Tax Administration:

IRS Can Better Pursue Noncompliant Sole Proprietors

GGD-94-175: Published: Aug 2, 1994. Publicly Released: Sep 1, 1994.

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Pursuant to a congressional request, GAO reviewed the Internal Revenue Service's (IRS) monitoring of income reporting by sole proprietors, focusing on: (1) the extent of noncompliance by type of sole proprietor; (2) IRS actions to correct such noncompliance; and (3) additional steps IRS could take to improve compliance.

GAO found that: (1) although they constituted about 13 percent of individual taxpayers, sole proprietors accounted for 36 percent to 40 percent of the underreported total income by individuals in 1988; (2) sole proprietors materially differ from nonbusiness taxpayers in that they are less compliant, file more complex tax returns, are deliberately noncompliant more often, and tend to be better off financially; (3) nonbusiness taxpayers have more income reported on information returns by third parties, which is probably why they are more compliant; (4) income reporting varies widely by type of sole proprietor, but in general, sole proprietors report only 75 percent of their net business income; (5) IRS does not link its compliance strategy and its compliance efforts for sole proprietors; (6) IRS compliance efforts are constrained by resource and information reporting limitations; (7) IRS does not know if its new information systems, which will not be online until after 2000, will provide the data needed to systematically improve sole proprietor compliance; (8) IRS plans to improve its Taxpayer Compliance Measurement Program (TCMP) to identify local problems and causes for noncompliance; and (9) IRS could better use existing TCMP data to identify the root causes of noncompliance.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: IRS implemented this system during the summer.

    Recommendation: The Commissioner of Internal Revenue should develop a system for managing and monitoring all sole proprietor compliance projects, linking them to IRS-wide plans, and disseminating their results throughout IRS.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  2. Status: Closed - Not Implemented

    Comments: IRS claims the 1988 TCMP data--the most recent--are too old to use. IRS said it will use the data from its planned TCMP for 1994. The data will not be fully collected until 1998.

    Recommendation: The Commissioner of Internal Revenue should use existing TCMP information, including workpapers, to help identify projects that would address the most noncompliant sole proprietor market segments on a nationwide basis and analyze the underlying causes of noncompliance.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  3. Status: Closed - Implemented

    Comments: With industry representatives' input, IRS developed and issued an audit technique guide to help clarify recordkeeping issues.

    Recommendation: The Commissioner of Internal Revenue should work with trucking industry groups to improve recordkeeping and with other sectors where TCMP indicates that recordkeeping may be a problem.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  4. Status: Closed - Implemented

    Comments: IRS worked with the insurance industry to clarify the instructions on reporting third-party payments. The Assistant Chief Counsel (Income Tax and Accounting) forwarded to the Department of the Treasury draft reporting regulations on third party payments for services rendered. In October 2000, Treasury approved the draft regulations and received public comments in February 2001. Revisions are being made based on these comments.

    Recommendation: The Commissioner of Internal Revenue should clarify information return filing instructions for insurance companies and work with these companies to improve compliance with information reporting requirements.

    Agency Affected: Department of the Treasury: Internal Revenue Service


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