Tax Administration:

Better Coordination Could Improve IRS's Use of Third-Party Information Reporting to Help Reduce the Tax Gap

GAO-21-102: Published: Dec 15, 2020. Publicly Released: Jan 14, 2021.

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James R. McTigue
(202) 512-9110
McTigueJj@gao.gov

 

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How does the IRS ensure that your taxes are accurate?

The IRS gets information from employers, banks, and other third-parties about your income and other factors that can affect your tax bill. Mismatches between this information and what you report on your taxes can indicate errors or potential fraud.

The IRS processes billions of third-party information returns. But the system isn't managed strategically—returns come on paper and electronically, with different due dates, and are used by different compliance programs managed in different IRS offices.

Our recommendations are to increase coordination and improve IRS's use of information returns.

W-2 and W-3 tax forms

Additional Materials:

Contact:

James R. McTigue
(202) 512-9110
McTigueJj@gao.gov

 

Office of Public Affairs
(202) 512-4800
youngc1@gao.gov

What GAO Found

Information returns are forms filed by third parties, such as employers and financial institutions that provide information about taxable transactions. These forms are submitted to the Internal Revenue Service (IRS), the Social Security Administration, and taxpayers. Fifty unique types of information returns provide information on individual taxpayers and have a variety of purposes, such as reporting on wages earned or amounts paid that qualify for a tax credit or deduction. IRS identifies mismatches between information returns and tax returns for potential additional review, including enforcement actions. According to IRS research, taxpayers are more likely to misreport income when little or no third-party information reporting exists than when substantial reporting exists.

Overview of Internal Revenue Service's (IRS) Process for Matching Information Returns

Overview of Internal Revenue Service's (IRS) Process for Matching Information Returns

IRS's ability to process and use information returns is limited by its outdated legacy information technology (IT) systems. In 2017, IRS developed a plan to modernize its information return processing systems; however, IRS paused its efforts due to, according to IRS, resource constraints. IRS has an opportunity to capitalize on prior planning efforts by re-evaluating and updating these efforts and integrating them into its broader IT modernization efforts.

IRS does not have a coordinated approach with cross-agency leadership that strategically considers how information reporting could be improved to promote compliance with the tax code. While information returns affect many groups across IRS and support multiple compliance programs, no one office has broad responsibility for coordinating these efforts. A formalized collaborative mechanism, such as a steering committee, could help provide leadership and ensure that IRS acts to address issues among the intake, processing, and compliance groups. For example, IRS has not undertaken a broad review of individual information returns to determine if thresholds, deadlines, or other characteristics of the returns continue to meet the needs of the agency.

Why GAO Did This Study

For tax year 2018, IRS received and processed more than 3.5 billion information returns that it used to facilitate compliance checks on more than 150 million individual income tax returns. By matching information reported by taxpayers against information reported by third parties, IRS identifies potential fraud and noncompliance.

GAO was asked to review IRS's use of information returns. This report provides an overview of information returns and assesses the extent to which IRS has a coordinated approach to identifying and responding to risks related to the use of information returns in the tax system, among other objectives.

GAO reviewed IRS documents and data on information returns filing, processing, and use, and interviewed cognizant officials. GAO compared IRS's efforts in this area to federal internal control standards, and IRS's strategic plan.

What GAO Recommends

GAO is making nine recommendations to IRS, including that IRS revise its modernization plans for its information returns processing systems and incorporate it into broader IT modernization efforts and develop a collaborative mechanism to improve coordination among IRS groups that use information returns. IRS neither agreed, nor disagreed with the recommendations; however, IRS outlined actions it plans to take to address the recommendations. Social Security Administration had no comments.

For more information, contact James R. McTigue at (202) 512-9110 or McTigueJj@gao.gov.

Recommendations for Executive Action

  1. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: The Commissioner of Internal Revenue should expedite final planning efforts and implement the expansion of IRS's capacity to allow for additional transcription of K-1 Schedules. (Recommendation 1)

    Agency Affected: Department of the Treasury: Internal Revenue Service

  2. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: The Commissioner of Internal Revenue should research, evaluate, and develop potential recommendations to expand third-party information reporting to include more information on sole proprietor's income and expenses. (Recommendation 2)

    Agency Affected: Department of the Treasury: Internal Revenue Service

  3. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: The Commissioner of Internal Revenue should evaluate characteristics of late information return filers to determine the effect of penalty assessment for late and incorrect information returns on third-party information reporting compliance. (Recommendation 3)

    Agency Affected: Department of the Treasury: Internal Revenue Service

  4. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: The Commissioner of Internal Revenue should reassess the risks described and recommendations made in its internal 2016 report related to information returns and identify potential new risks and recommendations as a result of changes to the tax administration environment. (Recommendation 4)

    Agency Affected: Department of the Treasury: Internal Revenue Service

  5. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: The Commissioner of Internal Revenue should prioritize and develop a timeline for implementing the remaining recommendations from its internal 2016 report related to information returns, along with any newly identified recommendations. (Recommendation 5)

    Agency Affected: Department of the Treasury: Internal Revenue Service

  6. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: The Commissioner of Internal Revenue should revise the 2017 Information Returns Systems Modernization plans by evaluating changes in the environment, assessing risks to systems and programs, and detailing how the agency plans to address issues in the intake, processing, and use of information returns across business units. (Recommendation 6)

    Agency Affected: Department of the Treasury: Internal Revenue Service

  7. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: The Commissioner of Internal Revenue should submit a revised information returns system modernization plan to Congress that describes how it integrates with IRS's broader IT modernization efforts, the resources needed to achieve effective and timely modernization, and the proposed schedule and scope of the effort. (Recommendation 7)

    Agency Affected: Department of the Treasury: Internal Revenue Service

  8. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: The Commissioner of Internal Revenue should develop a plan and schedule to systematically evaluate the suite of information returns with a goal of improving compliance, and reducing fraud and reporting burden. The evaluation should consider factors such as filing requirement thresholds, deadlines for filing, corrections and amendment data, and the potential to consolidate similar forms and include recommendations for needed changes. (Recommendation 8)

    Agency Affected: Department of the Treasury: Internal Revenue Service

  9. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: The Commissioner of Internal Revenue should develop a collaborative mechanism to coordinate among the internal stakeholders who are responsible for the intake, processing, and use of information returns, as well as to improve outreach to external stakeholders in relation to information returns. (Recommendation 9)

    Agency Affected: Department of the Treasury: Internal Revenue Service

 

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