Appendix I

Processing Tax Payments Through

Lockboxes

IRS envisions that by the year 2001, 90 percent of tax payment processing will be done by lockboxes. Under this concept, which is already being used for some types of tax payments, taxpayers are to mail payments to a lockbox, which is a postal rental box serviced by a commercial bank. The bank processes the payments and transfers the funds to a federal government account. The payment and payer information is then recorded on a computer tape and forwarded to IRS where the tape is to be used to update taxpayers' accounts on IRS' master file.

IRS conducted two lockbox tests during the 1995 filing season to assess
taxpayers' willingness to use different procedures for mailing tax
payments associated with their returns. For each test, IRS sent special
Form 1040 packages to specific taxpayers. These packages included
(1) mailing instructions that were different for each of the two tests and
(2) a payment voucher that could be scanned by optical character
recognition equipment.

One test package contained one return envelope with two different
tear-off address labels-one label addressed to the lockbox was to be used
for a return with a tax balance due, while the other label addressed to the
service center was to be used for a return with a zero balance or with a
refund due to the taxpayer. Taxpayers with balance-due returns were
instructed to include the return, payment, and voucher in one envelope
and to affix the label addressed to the lockbox. The bank that serviced the
lockbox separated the return from the payment, deposited the payment,
recorded the payment information on a computer tape, and forwarded the
return and the computer tape to IRS for processing.

The other test package used two envelopes-one addressed to the service
center, the other addressed to the lockbox. All taxpayers were instructed
to send their returns in the envelope addressed to the service center.
Taxpayers who owed a balance were to use the second envelope to send
their
payments and vouchers to the lockbox. The bank processed the
payment and voucher as described above.

As of mid-June 1995, IRS had not yet received the management information needed to evaluate the two lockbox tests. However, IRS had already made decisions to (1) continue testing the two-label method in certain tax packages for the 1996 filing season, (2) include a voucher inside every 1996 Form 1040 tax package (except 1040A and 1040EZ), 12 (3) instruct

12 According to an IRS official, forms 1040A and 1040EZ are being excluded because historical data indicate that only 14 percent and 1 percent respectively of taxpayers who file those forms will have a remittance.

Appendix I

Processing Tax Payments Through
Lockboxes

practitioners to send all returns with remittances, no matter what 1040 tax form they are associated with, to the lockbox, and (4) implement the two-envelope method in all 1040 packages (with the possible exception of Forms 1040A and 1040EZ) starting with the 1997 filing season. According to an IRS official, the purposes of including a standard voucher in tax packages not included in the lockbox test are (1) to familiarize taxpayers with the use of a voucher and (2) to lighten the workload being processed through the old remittance processing system (RPS) at service centers. IRS plans to use a newer system, RPSII, to scan the scannable vouchers sent to the service centers from the test tax packages.

According to an IRS official, the two-envelope method will not be used for the 1996 filing season because IRS cannot easily determine if the return inside the envelope is one that involves a refund. That determination is important because IRS gives priority to refund returns to help ensure that the return gets processed and the refund gets issued before the government has to pay interest on the refund. In the past, a service center knew a return did not involve a refund if it opened the envelope and found a check inside. Under the two-envelope system, the service center only receives the tax return and thus has no quick way to isolate those returns involving payments from those involving refunds. For the 1997 filing season, IRS is considering redesigning the tax forms to help service centers more easily identify the type of return received.

According to information obtained from IRS, the use of lockboxes to process remittances associated with Forms 1040 in 1995 resulted in an interest cost avoidance of about $44.3 million by getting money deposited faster through the lockbox. This means that the Treasury did not have to borrow this money to pay towards certain government obligations. At the same time, according to IRS, it cost about $3.4 million to process those remittances through the lockboxes, leaving a net savings of about $40.9 million. IRS expects that the amount of interest cost avoidance will decrease each year as the lockboxes take on higher volumes of remittances thereby slowing the banks' productivity. As the program is expanded to all types of tax packages, volumes at the lockbox will increase while average dollar amount remitted will decrease. Bank costs associated with the larger volumes are also expected to increase.

Treasury Financial Manual Bulletin No. 94-07, dated March 1, 1994, provides that if the interest cost avoidance of a lockbox's accelerated deposits is less than the cost charged by the lockbox, the agency (in this case, IRS) is required to pay all lockbox bank charges, other than those

Appendix I

Processing Tax Payments Through
Lockboxes

needed to maintain a regular bank account. Otherwise Treasury's Financial Management Service (FMS) pays the charges. Because the amount of interest cost avoidance resulting from IRS' lockbox program has exceeded the related bank charges, FMS has paid those charges. According to an IRS National Office official responsible for the lockbox program, neither IRS nor FMS expects the amount of interest cost avoidance in the future to fall below the amount of bank charges.