Why This Area Is Important

The financing of the federal government depends largely on the Internal Revenue Service’s (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 gap—estimated in 2012 for the 2006 tax year to be a $385 billion difference between the taxes owed and taxes IRS ultimately collected for that year—highlight the need to make progress in improving compliance by those taxpayers who do not voluntarily pay what they owe. IRS’s enforcement of tax laws remains on GAO’s 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 compliance—one that covers both IRS’s enforcement and taxpayer service programs and also leverages external resources such as tax whistleblowers—could increase legally owed revenue collection by billions of dollars and result in cost savings for IRS. Without continued attention to IRS’s 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.

What GAO Found

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 IRS’s costs. These include pursuing stronger enforcement through increasing third-party information reporting and identifying and pursuing abusive tax avoidance transactions;[1] 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.

• Expanding third-party information reporting improves taxpayer compliance and enhances IRS’s enforcement capabilities. The tax gap is due predominantly to taxpayer underreporting and underpayment of taxes owed. At the same time, taxpayers are much more likely to report their income accurately when the income is also reported to IRS by a third party. By matching information received from third-party payers with what payees report on their tax returns, IRS can detect income underreporting, including the failure to file a tax return.

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 corporations—which would match the provision for unincorporated persons or businesses—remains an important option for improving compliance.[2]

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.

• Pursuing abusive tax avoidance transactions has been a long-standing tax evasion problem that results in potentially billions of dollars in tax losses. As GAO reported in May 2011, IRS had incomplete data on the results of abusive tax avoidance transaction (ATAT) related enforcement efforts, so it is unable to assess the effectiveness of these efforts. More could also be done to ensure compliance with ATAT disclosure requirements. For example, while investigations of those who promoted ATATs were often closed without penalties or injunctions to stop promoters, IRS had incomplete data on why these investigations were closed. During fiscal year 2011, IRS started tracking the amount of additional taxes collected as a result of taxpayer audits, where ATATs were at least one of the audited issues, but the amounts collected from ATAT issues alone could not be isolated.

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 disclosure—failure 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.

• Leveraging external resources such as tax whistleblowers can contribute to taxpayer compliance. GAO reported in August 2011, IRS did not collect or report complete data on, nor have a systematic process to manage the timeliness of, processing claims from whistleblowers, in part, because of how it set up its claims tracking system. As a result, claims alleging millions or potentially billions of dollars in tax noncompliance may not receive the attention or resources they need. Moreover, without complete and accurate data or processes to follow up on claims that exceed established review time targets, IRS may not be able to identify aspects of the program that could be improved to more effectively address noncompliance. Collecting and reporting such data could also improve the transparency of the program, which may result in additional whistleblowers coming forward.
• Improving taxpayer services can benefit voluntary compliance by making it easier for taxpayers to pay what they owe. As GAO reported in December 2011, determining the costs and benefits of enhancing certain services for taxpayers, such as providing more automated telephone applications, could lead to faster service for taxpayers and lower IRS costs. Similarly, GAO also reported that completing a comprehensive online services plan might include an assessment of and justification for giving taxpayers the ability to access and update account information online, which may simultaneously improve taxpayer services and lower IRS’s costs. In addition to reducing costs, providing more automated taxpayer services could increase revenue collection by supporting greater voluntary compliance and allow resources to be shifted to other priorities.

Actions Needed

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

• make owners of rental real estate subject to the same payment reporting requirements regardless of whether they engaged in a trade or business under current law (GAO-08-956); and
• require payers to report service payments to corporations, thereby reducing payers’ burden to determine which payments require reporting (GAO-11-218T, GAO-09-238).

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:

• track the examination results for ATAT versus non-ATAT issues separately and check whether taxpayers filed all required ATAT-related disclosure forms (GAO-11-493);
• collect and report more information on the whistleblower program and establish a process to follow up on claims that exceed review time targets (GAO-11-683);
• determine the costs and benefits of creating automated telephone applications and automate those where benefits exceed the costs (GAO-12-176); and
• finalize a more comprehensive plan for online services, including an assessment of granting taxpayers the ability to update their account information online (GAO-12-176).

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.

How GAO Conducted Its Work

The information contained in this analysis is based on findings from the products listed in the related GAO products section.

Agency Comments & GAO Contact

GAO provided a draft of its previously issued reports to IRS for review and comment. IRS generally agreed with GAO’s 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.

For additional information about this area, contact Michael Brostek or James R. White at brostekm@gao.gov or whitej@gao.govor (202) 512-9110.

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