4.00 basic charge for CTS includes Federal and state re— turns, applicable city returns (New York or Detroit), 51"CTS Puts The States Together!" The National Public Accountant, XIII, No. 10 (October, 1968), p. ll. 351 Income Averaging Schedule, Retirement Income Credit Sched- ule, Declarations of Estimated Tax for Federal, state and city levels. There is a $20 office registration fee. The charge is $3.50 for Federal return only. CTS has listed the following seventeen local com— puter centers for processing returns during the 1969 tax season. Atlanta, Georgia Minneapolis, Minnesota Boston, Massachusetts Munster, Indiana Detroit, Michigan New Orleans, Louisiana District of Columbia New York, N. Y. Glendale, California Philadelphia, Pennsylvania Honolulu, Hawaii San Francisco, California Houston, Texas Seattle, Washington Kansas City, Missouri St. Louis, Missouri Miami, Florida Returns prepared by CTS are only partially prepared by computers; the accountant or practitioner makes the necessary calculations for the supporting schedules but CTS makes the computation of tax liability.52 In the CTS system supporting schedules to the 1040 Form are obtained from nearly IRS offices and the calculations on them are made by the accountant or tax practitioner and then entered as summary figures on the CTS input forms. In 1967 CTS ran an advertisement in the Los Angeles Times offering its service directly to the public at prices 52Dominic A. Tarantino, "Computerized Tax Returns Still Have Growing Pains But Continue To Improve," Taxation ggr Accountants, II, No. 5 (November—December, 19675, p. 73. 352 slightly higher than those charged practitioners.53 This test Of the public market was found to be unsatisfactory.54 CTS, like all the other firms in the industry, now limits its services to the tax practitioners. A successful program was developed for operation on the Control Data LGP-Zl computer. One thousand tax returns were prepared during the 1965 tax season; about 5,000 re- turns were prepared in the 1966 tax season. Five CTS systems are now installed and operating in accounting offices in Southern California. A large computer program was developed in 1966 in order to supply the major share of the market with a service system. The objectives pro- jected for this undertaking were to establish the base for a national service Operation which would cover the largest share Of the professional market not available to compet- itors who Offered the fully computerized service with their long and detailed multiplicity Of input forms, high cost, and long turn-around times. A detailed one year study of the competitive systems in the industry revealed the fOl- lowing important data: (1) costs averaged $20 per tax client, (2) the fully-computerized systems were tOO complex for the average tax man to use without extensive training 53213., p. 272. 54"Erratum," Taxation for Accountants, II, NO. 6 (January-February, 19687) p. 339. L. 353 on unfamiliar forms, (3) in-Office costs for preparation Of input data to the computer and terminal checkout Of the computer printout averaged $5 per client, (4) computer processing required five to seven days due to extensive keypunching and clerical collating. A simultaneous study Of the professional market by CTS indicated the following points: (1) professional reluctance to incur the cost and time loss in learning a new system was in evidence, (2) little savings Of professional time was experienced in not doing the simple arithmetic associated with most schedules, (3) a need existed to minimize professional time in compu- tation Of schedules which were complicated, such as Income Averaging and Retirement Income Credit, (4) outside services must not require increased in-Office costs and original interview work sheets should be input to computer systems, (5) computer processing time (turn—around) had to be less than two days, (6) total cost of outside service and in- Office cost should be about $5.00, and (7) the real need was evident for a simple system to prepare pages one and two Of the Federal 1040 Form, and any state or city form, and a simple method Of inputing schedule data without the expense of computer-preparation Of schedules. As a result Of researching, developing, testing and establishing a unique technical achievement to meet the above requirements, Computer Tax Service, Incorporated was incorporated in 1966. 354 CTS is privately owned and Operated by the original members of the venture. Objectives were then established for the CTS system for the 1966 tax season as follows: (1) improve the capac- ity Of programs and provide for Operation on both IBM 1401 and 360 computers, (2) add an exclusive feature ("Comparo") which would compare deduction items on a return to national Internal Revenue Service statistical averages, (3) secure IRS approval Of the improved system, (4) market the system to professionals in California via direct mail, (5) estab- lish remote computer service centers and develop specific processing methods for use under national franchising, (6) establish simplified, controlled handling methods for use under national franchising. All Of these 1966 Objectives were achieved by CTS and the feasibility for marketing nationally in 1967 was justified. All other competitive services experienced large financial losses in 1966. Com— puter Tax Service broke even financially. In 1967 eight franchises were established by CTS as follows: California, Florida (including Georgia), Indiana, Louisiana, New Jersey, Massachusetts (including Connecticut and Rhode Island), New York, and South Carolina (including North Carolina). These franchises covered twenty-eight million taxpayers. Direct marketing by CTS was established in the states of Illinois, Ohio, Pennsyl- vania, Texas and Washington. This direct marketing covered 355 sixteen and one—half million taxpayers. All franchises except for New York were established under contract in force for a number Of years. New York State was estab- lished as a one year franchise at the request of the franchisee. Computer Tax Service undertook an unprecedented approach and received excellent cooperation from the eight state tax authorities for which it provided the state income tax return in the 1967 tax season. CTS proposed a complete revision Of the complicated Massachusetts state tax return. This proposal was accepted by the state authorities and became the Official 1967 tax form. In cooperation with the New York State tax authorities, CTS established a new standard for computerized tax returns which consolidated four two-page returns into one single computer page. Marketing in all areas started in October, 1967. Free test cases were Offered prior tO the tax season. Only a California state return was provided as typical Of other state returns. National advertising consisted of full page two-color ads in the Journal Of Accountancy, National Public Accountant, Practical Accountant, Taxation for Accountants, and Journal Of Taxation. The response from national and local advertising was very gratifying. Pilot demonstration sessions for tax practitioners were tried in California late in the year. The favorable reaction proved that this would be a very beneficial technique tO use in subsequent years. 356 The CTS system was built on the basic concept of simplicity. The short tax interview sheet reflects this concept. The fact sheet first developed in 1965 proved to be a useful source to record data at the time Of interview with the client. In 1966 this form was refined and devel- Oped as a document for direct input to the computer service. A simple sheet was developed for submitting supplementary schedule totals for adjustments to income and to tax. The simplicity Of the CTS Interview Sheets (customized to meet each state's requirements) has been received with enthusiasm by tax practitioners. The use of these forms as attached schedules for income and deductions has been given approval by Internal Revenue Service and state taxation authorities. Schedule G for income averaging is included in the CTS package Of service. A survey Of tax specialists showed that the complex calculation Of Schedule G deterred many practitioners from testing the advantage Of income averaging except in the Obvious cases. In order tO bring the advan- tages of tax savings tO all, a computer method was devised that required submitting only the taxable income and long- term gains data from the four previous years. With this data and other current year data already provided, the computation of income averaging is made automatically. If averaging is advantageous, it is applied in the determina- tion Of the tax liability. In 1967, Internal Revenue Serv- ice approved submitting Schedule G with only entry Of the 357 calculations provided to the practitioners by CTS. In 1968, CTS expanded on its system and now provides a complete computer-printed Schedule G--Officially approved by IRS. Schedule B Retirement Income Credit is included in the CTS package. A survey showed that a large proportion Of the retired population used the services Of practition— ers. In order to aid the practitioners, CTS included the calculation Of Retirement Income Credit in 1967. In 1968, CTS expanded on its system and now provides a complete computer-printed Schedule B, Part 5--Officially approved by IRS. In 1968, CTS expanded on its system and now provides a computer-printed Federal 1040 ES (Declaration Of Estimated Taxes) and, where applicable a state declaration. The ac— countant has complete flexibility tO have the declaration prepared based on (1) current year's return data, (2) a specific precalculated amount, or, he may elect tO have CTS fill in name and address Of the taxpayer only, so the amount Of estimate may be determined after he reviews the return. Deductions receive careful scrutiny in the CTS system. A feature which is exclusive to CTS was added in 1966 tO aid taxpayers in determining whether items Of deduction were abnormal and thus subjecting the return tO possible audit. This feature is a CTS copyrighted Trade Mark name called “Comparo.” It is included as part Of the 358 "diagnostic report," sometimes called the "audit report." Other competitive services have audit or diagnostic reports but nothing like "Comparo." Each return processed by CTS is compared on the basis Of income and marital status tO the IRS statistical average of thirteen deduction categor- ies. The taxpayer is notified whether these deductions are less than 20% Of average, 20—49% above, 50-74% above, or 75% or more above the average. This comparison is similar to that made by IRS in their computer system audit check Of all returns. Instead Of a narrative "audit report," which competitors use, CTS features the use Of codes. On the bottom margin Of every tax return processed by Computer Tax Service, one or more Of the "Comparo" codes may appear. By use Of these codes, CTS directs attention tO items which may require review before filing the tax return with the IRS. These "red flags" are very beneficial, as IRS audit criteria are based on abnormalities or excesses above cer- tain research-determined averages for a particular item in its class, group or industry. "Potential IRS audit" is what these "red flags" Of the Comparo codes of the CTS are warning when they appear on the bottom Of a tax return. It is an ingenious service provided exclusively by CTS. Proper substantiation Of any such items identified by these codes should be instigated so that evidence is available if needed. Some examples Of these "Comparo" codes are: 359 75%-or 20% 20%-49% 50%—74% More Below Above Above Above C O M P A R 0 Average Average Average Average Adjustments (Moving, Travel, Sick Pay) . . . A-l A-2 A-3 A-4 Business or Professional Loss . . . . . . . . . B-l B-2 B-3 B-4 Contributions . . . . . . C-1 C-2 C-3 C—4 Total Deductions . . . . D-l D—2 D-3 D-4 Farm Loss . . . . . . . . F-l F-2 F-3 F-4 Medical Expenses . . . . M—1' M—2 M—3 M-4 Interest Paid . . . . . . N-l N-2 N-3 N-4 Other Deductions . . . . 0-1 0-2 0-3 0-4 Partnership Loss . . . . P-l P-2 P-3 P-4 Rent Loss . . . . . . . . R-l R-2 R-3 R-4 Sales Of Assets Loss . . S-l S-2 S-3 S-4 Taxes Paid . . . . . . . T-l T-2 T-3 T—4 _Other numerical reference codes found on the returns as part Of the "diagnostic report" indicate that certain inconsistencies have been detected in the data submitted and that action has been taken to prepare the return on the basis Of an assumption. These reference codes must be reviewed by the practitioner before the return is given to the taxpayer for filing. If the action taken by CTS is correct, the practitioner changes the data sheet to agree with the assumption before assembling the return for filing. If the action taken by CTS is not correct, the practitioner changes the data as required and resubmits the entire set Of data sheets for the return with $3.00 for reprocessing. Some examples of these reference codes with conditions found and the action taken are as follows: Code 360 Condition Filing status is given as SINGLE, HEAD OF HOUSEHOLD or WIDOW (ER). Both self and spouse's names are given. Filing status given is get MARRIED, FILING JOINTLY. Extra exemptions are given for spouse. Filing status given is 22E MARRIED, FILING JOINTLY. Retirement income is given for spouse. Filing status given is £22 MARRIED, FILING JOINTLY. Dividend income is given for spouse. Filing status is Spouse's name is given. Filing status is Spouse's name is Filing status given is WIDOW(ER) WITH DEPENDENT CHILD. Dependent children are not given. Filing status given is MAR- FILING SPLIT RETURNS. RIED, Income averaging data is given. not given. not given. not given. 52292 Return prepared with fil- ing status as given. First name is assumed to be taxpayer. Spouse's name is ignored. Return prepared with fil— ing status as given. Extra exemptions for spouse are ignored. Return prepared with fil- ing status as given. Re- tirement income for spouse is ignored. Return prepared with fil- ing status as given. Dividend income for spouse is ignored. Return prepared as MARE RIED, FILING JOINTLY. Return prepared as SINGLE filing status. Return prepared as HEAD OF HOUSEHOLD filing status. NO dependent exemption is taken. Return prepared with fil- ing status as given. Income averaging cannot be used. Code letters are used for special notations. A feature, exclusive with CTS, directs taxpayer attention by letter code tO any Of twenty-four items which may require review before filing the return. would be (1) data omitted, overs, (3) possible credits not taken, Examples Of these items (2) limits exceeded and carry- (4) aids in preparing 361 next year's return. Some specific citations Of these code letters and what they mean are as follows: Code A Notes A refund Of overpaid Federal tax is due to you. DO not submit any payment when you file this return. Enter on Federal form 1040, page 1, lines 24 or 25 how you wish this refund applied. Your withholding plus your estimated tax is less than 70% Of the total tax calculated. You may be subject to a penalty this year. Federal medical eXpenses were greater than allowable limit. Limit was used. Federal contributions were greater than allowable limit. Limit was used. You may apply excess contri- butions tO future year's returns. Federal Standard Deductions were used tO Obtain minimum tax. Federal Income Averaging was used to Obtain minimum tax. Federal Income Averaging was tried but was not beneficial. Federal Alternative Capital Gains tax was used to Obtain minimum tax. Total Federal tax credits were greater than total tax. Tax credits equal to total tax were used. State contributions were greater than allowable limit. Limit was used. State medical expenses were greater than allowable limit. Limit was used. State Standard Deductions were used tO Obtain minimum tax. ‘ State income averaging was used to Obtain minimum tax. State income averaging was tried but was not beneficial. Tax table used on Federal return. 362 Code Notes Q Business or professional loss exceeded your income. This excess may be carried over to prior or future year's returns. T Wages were given. NO withholding was given. Is this correct? If not, correct withholding information on data sheet. Mail corrected data sheets with $3.00 to COMPUTER TAX SERVICE, INC. and we will prepare a new return. U You may be subject to a possible retirement tax credit. V You filed as Head Of Household. Please complete the qualifying information if required on your State form. W Your Social Security number was omitted. Please refer tO your Social Security card for the correct number. Write in your number before you file this return. X You file as "Married, Filing Jointly," but do not give your wife's name or Social Security number. If the filing status is correct, write in spouse's name and Social Security number before filing this return. CTS guarantees computer-perfect returns. Accurate tax computation based on data submitted is assured by the strict controls which are maintained in the system. Cler— ical checks are confirmed by computer processing. Key- punching is fully verified. Computer programs are thoroughly proven. Mathematical accuracy is guaranteed by CTS. Should IRS penalty or interest be assessed due to mathematical error, CTS will pay them. The following steps are taken by CTS in preparing returns for the professional tax practitioner: 1. Professional tax practitioners are provided input data sheets as masters for reproduction on Xerox, Thermofax or Brunning equipment or equivalent. 363 2. Data sheets are submitted to the local processing center in batches with transmittal sheet and payment. 3. Clerical control verifies submittal, deposits pay— ment and identifies each submittal with control number. 4. Data sheet totals are verified. 5. The processing center (Franchisee) submits the day's batch Of data sheets, under control, to the local CTS Com- puter Center with payment. 6. Data sheets are keypunched and key-verified. 7. Computer audits all input for completeness and accuracy of totals. An audit report is prepared which provides notations Of input inaccuracies or incompleteness and full accounting for the batch. 8. Computer prepares pages 1 and 2 Of Federal return and, where required, prepares state return. Also, where applicable, the computer prepares income averaging schedule, retirement income credit schedule, Federal and State Decla- rations Of Estimated Tax. 9. All computer output is delivered to the processing center. 10. Returns are collated with the data sheets submitted. 11. Returns, in triplicate, original data sheets, and transmittal sheet are sent to client within twelve tO twenty-four hours after receipt. 12. Client reproduces the data sheets, attaches his supplemental schedules and assembles the return package for the taxpayer. 364 CTS made careful plans in regard to Obtaining its share Of the market of computer—prepared tax returns. In 1966, four thousand certified public accounting and public accounting firms in California were contacted by direct mail. Without any additional sales effort, some two hundred tax practitioners used the service. The quantity Of returns varied from a minimum Of six returns tO a maximum Of four hundred returns per registrant. Numerous unsolicited in- quiries from outside California were encouraging. In 1967, some 40,000 brochures were distributed tO tax practitioners in eighteen states by direct mail. In response to CTS national advertising, requests for information were received from tax practitioners in forty-eight states and five foreign countries. Over a thousand practitioners in thirty-eight states registered for the CTS service. Cal- ifornia registrants increased 111%. National registrants increased 592%. California returns processed increased 389%. National returns processed increased 985%. Prac— titioners were Offered processing Of test cases prior tO the tax season without charge. Thirty per cent Of those submitting test cases registered for the service. The registrants who were second-year users or had submitted test cases processed 51% more returns than the first-time users who did not submit test cases. The quantity Of reg- istrants in the eight states most actively marketed consti- tuted from 5% tO 7% Of all licenses tax professionals. 365 As part Of their sales promotion, CTS made available tO practitioners who registered for their service a free subscription to Computers and Taxes.55 CTS is Optimistic about the future. The quantity Of returns submitted to IRS and state tax authorities in- creases each year. The quantity of taxpayers using the services Of tax practitioners increases at even a more rapid rate. In 1967, fifty-two million long forms (1040) were submitted tO IRS; in 1968, fifty-four million. About one third (18,000,000) were prepared by tax practitioners. Within about eight years, it is estimated that practitioners will prepare thirty-two tO thirty-five million returns. It is CTS's Objective to process 20% Of this market, or 7,000,000 returns. CTS has a national franchising plan. Final evalua- tion Of the marketing and processing indicated that a local area management is absolutely required to service the pro- fessional tax practitioners. One Office could adequately handle an area Of approximately two tO three million tax- payers. The franchised areas are growing in number. CTS established eight area franchises in 1967 and contracted with eleven data processing centers to support the fran- chises. Additional data processing centers were added in 55See New York Certified Public Accountant, XXXVIII, NO. 1 (January, 1965), PP. 4-5. Computers and Taxes is a newsletter. 1 N7 ‘ 366 1968 and 1969 to support the additional franchises that were established. The franchise areas are defined by state boundaries and are based on groupings to service major portions Of taxpayers. Data processing center locations are selected for best logistics in each area. In several areas a license agreement may be made between the Franchisee and other parties within guidelines established by CTS. All license plans must be approved by CTS. In general, the Franchisee will service an area Of one or two million tax— payers. Licensees will be established for smaller areas normally with county or city boundaries. Complete national coverage is planned for 1969. The franchise marketing program is required tO be followed by each franchisee. This simple marketing program, effective in 1968, takes the following steps: 1. Employ a full-time salesman or equivalent, with tax background from September through February. 2. Advertise in state and area professional journals. 3. Distribute on a scheduled basis the direct-mail package to all C.P.A.'s, P.A.'s and Tax Specialists in the area. 4. Conduct scheduled local demonstrations Of the CTS system based on marketing plan provided by CTS. Where computer facilities are available locally, the test cases prepared by the attendees at the demonstration will be viewed as they are prepared by the computer. Otherwise, 367 test cases will be run weekly and mailed to attendees. Actual experience shows that 30 tO 50% Of those submitting test cases register. Registrants who have submitted test cases submit twice as many returns during the season as those registrants who did not have a test case. 5. Provide free test Of any prior return for each respondent Of advertising. The Objective Of CTS's professional marketing pro— gram per two-million taxpayer franchise area is 20% Of the available market. This Objective means (1) the registration Of a minimum of 500 professionals at a fee Of $20 each, (2) preparation Of 100,000 tax returns, (3) gross sales Of $400,000, and (4) net profit of from $80,000 to $100,000. Programmed Tax Systems, Incorporated (PTS) Programmed Tax Systems (PTS)56 is a computerized tax return preparation service organized by Edward C. Horowitz, C.P.A., in 1968. It is independently owned. PTS is in the business Of computer-processing tax returns on the IBM 360-30 for professionals only. It is staffed by accountants for accountants. This newly formed service caters to accountants with clients in the $20,000 to $30,000 income bracket.57 56Address is 150-09 Hillside Avenue, Jamaica, N. Y. 11432. 57Leroy Pope, "Computers Take Over Tax Chore," The State Journal (Lansing, Michigan), Wednesday, July 24, 1968, p0 F-B' com 60 368 Horowitz franchises his computerized tax service to practitioners who are accustomed to getting $25 tO $50 for hand-preparing each return. These practitioners fill out forms and Horowitz charges them a flat $5 each to run them through the computer. Franchises available have an invest- ment requirement of $2,000 tO $3,500. The services received for the $5 fee includes a Federal, a state, and a city tax 58 return. Prices actually range between $3.50 and $5.00 per client, depending upon the total number of returns processed through PTS during the tax season. The price is total; that is, it is a package price which includes the tax returns at all three levels--Federal, state, and city—- for a particular client. If a practitioner submits less than 100 returns, the charge amounts to $5.00 per return. When returns submitted range between 100 and 300, the price is reduced tO $4.50 each; from 301 to 500, the price is reduced to $4.00. Practitioners who submit over 500 returns get the bottom price Of $3.50. These base charges include pages one and two Of the Federal Form 1040 and the state and city returns. Additional charges include $.50 for preparation Of the retirement income schedule, $.50 for estimated returns, a $.25 charge for making the income average computations, and $.50 for preparing Schedule G.59 ¥ 58Journal Of Accountancy, CXXVI, NO. 2 (August, 1968), p. 96. 59"Should You Use a Computer Service to Prepare Tax Returns? If SO, What Kind?", Taxation for Accountants, III, NO. 5 (November—December, 1968), pp. 275476. 369 The minimum number Of returns required in order tO Obtain a contract with PTS is 30 returns. The PTS is a completely tested tax program that works according to the following steps: 1. PTS provides subscribing accountants with a special two-page sheet on which to record the client's tax information. While interviewing his client, the professional accountant fills in the pertinent information on the data sheet. This form is so complete and streamlined that most tax returns can be completed in fifteen tO twenty minutes. The data sheet is then mailed to PTS in a pre—addressed envelope furnished at nO additional cost. At PTS the skilled tax specialists audit and review the data sheet for accuracy and completeness. The audited figures are keypunched, verified, and fed into the specially programmed IBM 360-computer. The computer automatically selects the proper filing method, computes the lowest possible tax, and prints out three COpieS Of each client's Federal, state, and city returns. The completed returns are rushed back to the sub- scribing accountant, ready for the signature Of his client and filing, within 48 hours of receipt Of the data sheets at PTS. 370 Taxes are calculated at PTS by every allowable computation (alternative capital gains tax, income averag- ing, returement income credit, etc.), and the lowest pos- sible Federal, state, and city filing methods are selected. The computer automatically tests for allowable limitations on contributions and medical expenses and corrects any figures given if they are over the limitations. PTS guarantees accuracy or it will pay the penalty and interest. Strict confidential processing Of all infor- mation is assured. PTS Operates on a 48 hour turn-around, regardless Of price. Within two days, PTS will process and return three COpies Of each client's tax returns, computer- perfect and ready for signature and filing. SO, when the client leaves the Office Of the professional accountant after providing information for the data sheets, the ac- countant's work is done. The 1969 tax season was PTS's first large scale effort at providing computerized tax return preparation service. Coverage Of the service, therefore, was limited tO New York and the neighboring states of Connecticut, New Jersey, and Pennsylvania. PTS expects to expand across the nation for the 1970 tax season after it has arranged public financing for franchises. Digitax Digitax, Division Of COAP Systems, Incorporated, 14 Plaza Road, Greenvale, L. I., N. Y. 11548, is the 371 newest firm to appear for business in the computer-prepared income tax return industry which is relatively young and has less than a dozen concerns in the field. It has been advertising its service during the 1968 and 1969 tax seasons in the New York Times, The New York Certified Public Ac- countant, CPA, and Journal Of Accountancy, inviting tax I? 1'":- . .- practitioners to send for additional information, input forms, and a free test Of any 1967 tax return. Digitax's Operation classifies it as a partially 1'“ computerized firm in the industry, like Unitax, CTS, and W PTS. Digitax was designed to Offer the tax practitioner significant advantages over the more expensive fully- computerized tax services like Computax, Autotax, and Fast- Tax. Digitax charges the low, single price of $7.50 per client which includes computer printed schedules and free pro formas. From a set Of only four simple input forms, Digitax prints and collates three copies Of the Federal, New York State, and New York City Official income tax forms together with schedules Of dependency exemption, wages, dividends, interest, miscellaneous income, medical expenses, contributions, interest expense, miscellaneous deductions, and income averaging. A unique feature Of Digitax is the use Of only four single input sheets, all Of which have the identical format of four working columns. These four input sheets can serve as original work papers. They are also eXpandable; that is, should there be insufficient space on 372 any designed sheet, such overflow data can be entered on a similarly designed blank sheet. Digitax guarantees a maximum Of 48 hours in-house processing time during the tax season. Digitax required users to sign a service agreement for the processing Of 1968 income tax returns from January Efi? l, 1969 through May 15, 1969. An estimate Of the number Of tax returns was required at billing price Of $7.50 for each return processed which included the package Of Federal, : state, and local New York City levels. Digitax charged a ’ minimum fee Of $150 which covered the processing Of the first 20 tax returns. Supplies were issued at no addi- tional cost. Regarding liability, the Digitax contract states the following: Digitax shall incur nO liability to client, or to any person, firm, or corporation for whom or which client may be acting, for any error or for any performance failure Of any kind; however, Digitax will process any return containing an error due to Digitax processing without charge to client, and Digitax in its sole dis- cretion may reimburse client for his losses, to a maximum Of $100. Digitax is headed by Gary D. Ritter,:its developer and director. Ritter is a young man, just past thirty years of age, who began as a tax accountant after earning his Bachelor Of Science degree in accountancy at Queens College. Ritter worked at several accounting firms where he labored through mountains Of paperwork during each tax season. His mind was quickly challenged by the excessive 373 input forms and seven tO nine processings that were required by the completely computerized firms. The big challenge to him was to design a new system, a simpler one. He exper- imented, reworked and refined his experiments until the present Datatax system emerged, requiring only four input sheets and 48 hours for processing. Ritter took his system to Carl Paffendorf, president Of COAP Systems, a publicly- held organization Of business systems. Digitax became a Division Of COAP Systems, Incorporated. APPENDIX B GLOSSARY ASSEMBLER LANGUAGE: Refers to assembler or assembly program or assembly routine. A computer program which translates computer instructions written in symbolic coding into machine language instructions. The assembler translates symbolic Operation codes into absolute codes and assigns absolute addresses to the symbolic addresses. One sym- bolic instruction usually results in one absolute instruction. BATCH PROCESSING: A systems approach to processing where a number Of similar input items are grouped for processing during the same machine run. Sometimes called sequential processing. BMF: Business Master File at the National Computer Center. BUG: Any mechanical electrical, or electronic defect that interferes with computer Operation including a defect in programming. Correcting this defect is usually called debugging. CENTIPHONE: Telephone tax assistance from IRS central points in large cities. CHAMBLEE: A suburb Of Atlanta, Georgia which became the original processing center Of the IRS's new computer system. Commonly known as the pilot center. CLIC: Counsel Legal Information Centers. COBOL: An acronym for COmmon Business Oriented Language-— instruction language oriented toward commercial data- processing problems. COLLATE: TO take two or more sets Of related information already in the same sequence and merge them in sequence into a single group. 374 m 375 COMPARO: Trade Mark name for part Of diagnostic report codes which indicate percentages above and below normal averages for certain tax deductions. Used by Computer Tax Service. COMMON LANGUAGE: A language in machine-sensible form which is common to a group Of computers and associated equip- ment. COMPILER: A computer program tO compile a source language _ into an Object language. The compiler translates the FT; source statements, provides linkage tO subroutines, ‘] selects the required subroutines from a library Of rou- tines, and assembles these parts into an Object program. CSC: Computer Science Corporation. CTS: Computer Tax Service. v DIF: Discriminant function method Of selecting returns by computer for audit. DIRECT ACCESS: (see random access) DISK STORAGE DRIVE: Refers to disk storage which is a storage device that uses magnetic recording on flat rotating disks. DOSSIER: Bundle Of papers containing a detailed report or detailed information. FORTRAN: An acronym for FORmula TRANslation, a programming language designed for writing prOgrams to solve problems which can be stated in terms Of arithmetic procedures. This is the most pOpular Of the algebraic procedure- oriented languages. There are several versions of FORTRAN. GIGO: Garbage in, garbage out. HYPERTAPE: Magnetic tape that is wider than the regular kind. Widest possible kind and yet go through the com— puter is called Super-hypertape. INFORMATION UTILITIES: Companies that provide public with computerized information much in the same fashion as a power utility supplies electrical power to consumers. IMF: Individual Master File at the National Computer Center. 376 INTERPRETERS: Refers to interpretive routine which is a routine that decodes instructions written as pseudocodes and immediately executes those instructions, as contrasted with a compiler which decodes the pseudocodes and produces a machine-language routine tO be executed at a later time. JULIAN DATE OF THE YEAR: Julian Calendar: calendar intro- duced in Rome in 46 B.C. establishing the lZ-month year of 365 days with each fourth year having 366 days and the months each having 31 or 30 days except for February which has 28 or in leap year 29 days--Compare Gregorian Calendar. MACHINE LANGUAGE: The set Of symbols, characters, or signs, and the rules for combining them, which conveys to the computer instructions or information to be processed. MEMORY: Any device into which units Of information can be COpied, which holds this information and from which it can be Obtained at a later time (interchangeable with storage). MILLISECOND: One thousandth Of a second. NCC: National Computer Center at Martinsburg, West Virginia. OFF-LINE: Not connected with the main processor Of the central computer. Detroit Data Center is known as an Off-line center; it is not connected with the main processor at the NCC. ON-LINE: Pertains to Operating devices under the direct control of the central processing unit. PERIPHERAL EQUIPMENT: Units or devices that are part Of an entire data processing system, but not actually part Of a computer; i.e., a Flexowriter functioning Off-line, card sorter, reproducer, a forms burster, forms encoder, etc. PPBS: Planning-Programming-Budgeting System Of the Federal government. PRINTER: An output device for printing out computer results as numbers, words, or symbols. They can be anything from electric typewriters tO high speed printers Operating at thousands Of lines a minute. PRO FORMAS: Input forms Of computer-prepared tax returns firms on which the information from last year's season is printed, ready for next year as the information is repetitive. 377 PL 1: Programming Language 1. PSEUDO-CODE; An arbitrary code, which must be translated into computer code. PTS: Programmed Tax System. RANDOM ACCESS STORAGE: A storage device wherein access tO the next position from which information is to be Obtained is in no way dependent on the position from.which infor- mation was previously secured. Also called Direct Access Storage. REAL-TIME: A method Of processing data so fast that there is virtually no passage Of time between inquiry and result. RIRA: Reports and Information Retrieval Activity. SAT: Systems and Taxes, Inc. TCMP: Taxpayer Compliance Measurement Program Of the IRS. TIME SHARING: The use of a device for two or more purposes during the same overall time interval. TIR: Treasury Information Release. TRANSCRIPTION: Keypunching data from paper into cards. UIL: Uniform Issue List which is part Of the Reports and Information Retrieval Activity Of the Chief Counsel's Office Of the IRS. BIBLIOGRAPHY OF LITERATURE CONSULTED BIBLIOGRAPHY OF LITERATURE CONSULTED Books, Monographs, and Proceedings Armstrong, Lancelot W. "The DevelOpment and Operation Of the Internal Revenue Service Network," The Computer: Tool FOr Management. Elmhurst, Illinois: The Business Press,il968. Awad, Elias M. Business Data Processing. 2nd ed. Pren- tice-Hall, Inc., 1968. Berkeley, Edmund C. The Computer Revolution. Garden City, New York: Doubleday &_CO.,‘1962. Bigelow, Robert P. “Remarks on Computer Assisted Tax Return Preparation," 1967 Proceedipgs Of the Second Appual Conference on Computers and Taxes. Computer- In-Law Institute, The George Wa§hington University, 1967. Burck, Gilbert and Editors Of Fortune. The Computer Age. New York: Harper and Row, Publishers, 1965. Cohen, Sheldon S. 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