Tax Policy and Administration:

Using Data from the Internal Revenue Service's National Research Program to Identify Potential Opportunities to Reduce the Tax Gap

GAO-07-423R: Published: Mar 15, 2007. Publicly Released: Apr 19, 2007.

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The Internal Revenue Service (IRS) most recently estimated that the gross tax gap--the difference between what taxpayers pay in taxes voluntarily and on time and what they should pay under the law--reached $345 billion for tax year 2001. The tax gap arises when taxpayers fail to comply with their individual income, corporate income, employment, estate, or excise tax obligations through (1) underreporting of tax liabilities on tax returns; (2) underpayment of taxes due from filed returns; or (3) nonfiling, which refers to the failure to file a required tax return altogether or on time. IRS's tax gap estimates are based on a variety of data sources. Recently, IRS studied individual taxpayer compliance through the National Research Program (NRP), and used the resulting compliance data to estimate the tax gap for individual income tax underreporting and the portion of employment tax underreporting attributed to self-employment taxes for tax year 2001. NRP, which involved reviewing around 46,000 individual tax returns, has yielded very important new information on taxpayer compliance for the first time since IRS's previous compliance measurement study was undertaken for tax year 1988. Compliance measurement studies such as NRP have the potential to identify ways to improve taxpayer compliance, which could in turn reduce the tax gap and improve the nation's fiscal stability. For example, each 1 percent reduction in the net tax gap would likely yield around $3 billion annually. Given its potential to improve individual taxpayer compliance, you asked us to review the results of the 2001 NRP study. In response, we agreed to identify (1) specific areas of individual taxpayer noncompliance that are promising targets for additional research to improve reporting compliance, and (2) opportunities, if any, found through the course of our work to improve future NRP studies.

Areas of individual taxpayer noncompliance that are promising targets for additional research to improve reporting compliance include: income/losses from partnerships and S corporations, income/losses from rental real estate, sole proprietor income/losses, income/losses from farming, other income--net operating losses, gambling income/losses, capital gains for assets other than securities, other gains/losses, Earned Income Tax Credit, Additional Child Tax Credit, deduction for charitable contributions, deduction for medical and dental expenses, deduction for job expenses and most other deductions, and exemptions. IRS could benefit from electronically capturing complete NRP examination case files. Although IRS creates an electronic record for each tax return reviewed for NRP, these records do not contain all of the information contained in the corresponding hard copy examination case files. For example, information taxpayers provide to IRS during examinations is only included in the paper case file and not in the electronic records. Furthermore, some paper case files are not obtainable. For a prior review on the capital gains tax gap for securities, IRS was not able to provide 11 percent of NRP examination case files we requested because complete files could not be located or were being used by IRS units. Having complete electronic NRP examination case files would make it easier for IRS to get the full value from NRP studies because the files could be assessed more easily than hard copy files. Additionally, complete electronic case files would lower the risk of lost files and would allow files to be accessed simultaneously by multiple users. According to IRS research and examination officials, the cost and timing of electronically capturing complete examination case files would vary by how they are made electronic.

Status Legend:

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  • Review Pending-GAO has not yet assessed implementation status.
  • Open-Actions to satisfy the intent of the recommendation have not been taken or are being planned, or actions that partially satisfy the intent of the recommendation have been taken.
  • Closed-implemented-Actions that satisfy the intent of the recommendation have been taken.
  • Closed-not implemented-While the intent of the recommendation has not been satisfied, time or circumstances have rendered the recommendation invalid.
    • Review Pending
    • Open
    • Closed - implemented
    • Closed - not implemented

    Recommendation for Executive Action

    Recommendation: To ensure that IRS maximizes its return on investment from future NRP studies, IRS should develop a plan for capturing complete NRP examination case files that (1) determines the most cost effective means for capturing information electronically and (2) lays out a schedule for when it will begin to capture information electronically.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Implemented

    Comments: IRS completed a study of capturing electronic information for National Research Program (NRP) examination cases in December 2008. For the tax year 2006 NRP study of individual tax returns, IRS recommended that examiners complete workpapers electronically, and mandated electronic workpapers for the tax year 2007 study. In a December 2008 document, IRS said that it will require all IRS developed documentation to be in electronic form, but will not scan taxpayer-provided documentation. We consider IRS to have substantially implemented this recommendation with these requirements.

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