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entitled 'Using Data from the Internal Revenue Service's National 
Research Program to Identify Potential Opportunities to Reduce the Tax 
Gap' which was released on April 19, 2007. 

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March 15, 2007: 

The Honorable Max Baucus: 
Chairman: 
Committee on Finance: 
United States Senate: 

The Honorable Charles E. Grassley: 
Ranking Minority Member: 
Committee on Finance: 
United States Senate: 

Subject: Using Data from the Internal Revenue Service's National 
Research Program to Identify Potential Opportunities to Reduce the Tax 
Gap: 

The Internal Revenue Service (IRS) most recently estimated that the 
gross tax gap--the difference between what taxpayers pay in taxes 
voluntarily and on time and what they should pay under the law--reached 
$345 billion for tax year 2001.[Footnote 1] The tax gap arises when 
taxpayers fail to comply with their individual income, corporate 
income, employment, estate, or excise tax obligations through (1) 
underreporting of tax liabilities on tax returns; (2) underpayment of 
taxes due from filed returns; or (3) nonfiling, which refers to the 
failure to file a required tax return altogether or on time. 

IRS's tax gap estimates are based on a variety of data sources. 
Recently, IRS studied individual taxpayer compliance through the 
National Research Program (NRP), and used the resulting compliance data 
to estimate the tax gap for individual income tax underreporting and 
the portion of employment tax underreporting attributed to self- 
employment taxes for tax year 2001.[Footnote 2] NRP, which involved 
reviewing around 46,000 individual tax returns, has yielded very 
important new information on taxpayer compliance for the first time 
since IRS's previous compliance measurement study was undertaken for 
tax year 1988.[Footnote 3] Compliance measurement studies such as NRP 
have the potential to identify ways to improve taxpayer compliance, 
which could in turn reduce the tax gap and improve the nation's fiscal 
stability. For example, each 1 percent reduction in the net tax gap 
would likely yield around $3 billion annually. 

Given its potential to improve individual taxpayer compliance, you 
asked us to review the results of the 2001 NRP study. In response, we 
agreed to identify (1) specific areas of individual taxpayer 
noncompliance that are promising targets for additional research to 
improve reporting compliance, and (2) opportunities, if any, found 
through the course of our work to improve future NRP studies. 

To identify specific areas of individual taxpayer noncompliance that 
are promising targets for additional research to improve reporting 
compliance, we examined IRS's tax gap estimates for tax year 2001 and 
the underlying data from NRP upon which IRS based its estimates. We 
determined that IRS's tax gap and compliance estimates were 
sufficiently reliable for the purposes of this engagement based on our 
previous reviews of the tax gap and NRP data. For a fuller description 
of how we selected promising targets, see enclosure 1. To identify 
opportunities, if any, found through the course of our work to improve 
future NRP studies, we identified weaknesses in NRP that we found 
during this and other GAO reviews that used NRP data and, based on 
discussions with IRS research and compliance officials, identified 
opportunities to address any such weaknesses. We conducted our work 
from September 2006 through February 2007 in accordance with generally 
accepted government auditing standards. 

On February 28, 2007, we briefed your staff on the results of our work. 
This report formally conveys the information provided during that 
briefing (which appears in enclosure 1). 

Results: 

Areas of individual taxpayer noncompliance that are promising targets 
for additional research to improve reporting compliance include: 

≤ income/losses from partnerships and S corporations, 

≤ income/losses from rental real estate, 

≤ sole proprietor income/losses, 

≤ income/losses from farming, 

≤ other income--net operating losses, 

≤ gambling income/losses, 

≤ capital gains for assets other than securities, 

≤ other gains/losses, 

≤ Earned Income Tax Credit, 

≤ Additional Child Tax Credit, 

≤ deduction for charitable contributions, 

≤ deduction for medical and dental expenses, 

≤ deduction for job expenses and most other deductions, and: 

≤ exemptions. 

Our process for selecting these areas and further information on these 
areas appears in enclosure 1. 

IRS could benefit from electronically capturing complete NRP 
examination case files. Although IRS creates an electronic record for 
each tax return reviewed for NRP, these records do not contain all of 
the information contained in the corresponding hard copy examination 
case files. For example, information taxpayers provide to IRS during 
examinations is only included in the paper case file and not in the 
electronic records. Furthermore, some paper case files are not 
obtainable. For a prior review on the capital gains tax gap for 
securities,[Footnote 4] IRS was not able to provide 11 percent of NRP 
examination case files we requested because complete files could not be 
located or were being used by IRS units. Having complete electronic NRP 
examination case files would make it easier for IRS to get the full 
value from NRP studies because the files could be assessed more easily 
than hard copy files. Additionally, complete electronic case files 
would lower the risk of lost files and would allow files to be accessed 
simultaneously by multiple users. According to IRS research and 
examination officials, the cost and timing of electronically capturing 
complete examination case files would vary by how they are made 
electronic. 

Conclusion: 

NRP is an important research program that could help IRS identify ways 
to reduce taxpayer noncompliance and the tax gap. An evaluation of NRP 
data revealed a variety of areas of noncompliance where further 
research could provide information on how to address noncompliance. 
However, IRS cannot maximize the value of information it collects 
through NRP if it cannot locate or efficiently access examination case 
files. 

Recommendation for Executive Action: 

To ensure that IRS maximizes its return on investment from future NRP 
studies, IRS should develop a plan for capturing complete NRP 
examination case files that: 

(1) determines the most cost effective means for capturing information 
electronically and (2) lays out a schedule for when it will begin to 
capture information electronically. 

Agency Comments and Our Evaluation: 

In commenting on a draft of this report, the Commissioner of Internal 
Revenue concurred with our recommendation (see enclosure II for the 
full text of IRS's comments). IRS also provided separate comments on 
several technical issues, which we incorporated into this report where 
appropriate. 

As agreed with your offices, unless you publicly announce its contents 
earlier, we plan no further distribution of this report until 30 days 
from its issue date. At that time, we will send copies to the Chairman 
and Ranking Minority Member, House Committee on Ways and Means; the 
Secretary of the Treasury; the Commissioner of Internal Revenue; and 
other interested parties. We will also make copies available to others 
upon request. In addition, this letter will be available at no charge 
on the GAO Web site at http://www.gao.gov. 

If you or your staff have any questions, please contact me on (202) 512-
9110 or whitej@gao.gov. Contact points for our offices of Congressional 
Relations and Public Affairs may be found on the last page of this 
letter. Individuals making key contributions to this report are listed 
in enclosure III. 

Signed by: 

James R. White: 
Director, Tax Issues: 
Strategic Issues Team: 

Enclosures: 

[End of section] 

Enclosure I: Congressional Briefing on NRP Data: 

Using Data from The Internal Revenue Service's National Research 
Program to Identify Potential Opportunities to Reduce the Tax Gap: 

Briefing for the Senate Committee on Finance: 
February 28, 2007: 

Engagement Objectives: 

Analyze data from the Internal Revenue Service's (IRS) National 
Research Program (NRP) Tax Year 2001 study of individual taxpayer 
compliance to identify: 

* specific areas of individual taxpayer noncompliance that are 
promising targets for additional research to improve reporting 
compliance: 

* opportunities, if any, found through the course of our work to 
improve future NRP studies: 

Background: Taxpayer Noncompliance and the Tax Gap: 

The tax gap is the difference between tax amounts that should have been 
paid voluntarily and on time and what was actually paid for a 
particular year, and is the result of three types of taxpayer 
noncompliance: 

* Underreporting-when taxpayers misreport tax liabilities on tax 
returns filed on time: 

* Underpayment-when taxpayers fail to pay on time the taxes due from 
tax returns filed on time: 

* Nonfiling-when taxpayers fail to file a return altogether or on time: 

Background: IRS's Most Recent Tax Gap Estimate Is Based on NRP: 

IRS reviewed tax returns from tax year 2001 for about 46,000 individual 
taxpayers, most of whom were subject to a face-to face examination: 

NRP has yielded very important and new information on taxpayer 
compliance for the first time since IRS's previous compliance 
measurement study was undertaken for tax year 1988: 

* NRP data allowed IRS to update its tax gap estimates for 
underreporting of individual income taxes and the portion of employment 
taxes from self employment: 

* IRS will use NRP data to improve examination selection beginning with 
tax returns filed in 2006: 

Background: IRS's Tax Gap Estimate for Tax Year 2001: 

[See PDF for image] 

Source: IRS. 

[End of figure] 

IRS estimates its enforcement activities, coupled with other late 
payments, will recover about $55 billion of the tax gap, leaving a net 
tax gap of $290 billion for tax year 2001: 

Background: Tax Gap Details: 

IRS estimates the tax gap for some specific line items from the 
individual tax return and in aggregate for other broad categories, such 
as tax credits and deductions: 

For each line item or broad category, IRS estimates include: 

* the amount of the tax gap in dollars: 

* net misreporting percentage (NMP), which is the net amount 
misreported on a given line item or category expressed as a percentage 
of the sum of the absolute values of the amounts that should have been 
reported for that item or category: 

Background: Components of the 2001 Tax Gap for Individual Income Tax 
Underreporting: 

Type of income or offset: Business income; 
Tax gap amount (dollars in billions): $109; 
Net misreporting percentage: 43. 

Type of income or offset: Nonbusiness income; 
Tax gap amount (dollars in billions): $56; 
Net misreporting percentage: 4. 

Type of income or offset: Credits; 
Tax gap amount (dollars in billions): $17; 
Net misreporting percentage: 26. 

Type of income or offset: Deductions; 
Tax gap amount (dollars in billions): $14; 
Net misreporting percentage: 5. 

Type of income or offset: Exemptions; 
Tax gap amount (dollars in billions): $4; 
Net misreporting percentage: 5. 

Type of income or offset: Adjustments; 
Tax gap amount (dollars in billions): $-3; 
Net misreporting percentage: -21. 

Total; 
Tax gap amount (dollars in billions): $197; 
Net misreporting percentage: 18. 

Source: IRS. 

[End of table] 

Background: 2001 Individual Income Tax Gap - Business Income: 

Type of income: Farm income; 
Tax gap amount (dollars in billions): $6; 
Net misreporting percentage: 72. 

Type of income: Sole proprietor (nonfarm); 
Tax gap amount (dollars in billions): $68; 
Net misreporting percentage: 57. 

Type of income: Rental real estate, royalties; 
Tax gap amount (dollars in billions): $13; 
Net misreporting percentage: 51. 

Type of income: Partnerships, S corporations, estates, and trusts; 
Tax gap amount (dollars in billions): $22; 
Net misreporting percentage: 18. 

Total business income; 
Tax gap amount (dollars in billions): $109; 
Net misreporting percentage: 43. 

Source: IRS. 

[End of table] 

Background: 2001 Individual Income Tax Gap - Nonbusiness Income: 

Type of income: Other income; 
Tax gap amount (dollars in billions): $23; 
Net misreporting percentage: 64. 

Type of income: Other gains/losses; 
Tax gap amount (dollars in billions): $3; 
Net misreporting percentage: 64. 

Type of income: Capital gains; 
Tax gap amount (dollars in billions): $11; 
Net misreporting percentage: 12. 

Type of income: State income tax refunds; 
Tax gap amount (dollars in billions): $1; 
Net misreporting percentage: 12. 

Type of income: Unemployment compensation; 
Tax gap amount (dollars in billions): $<0.5; 
Net misreporting percentage: 11. 

Type of income: Alimony income; 
Tax gap amount (dollars in billions): $<0.5; 
Net misreporting percentage: 7. 

Type of income: Social security benefits; 
Tax gap amount (dollars in billions): $1; 
Net misreporting percentage: 6. 

Type of income: Pensions and annuities; 
Tax gap amount (dollars in billions): $4; 
Net misreporting percentage: 4. 

Type of income: Dividend income; 
Tax gap amount (dollars in billions): $1; 
Net misreporting percentage: 4. 

Type of income: Interest income; 
Tax gap amount (dollars in billions): $2; 
Net misreporting percentage: 4. 

Type of income: Wages, salaries, tips; 
Tax gap amount (dollars in billions): $10; 
Net misreporting percentage: 1. 

Total nonbusiness income; 
Tax gap amount (dollars in billions): $56; 
Net misreporting percentage: 4. 

Source: IRS. 

[End of table] 

[End of figure] 

Background: 2001 Individual Income Tax Gap - Credits, Deductions, and 
Exemptions: 

Type of income: Credits; 
Tax gap amount (dollars in billions): $17; 
Net misreporting percentage: 26. 

Type of income: Deductions; 
Tax gap amount (dollars in billions): $14; 
Net misreporting percentage: 5. 

Type of income: Exemptions; 
Tax gap amount (dollars in billions): $4; 
Net misreporting percentage: 5. 

Type of income: Adjustments; 
Tax gap amount (dollars in billions): $-3; 
Net misreporting percentage: -21. 

Type of income: Adjustments: Self-employment tax deduction; 
Tax gap amount (dollars in billions): $-4; 
Net misreporting percentage: -51. 

Type of income: Adjustments: All other adjustments; 
Tax gap amount (dollars in billions): $1; 
Net misreporting percentage: 6. 

Source: IRS. 

[End of table] 

Methodology: Selecting Targets for Additional Research: 

To select promising targets for additional research to improve 
reporting compliance, we followed a three-stage methodology: 

Stage 1-from IRS's tax gap estimates, we identified specific line items 
from the individual tax return or broad categories (e.g., credits, 
deductions) with: 

* a net misreporting percentage of 5 percent or greater and: 

* a tax gap amount of $1 billion or greater: 

Stage 2-to determine what specific line items appear to drive 
noncompliance within broad categories that met the criteria from stage 
1, we: 

reviewed IRS's compliance estimates from the raw NRP data (which differ 
from the tax gap because of additional information IRS uses to estimate 
the tax gap) to identify line items with: 

- a net misreporting percentage of 5 percent or greater: 

- an estimated dollar amount of net misreporting of $3 billion or 
greater and: 

- an average misreported amount of $450 or greater per taxpayer: 

Stage 3-to determine which identified areas of noncompliance would be 
promising targets for future research with the end result of improving 
compliance, we: 

* obtained the views of IRS examiners and compliance officials: 

* determined if the type of income or expense was subject to tax 
withholding or information reporting, which have been shown to lead to 
high levels of compliance: 

Methodology: Opportunity to Improve Future NRP Studies: 

To identify opportunities, if any, found through the course of our work 
to improve future NRP studies, we: 

* identified weaknesses in NRP that we found during this and other GAO 
reviews that used NRP data and, 

* based on discussions with IRS research and compliance officials, 
identified opportunities to address any such weaknesses: 

Targets for Additional Research: 

Based our methodology, we identified the following promising targets 
for additional research to improve reporting compliance: 

* income/losses from partnerships and S corporations: 

* income/losses from rental real estate: 

* income/losses from farming: 

* sole proprietor income/losses: 

* "other" income-net operating losses: 

* gambling income/losses: 

* capital gains for assets other than securities: 

* other gains/losses: 

* Earned Income Tax Credit: 

* Additional Child Tax Credit: 

* deduction for charitable contributions: 

* deduction for medical/dental expenses: 

* deduction for job expenses and most other deductions: 

* exemptions: 

Targets for Additional Research: Potential Questions to Evaluate: 

For each promising target for additional research to improve reporting 
compliance, potential questions to evaluate are: 

* What is the extent of, and reasons for, noncompliance? 

* How does IRS address the noncompliance and what challenges, if any, 
does it face? 

* What are options to improve compliance (legislative or 
administrative)? 

Targets for Additional Research: Income and Losses from Partnerships 
and S Corporations: 

Net misreporting percentage: 18. 
Tax gap amount (dollars in billions): $22. 
Percentage of individual income tax underreporting tax gap: 11. 

The above NMP and tax gap figures include income from estates and 
trusts, but the NRP data show that partnerships and S corporations are 
the primary drivers of noncompliance for this area: 

NMP and share of individual income tax underreporting tax gap have 
increased for this line item from about 8 percent and about 4 percent 
for tax year 1988, respectively: 

The 2001 NRP studied the income and losses passed through to taxpayers 
from these entities; IRS is currently studying compliance of S 
corporations: 

Losses that taxpayers can deduct from partnerships and S corporations 
may be limited by "at risk" and passive activity loss rules: 

Taxpayers' losses and deductions from S corporations are limited to the 
adjusted basis of the taxpayers' stock and any debt the corporations 
owe to the taxpayers: 

IRS and the tax courts have determined that some S corporation owners 
improperly treat payments for services they perform as corporate 
distributions or dividends instead of salaries to avoid employment 
taxes: 

Targets for Additional Research: Income and Losses from Rental Real 
Estate: 

Net misreporting percentage: 51. 
Tax gap amount (dollars in billions): $13. 
Percentage of individual income tax underreporting tax gap: 7. 

These NMP and tax gap figures include income from royalties, but the 
NRP data show that rental real estate is the primary driver of 
noncompliance for these two income sources, as, collectively, taxpayers 
overreported their income from royalties: 

NMP and share of individual income tax underreporting tax gap have 
increased for this line item from about 17 percent and about 3 percent 
for tax year 1988, respectively: 

Targets for Additional Research: Income and Losses from Farming: 

Net misreporting percentage: 72. 
Tax gap amount (dollars in billions): $6. 
Percentage of individual income tax underreporting tax gap: 3.  

NMP has increased for this line item from about 32 percent for tax year 
1988, while the share of the tax gap remains largely unchanged: 

Deductions for losses from farming activities not carried on with the 
intent of profits, such as for hobby or recreation activities, are 
limited: 

The Internal Revenue Code provides that activities, such as farming, 
are presumed to be carried on for profit if a profit is produced in at 
least 3 out of the last 5 years: 

Taxpayers cannot deduct expenses for anything raised for personal use: 

Targets for Additional Research: Sole Proprietor Income and Losses: 

Net misreporting percentage: 57. 
Tax gap amount (dollars in billions): $68. 
Percentage of individual income tax underreporting tax gap: 35. 

Accounts for largest share of the entire tax gap: 

GAO is reviewing sole proprietor tax compliance under a separate 
engagement that will: 

* identify specific options that could improve compliance: 

* use data sources in addition to NRP: 

Targets for Additional Research: Other Income: 

Net misreporting percentage: 64. 
Tax gap amount (dollars in billions): $23. 
Percentage of individual income tax underreporting tax gap: 12. 

NMP and share of individual income tax underreporting tax gap have 
increased for this line item from 25 percent and 9 percent for tax year 
1988, respectively: 

IRS does not have separate NMP or tax gap estimates for the various 
types of income or losses taxpayers report as other income, which IRS 
estimated taxpayers to have reported for 2001 as follows: 

* other net income: $28.2 billion; 
* net operating losses: ($54.5 billion): 
* gambling income: $17.1 billion; 
* exclusion of foreign income: ($13.9 billion); 
* other net losses: ($8.7 billion): 

Targets for Additional Research: Other Income-Net Operating Loss (NOL): 

Taxpayer can carry back or carry forward certain losses to previous or 
subsequent years: 

The NRP data show that taxpayers misreported these net operating 
losses: 

Targets for Additional Research: Gambling: 

Taxpayers are to report gambling winnings as other income and report 
gambling losses as a miscellaneous, itemized deduction: 

Withholding and information reporting may apply to gambling winnings; 
reporting is not required for gambling losses: 

The NRP data show that taxpayers misreported gambling losses: 

Targets for Additional Research: Capital Gains for Assets Other Than 
Securities: 

Net misreporting percentage: 12. 
Tax gap amount (dollars in billions): $11. 
Percentage of individual income tax underreporting tax gap: 6. 

NMP increased for this line item from about 7 percent for tax year 
1988, while the share of the tax gap remains largely unchanged: 

GAO recently reported on ways to improve compliance for capital gains 
from securities (GAO-06-603): 

In reviewing securities reporting compliance, we found that taxpayers 
misreported capital gains for these other assets: 

* residential rental property; 
* land, including farmland: 
* residences; 
* business personal property and real estate; 
* ownership in an S corporation, partnership, estate, or trust;
* other assets.  

Targets for Additional Research: Other Gains and Losses: 

Net misreporting percentage: 64. 
Tax gap amount (dollars in billions): $3. 
Percentage of individual income tax underreporting tax gap: 2. 

NMP and share of individual income tax underreporting tax gap have 
increased for this line item from about 28 percent and about 1 percent 
for tax year 1988, respectively: 

Other gains and losses include those for the sale of business property: 

When selling business property, taxpayers must determine whether to 
report gains or losses as capital or ordinary: 

Targets for Additional Research: Earned Income and Additional Child Tax 
Credits: 

IRS estimates noncompliance for these credits jointly: 

IRS does not separately estimate the tax gap for these credits, but 
estimated that taxpayers misreported $14.3 billion in claiming these 
two credits: 

In a separate study for 1999, IRS estimated a tax loss of up to $10 
billion for the Earned Income Tax Credit: 

Targets for Additional Research: Deductions for Charitable 
Contributions: 

IRS does not separately estimate the tax gap for these deductions, but 
estimated that taxpayers misreported $13.6 billion in deductions for 
charitable cash contributions and $3.8 billion in deductions for 
charitable noncash contributions: 

Taxpayers are required to keep records of their contributions: 

* Taxpayers must have written acknowledgment from charities for 
contributions of $250 or more: 

* A 2006 law requires that taxpayers must keep bank records or written 
acknowledgment from charities for all cash contributions (previously, 
taxpayers could use reliable, written records to substantiate cash 
contributions of less than $250): 

Generally, charities are not required to report taxpayers' charitable 
contributions to IRS: 

Targets for Additional Research: Deduction for Medical and Dental 
Expenses: 

IRS does not separately estimate the tax gap for these deductions, but 
estimated that taxpayers misreported $7.6 billion in deductions of 
medical and dental expenses: 

Taxpayers can deduct the portion of certain medical expenses that 
exceed 7.5 percent of their adjusted gross income: 

Targets for Additional Research: Deduction for Job Expenses and Most 
Other Deductions: 

IRS does not separately estimate the tax gap for these deductions, but 
estimated that taxpayers misreported $24.3 billion in deductions of job 
expenses and most other miscellaneous deductions (which IRS estimates 
jointly): 

Taxpayers can deduct job expenses and certain miscellaneous deductions 
that exceed 2 percent of their adjusted gross income, such as: 

* unreimbursed employee expenses: 

* tax preparation fees: 

* certain legal and accounting fees: 

Targets for Additional Research: Exemptions: 

Net misreporting percentage: 5. 
Tax gap amount (dollars in billions): $4. 
Percentage of individual income tax underreporting tax gap: 2. 

NMP remains largely unchanged from tax year 1988, while the share of 
the tax gap has decreased from about 5 percent: 

Taxpayers can usually claim exemptions for themselves, spouses, and 
qualified dependents (children and relatives): 

Targets for Additional Research: Areas Not Selected: 

Other areas of noncompliance that met the first stage of selection 
criteria (or are within a broad category that met the initial 
criteria), but failed to meet subsequent criteria are: 

state income tax refunds; 
Social Security benefits; 
all other credits; 
deduction for state and local income taxes: 
deduction for real estate taxes; 
deduction for personal property and other taxes: 
deduction for home mortgage interest and points: 
deduction for investment interest; 
deduction for charitable contribution carryovers; 
deduction for casualty or theft losses: 
other miscellaneous deductions: 

Opportunity to Improve Future NRP Studies: NRP Examination Case Files: 

For NRP, IRS maintains electronic records for each tax return reviewed 
in addition to hard copy case files for each examination: 

IRS's research organization and GAO sometimes review examination case 
files to learn more about a particular compliance issue: 

However, IRS's electronic records do not contain all of the information 
developed during examinations, and IRS cannot consistently locate its 
paper files: 

NRP electronic records contain examination results such as the amount 
of income adjustments examiners made: 

Only NRP hard copy examination case files contain additional 
information such as documents provided by taxpayers during 
examinations: 

GAO requested examination case files from IRS for two recent 
engagements: 

For our review of compliance for capital gains from securities, we 
requested 1,043 NRP examination case files, but IRS was not able to 
provide 115 (11 percent) of them: 

For our ongoing work focused on sole proprietors, we requested 250 case 
files but IRS has not provided 38 (15 percent) of them: 

Paper case files were sometimes not available because IRS could not 
locate them, and sometimes because they were being used by IRS units: 

Opportunity to Improve Future NRP Studies: Benefits of Electronic 
Examination Case Files: 

Having complete electronic NRP examination case files would make it 
easier to get the full value from NRP studies because the files could 
be accessed more easily than hard copy files: 

Additionally, complete electronic case files would lower the risk of 
lost files and allow files to be accessed simultaneously by multiple 
users: 

Opportunity to Improve Future NRP Studies: Costs of Electronic 
Examination Case Files: 

According to IRS research and examination officials, the cost and 
timing of electronically capturing complete examination case files 
would vary by how they are made electronic; options include: 

* having examiners input all information on examination results into an 
electronic system: 

* using an "imaging" process to import information from hard copy files 
into an electronic system: 

* scanning hard copy files as stand-alone electronic documents: 

Conclusion: 

Evaluation of NRP data reveals a variety of areas of noncompliance 
where further research could provide information on how to address 
noncompliance: 

IRS cannot maximize the value of information it collects through NRP if 
it cannot locate or efficiently access examination case files: 

Recommendation: 

To ensure that IRS maximizes its return on investment from future NRP 
studies, IRS should develop a plan for capturing complete NRP 
examination case files that: 

* determines the most cost-effective means for capturing information 
electronically: 

* lays out a schedule for when it will begin to capture information 
electronically: 

[End of section] 

Enclosure II: Comments from the Internal Revenue Service: 

Department Of The Treasury: 
Internal Revenue Service: 
Washington, D.C. 20224: 
Commissioner: 

March 14, 2007: 

Mr. James R. White: 
Director, Tax Issues: 
Strategic Issues Team: 
United States Government Accountability Office: 
Washington, DC 20548: 

Dear Mr. White: 

Thank you for the opportunity to respond to your draft report entitled 
"Using Data from the Internal Revenue Service's National Research 
Program to Identify Potential Opportunities to Reduce the Tax Gap" (GAO-
07-423R). 

We appreciate that your report notes the importance of the Internal 
Revenue Service's (IRS) National Research Program (NRP) for identifying 
ways to reduce taxpayer noncompliance and to estimate the tax gap. The 
Government Accountability Office's support for these efforts has helped 
improve operations at the IRS. 

We concur with the recommendation that electronically capturing 
complete NRP examination case files would be beneficial to the IRS. 
Accordingly, the IRS will explore options for cost-effective ways to 
electronically capture and store this data. 

A response to the recommendation is enclosed. If you have any 
questions, please call me or a member of your staff may contact Mark 
Mazur, Director of the Office of Research, Analysis, and Statistics, at 
(202) 874-0100. 

Sincerely, 

Signed by: 

Mark W. Everson: 

Enclosure: 

To ensure that IRS maximizes its return on investment from future NRP 
studies, GAO recommends: 

Recommendation: 

IRS should develop a plan for capturing complete NRP examination case 
files that (1) determines the most cost effective means for capturing 
information electronically and (2) lays out a schedule for when it will 
begin to capture information electronically. 

Response: 

We concur that ready access to case file information is beneficial to 
the IRS and that we should determine the most cost effective means to 
capture this information. Case files from prior research studies under 
the Taxpayer Compliance Measurement Program (TCMP) were captured via 
microfiche, a procedure that was appropriate when those studies were 
conducted. NRP will consider all means, electronic or other, for 
accomplishing this objective. NRP has already implemented procedures 
for electronic capture of selective case file information. Examiner 
reports (i.e. Forms 4605, 4549, 886zc and 5344) for the current NRP 
reporting compliance study of S corporation returns are imaged and 
captured in the Reports Generation Software (RGS). Also, NRP is 
developing procedures to integrate the process of imaging tax returns 
into the case building process for the next NRP reporting compliance 
study. These imaged files will be readily accessible for case 
processing and research activities. However, we recognize that these 
procedures do not encompass capture of other case file information such 
as examiner workpapers and copies of source documents obtained from 
taxpayers. NRP and SB/SE staff will explore options for developing a 
plan and procedures to capture and store complete case file information 
contingent on there being cost effective ways of capturing that 
information. 

[End of section] 

Enclosure III: Contact and Staff Acknowledgments: 

GAO Contact: James R. White, (202)512-9110 or whitej@gao.gov. 

Staff acknowledgments: 

In addition to the contact named above, David Lewis, Assistant 
Director; Jeff Arkin; John Mingus; Karen O'Connor; Cheryl Peterson; 
Jeff Procak; and Sam Scrutchins made key contributions to this report. 

[End of section] 

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Tax Compliance: Multiple Approaches Are Needed to Reduce the Tax Gap. 
GAO-07-391T. Washington, D.C.: January 23, 2007.   

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Tax Administration: Information on IRSí Taxpayer Compliance Measurement 
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1995.   

Tax Compliance: 1994 Taxpayer Compliance Measurement Program. GAO/T-GGD-
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Tax Compliance: Status of the Tax Year 1994 Compliance Measurement 
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Tax Administration: IRSí Plans to Measure Tax Compliance Can Be 
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IRSí Compliance Programs to Reduce the Tax Gap. GAO/T-GGD-91-11. 
Washington, D.C.: March 13, 1991.   

IRS Can Use Tax Gap Data to Improve Its Programs for Reducing 
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Tax Administration: Profiles of Major Components of the Tax Gap. 
GAO/GGD-90-53BR. Washington, D.C.: April 4, 1990.   

(450510) 

FOOTNOTES 

[1] IRS estimated that it would eventually collect about $55 billion of 
the gross tax gap through late payments and IRS enforcement actions, 
leaving a net tax gap of around $290 billion. Unless otherwise noted, 
references to the tax gap refer to the gross tax gap. 

[2] Self-employed individuals are generally required to calculate and 
remit Social Security and Medicare taxes to the U.S. Treasury each 
quarter. As employment taxes and income taxes for self-employed 
taxpayers are largely assessed on the same income, self-employed 
individuals who underreport their income consequently underreport the 
employment tax due on that income. 

[3] For tax years 1963 through 1988, IRS measured compliance for 
various types of tax and taxpayers through its Taxpayer Compliance 
Measurement Program (TCMP). IRS did not implement any TCMP studies 
after tax year 1988 because of concerns about costs to and burdens on 
taxpayers. See GAO, Tax Compliance: Better Compliance Data and Long- 
term Goals Would Support a More Strategic IRS Approach to Reducing the 
Tax Gap, GAO-05-753 (Washington, D.C.: July 18, 2005). 

[4] GAO, Capital Gains Tax Gap: Requiring Brokers to Report Securities 
Cost Basis Would Improve Compliance if Related Challenges Are 
Addressed, GAO-06-603 (Washington, D.C.: June 13, 2006).