Lending a helping hand: two governments can work together.

Since 2000, states have been participating in the federal Tax Refund Offset Program where a certified delinquent state income tax debt is offset against a federal tax refund. This produces about $200 million per year for the states. The program is limited, however, to resident taxpayers. States are seeking federal legislation to expand the program to nonresident taxpayers. Likewise, the IRS participates in state offset programs through the State Income Tax Levy Program (SITLP) in something over half of the states, and this produces upwards of $100 million per year for the IRS. The IRS may levy income tax refunds by matching federal delinquent accounts against a database of states participating in the SITLP. (15) State participation is just now beginning to pick up after the program was suspended to bring it into compliance with the revised delinquency procedures of the IRS Restructuring Act of 1998. In addition, three states are now piloting a program with the federal government in which the federal tax debt files are matched to all vendor payments made by states in order to recover tax delinquencies. Presuming success, this sort of program could pay some substantial benefits to closing the federal tax gap. If successful, the federal government should consider offsetting other types of federal payments for state tax debts.

Cooperative Taxpayer Assistance

Beyond the audit and enforcement efforts, state and federal tax authorities have undertaken a wide range of cooperative taxpayer service and education activities. Of particular note are cooperative or joint programs for providing training and education to tax practitioners and preparers as well as providing cooperative registration and filing assistance to new businesses. It is also not uncommon for state and federal authorities to offer onsite taxpayer assistance at a single site.

The most ambitious effort has been in the area of cooperative or coordinated electronic filing. Each of the 42 states (including D.C.) with an individual income tax has a program for electronic filing of the returns. All but four of these states participate in the FedState E-file program in which the taxpayer (using a participating tax preparer or approved third-party software) may file his/her federal and state tax return in a single electronic transmission. (16) The return is transmitted to the IRS, which performs limited validity checks and then makes the state return information available for download by the states. (17) This close program coordination facilitates the use of common formats, data definitions, etc., all of which eases any burden of electronic filing on taxpayers and tax preparers and promotes participation in electronic filing. Electronic filing is generally seen as improving tax compliance by eliminating mathematical and data-entry errors and improving overall service to taxpayers. In 2006, about 54 percent of all state income tax returns were filed electronically, the vast majority through the cooperative FedState program. (18)

Cooperative electronic filing efforts are also being extended to areas beyond the individual income tax. As the IRS has moved into electronic filing of corporation income and other types of returns, states have worked closely with the Service to fashion counterpart state-level programs. In 2007, about one-half of the states will implement electronic filing programs for the corporate income tax. Nearly all of them will be "FedState programs" that will operate like the individual tax program with the returns being filed using common formats, definitions, protocols, etc. with the IRS and then being made available to the states. Likewise, a number of states will be developing similar programs for the electronic filing of partnership returns over the next few years.

The IRS and states have entered into some other, more minor, cooperative programs to take advantage of online convenience. As of this writing, two states (Georgia and New York) will take online applications for business registrations and transmit that information to the IRS. The IRS will use that information to immediately issue an employee identification number (EIN), and will follow up with the traditional letter confirming the federal EIN in about two weeks. The hope is that this one-stop paperless application will be convenient to both taxpayers and tax administrators.

According to the IRS, several other programs are in development or in the initial operational stages. Under the Fed/State Offshore Payment Card Matching Initiative, the IRS is expanding the use of state databases to identify and locate taxpayers who have participated in offshore credit-card abuse. The Title 31 Money Servicing Businesses Memorandum of Understanding (MOU) is a federal-state information exchange program targeted at increasing compliance by money services. The initiative includes personnel from the IRS, the Financial Crimes Enforcement Network (FinCEN), and state regulatory agencies.

Collaborative Training Efforts

A final area of collaboration between state and federal tax authorities is in training personnel. This cooperation takes three forms: First, state tax agency personnel are able to take part in all IRS-sponsored training sessions if space is available. This includes access to a wide range of courses from short-term, specialized courses to more basic courses, which might be several weeks in length (e.g., basic criminal investigation). This enables states to leverage the resources of the IRS to meet certain training needs for which it would be impractical to develop their own offerings.

Second, state and federal tax authorities have on occasion jointly developed specialized training programs. Most recently, they cooperated in developing basic and advanced courses in motor fuel audit and investigation; over 1,200 state and federal agents attended the course over the last three years.

Finally, IRS personnel regularly participate, both as instructors and students, in training sessions conducted by state agencies or their representatives. For example, the Federation of Tax Administrators (FTA) (19) regularly sponsors training workshops and conferences on current topics and techniques in tax administration for state agency personnel. IRS personnel regularly participate in such events.

Procedures for Cooperation

The process by which these cooperative tax administration activities are initiated, developed, and implemented is diverse and somewhat dependent on the nature of the initiative. Outside the information and data exchange area, the cooperative efforts are generated largely by individual state tax authorities and their counterpart IRS district office. Representatives from the IRS and state tax agency regularly meet to examine ways to cooperate, and it is out of such liaisons that many individual initiatives grow. Once developed and tested, they are likely to be replicated in other states. But the implementation of many efforts may not occur in all areas of the country.

There is a similar coordinative mechanism at the national level for efforts affecting all states. The leadership of the FTA, as representatives of state tax authorities, holds regular liaison sessions with the executive leadership of the IRS to discuss and coordinate cooperative activities. The IRS maintains a small National Office staff (about 15 persons) dedicated to assisting states in working with the IRS and in providing information on the types of cooperative activities being conducted across the country. Numerous IRS staff throughout the country and in various functions devote at least part-time to working with states. Leadership and staff of the IRS and FTA play a lead role in designing and implementing efforts that are nation-wide in implementation, e.g., the joint electronic filing program and the information exchange program. They are also active in facilitating the adoption of initiatives generated at the state-district level to other regions of the country.

PROMISING CURRENT INITIATIVES

The discussion above highlights a number of good examples of the federal and state governments working together, particularly in the areas of information sharing and taxpayer assistance. Many of theses initiatives simplify and improve compliance with routine requirements and are mutually beneficial to both the federal and state taxing authorities. Although those programs are very helpful to the governments administering taxes, there has been little reduction in overall taxpayer compliance costs and no true economies of scale. For example, the cost-savings benefits from coordinated electronic filing should be substantial as paperless returns become the norm, but the overall taxpayer burden of dealing with multiple taxing jurisdictions is relatively unaffected by such measures. The programs discussed below could potentially have a real beneficial impact on the overall complexity of the U.S. tax system.

The Streamlined Sales Tax Project