Tax Compliance:

Better Compliance Data and Long-term Goals Would Support a More Strategic IRS Approach to Reducing the Tax Gap

GAO-05-753: Published: Jul 18, 2005. Publicly Released: Aug 17, 2005.

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According to the Internal Revenue Service (IRS), a gap arises each year between what taxpayers pay accurately and on time in taxes and what they should pay under the law. The tax gap is composed of underreporting of tax liabilities on tax returns, underpaying of taxes due from filed returns, and nonfiling of required tax returns altogether or on time. GAO was asked to provide information on (1) the estimated amount that each major type of noncompliance contributed to the 2001 tax gap and IRS's views on the certainty of its tax gap estimates, (2) reasons why noncompliance occurs, and (3) IRS's approach to reducing the tax gap and whether the approach incorporates established results-oriented planning principles.

IRS estimates that underreporting of taxes accounted for about $250 billion to $292 billion of the $312 billion to $353 billion tax gap for 2001, while underpayment and nonfiling accounted for about $32 billion and $30 billion, respectively. Although IRS has collected recent compliance data, it still has concerns with some outdated methodologies and data used to estimate the tax gap. IRS is taking laudable steps intended to improve the estimate, which it plans to revise by the end of 2005. IRS has also developed a proposed schedule of compliance studies, but it has no approved plans to periodically measure compliance for the tax gap components. While it may not be feasible or necessary to measure compliance for all components at the same frequency or level of investment, periodic compliance studies would support a more data-driven and risk-based approach to reducing the tax gap. IRS recently began to capture data on the reasons why taxpayers are noncompliant. However, IRS has concerns about the data, such as examiners assigning the same reason for noncompliance regardless of situation. Also, it is often difficult for examiners to determine a taxpayer's intent--whether the noncompliance is unintentional or intentional. Collecting better data on reasons can help IRS focus its activities on taxpayer service or enforcement. Although IRS is developing a system intended to capture better examination data, IRS does not have firm or specific plans to develop better reason data. IRS approaches tax gap reduction through improving taxpayer service and enforcing tax laws and has two broad strategic goals and related key efforts that are intended to support this approach. However, IRS has not established long-term, quantitative compliance goals and regularly collected data to track its progress, which would complement its current, important compliance efforts. Establishing clear goals and measuring progress towards them would be consistent with results-oriented management principles. IRS has begun to consider additional goals, but it is not yet clear if they will be compliance related. Long-term, quantitative compliance goals, coupled with updated compliance data, would provide a solid base upon which to develop a more strategic, results-oriented approach to reducing the tax gap.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: In June 2007, Internal Revenue Service (IRS) officials announced plans to launch a new National Research Program (NRP) reporting compliance study for individual taxpayers that will provide updated and more accurate audit selection tools and support efforts to reduce the nation's tax gap. According to IRS, the latest NRP study will be the first of an ongoing series of annual individual studies using a multi-year rolling methodology. The study will start in October 2007 and examine about 13,000 randomly selected tax year 2006 individual returns. Also, according to IRS, it updated its audit selection system, which will enable the agency to audit more efficiently by improving the detection of underreported income and overstated deductions and credits while auditing fewer taxpayers with accurate tax returns. In addition to the NRP for individuals, IRS is in the final stages of a compliance research project examining reporting compliance of S corporations. This research encompasses approximately 5,000 returns filed for tax years 2003 and 2004. Since the income and expense items for S corporations flow through to individual shareholders, this study will also help refine the tax gap estimates for individual income tax.

    Recommendation: To establish a stronger foundation for improving IRS's efforts to reduce the tax gap, the Commissioner of Internal Revenue should develop plans to periodically measure tax compliance for areas that have been previously measured, such as for individual income tax underreporting, and study ways to cost effectively measure compliance for other components of the tax gap that have not been measured, such as for excise tax and large corporations. Those plans and that study should take into account risk management factors such as the amount the component contributes to the gap, changes that may have affected compliance levels since a measurement was last taken, and the cost of measuring compliance.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  2. Status: Closed - Implemented

    Comments: IRS improved the reason codes for the new individual reporting compliance study for tax year 2006. IRS eliminated some codes that were not useful, expanded the coding to make the reasons more precise, better trained the auditors on how to use the codes, and allowed auditors to select a code for intentional noncompliance without asserting a penalty. IRS also believes that doing a smaller individual NRP study annually, using the same auditors from year to year, will lead to better/more consistent use of the new reason codes and thus better data. Finally, IRS updated auditors' desktop tools, which it hopes will facilitate use of the reason codes. IRS plans to check the status of the initial data output on closed NRP audits, including the use of the reason codes, during November 2008 to see whether the data on reasons are better than they were for the 2001 NRP study, and plans to create a preliminary database for the whole study by winter 2009.

    Recommendation: To establish a stronger foundation for improving IRS's efforts to reduce the tax gap, the Commissioner of Internal Revenue should take steps to ensure that IRS regularly collects complete, accurate, and consistent data, to the extent possible, on the reasons taxpayers are noncompliant and that sufficient broader research is undertaken to continue learning about the reasons why noncompliance occurs.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  3. Status: Closed - Implemented

    Comments: Although not specifically targeted at individual income tax underreporting and underpayment, IRS has established a voluntary compliance rate goal of 85 percent by 2009 and has published this goal in the Administration's FY2007 budget request.

    Recommendation: To establish a stronger foundation for improving IRS's efforts to reduce the tax gap, the Commissioner of Internal Revenue should establish a long-term, quantitative voluntary compliance goal for individual income tax underreporting and for tax underpayment, as well as for other areas of noncompliance as data become available.

    Agency Affected: Department of the Treasury: Internal Revenue Service

 

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