The financing of the federal government depends largely on the Internal Revenue Services (IRS) ability to collect federal taxes every year, which totaled $2.34 trillion in 2010. For the most part, taxpayers voluntarily report and pay their taxes on time with no direct enforcement and little interaction with IRS. However, the size and persistence of the tax gapestimated in 2012 for the 2006 tax year to be a $385 billion difference between the taxes owed and taxes IRS ultimately collected for that yearhighlight the need to make progress in improving compliance by those taxpayers who do not voluntarily pay what they owe. IRSs enforcement of tax laws remains on GAOs high-risk list.
Given that tax noncompliance ranges from simple math errors to willful tax evasion, no single approach is likely to fully and cost-effectively address the tax gap. A multifaceted approach to improving complianceone that covers both IRSs enforcement and taxpayer service programs and also leverages external resources such as tax whistleblowerscould increase legally owed revenue collection by billions of dollars and result in cost savings for IRS. Without continued attention to IRSs enforcement and taxpayer service efforts, taxpayers could feel that the tax system is not administered fairly and not everyone is paying their fair share, which could undermine voluntary compliance.
GAO identified a range of areas where IRS can improve its programs which can help it collect billions in tax revenue, facilitate voluntary compliance, or reduce IRSs costs. These include pursuing stronger enforcement through increasing third-party information reporting and identifying and pursuing abusive tax avoidance transactions; making more use of external resources such as tax whistleblowers to prevent and detect compliance problems; and improving telephone and online services provided to taxpayers.
As GAO reported in August 2008, one area where information reporting could be expanded is payments made to contractors (payees) by owners of rental real estate (third-party payers). Like other businesses entities, under current law, taxpayers who rent out real estate are required to report to IRS expense payments for certain services, such as payments for property repairs, as long as their rental activity is considered a trade or business (which includes activities engaged in for profit as well as activities by certain nonprofits). However, the law does not clearly spell out how to determine when rental real estate activity is considered a trade or business. Consequently, determining whether an information return should be filed requires a case-by-case analysis of when rental real estate is, or is not, a trade or business depending on the facts and circumstances for each taxpayer. As GAO reported in August 2008, without clear statutory language, it may be difficult for payers with rental real estate activity to determine if they are required to report certain expense payments to IRS, and as a result, it is possible that some third-party payers who should report do not. Expanding information reporting to cover payment for services by all owners of rental real estate would provide clarity on reporting requirements and improve payee compliance.
In another case, as GAO reported in November 2010, under existing law, businesses (payers) must report to IRS payments for services they made to unincorporated persons or businesses, but payments to corporations generally do not have to be reported. Extending reporting to cover payments to corporations for services would increase payee compliance. Congress enacted a more expansive regime in March 2010, covering goods as well as services, and repealed it in 2011. GAO believes the more narrow extension to include services, but not goods, provided by corporationswhich would match the provision for unincorporated persons or businessesremains an important option for improving compliance.
In 2010, the Joint Committee on Taxation estimated revenue increases for a 10-year period from third-party reporting of (1) rental real estate service payments to be $2.5 billion and (2) service payments to corporations to be $3.4 billion.
Pursuant to the American Jobs Creation Act of 2004, IRS expanded requirements for both promoters and taxpayers to disclose their use of certain transactions and enhanced penalties for improper disclosurefailure to disclose, delinquent disclosure, and incomplete disclosure. However, as GAO reported in May 2011, IRS did not know whether it received all the disclosures it should have from taxpayers and did not verify the completeness of those disclosures it received. IRS also did not track how quickly all those who promoted ATATs provided lists of their investors when either required or requested. Without complete data on enforcement outcomes or full disclosure from promoters and taxpayers, IRS is less able to assess the effectiveness of ATAT enforcement efforts, make informed resource allocation decisions, or identify transactions that merit auditing or penalties.
Abusive tax avoidance transactions range from tax schemes based on clearly frivolous arguments to highly technical and abusive tax shelters.
In March 2010, pursuant to the Patient Protection and Affordable Care Act, information reporting requirements were expanded to cover payments for goods as well as services and payments to corporations. Pub. L. No. 111-148, § 9006. Later in September 2010, pursuant to the Small Business Jobs Act of 2010 information reporting requirements were expanded to include landlords who have generally not been considered to be engaged in a trade or business. Pub. L. No. 111-240, § 2101.These provisions were repealed by the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011. Pub. L. No. 112-9, §§ 2(a), 3 (2011).
GAO continues to suggest Congress consider expanding third-party information reporting, which improves taxpayer compliance, by amending the Internal Revenue Code. GAO recommended that Congress may wish to
IRS has agreed with and taken action on some GAO recommendations for example, by providing taxpayers with rental real estate activity additional guidance on their reporting obligations. However, other recommendations remain to be addressed. Specifically, to increase revenue, reduce costs, and promote voluntary compliance, GAO recommended that IRS:
These actions can lead to increased revenue collections and cost savings totaling billions of dollars, which would help reduce the $385 billion tax gap. Although precise estimates of total cost savings are not available, for just the two congressional actions cited above, the Joint Committee on Taxation estimated revenue increases of $5.9 billion over 10 years. As part of its routine audit work, GAO will continue to track the extent to which progress has been made to address the identified actions and report to Congress.
The information contained in this analysis is based on findings from the products listed in the related GAO products section.
GAO provided a draft of its previously issued reports to IRS for review and comment. IRS generally agreed with GAOs recommendations on checking taxpayer ATAT filing obligations, return preparer oversight, and whistleblower information and processing but has not yet completed the recommended actions. IRS said it will consider reporting summary whistleblower statistics and improving online taxpayer services. Finally, IRS agreed that the recommendations regarding tracking ATAT issues and determining the costs and benefits of automating selected telephone applications had merit, but that resources for tracking or telephone automation were not available.