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entitled 'Tax Gap: IRS Has Modernized Its Business Nonfiler Program 
but Could Benefit from More Evaluation and Use of Third-Party Data' 
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Report to the Committee on Finance, U.S. Senate: 

United States Government Accountability Office: 
GAO: 

August 2010: 

Tax Gap: 

IRS Has Modernized Its Business Nonfiler Program but Could Benefit 
from More Evaluation and Use of Third-Party Data: 

GAO-10-950:  

GAO Highlights: 

Highlights of GAO-10-950, a report to the Committee on Finance, U.S. 
Senate.  

Why GAO Did This Study: 

The Internal Revenue Service (IRS) does not know how many businesses 
failed to file required returns, nor does it have an estimate of the 
associated lost tax revenue—the business nonfiling tax gap. Many cases 
it does investigate are unproductive because the business does not owe 
the return IRS expects. GAO was asked to assess (1) the data 
challenges of estimating the business nonfiler tax gap, (2) how recent 
program changes have affected IRS’s capacity to identify and pursue 
business nonfilers, and (3) additional opportunities for IRS to use 
third-party data. GAO reviewed IRS’s tax gap estimates, nonfiler 
program processes and procedures, and matched closed nonfiler cases 
with various other data.  

What GAO Found: 

IRS cannot develop a comprehensive estimate of the business nonfiling 
rate and associated tax gap because it lacks data about the population 
of all businesses. However, IRS could develop a partial estimate using 
its business nonfiler inventory. IRS identifies several million 
potential business nonfilers each year, more than it can thoroughly 
investigate. IRS could take a random sample of its inventory, 
thoroughly investigate those cases, and use the results to estimate 
the proportion of actual nonfilers in its inventory of potential 
nonfilers.  

Until recently IRS has not had a way to prioritize cases in its large 
inventory. IRS modernized its business nonfiler program in 2009 by 
incorporating income and other data in its records indicating business 
activity. Active businesses generally have an obligation to file a 
return. IRS’s Business Master File Case Creation Nonfiler 
Identification Process (BMF CCNIP) now assigns each case a code based 
on this data. IRS uses the code to select cases to work with the goal 
of securing tax returns from nonfilers and collecting additional 
revenue.  

This is a significant modernization, but IRS lacks a formal plan to 
evaluate how well the codes are working. IRS has performance 
information on its individual nonfiler program but less on its 
business nonfiler program. Key management reports needed to provide 
program data are under development but no deadline has been set. IRS 
could also use more information on why many nonfiler cases are 
unproductive. This could potentially lead IRS to identify actions that 
could reduce IRS resources used on these cases and associated taxpayer 
burden.  

GAO identified several opportunities including the following to 
enhance IRS’s identification and pursuit of business nonfilers.  

* The new BMF CCNIP selection codes provide a quick way to verify 
taxpayer statements that a business has ceased operations and does not 
need to file a return. Collections staff have been instructed to use 
the codes when making case closure decisions. They were previously 
instructed to use other income data but GAO’s analysis indicated this 
may not have been done in all cases.  

* Non-IRS data on businesses including federal contractors could be 
used to verify taxpayer statements about whether a tax return should 
have been filed. GAO’s analysis of cases in two states that were 
closed as not liable to file a return found 7,688 businesses where non-
IRS data showed business activity as measured by sales totaling $4.1 
billion. GAO also found cases closed as not liable to file a return 
involving 13,852 businesses on the federal contractor registry. GAO’s 
analyses illustrated the potential value of non-IRS data but GAO did 
not assess which non-IRS data would be most useful nor examine the 
capacity of IRS’s systems to use such data on a large scale.  

What GAO Recommends: 

GAO recommends that the Commissioner of Internal Revenue develop a 
partial business nonfiler rate estimate; set a deadline for developing 
performance data; develop a plan for evaluating the selection codes; 
reinforce the need to use income data and selection codes in verifying 
taxpayer statements; and study the feasibility and cost-effectiveness 
of using non-IRS data to verify taxpayer statements.  

In written comments on a draft of this report IRS agreed that 
identifying and pursuing active business nonfilers is key to 
enforcement efforts and acknowledged that our recommendations could 
assist these efforts. IRS agreed with four of GAO’s recommendations 
and indicated some steps it would take to address the other four. 

View [hyperlink, http://www.gao.gov/products/GAO-10-950] or key 
components. For more information, contact James R. White at (202) 512-
9110 or whitej@gao.gov.  

[End of section]  

Contents: 

Letter: 

Background: 

A Comprehensive Estimate of the Business Nonfiling Tax Gap May Be 
Infeasible, but IRS Operational Data Could Provide Partial Information: 

More Performance Information and Evaluation Is Needed to Measure the 
Success of IRS's Business Nonfiler Program: 

IRS Could Improve Business Nonfiler Case Closure Decisions through 
Additional Use of Information Returns and External Data: 

Conclusions: 

Recommendations for Executive Action: 

Agency Comments and Our Evaluation: 

Appendix I: Scope and Methodology: 

Appendix II: Additional Information on Businesses' Filing Requirements: 

Appendix III: How IRS Identifies and Pursues Business Nonfilers: 

Appendix IV: Comments from the Internal Revenue Service: 

Appendix V: GAO Contact and Staff Acknowledgments: 

Tables: 

Table 1: IRS's Inventory of Potential Business Nonfiler Cases by 
Selected Return Type as of the End of Calendar Year 2009: 

Table 2: Number of Partnership and Corporation Tax Year 2007 Nonfiler 
Cases Closed As Not Liable to File Returns: 

Table 3: California and Illinois Partnership and Corporation Nonfiler 
Cases Closed as Not Liable to File in Tax Year 2007 with Gross Sales: 

Table 4: California and Illinois Employment Tax Cases Closed as Not 
Liable to File in Tax Year 2007 with Gross Sales: 

Table 5: California and Illinois Cases with No Filing Requirements 
Indicated in the BMF That Had Sales and Employees: 

Figures: 

Figure 1: Business Nonfiler Cases Can Go through a Multistage Process 
from Identification to Pursuit: 

Figure 2: Cases Selected for Pursuit Can Take Multiple Paths after 
Receiving First Notice: 

Abbreviations: 

A6020(b): Automated 6020(b) program: 

ACS: Automated Collection System: 

AIR: Aggregated Information Return: 

BMF: Business Master File: 

BMF CCNIP: Business Masterfile Case Creation Nonfiler Identification 
Process: 

CAWR: Combined Annual Wage Reporting: 

CCR: Central Contractor Registration: 

CSCO: Compliance Services Campus Organization: 

D&B: Dun and Bradstreet: 

EIN: Employer Identification Number: 

FERDI: Federal Employee/Retiree Delinquency Initiative: 

FICA: Federal Insurance Contribution Act: 

FPLP: Federal Payment Levy Program: 

IDS: Inventory Delivery System: 

IRM: Internal Revenue Manual: 

IRS: Internal Revenue Service: 

NAP: National Accounts Profile: 

NFEAC: Nonfiler Executive Advisory Council: 

NRP: National Research Program: 

PMF: Payer Master File: 

RAS: Research, Analysis, and Statistics: 

SBSE: Small Business/Self-Employed: 

SRFMI: State Reverse File Match Initiative: 

TIC: Type Indicator Codes: 

TIGTA: Treasury Inspector General for Tax Administration: 

TIN: Taxpayer Identification Number: 

[End of section] 

United States Government Accountability Office:
Washington, DC 20548: 

August 31, 2010: 

The Honorable Max Baucus:
Chairman:
The Honorable Charles E. Grassley:
Ranking Member:
Committee on Finance:
United States Senate: 

In fiscal year 2009, businesses filed 14 million income tax returns 
and 30 million employment tax returns and remitted over $1 trillion in 
federal taxes. While the Internal Revenue Service (IRS) catches some 
nonfilers, it does not know how many businesses failed to file returns 
that they should have filed nor does it have an estimate of the 
business nonfiling tax gap, which is the amount of tax revenue 
associated with returns that were not filed.[Footnote 1] IRS's most 
recent tax gap estimates for tax year 2001 include an estimate of $25 
billion in revenue loss due to nonfiling by individuals. 

The lack of an estimate of the business nonfiling tax gap matters 
because the tax gap estimate is routinely used as a measure of the 
total amount of tax noncompliance IRS needs to address.[Footnote 2] 
Without a tax gap estimate for business nonfiling, there is no way to 
know whether IRS's strategy to reduce the tax gap, including its 
resource allocation decisions, places appropriate priority on this 
type of noncompliance relative to others. Further, nonfiling of 
required tax returns and nonpayment of taxes owed is not fair to 
businesses and individuals who do file returns and pay their taxes. 

Historically, IRS has identified more potential business nonfilers 
than it can thoroughly investigate through its enforcement programs. 
For tax year 2007, IRS had identified almost 2 million businesses as 
potential nonfilers whose cases had not been resolved as of June 2009. 
Until recently IRS has not had a way to prioritize the millions of 
potential nonfiler cases it identifies each year. After several years 
of study IRS modernized its business nonfiler program in 2009 by 
incorporating data about businesses indicating business activity and a 
likely filing requirement. IRS's Business Masterfile Case Creation 
Nonfiler Identification Process (BMF CCNIP) now assigns each case a 
code based on these data. IRS uses the code to select cases to work 
with the goal of securing tax returns from nonfilers and collecting 
additional revenue. 

Because of your interest in IRS's business nonfiler program and IRS's 
use of information returns, you asked us to assess (1) the data 
challenges of estimating the business nonfiler tax gap, (2) how recent 
program changes in IRS's processes and procedures have affected its 
capacity to identify and pursue business nonfilers, and (3) what 
opportunities exist for IRS to improve its use of third-party 
information returns or other sources to identify and pursue business 
nonfilers. 

To meet our report's objectives, we conducted an evaluation involving 
multiple elements including document review, data analysis, and 
interviews. To assess the data challenges of estimating the business 
nonfiler gap, we reviewed GAO and Treasury Inspector General for Tax 
Administration (TIGTA) reports, IRS documents on the tax gap, past 
research on the tax gap and business nonfilers; analyzed IRS 
operational data; and interviewed IRS research officials. To assess 
how recent program changes in IRS's processes and procedures have 
affected its capacity to identify and pursue business nonfilers, we 
reviewed program documents pertaining to IRS's new business nonfiler 
program, portions of the Internal Revenue Manual, and IRS documents on 
its Nonfiler Strategy and its implementation. We also observed IRS's 
collections functions at IRS's Philadelphia service center, and 
interviewed officials involved in the program. To assess what 
opportunities exist for IRS to improve its use of third-party 
information returns or other sources to identify and pursue business 
nonfilers, we identified non-IRS data sources--including government 
contractor data and private third-party data--that could have 
information on business nonfilers and assessed the potential of this 
information to help IRS better identify and pursue business nonfilers. 
We matched closed nonfiler cases from businesses located in California 
and Illinois against Dun and Bradstreet (D&B) data to determine 
whether private sector data could be useful for IRS.[Footnote 3] The 
data we include in our analysis are IRS data from BMF records, the 
Central Contractor Registration (CCR) database, and D&B data. Detailed 
information about our methodology can be found in appendix I. 

We conducted this performance audit from March 2009 through August 
2010 in accordance with generally accepted government auditing 
standards. Those standards require that we plan and perform the audit 
to obtain sufficient, appropriate evidence to provide a reasonable 
basis for our findings and conclusions based on our audit objectives. 
We believe that the evidence obtained provides a reasonable basis for 
our findings and conclusions based on our audit objectives. 

Background: 

IRS Requires Various Types of Tax Returns from Business Entities 
Depending on Their Form and Activities: 

Many businesses, including corporations, partnerships, and any 
business that has employees, are required to request an Employer 
Identification Number (EIN) from IRS to be used in filing returns. 
[Footnote 4] Entities that must file business returns include 
corporations, partnerships, trusts, estates of decedents, and 
government agencies.[Footnote 5] On its EIN application, a business 
gives IRS information about its structure and whether or not it has 
employees. Based on this information, IRS establishes an account for 
the business, notifies the business of its EIN and filing requirement, 
and records its filing requirement on IRS's BMF. The filing 
requirements on the BMF are the basis for IRS's efforts to ensure that 
businesses file their required returns. Businesses may have to file 
several types of returns. A business that does not file the return in 
IRS's records by the due date including any extensions is considered 
by IRS to be a potential nonfiler.[Footnote 6] This is the case 
including where the business has filed a different return than the one 
IRS expects, e.g., where a partnership has restructured itself as a 
corporation and filed a corporate return. (For more information on 
selected business returns and restructuring, see appendix II.)  

Employment taxes from employers and employees account for the largest 
share of revenue collected from businesses. Employment tax returns 
report income taxes withheld on behalf of employees, the employees' 
share of Federal Insurance Contribution Act (FICA) taxes, that is, 
Social Security and Medicare taxes, and the employer's matching share 
of FICA taxes. A business with employees, regardless of its structure, 
is generally required to file employment tax returns. In fiscal year 
2009, IRS collected an estimated $792.8 billion in FICA taxes and 
$880.8 billion in individual income tax withholding, or 71.4 percent 
of all federal tax collections. 

Businesses also may be required to file an annual return reporting 
income and losses. Businesses structured as C corporations[Footnote 7] 
are generally required to file annual income tax returns including 
when they did not have taxable income. C corporations pay the 
corporate income tax.[Footnote 8] Other types of businesses including 
businesses structured as S corporations and partnerships are required 
to also file annual returns, but their income is not taxable at the 
business level.[Footnote 9] Rather, income and losses are generally 
passed through to others, e.g., to the shareholders of an S 
corporation or the partners of a partnership.[Footnote 10] 

Many businesses are also required to file third-party information 
returns about various payments they make. Payments subject to 
information reporting include interest earned from banks, mortgage 
interest paid, wages paid, and some payments to contractors. 

Over 30 types of information returns are filed on businesses. For tax 
year 2008, IRS received 421.5 million such returns. Of these, about 
347.5 million, or about 80 percent of all information returns filed on 
businesses, reported broker and barter transactions (Form 1099B). 
[Footnote 11] IRS also receives information returns on the amount of 
federal contract obligations made to businesses awarded federal 
contracts.[Footnote 12] 

Recent IRS Actions Seek to Address Long-Standing Business Nonfiler 
Issues: 

GAO,[Footnote 13] TIGTA,[Footnote 14] and IRS itself have documented 
long-standing issues with IRS's business nonfiler compliance 
activities. Each year IRS identifies a large number of potential 
business nonfiler cases, more than IRS has the capacity to work. Many 
cases go unresolved, and many that IRS does pursue are closed with a 
determination that the business does not owe IRS a return--a generally 
unproductive use of IRS's enforcement resources. 

In 2005 TIGTA found that IRS's nonfiler efforts for individuals and 
businesses were fragmented and recommended that IRS develop a 
coordinated national strategy. Following TIGTA's report, in August 
2007 IRS adopted a Servicewide Nonfiler Strategy, governed by the IRS 
Enforcement Committee. The Strategy recognized that large inventories 
and pursuit of unproductive business nonfiler cases continued to 
present challenges. The Strategy further noted that IRS did not apply 
resources to more productive business nonfiler cases but rather to 
cases closed with a determination that the taxpayer did not owe IRS a 
tax return. As one of several goals, the Strategy proposed to expand 
the use of third-party information and research tools to enhance 
identification, selection and resolution of nonfiler cases. The 
Strategy also set a goal of developing and implementing consistent 
Servicewide performance and outcome measures to determine the impact 
of its initiatives on filing compliance.[Footnote 15] 

To provide Servicewide oversight for all IRS nonfiler initiatives and 
actions, IRS established the Nonfiler Executive Advisory Council 
(NFEAC), a Servicewide body chartered by the IRS Enforcement Committee 
and consisting of representatives from all IRS divisions. The NFEAC 
was to coordinate nonfiler initiatives across IRS's operating 
divisions. In addition, its mission included developing, monitoring, 
and measuring the effectiveness of the Strategy across all IRS 
divisions. 

Following adoption of the Nonfiler Strategy, IRS developed several 
nonfiler initiatives affecting how it identifies and pursues 
nonfilers. The initiative aimed at addressing long-standing business 
nonfiler issues is the Business Master File Case Creation Nonfiler 
Identification Process (BMF CCNIP). This project, implemented in April 
2009, uses third-party information data and IRS account data to select 
potential business nonfiler cases for pursuit based on the likelihood 
of securing returns and revenue. This change represents a 
modernization of IRS's business nonfiler compliance activities as well 
as the introduction of a concept--use of information return data--we 
have long endorsed.[Footnote 16] (For additional information on IRS's 
process for identifying and pursuing business nonfilers, see appendix 
III.)  

The Nonfiler Strategy also envisioned that IRS would use state data in 
its nonfiler activities. IRS officials told us that IRS originally 
planned to expand BMF CCNIP to include use of state tax information in 
its business nonfiler activities, ultimately from IRS's State Reverse 
File Match Initiative (SRFMI), an initiative aimed at matching state 
and federal taxpayer data to identify noncompliance with federal tax 
law by individual and business taxpayers.[Footnote 17] Another 
expansion was to develop business rules that would close cases where 
filing requirements no longer existed. At the time we finished our 
work, no documentation was available on the planned expansions, and 
IRS officials told us that these were on hold pending funding. 

A Comprehensive Estimate of the Business Nonfiling Tax Gap May Be 
Infeasible, but IRS Operational Data Could Provide Partial Information: 

According to IRS, the primary challenge for IRS in developing a 
business tax gap estimate is a lack of data. IRS officials told us IRS 
has no plans to develop a business nonfiler estimate due to a lack of 
the necessary data. They said that IRS's tax gap estimates for 
individual and estate nonfiling were comprehensive,[Footnote 18] but 
data similar to that used in those estimates do not exist for 
businesses. According to IRS officials we spoke with and an expert on 
tax gap estimation issues we consulted, no comparable population data 
set of all U.S. businesses exists and developing one would be very 
expensive. IRS officials we spoke with identified a number of 
alternative methods for conducting a comprehensive study of the 
business nonfiler tax gap, but also stated that these studies would be 
costly, overly complex, or inconsistent with other estimates. 

We agree that a comprehensive approach may not be feasible, but there 
may be ways IRS could build a partial estimate of business nonfilers. 
A partial estimate could be based on IRS's inventory of over 40 
million potential nonfiler cases. IRS does not know what share of its 
inventory represents instances of actual nonfiling. On the basis of 
IRS's historical experience, many of the businesses in the inventory 
do not have a current filing requirement. For example, they may have 
closed, merged with another business, no longer have employees, or 
filed under a different EIN. Table 1 shows IRS's inventory for 
selected business return types. 

Table 1: IRS's Inventory of Potential Business Nonfiler Cases by 
Selected Return Type as of the End of Calendar Year 2009: 

Number of potential cases: 
Employment tax (Form 941): 25,315,033; 
Unemployment tax (Form 940): 3,878,431; 
Corporate income tax (Form 1120): 5,080,271; 
Partnership return (Form 1065): 3,825,244; 
Estate tax return (Form 1041): 5,668,713; 
Excise tax return (Form 720): 346,971. 

Source: IRS. 

Notes: In this table, a case involves an instance of nonfiling of one 
return. Cases shown are in the BMF CCNIP inventory, which includes all 
identified instances of business nonfiling whether or not selected for 
pursuit.  

[End of table]  

IRS could estimate the extent of actual nonfiling among businesses 
with EINs by taking a sample of each type of return, such as C and S 
corporation returns, from this inventory and thoroughly investigating 
them. The results would not be comparable to IRS's estimate for 
individual nonfiling because they would not include businesses not 
already in the inventory, but this study would begin to quantify the 
extent of business nonfiling and could give IRS a better basis to 
decide what priority it should place on this type of noncompliance. 
Despite its limitations, this type of estimate could give IRS 
information that would be useful in its long-term strategic planning. 
If done with a sufficient sample size, IRS could determine the 
characteristics of nonfiling entities and use this information to make 
changes to its nonfiler compliance activities as appropriate. On the 
basis of the results of this work, IRS could then decide whether the 
benefits of a larger study to quantify the revenue impact of business 
nonfiling would outweigh the costs. 

More Performance Information and Evaluation Is Needed to Measure the 
Success of IRS's Business Nonfiler Program: 

As previously noted, IRS has already taken actions to address the long-
standing issues presented by business nonfilers. The BMF CCNIP 
represents a significant modernization of IRS's business nonfiler 
compliance program. BMF CCNIP's use of information return and account 
data for the first time gives IRS a way to identify those potential 
nonfilers most likely to be active businesses. Prioritizing business 
nonfiler cases based on information return and account data could 
increase productivity without any increase in resources. In addition 
to the BMF CCNIP, IRS has developed overall performance measures that 
could be used to gauge the success of the full range of its business 
nonfiler compliance activities, from identification through case 
selection through pursuit by IRS's collections functions. However, IRS 
does not have all the information it needs to know how well the new 
initiative is working. 

Information on the Results of IRS's New Modernized Business Nonfiler 
Program Is Not Yet Available: 

As the BMF CCNIP was being designed, IRS developed goals and measures 
that could be used to assess its progress. A key goal for the BMF 
CCNIP was a 50-percent reduction in the number of unproductive cases. 
[Footnote 19] This was based on an IRS research finding that where 
businesses had information return data, closures of cases as "not 
liable to file a return" were reduced by 50 percent. In 2006, IRS 
developed a Performance Management Plan for the BMF CCNIP which 
established performance measures aligned to the IRS Strategic Plan and 
identified sources of data that could be used to monitor the goals. 
This plan stated that baseline data to track progress towards goals 
would be from 2005. 

IRS officials told us that BMF CCNIP management reports and data 
needed to gauge program performance were not yet available. A key 
report that will show information on resolution type for each case, 
selection code, return type, whether the return was secured, and 
revenue collected with the return was planned. IRS plans to use the 
report in assessing the effectiveness of the selection codes and 
tracking the volume of cases closed as not liable to file a return. 
Officials did not know when the report would be available. As of June 
2010, BMF CCNIP staff were working on developing the specifications 
for this report, and no deadline for its completion had been set. BMF 
CCNIP management reports that were operational at the time we finished 
our work were being used to monitor workload, for example, by return 
type, selection code, and the IRS service center that processed the 
case. In discussing plans to assess the BMF CCNIP, officials also said 
that using data from before the start of the CCNIP would be difficult 
and baseline program data to track progress would come from 2010. 

IRS officials said that until additional BMF CCNIP management reports 
are developed they were using other routine reports to monitor the 
response rate to business nonfiler notices as an indicator of BMF 
CCNIP effectiveness. Officials said the response rate to notices had 
doubled since the start of BMF CCNIP, increasing from about 15 percent 
to about 30 percent. Officials interpreted this increase as showing 
that the new system is having a positive impact but noted that it was 
too soon to identify a trend. 

IRS Has Performance Information for Its Individual Nonfiler Program 
but Not for Its Business Nonfiler Program: 

In addition to measures specific to the BMF CCNIP, IRS has also 
developed four Servicewide performance and outcome measures for IRS's 
nonfiler activities overall. As of December 2009 IRS had data for its 
four performance measures for its individual nonfiler program 
including trend data going back to fiscal year 2005. At the time we 
finished our work, IRS did not have comparable information on business 
nonfilers it could use to identify trends, assess how well the new 
initiative is working, or decide whether adjustments needed to be made. 

* Voluntary filing rate. The voluntary filing rate is defined as the 
total number of required returns filed on time divided by the 
estimated number of returns required to be filed. At the time we 
finished our work IRS had not estimated a voluntary filing rate for 
business nonfilers. As discussed earlier in this report, no data set 
for the population of all U.S. businesses exists that could be used to 
estimate the tax gap for businesses or the total number of business 
returns that should have been filed. 

* Percentage of returns secured. This measure is calculated by 
dividing the total number of nonfiler returns secured during the 
fiscal year by the total number of nonfiler cases closed. IRS 
originally planned to develop management reports on business nonfiler 
cases comparable to the management reports it uses to calculate this 
measure for individual nonfiler cases. Developing the business 
reports, however, presented technical difficulties. At the time we 
finished our work IRS was planning to use BMF CCNIP management reports 
not yet developed as the data source. 

* Repeater rate. Under the Servicewide definition established by the 
NFEAC, a repeat nonfiler is defined as a current-year nonfiler that 
was also a nonfiler in any year of a 2-year look-back period. IRS's 
automated systems do not track repeat nonfiling by businesses. IRS has 
identified recidivism as a significant problem among individual 
nonfilers but has no way to know if this is also a problem among 
businesses.[Footnote 20] If it is, IRS will not be able to assess the 
effect of current and planned changes to its business nonfiler 
compliance activities on repeat business nonfiling due to a lack of 
baseline data. 

* Efficiency rate. The efficiency rate is calculated by summing all 
individual and business nonfiling closed cases and dividing by the 
number of staff-years expended. IRS officials told us efficiency is 
calculated on a combined basis because IRS does not differentiate 
between individual and business cases when tracking staff time 
expended. IRS's Servicewide nonfiler efficiency measure does include 
data on business nonfilers, but without separate business and 
individual measures, IRS has no way to compare the relative efficiency 
of the two types of cases. 

At the time we finished our work IRS officials told us they planned to 
put BMF measures on the agenda for the September 2010 NFEAC meeting. 
However, it is not clear whether the meeting will include setting a 
deadline for developing such measures. 

IRS Is Monitoring the Use of Selection Codes but Does Not Yet Have a 
Formal Plan to Evaluate Them: 

Selection codes are a key feature of the BMF CCNIP because they 
distill the business information that IRS has on a case into a 
prioritized code. Since IRS seeks to reduce the number of cases closed 
as "not liable to file a return," the design and priority order of the 
codes are important to program success. If selection codes do not 
accurately identify businesses with a greater potential for securing 
delinquent returns and generating more revenue, the proportion of 
unproductive cases may not decline. 

IRS did not test or evaluate the selection codes prior to the 
beginning of the BMF CCNIP in April 2009. Rather, IRS developed the 
selection codes using input from those in the agency with knowledge of 
business nonfiler activity. According to those involved in the 
process, selection codes were developed through discussions among IRS 
staff working on business nonfiler programs and included 
representation from multiple IRS business operating divisions. 
However, IRS did not conduct a formal study or pilot test to aid in 
designing the selection codes. 

Since BMF CCNIP implementation, IRS has been monitoring the selection 
codes including changes in the number of taxpayer responses to 
notices. According to IRS officials, BMF CCNIP issues are discussed at 
two annual meetings. One meeting concerns coordinating workflow for 
both business and individual nonfiler programs, and the other is a 
meeting of BMF CCNIP stakeholders where work plans are reviewed and 
any changes to the system including to the selection codes are 
discussed. IRS has made some changes to refine the selection codes but 
has not formally evaluated them. As a result, IRS does not know if the 
changes improved the codes, nor do they have a basis for knowing 
whether they now have an optimum set. A more formal and extensive 
evaluation could give IRS data to identify any need to change 
selection code priority, or create new or redefine existing selection 
codes. Our past work has shown that evaluations are beneficial in 
generating information to guide program decisions.[Footnote 21] IRS's 
Performance Measures Plan for the program identifies many of the 
components of an evaluation including goals for the program and 
potential data sources to monitor it. However, this plan does not 
present a method for conducting an evaluation or a timeline for its 
completion. 

IRS officials told us they plan to revisit the selection codes and 
evaluate the BMF CCNIP in the future, but they have no formal 
evaluation plan or timetable. They told us that it was too early to 
evaluate the BMF CCNIP due to the time needed for a case to go through 
all the stages of pursuit. According to the officials, the earliest 
date when complete information would be available to analyze the 
effectiveness of the BMF CCNIP would be 2011. Those directly involved 
with the BMF CCNIP said that choices of selection codes in weekly case 
selection were being made with an evaluation in mind, so they attempt 
to select cases for pursuit from a wide variety of selection codes. In 
our analysis of fiscal year 2009 management report data, we found that 
cases had been selected from across most selection codes. This 
practice may provide useful data but without a formal evaluation, IRS 
will not know how the selection codes are affecting the program 
outcomes. 

Refinements to Closing Codes Could Provide More Information on Why 
Businesses That Did Not Owe a Return Were Identified as Potential 
Nonfilers: 

When a nonfiler case is closed, IRS collections staff use a two-digit 
closing code that in some instances provides information on why a case 
was closed. For some types of cases closed as not liable to file a 
return, the closing code may explain why. For example, a case can be 
closed as not liable to file for the period in question because the 
business was identified as a subsidiary and the parent company filed 
the return. A case may also be closed as not liable to file if IRS 
determines that little or no tax is due from the business. Each of 
these situations has a separate and distinct two-digit closing code. 
In contrast, there are other closing codes that do not specify why the 
case was closed as not liable to file. These types of closing codes 
specify which collections function closed the case but do not provide 
any additional information. Our analysis of IRS management data shows 
that of the cases closed as not liable to file in fiscal year 2009, 65 
percent were assigned closing codes that do not indicate the reason 
the case was closed. 

More detailed closing code information could be useful to IRS by 
providing information on business nonfiler cases that it currently 
lacks. IRS's closing codes do not specify many of the reasons that a 
case could be closed as not liable to file. For example, a business 
may no longer be operational but may have failed to indicate to IRS 
that its last return was a final return. IRS does not have closing 
codes for other types of situations, such as when a business has 
changed its structure but failed to notify IRS or where a business 
does not have employees for a given tax period but failed to indicate 
on its last filed employment tax return that it is a seasonal 
employer. Because there are no closing codes indicating these reasons 
for case closure, IRS does not know the extent to which these 
situations are a problem and it cannot begin to identify actions that 
might reduce their frequency. 

Developing more detailed closing codes could provide data that would 
be valuable in program evaluation. Depending on results, the data 
might also lead to education and outreach activities targeted at 
reducing the number of identified business nonfilers. For example, 
better information on case closing decisions might identify a need to 
improve guidance or forms. 

IRS Could Improve Business Nonfiler Case Closure Decisions through 
Additional Use of Information Returns and External Data: 

Selection Codes Can Help Verify Business Activity When Closing Cases: 

Under BMF CCNIP, information returns play an important role in 
selecting potential nonfiler cases for investigation because they are 
good indicators of business activity. Information returns also play an 
important role in making case closure decisions on whether a business 
is liable to file a return. The Internal Revenue Manual (IRM) requires 
that, before closing a case as not liable to file a return, IRS 
collection staff are to do a full compliance check including checking 
whether information returns and other IRS records indicate business 
activity. For example, where a business taxpayer claims to not be 
operational for the tax period under investigation, collections staff 
are to review information returns to determine if there was business 
activity. If this check of information returns showed that there was 
business activity, staff is not to close the case until more research 
is performed. 

BMF CCNIP selection codes are concise indicators of what IRS knows 
about a business's activity including its information return income. 
For this reason, the codes have potential to be helpful to collections 
staff when closing cases. Selection codes are readily available on the 
computer screens that IRS collections staff use to research cases and 
record case closings. Selection codes can therefore be used to check 
taxpayers' claims that they do not owe a return. If the selection code 
indicates business activity, this could help guide IRS enforcement 
staff in doing the full compliance check. In December 2009 IRS updated 
the IRM to include a statement that staff should refer to the 
selection code to assist them in determining whether a taxpayer is 
liable to file a return. A 2008 tax examiner training manual also 
provided guidance on how to effectively use selection codes. 

Our analysis of nonfiler cases that were selected for work prior to 
the implementation of BMF CCNIP and that were mostly closed in 2008 
and 2009[Footnote 22] suggests that full compliance checks may not 
have been done to the fullest extent possible, since cases with 
information return income were closed as not liable to file a return. 
As shown in table 2, 39,931 tax year 2007 partnership and corporation 
cases[Footnote 23] with information return income totaling over $193 
billion were closed as not liable to file returns.[Footnote 24] 

Table 2: Number of Partnership and Corporation Tax Year 2007 Nonfiler 
Cases Closed As Not Liable to File Returns: 

Business type: Partnerships; 
Number of cases: 19,592; 
Amount of information return income: $113.5 billion. 

Business type: C corporations; 
Number of cases: 16,018; 
Amount of information return income: $65.3 billion. 

Business type: S corporations; 
Number of cases: 4,321; 
Amount of information return income: $14.7 billion. 

Business type: Total; 
Number of cases: 39,931; 
Amount of information return income: $193.5 billion. 

Source: GAO analysis of IRS data.  

[End of table]  

It is difficult to determine whether knowing that a business had 
information return income would have led to different case closure 
decisions. About 90 percent of the cases shown in table 2 were closed 
without any explanation.[Footnote 25] Although these results in table 
2 do not indicate that these cases were closed inaccurately, they do 
call into question the extent to which IRS staff took into 
consideration information return income data when making decisions to 
close cases. While information return income does not indicate the 
amount of tax due, it does indicate business activity, meaning that 
some of these businesses may have been required to file returns and 
pay taxes. 

Our observations shortly after BMF CCNIP implementation and prior to 
the IRM update at one of the five IRS service centers that process 
business nonfiler cases suggest selection codes were not being used in 
closing cases. Tax examiners we spoke with had mixed awareness of the 
BMF CCNIP and selection codes. Although the staff was able to view the 
codes, tax examiners we observed during our site visits did not use 
selection codes nor view information returns when making decisions to 
close cases. 

With the December 2009 revisions to the IRM, tax examiners are 
instructed to use selection codes as indicators of business activity 
when doing their full compliance checks. However, in the past they 
were instructed to use information returns for these checks. Our 
analysis shows that cases were closed in spite of the fact that 
information returns showed business activity. To the extent that staff 
do not make full use of the potential of selection codes and 
information returns, opportunities may likely be missed to secure tax 
returns and collect revenue from business nonfilers. 

Private Sector Data on Business Activity May be Useful in Deciding 
Whether Businesses Are Liable for Filing Delinquent Returns: 

As discussed earlier, information return data are good indicators of 
business activity, but not all payments for goods and services are 
subject to information return reporting and not all businesses receive 
information return income. According to IRS data, about 19 percent of 
its business nonfiler inventory had selection codes that reflect third-
party information. This number should increase once information return 
requirements for reporting businesses credit card payments go into 
effect in 2012 and requirements for reporting service payments made to 
corporations go into effect in 2013. Even after these payments are 
reported to IRS, certain other payments made with cash or by check 
will not be subject to information reporting. However, there are a 
number of private sector companies that maintain business activity 
data, such as data on a business's gross sales and number of 
employees, which might help IRS identify business nonfilers and help 
it determine whether a business is required to file tax returns. While 
IRS does not use private sector data to help it determine whether a 
business should file a tax return, it does have contracts with private 
sector companies for locating taxpayers' assets and obtaining credit 
reports on taxpayers that can be used by its collection field staff 
during their investigations.[Footnote 26] 

To test whether private sector data on business activity could be 
useful for determining whether businesses are liable for filing tax 
returns, we matched tax year 2007 nonfiler cases that IRS closed as 
not liable to file returns with a calendar year 2007 Dun & Bradstreet 
(D&B) database of businesses located in California and Illinois. Our 
test results showed that there were a total of 40,223 cases in those 
two states that IRS closed as not liable to file returns where there 
was a match on name and address between IRS and D&B records.[Footnote 
27] Of the 40,223 cases, 9,740 were for corporation and partnership 
delinquent returns and the remaining 30,483 were for delinquent 
employment tax returns. Of the 9,740 partnership and corporation 
cases, 7,688 cases had either little or no information return income 
but, as shown in table 3, had D&B total sales of about $4.1 billion. 
[Footnote 28] 

Table 3: California and Illinois Partnership and Corporation Nonfiler 
Cases Closed as Not Liable to File in Tax Year 2007 with Gross Sales: 

Business type: Partnerships; 
Number of active businesses: 2,658; 
Total sales for active businesses: $1.3 billion. 

Business type: C corporations; 
Number of active businesses: 4,366; 
Total sales for active businesses: $2.5 billion. 

Business type: S corporations; 
Number of active businesses: 664; 
Total sales for active businesses: $0.4 billion. 

Business type: Totals; 
Number of active businesses: 7,688; 
Total sales for active businesses: $4.1 billion. 

Source: GAO analysis of IRS and D&B data.  

[End of table]  

Since these 7,688 cases had little or no information return income, 
IRS would have had little if any business activity data on which to 
make decisions on whether the businesses were liable to file returns. 
Private sector data, such as the D&B sales data, could fill that void. 

Of the 30,483 employment tax cases that were closed as not liable to 
file employment (Form 941) and unemployment (Form 940) tax returns, 
4,523 cases had employees according to D&B data. Table 4 shows that 
these 4,523 businesses had a total of 11,418 employees in calendar 
year 2007, which indicates that they may have been required to file 
employment tax returns. 

Table 4: California and Illinois Employment Tax Cases Closed as Not 
Liable to File in Tax Year 2007 with Gross Sales: 

Type of form: 941; 
Number of businesses with employees: 3,015; 
Total number of employees: 7,836; 
Total sales for businesses with employees: $8.4 billion. 

Type of form: 940; 
Number of businesses with employees: 1,508; 
Total number of employees: 3,582; 
Total sales for businesses with employees: $3.8 billion. 

Type of form: Totals; 
Number of businesses with employees: 4,523; 
Total number of employees: 11,418; 
Total sales for businesses with employees: $12.2 billion. 

Source: GAO analysis of IRS and D&B data.  

[End of table]  

Under BMF CCNIP, IRS identifies potential nonfilers when the Business 
Master File records for the businesses indicate that they have a 
requirement to file returns. If the BMF does not indicate a filing 
requirement, then a potential nonfiler case would not be developed. To 
determine whether businesses with no BMF filing requirements may be 
liable for filing returns, we matched business entities that had been 
established on IRS's Business Master File in 2006 that had no filing 
requirements to D&B calendar year 2007 records of businesses that had 
California and Illinois addresses. The results of the match showed 
that 39,920 cases matched the names and addresses on both the IRS and 
D&B records. Table 5 shows that 39,920 cases had total sales of $29.5 
billion and 4,185 of the 39,920 cases had a total of 16,869 employees. 

Table 5: California and Illinois Cases with No Filing Requirements 
Indicated in the BMF That Had Sales and Employees: 

(dollars in billions). 

Type of case: Cases without employees; 
Number of cases: 35,735; 
Total sales: $9.2 billion; 
Number of employees: 0. 

Type of case: Cases with employees; 
Number of cases: 4,185; 
Total sales: $20.3 billion; 
Number of employees: 16,869. 

Type of case: Totals; 
Number of cases: 39,920; 
Total sales: $29.5 billion; 
Number of employees: 16,869. 

Source: GAO analysis of IRS and D&B data.  

[End of table]  

These data indicate that the businesses were active in 2007 and that 
the businesses might have been liable for filing income tax or 
employment tax returns. Taxpayer contact would have to be made in 
order to determine whether the businesses were liable to file returns. 

Federal Contract Data May Be Useful in Identifying Federal Contractors 
Who Owe Tax Returns: 

In addition to examining potential private sector data, we also 
examined the Central Contractor Registration (CCR) file, which 
contains self-reported revenue and employment data on businesses that 
register annually to be awarded federal contracts, to determine 
whether it could be used by IRS in its business nonfiler program. This 
database generally dealt with federal contracts so its usefulness 
would be limited to the subset of the total business nonfiler 
population that had registered for federal contract consideration. 
[Footnote 29] 

We matched the calendar year 2007 CCR file, which contained over 
400,000 registrants nationwide, to the tax year 2007 partnership, 
corporation, and employment tax cases that were closed as not liable 
to file returns. This match showed that there were 3,589 entities on 
the CCR file with reported revenue that were closed as not liable to 
file partnership (1,210 cases) or corporation (2,379 cases) returns. 
The match also found that 10,263 entities on the CCR file reported 
that they had employees that were closed as not liable to file either 
Forms 941 (8,694 cases) or Forms 940 (1,569 cases). 

The above data show that there are a number of federal contractors 
with income that IRS closed as not liable to file returns. As noted 
earlier, in many cases IRS's records do not indicate the specific 
reason for closing a nonfiler case; therefore, we do not know why 
these cases were closed when the CCR data indicate that they may have 
been required to file returns because they had indications of business 
activity. 

IRS does not give a high priority to potential business nonfilers that 
receive federal contracts when it selects business nonfiler cases for 
review but does so for federal workers and retirees who fail to file 
tax returns under its Federal Employee/Retiree Delinquency Initiative 
(FERDI) program. This program was developed in 1993 by IRS to promote 
federal tax compliance among current and retired federal employees. 
FERDI cases are given a specific priority selection code and are 
subject to the full range of compliance treatments, including return 
delinquency notices and field investigations. According to IRS data, 
in fiscal year 2009, IRS closed over 100,000 FERDI cases. 

IRS recognizes that businesses receiving federal contracts should be 
identified and that appropriate and timely actions should be taken to 
ensure they remain in full compliance with federal tax laws.[Footnote 
30] IRS also has delinquent return procedures that address federal 
contractors. IRS has special procedures for investigating federal 
contractors who have been or will be awarded a contract by the IRS and 
who owe both outstanding taxes and tax returns. These procedures do 
not apply to federal contractors who only have unfiled returns. Also, 
according to IRS, during field return delinquency investigations, 
revenue officers are instructed to determine on initial contact with 
all taxpayers if the taxpayer is a federal contractor and, if so, to 
take prompt action to secure any delinquent business returns including 
their delinquent taxes. 

Also, unlike federal employees and retirees covered by the FERDI 
program, federal contractor cases do not have a specific nonfiler 
selection code, which could give them a priority ranking at the 
beginning of the investigation process. Currently, IRS has an 
indicator on its Business Master File that identifies businesses that 
have federal contracts, but it is not used to prioritize federal 
contractor nonfiler cases. The source of the BMF federal contractor 
indicator is Form 8596 (Information Return for Federal Contracts), 
which certain federal executive agencies are required to file 
quarterly to report information about persons with whom they have 
entered into contracts.[Footnote 31] 

Since IRS already has a federal contractor indicator on its Master 
File records, it may be able to cost-effectively develop a specific 
nonfiler selection code that would give these cases a higher priority 
in its nonfiler program. 

Conclusions: 

Identifying and pursuing nonfilers including businesses is a key part 
of IRS's enforcement efforts. Absent a robust nonfiler program, 
compliant taxpayers will not have confidence that others are paying 
their fair share. IRS has faced several challenges in its business 
nonfiler program. IRS generally identifies more potential nonfilers 
than it can thoroughly investigate, and many of those it does 
investigate turn out not to owe the return IRS expects based on its 
records. Our analyses suggest IRS cannot be sure these types of cases 
are all being closed correctly. 

IRS has significantly improved its business nonfiler efforts by 
developing and implementing the BMF CCNIP. This initiative gives IRS 
for the first time a way to set priorities among its voluminous 
inventory by making use of information return and other IRS data to 
predict the likelihood that IRS will secure additional returns and 
revenue. This initiative should help IRS choose cases to work, but 
without an estimate of the business nonfiler tax gap, IRS does not 
have a data-driven basis for allocating resources to its business 
nonfiler efforts. 

While IRS has made good progress in implementing BMF CCNIP, it has not 
calculated the performance measures or planned the evaluations it 
would need to assess success. IRS also has little data on why it 
identifies millions of potential business nonfilers only to find that 
many of them do not owe IRS the return IRS is expecting based on its 
records. Absent better information on cause, IRS may continue to 
expend resources on too many unproductive cases, leading to 
unnecessary taxpayer burden. Until and unless IRS has better 
information, it will not be able to measure its success or identify 
the best ways to continue to move in the right direction. 

While IRS is gathering data needed to manage the program, it can also 
explore opportunities to build on what it has already achieved. IRS 
could leverage the information in the BMF CCNIP selection codes by 
using them to help verify taxpayers' claims that they do not owe a 
return because they have gone out of business. IRS could also explore 
adding non-IRS data to the BMF CCNIP. Private sector and federal 
contractor data on business activity would give IRS more third-party 
information and enlarge the capacity of the BMF CCNIP to identify 
active businesses, thereby potentially leading to fewer cases being 
closed as not liable to file a return. 

Recommendations for Executive Action: 

We recommend that the Commissioner of Internal Revenue take the 
following eight actions: 

Understanding the Scope of the Business Nonfiler Population: 

* Estimate the magnitude of business nonfiling among businesses 
registered with IRS, using data from its operational files to select 
cases for further investigation. Based on the results of this work IRS 
should develop a tax gap estimate for the impact of business nonfiling 
insofar as doing so is cost-effective. 

Monitoring the Performance of Business Nonfiler Activities: 

* Set a deadline for developing data that can be used to measure the 
performance of the BMF CCNIP and its business nonfiler compliance 
activities overall. 

* Develop a separate efficiency measure for business nonfilers insofar 
as doing so is cost-effective. 

* Develop an evaluation plan for the BMF CCNIP selection codes, 
including both an initial evaluation and an ongoing monitoring plan, 
and conduct an evaluation based on this plan. Results from the study 
and the ongoing monitoring could be used to refine the selection codes 
to improve the effectiveness of the program. 

Identifying Additional Actions to Help Achieve the Goal of Fewer 
Unproductive Cases: 

* Add closing codes that would better indicate all known causes for 
"not liable to file" determinations and use this information to 
analyze causes of unproductive cases and use them as appropriate to 
identify any actions IRS could take either administratively or through 
education and outreach that could reduce the number of business 
nonfiler cases where the filing requirement in IRS's records is not 
applicable. 

Ensuring That IRS Does Not Inappropriately Close Cases as Not Liable 
to File Returns: 

* Reinforce to collections staff the need to check for business 
activity using information return data and selection codes. 

* Study the feasibility and cost-effectiveness of using private sector 
business activity data and federal contract data to make a 
determination of whether federal contractors and other businesses are 
liable for filing tax returns. 

Ensuring Federal Contractors Comply with Filing Requirements: 

* Establish a process similar to the FERDI program for federal workers 
and retirees that will give a high priority to businesses identified 
as potential nonfilers that have federal contracts. 

Agency Comments and Our Evaluation: 

We provided a draft of this report to the Commissioner of Internal 
Revenue. We received written comments from the Deputy Commissioner 
which are reprinted in appendix IV. IRS agreed that identifying and 
pursuing active business nonfilers is key to enforcement efforts and 
acknowledged that our recommendations could assist these efforts. IRS 
agreed with four of our eight recommendations and indicated as 
discussed below some steps it would take to address the other four. 

With respect to our recommendation that IRS should estimate the 
magnitude of business nonfiling by selecting cases from its 
operational files for further investigation, IRS agreed to collect and 
report additional data on the number of delinquent business returns 
identified by its operational programs and the dollars assessed. IRS 
indicated that such data may overstate the extent of nonfiling because 
they would include cases such as businesses that filed returns under a 
parent entity. The intent of our recommendation, however, was to have 
IRS develop an estimate of the number of businesses that were actually 
liable for filing returns, which would exclude businesses that were 
not liable to file returns. It is not clear from IRS's response 
whether it intends to do the study we recommended or if IRS plans to 
report only the results currently available from its business nonfiler 
program. Our recommendation was that IRS draw a sample of potential 
business nonfilers and thoroughly investigate those cases to estimate 
the number of actual business nonfilers in IRS's business nonfiler 
inventory. 

With respect to our recommendation that IRS develop an evaluation plan 
for the BMF CCNIP selection codes, IRS identified monitoring 
activities for its new BMF CCNIP report as well as additional 
information that could be used to evaluate the program. IRS also said 
that data should not be studied until they are complete and available, 
which IRS estimates to be by the end of fiscal year 2011. We 
acknowledged many of IRS's monitoring activities in our report but 
these do not constitute an evaluation plan that would identify a 
method for conducting an evaluation and a timeline for its completion. 
We recognize that time will be needed for cases to complete the 
collections process and did not propose a timeline for IRS to complete 
its evaluation. Our recommendation addressed the need for IRS to 
develop an evaluation plan for the BMF CCNIP selection codes, 
including both an initial evaluation and an ongoing monitoring plan, 
and conduct a study based on this plan. 

With respect to our recommendation that IRS should study the 
feasibility and cost-effectiveness of using private sector business 
activity data and federal contract data, IRS agreed to evaluate the 
effectiveness of data mining using the Central Contractor Registration 
database but did not agree to study the feasibility of using private 
sector data. IRS stated that a study initiated in fiscal year 2009-- 
which IRS did not provide to us during the course of our audit work-- 
concluded that it would be difficult to quantify benefits because 
there is not an automated way to effectively match Taxpayer 
Identification Numbers to purchased lists of business names. IRS's 
response, however, does not address our analysis illustrating the use 
of private sector data in our report, which showed that using such 
data was not only possible but potentially beneficial. While we cannot 
determine the revenue implications of these cases including whether 
potential revenue would exceed IRS's threshold, our analysis shows 
that private data can provide information not now available to IRS on 
the business activity of potential nonfilers. For this reason, we 
continue to recommend that IRS further explore the feasibility and 
cost-effectiveness of private sector business activity data. 

With respect to our recommendation that IRS establish a process for 
federal contractors similar to the process established by its FERDI 
program for individuals, IRS agreed to explore the feasibility of 
establishing a system for prioritizing and routing federal contractor 
nonfiler cases through its current Inventory Delivery System. IRS also 
stated that it is working on further actions--including implementing 
legislative changes--that will identify noncompliant federal 
contractors. IRS stated that a federal contractor with an unfiled 
employment tax return is a high priority in the case selection 
process. While employment tax cases are prioritized in IRS's case 
selection process, federal contractors do not receive higher priority 
than nonfederal contractors because there is no selection code 
specifically aimed at federal contractors. Since IRS already has a 
federal contractor indicator on its Master File records, our 
recommendation was based on the assumption that IRS could cost 
effectively develop a specific nonfiler selection code that would give 
these cases a higher priority. 

As agreed with your offices, unless you publicly announce its contents 
earlier, we plan no further distribution of this report until 30 days 
from its issue date. At that time, we will send copies to the Chairman 
and Ranking Member, House Committee on Ways and Means; the Secretary 
of the Treasury; the Commissioner of Internal Revenue; and other 
interested parties. This report will be available at no charge on the 
GAO Web site at [hyperlink, http://www.gao.gov]. 

If you or your staff have any questions, please contact me at (202) 
512-9110 or whitej@gao.gov. Contact points for our Offices of 
Congressional Relations and Public Affairs may be found on the last 
page of this report. Key contributors to this report are listed in 
appendix V.  

Signed by:  

James R. White: 
Director, Tax Issues: 
Strategic Issues Team: 

[End of section] 

Appendix I: Scope and Methodology: 

The objectives of this report were to assess (1) the data challenges 
of estimating the business nonfiler tax gap, (2) how recent program 
changes in the Internal Revenue Service's (IRS) processes and 
procedures have affected its capacity to identify and pursue business 
nonfilers, and (3) what opportunities exist for IRS to improve its use 
of third-party information returns or other sources to identify and 
pursue business nonfilers. 

To assess the data challenges of estimating the business nonfiler tax 
gap, we reviewed IRS documents and prior GAO and Treasury Inspector 
General for Tax Administration (TIGTA) reports that dealt with tax gap 
measurement and IRS's National Research Program, which develops data 
for use in making estimates of the tax gap relating to tax reporting 
noncompliance. We analyzed Business Master File Case Creation Nonfiler 
Identification Process (BMF CCNIP) inventory data to determine the 
number of potential business nonfilers IRS identifies and analyzed 
IRS's fiscal year 2009 Collection Activity Reports to determine the 
number of business nonfiler cases IRS closed as not liable to file 
returns. We interviewed IRS research officials from the Small 
Business/Self-Employed (SBSE) and the Research, Analysis, and 
Statistics (RAS) Divisions on the types of data that would be needed 
to develop a business nonfiler tax gap estimate and the problems 
associated with obtaining such data. 

To assess how recent program changes in IRS's processes and procedures 
have affected its capacity to identify and pursue business nonfilers, 
we reviewed program documents pertaining to BMF CCNIP. These documents 
dealt with the cost and benefits of the program; program evaluation 
and performance measurement processes; and procedures for identifying, 
prioritizing, selecting, working, and closing business nonfiler cases. 
We also reviewed Internal Revenue Manual (IRM) sections dealing with 
handling taxpayer responses to delinquent return notices and 
procedures for closing business nonfiler cases and IRS documents on 
its Nonfiler Strategy and its implementation. We interviewed IRS 
officials from SBSE to understand the various operational features and 
processes associated with the BMF CCNIP. To understand how IRS handles 
responses to delinquent return notices from businesses, we observed 
IRS's collections functions at IRS's Philadelphia service center. 

To assess what opportunities exist for IRS to improve its use of third-
party information returns or other sources to identify and pursue 
business nonfilers, we identified non-IRS data sources--including 
government contractor data and private sector data--that could have 
information on business nonfilers and assessed the potential of this 
information to help IRS better identify and pursue business nonfilers. 
To test whether information return income could be useful in making 
case closure decisions under BMF CCNIP, we matched IRS's calendar year 
2007 Aggregated Information Return (AIR) file, which is used in BMF 
CCNIP and contained summaries of information returns that were 
received by IRS, to IRS's Nonfiler Measurement file that contained 
data on all tax year 2007 cases that were closed as not liable to file 
partnership (Form 1065) and corporation (Form 1120) returns. We 
limited our analysis to tax year 2007 cases that had information 
return income of $1,000 or more. According to IRS officials, tax year 
2007 business nonfiler cases were selected prior to the implementation 
of BMF CCNIP. Our analysis showed that about 96 percent of the cases 
were closed in 2008 and 2009 while the remaining 4 percent were closed 
in 2007 and 2010. In doing this match we eliminated all cases that 
were closed because they were subsidiaries of other businesses and 
thus would not have been required to file returns under their Employer 
Identification Numbers (EIN). We did not follow up on any of the 
closed cases to determine whether using the information return income 
data would have resulted in a closure different than not liable to 
file a return. To determine whether these businesses would have been 
liable to file returns would have required IRS to reinvestigate the 
cases. To determine whether the data in IRS's Nonfiler Measurement 
file were of sufficient reliability for our analysis, we reviewed the 
program documentation associated with the file and discussed the 
various data elements with the IRS staff responsible for the file. As 
a result of our review and discussions, we determined that the data in 
this file were of sufficient reliability to be used in our analysis. 

To test whether private sector data on business activity could be 
useful for determining whether businesses may be required to file 
partnership, corporation, and employment tax returns, we matched IRS's 
tax year 2007 Nonfiler Measurement file of nonfiler cases that IRS 
closed as not liable to file returns to a Dun and Bradstreet (D&B) 
file of businesses located in California and Illinois. We judgmentally 
selected these two states to get a geographic mix of states that had 
sufficient cases that were closed as not liable to file tax year 2007 
returns to test the viability of using private sector data. The D&B 
file contained various data on business activity including name, 
address, sales, and employment information. Combined, California and 
Illinois had 130,336 or about 14.3 percent of the 914,505 
corporations, partnerships, and employment tax cases that were closed 
as not liable to file tax year 2007 returns. Since the D&B files did 
not include the businesses' EINs, the match was made on the 
businesses' name and address, which included the street address, 
state, and ZIP code. To make the name and address matches, we used 
D&B's onsite matching software program, which can be used to associate 
records with differences in name and addresses to a particular entity. 
Each match is assigned a confidence code from 0 to 10, with 10 being 
the highest confidence score and 0 the lowest or no match. According 
to D&B documents, scores of 8 to 10 are considered high-quality 
matches and were the matches we used for our analysis. Our match of 
the 130,336 California and Illinois cases resulted in 40,223 high-
quality matches (9,740 corporations and partnerships and 30,483 
employment tax cases). Of the 9,740 partnership and corporation cases, 
7,688 cases had either little or no information return income. Of the 
30,483 employment tax cases, 4,523 had employees. 

Also, to determine whether private sector data could be useful in 
identifying active businesses that IRS had not identified as 
nonfilers, we matched the D&B data files of California and Illinois 
businesses to a Business Master File (BMF) extract of 176,061 entities 
on the BMF that had been established in calendar year 2006 but had no 
filing requirements as of September 2009, which was when IRS produced 
the extract for us. As a data reliability check on this no filing 
requirement extract, both GAO and IRS staff spot checked selected 
output from this extract to IRS's National Accounts Profile (NAP) 
file, which contains all valid taxpayer names, addresses, taxpayer 
identification numbers, and filing requirements. These checks showed 
that the names were valid and that the businesses did not have any 
filing requirements. The match of D&B data to the no filing 
requirement extract produced 39,920 cases that were considered to be 
high-quality matches (i.e., they had confidence scores of 8 to 10) and 
were the ones we used for our analysis. Since D&B is a commercial 
business, we were not able to validate the sales and employment data 
contained in the file. However, according to data D&B officials 
provided to us, D&B collects its data through direct investigations, 
such as phone calls to businesses, and reviews of trade records on 
payment and financial data, public records, and government registries, 
and Web sources and directories. Also, since D&B data are used by 
various federal agencies, we determined that the data were of 
sufficient reliability to be used in our analysis. 

To test whether other federal data sources could be useful for 
identifying business nonfilers, we analyzed the 2007 Central 
Contractor Registration (CCR) file, which we received from the General 
Services Administration, which contains data on businesses that must 
register at least annually to compete for federal contracts. We tested 
this file because it contains various entity data such as name, 
address, and EIN, which could be readily matched to IRS's records. 
Businesses that want to vie for federal contracts must submit a valid 
EIN for inclusion onto the CCR. The EINs are validated against IRS's 
records before they are included in the CCR. Also, the CCR file 
contains various self-reported data on business activity data, such as 
total revenue and number of employees for each business, which could 
be useful for making decisions on whether a business would be required 
to file returns. We matched the calendar year 2007 CCR file, which 
consisted of 441,467 records, to IRS's tax year 2007 Nonfiler 
Measurement file of cases that were closed as not liable to file 
returns to determine whether CCR data would identify potential federal 
contractors that had business activity data that would indicate that 
they may have been required to file returns. The match identified 
3,589 entities on the CCR file with reported revenue that were closed 
as not liable to file partnership (1,210 cases) or corporation (2,379 
cases) returns. The match also found that 10,263 entities on the CCR 
file reported that they had employees that were closed as not liable 
to file either Form 941 (8,694 cases) or Form 940 (1,569 cases). We 
did not verify the accuracy of the data on the CCR file because these 
data are self-reported by businesses entering the data onto the CCR 
database. However, since the EINs on the CCR are validated to IRS's 
records, we determined that the CCR data we used for our analysis were 
sufficiently reliable to use in our assessment. 

We conducted this performance audit from March 2009 through August 
2010 in accordance with generally accepted government auditing 
standards. Those standards require that we plan and perform the audit 
to obtain sufficient, appropriate evidence to provide a reasonable 
basis for our findings and conclusions based on our audit objectives. 
We believe that the evidence obtained provides a reasonable basis for 
our findings and conclusions based on our audit objectives. 

[End of section] 

Appendix II: Additional Information on Businesses' Filing Requirements: 

Form: 940: Employer's Annual Federal Unemployment (FUTA) Tax Return; 
Who should File: Businesses with one or more employees that paid at 
least $1,500 in wages in a calendar quarter and businesses that had 
one or more employees for at least some part of a day in any 20 or 
more different weeks during the calendar year must file Form 940 to 
report Federal Unemployment Tax Act tax. Household employers that paid 
at least $1,000 in wages in a calendar quarter must file Form 940; 
Filing timeline: Annually. Return due on February 1st after the end of 
the calendar year. Those who made full payments prior to filing may 
file by February 10; 
Extensions: An extension may be requested via letter. Extensions are 
not to exceed 90 days.  

Form: 941: Employer's Quarterly Federal Employment Tax Return; 
Who should File: Businesses with one or more employees file Form 941 
to report information on employees including wages paid, federal 
income tax withheld, and Social Security and Medicare taxes paid by 
employers and employees; 
Filing timeline: Quarterly. Return due the last day of the month 
following the end of the quarter; 
Extensions: Extension requests are not allowed. Form 941 has a 10-day 
extended due date if 100% of the tax amount has been deposited on 
time.  

Form: 1120: U.S. Corporation Income Tax Return; 
Who should File: Domestic corporations--unless corporation meets the 
criteria and has elected to be treated as an S corporation. The return 
is used to report income, gains, losses, deductions, credits, and to 
figure the income tax liability of a corporation; 
Filing timeline: Annually. Return due by the 15th day of the third 
month following end of corporation's tax year. For example, if tax 
year is equivalent to calendar year, filing would be due March 15; 
Extensions: Business can file IRS Form 7004 to be granted a 6-month 
extension.  

Form: 1120S: U.S. Income Tax Return for S Corporation; 
Who should File: S corporations. An eligible domestic corporation can 
avoid double taxation (once to the shareholders and again to the 
corporation) by electing to be treated as an S corporation; 
Filing timeline: Annually. Return due by the 15th day of the third 
month following end of corporation's tax year. For example, if tax 
year is equivalent to calendar year, filing would be due March 15; 
Extensions: Business can file IRS Form 7004 to be granted a 6-month 
extension.  

Form: 1065: U.S. Return of Partnership Income; 
Who should File: Partnerships. A partnership is the relationship 
existing between two or more persons who join to carry on a trade or 
business. A partnership must file an annual information return to 
report the income, deductions, gains, losses, etc., from its 
operations, but it does not pay income tax. Instead, it generally 
"passes through" any profits or losses to its partners; 
Filing timeline: Annually. Return and Schedule K-1 information returns 
(which report income shares to partners) due on the 15th day of the 
4th month following the close of its tax year; 
Extensions: Business can file IRS Form 7004 to be granted a 5-month 
extension.  

Source: GAO analysis of IRS documents.  

[End of table]  

When a business changes its structure or hires employees, the business 
is required to notify IRS and in some cases may need a new EIN. 

* A business is required to notify IRS if its structure changes, for 
example if it restructures as an S corporation, a partnership, or a 
subsidiary of another company.[Footnote 32] A subsidiary that elects 
to have its income, losses, and deductions included in the parent 
business's consolidated income tax return is not required to file an 
annual return. 

* A business that ceases to operate is expected to inform IRS 
including by sending a letter and checking a "final return" box on its 
income tax return.[Footnote 33] A business is also required to notify 
IRS if it stops paying wages or is a seasonal employer. 

A business that fails to notify IRS of a change affecting its filing 
requirement risks being identified as a potential nonfiler by IRS when 
it matches its records against returns filed. 

[End of section] 

Appendix III: How IRS Identifies and Pursues Business Nonfilers: 

IRS identifies potential business nonfilers primarily using its return 
delinquency check process. Under its new Business Master File Case 
Creation Nonfiler Identification Process (BMF CCNIP), IRS prioritizes 
which of these potential business nonfilers will be pursued using 
information return and historical account data in IRS's records on the 
business entity. Once a case has been selected for pursuit, IRS mails 
the taxpayer a notice of delinquency. If IRS is not successful in 
resolving a case through this taxpayer correspondence, the case may 
proceed to one of IRS's collections functions. Figure 1 shows IRS's 
process for business nonfiler cases through the notice stage. 

Figure 1: Business Nonfiler Cases Can Go through a Multistage Process 
from Identification to Pursuit: 

[Refer to PDF for image: illustration]  

Business Master File Case Creation Nonfiler Identification Process 
(BMF CCNIP):  

Identification: 
IRS checks to see if all returns owed have been filed (Business Master 
File).  

Prioritization: 
Each nonfiler instance is coded to determine priority (includes 
Information return data, Payment data, Wage data). 
* Selection codes indicate business activity and cases are prioritized 
based on third-party information and account information; 
* Primary codes determine number of notices and are based on: 
- compliance history; 
- other taxpayer account information.  

Selection: 
Case creation analysts select and apply criteria to determine cases to 
be pursued (Nonfiler inventory).  

First, analysts set work schedules based on: 
* available inventory; 
* workloads of pursuit staff; 
* selection codes; 
* types of returns.  

Second, database program flags individual cases for pursuit that meet 
selection criteria set by case creation analysts.  

Pursuit: 
IRS pursues the selected delinquent cases. 
* IRS sends delinquency notice to taxpayer; 
* If taxpayer complies or filing requirement is incorrect, case is 
closed; 
* If no response or taxpayer does not comply, IRS may close case, 
defer pursuit, or pursue further through options such as: 
- sending additional notices; 
- calling taxpayer; 
- assigning revenue officers to taxpayer; 
- preparing a substitute return.  

Source: GAO analysis of IRS information.  

[End of figure] 

Identification: 

IRS's return delinquency program checks the filing requirement of each 
business against the returns filed by that business for a given tax 
period. This process is completed every week for all return types. If 
IRS identifies a business that has not filed a return for a filing 
requirement on IRS's BMF a specified number of weeks after the due 
date for the return including any extensions, a delinquency module is 
created for the missing return. Previously, the program identified as 
delinquent only those businesses that had filed in the past and then 
ceased filing or had made payments to IRS. However, since the 
introduction of the BMF CCNIP, IRS now includes some entities that 
have an income tax filing requirement but have never filed. 

Prioritization: 

The BMF CCNIP has changed IRS's business nonfiler activities by using 
several types of IRS taxpayer data provided by businesses and about 
businesses to create indicators of business activity and prioritize 
these businesses for pursuit based on the likelihood of generating 
revenue. The goal of the BMF CCNIP is for IRS to pursue more 
productive cases by reducing the number of these cases it pursues 
where the business is not liable to file a return, e.g., because it is 
no longer active. In this way, IRS aims to better use its limited 
resources for pursuing business nonfilers. 

Selection codes are the feature of the BMF CCNIP that assists IRS in 
prioritizing the inventory and determining which cases should be 
pursued. Specifically, selection codes are used to determine which 
cases are sent to IRS's campuses, which are the locations of the IRS 
service centers that handle initial pursuit activities. The campuses 
will send a taxpayer a notice of delinquency. This notice details the 
delinquent tax form and period and requests the taxpayer file the form. 

The third-party information IRS uses to assign the selection codes 
comes from three sources: 

* The Aggregated Information Return (AIR) file contains data from 
information return forms such as the Form 1099 series. This file is 
updated annually. 

* The Payer Master File (PMF) contains information on those who file 
these information returns and make payments documented by the 
information returns. 

* The Combined Annual Wage Reporting (CAWR) file contains information 
on business payments for employment taxes including Social Security 
and Medicare. 

Selection codes range from 01 to 99 and represent IRS's priority for 
working cases.[Footnote 34] Cases with a lower number selection code 
have a higher priority. Each code indicates characteristics of the 
information IRS has about the case. Examples of selection codes are 
"high dollar credits," "high information return income without broker 
sales," and "broker sales." Selection codes 97 through 99--the lowest 
priority codes--are typically for those cases with no indication of 
business activity.[Footnote 35] 

In addition to a selection code, a primary code[Footnote 36] is also 
assigned to each case. These codes indicate the number of delinquency 
notices a case should receive once it has been selected and whether 
the case will be pursued further after the notice stage. Primary codes 
are determined based upon compliance history and the type of return. 

Once these codes have been applied to cases,[Footnote 37] the cases 
are placed in the nonfiler inventory. The inventory includes all 
identified business nonfiler delinquencies, both cases that have and 
have not been forwarded to IRS's collections functions for collection. 
As of the end of calendar year 2009, the nonfiler inventory had 46.6 
million cases in it. All cases will remain on the nonfiler inventory 
for 6 years. 

Selection: 

Case creation analysts--a new position created with the BMF CCNIP-- 
decide on a weekly basis the number of cases to move from the nonfiler 
inventory for pursuit. Using the selection codes, case creation 
analysts are able to select not only the number of cases sent for 
further processing, but the selection code and return type as well. 
They are also able to direct the cases to one of five specific 
campuses.[Footnote 38] Case creation analysts we spoke with said they 
select cases to move to collections based upon several factors 
including: the makeup of the inventory, selection codes, return type, 
and input from the collection functions at the IRS campuses on their 
workloads. IRS officials told us that one goal is to assure coverage 
across the different return types; another goal is to match cases 
selected with the capacity of campuses to send the notices. 
Information from the BMF CCNIP, such as the number of cases in the 
inventory and selection codes used, is contained in management 
reports. IRS said that the information in these reports is used by 
case creation analysts to make selection decisions.[Footnote 39] 

Pursuit: 

Notice Stage: 

At the first stage of the collections process, the notice stage, IRS 
first attempts taxpayer contact by mailing a delinquency notice. This 
notice informs the taxpayer of the identified delinquency, and 
provides information on how to respond to the delinquency. According 
to IRS data, in fiscal year 2009, IRS issued 2.6 million initial 
notices to business nonfiler cases.[Footnote 40] 

If a response (either a return or an explanation of why no return is 
due) is received from the taxpayer, the response is forwarded to a tax 
examiner in IRS's Compliance Services Collection Operations (CSCO) 
function. The tax examiner is responsible for verifying that a return 
filed matches the filing requirement or that the response otherwise 
justifies closure of the case. In some cases where taxpayers claim 
that they do not owe a return, tax examiners are required to perform a 
full compliance check, which is a method to verify the taxpayer's 
response and to ensure that there are no other outstanding modules. If 
the taxpayer response does not resolve the delinquency, tax examiners 
will sometimes contact the taxpayer to discuss the matter. 

The primary code assigned to the case determines what happens next if 
the taxpayer does not respond. Business nonfiler cases generally 
receive a Primary Code B, A, or X. 

* If the case received a Primary Code B, it will not be pursued beyond 
the first notice. Cases receive a Primary Code B when they do not meet 
the criteria for any other primary code. Primary Code B cases, also 
known as "suppressed" cases, generally fall below a certain threshold 
for the tax liability from the entity's last return. 

* If the case received a Primary Code A, it will receive another 
notice before being forwarded for further pursuit. 

* Primary Code X cases receive one notice and if IRS receives no 
response, the case is forwarded for further pursuit after 6 weeks. 
Primary Code X is reserved for employment tax cases where the tax due 
by the business for the previous year was above a certain threshold. 

In some instances, if a delinquent module is identified and the 
taxpayer already has other modules further along in the pursuit 
process, the newly identified delinquent module is moved after 
receiving the first notice to the collection function with other 
modules from the same business; this process is called "association."  

Post-Notice Stage Collections Functions: 

If the notice or notices do not elicit a response from the taxpayer, 
IRS guidelines and a routing program are used to determine the next 
destination for the case. 

* If a case meets criteria established in the Internal Revenue Manual 
(IRM), it will go directly to the destination prescribed. One example 
of the criteria for a case to use the rules is where the last return 
amount--the tax liability from the last return--is above a certain 
threshold. 

* Alternatively, a case is routed further by the Inventory Delivery 
System (IDS). IDS governs movement to, from, and between IRS pursuit 
functions. The system makes these determinations based on risk and 
business rules. These rules include a set of criteria used to score a 
case based on the following factors: age of case, balance due, number 
of modules for the entity, the type of return, credit balances, the 
tax due from the prior year's tax return, and prior year net tax. In 
addition to these risk scores, IDS also uses predictive models to 
generate probability scores. These models predict the likelihood of 
certain outcomes, including securing a return and securing the full 
amount of money due. 

IDS moves cases to one of the following functions after a 
predetermined number of weeks from when the notice was sent: 

* The Automated Collection System (ACS) is responsible for making 
telephone contact with taxpayers who have not responded to notices. In 
some cases, the call site operators who make this contact must 
research contact information for the delinquent taxpayer. 

* The automated 6020(b) (a6020(b)) program can be used to prepare a 
substitute return for business nonfilers without the intervention of 
ACS or the field. This program is limited to employment tax cases with 
an amount below a certain threshold.[Footnote 41] This program 
automatically prepares a return for certain businesses that have not 
filed based on information that IRS has. The automatically prepared 
return is then sent to the entity, which has the ability to respond 
with its own return if it does not accept the prepared return. If no 
response is received, IRS has the authority to create an assessment 
for all taxes and penalties due. 

* The Queue is a holding area for cases. Cases can move from the Queue 
to the field. In certain circumstances, cases have been routed from 
the Queue to a6020(b) or CSCO. 

* Revenue officers in the Collection Field Function (the field) make 
in-person contact with delinquent taxpayers in efforts to secure 
returns. 

In addition, if IDS criteria determine that the case is of low enough 
priority, IDS can close the case. 

Generally, cases that receive further pursuit beyond notice stage 
first go to ACS. If ACS has not been successful in closing a case 
after 13 weeks or does not send it to a6020(b), the case may then be 
moved to the Queue, where it will be available for the field to pursue 
further. 

When a case goes to the Queue, it is assigned a level of risk and a 
probability score. The risk level--high, medium, or low--takes into 
account dollar amount, age of case, and type of return. Cases are 
assigned to one of four priority groups in the Queue based upon these 
scores. Those cases that are "high risk" and have a high probability 
score--indicating a greater likelihood of collecting revenue--become 
the highest priority cases. The other groups--high risk, medium risk, 
and low risk--are based solely on risk scores. When group managers 
need cases for the field, they review cases based on priority for 
potential selection to the field. If a case remains in the Queue for 
52 weeks, it is reevaluated by IDS. Based on this evaluation, it can 
be sent back to ACS, remain in the Queue, or--if the case has become a 
low-risk case based on the reevaluation--the case can be closed. 
[Footnote 42] 

Figure 2 provides an overview of the coding systems and automated 
systems that govern the path of a business nonfiler case that proceeds 
beyond the notice stage into IRS's collections functions. 

Figure 2: Cases Selected for Pursuit Can Take Multiple Paths after 
Receiving First Notice: 

[Refer to PDF for image: illustration]  

Taxpayer has not responded to first delinquency notice: 
* Primary Code A cases: Second notice is sent to taxpayer; 
* Primary Code X cases: Cases go to IDS; 
* Primary Code B cases: No further pursuit.  

IDS applies risk and predictability scores to each case: 
* ACS: Noncompliant taxpayers are pursued by phone; 
* a6020(b) cases: IRS automatically generates return for taxpayer; 
* No further pursuit.  

Queue: 
* Field Agents pursue noncompliant taxpayers in person;  

After 1 year in Queue case returns to IDS for rescoring.  

Source: GAO analysis of IRS information.  

[End of figure] 

Cases that leave the Queue for pursuit are generally high-dollar 
cases, cases involving more than one delinquent return,[Footnote 43] 
and cases involving both nonfiling of returns and nonpayment of taxes 
owed. Revenue officers have multiple methods of enforcement they can 
use to secure returns and payments, including preparing substitute 
returns using IRS's authority to do so under Internal Revenue Code 
6020(b) and legal options, such as injunctions or summons. 

[End of section] 

Appendix IV: Comments from the Internal Revenue Service:  

Department Of The Treasury: 
Internal Revenue Service: 
Deputy Commissioner: 
Washington, D.C. 20224: 
	
August 25 2010:  

Mr. James R. White: 
Director, Tax Issues: 
U.S. Government Accountability Office: 
Washington, DC 20548:  

Dear Mr. White:  

Thank you for the opportunity to review your draft report entitled, 
"Tax Gap: IRS Has Modernized Its Business Nonfiler Program But Could 
Benefit From More Evaluation and Use of Third-Party Data" (GA0-10-
950).  

We recognize that assigning the best possible nonfiler inventory for 
investigation will result in the best use of our resources. We agree 
that identifying and pursuing business nonfilers who remain in 
business is a key component of our enforcement efforts and that your 
recommendations may assist us in those efforts.  

In July 2008, the IRS adopted Servicewide Nonfiler Performance and 
Outcome Measures. These strategic measures gauge our overall 
performance in delivering the nonfiler mission and goals. Such 
measures describe the intended result of carrying out a program and 
emphasize outcome over process. The IRS will soon begin exploring new 
business nonfiler measures pursuant to your recommendation.  

Your report acknowledges our new potential business nonfiler filter, 
the Business Master File Case Creation Nonfiler Identification Process 
(BMF CCNIP). We regularly evaluate and monitor the BMF CCNIP inventory 
and evaluate possible enhancements to the process. Through BMF CCNIP, 
a federal contractor with an unfiled employment tax return is a high 
priority in our case selection process. In addition to BMF CCNIP, 
there are actions implementing legislative changes that will filter 
out or identify noncompliant federal contractors (e.g., Enhancing 
Payment Accuracy Through a "Do Not Pay List" and Internal Revenue Code 
section 3402(t)(1) "Three (3) percent withholding"). These actions 
implementing legislative changes, along with other business processes 
will assist the IRS in protecting the integrity of the tax system and 
addressing federal contractors that do not file required returns. 

The enclosed response addresses each recommendation separately.
If you have any questions, please contact me or members of your staff 
may contact Nikole Flax, Assistant Deputy Commissioner for Services 
and Enforcement, at (202) 622-6860.  

Sincerely,  

Signed by:  

Steven T. Miller:  

Enclosure:  

[End of letter]  

Enclosure: 
GAO Recommendations and IRS Responses to GAO Draft Report:  

Tax Gap: IRS Has Modernized Its Business Nonfiler Program But Could 
Benefit From More Evaluation and Use of Third-Party Data; GAO-10-950:  

Recommendation 1:  

Estimate the magnitude of business nonfiling among businesses 
registered with IRS, using data from its operational files to select 
cases for further investigation. Based on the results of this work IRS 
should develop a tax gap estimate for the impact of business
nonfiling insofar as doing so is cost-effective.  

Comment:  

The IRS will report the number of delinquent business returns 
identified by operational programs. However, this estimate may 
overstate the extent of nonfiling if a missing return is associated 
with a corporation that is defunct, has changed its name, changed its 
form of organization (e.g., from a partnership or C corporation to an 
S corporation), filed under a parent entity, filed under a different 
identification number, or merged with another entity. The IRS will 
report the dollars assessed on delinquent corporation and employment 
tax returns, but these amounts are not synonymous with the nonfiling 
gap, and are not a suitable basis for estimating that gap.  

Recommendation 2:  

Set a deadline for developing data that can be used to measure the 
performance of its business nonfiler compliance activities overall.  

Comment:  

We agree to set a deadline for developing data that can be used to 
measure the performance of IRS business nonfiler compliance 
activities. The NFEAC governs Servicewide Nonfiler Performance and 
Outcome Measures for the IRS Enforcement Committee. This topic will be 
included in the agenda for the September 2010 Nonfiler Executive 
Advisory Council (NFEAC) quarterly meeting.  

Recommendation 3:  

Develop a separate efficiency measure for business nonfilers insofar 
as doing so is cost effective.  

Comment:  

We agree to develop a separate efficiency measure for business 
nonfilers if doing so is cost effective. The NFEAC governs Servicewide 
Nonfiler Performance and Outcome Measures for the IRS Enforcement 
Committee. This topic will be included in the agenda for the September 
2010 NFEAC quarterly meeting. We will determine if it is cost 
effective to develop a separate BMF Nonfiler Efficiency measure and, 
if so, assign this for development. 

Recommendation 4:  

Develop an evaluation plan for the BMF CCNIP selection codes, 
including both an initial evaluation and an ongoing monitoring plan, 
and conduct a study based on this plan. Results from the study and the 
ongoing monitoring could be used to refine the selection codes to 
improve the effectiveness of the program.  

Comment:  

The BMF CCNIP team conducts weekly analysis to evaluate and monitor 
the volume, status, select codes, and primary codes of the BMF CCNIP 
inventory. Each week the team meets to discuss the current Campus 
inventories and previous week's analysis before they confirm and load 
the current week's selections. Meeting minutes and analysis are posted 
to BMF CCNIP's SharePoint site. Additionally, the Team recently held 
their initial BMF CCNIP annual meeting and met with developers on July 
20-21, 2010 to evaluate CCNIP and review planned enhancements. They 
also reviewed CCNIP Business Objects Reports and will formalize 
requirements for a "TC 141" report that will provide monthly data on 
selections. Requirements for the "Select Code Effectiveness Reports" 
will be developed within six months; however, complete results (i.e., 
resolution type and dollars collected) will not be available on cases 
created by CCNIP until the end of FY 2011. Many delinquencies must 
flow through the entire compliance stream before there is resolution, 
so data that predicts Select Code "effectiveness" should not be 
studied until it is complete and available. We expect the TC 141 
report to be in production within 90 days and the "Select Code 
Effectiveness Report" by the end of FY 2011.  

Recommendation 5:  

Add closing codes that would better indicate all known causes for "not 
liable to file" determinations and use this information to analyze 
causes of unproductive cases and use them as appropriate to identify 
any actions IRS could take either administratively or through 
education and outreach that could reduce the number of business 
nonfiler cases where the filing requirement in IRS's records is not 
applicable.  

Comment:  

We agree that additional closing codes to capture more specific 
reasons why BMF taxpayers are determined to be "not liable to file" a 
tax return may provide opportunities for IRS to improve upon its 
ability to identify potential nonfilers. The IRS currently uses 
roughly 30 different closing codes to satisfy modules for which the 
taxpayer was not liable to file a return. The IRS will conduct a
coordinated review of the existing closing codes to determine where 
capturing additional reasons for not liable determinations would prove 
valuable for future research efforts. Cost and added complexity may 
argue for not adding more codes.  

Recommendation 6:  

Reinforce to collection staff the need to check for business activity 
using information return data and selection codes.  

Comment:  

The BMF CCNIP Select Code training was developed and presented to 
Campus Return Delinquency managers and employees this year during 
Campus Filing and Payment Compliance Program reviews for FY 2010. The 
material addresses the use of BMF CCNIP Selection Codes as a research 
tool. With an understanding of the specific third-party criteria for 
each Select Code, employees can easily determine what type of 
additional research (i.e., income, payer, or Combined Annual Wage 
Reporting) is needed to resolve a case and conduct a full-compliance 
check. The training material will be shared with collection functional 
training coordinators for reinforcing use of information return data 
and selection codes to check for business activity.  

Recommendation 7:  

Study the feasibility and cost-effectiveness of using private sector 
business activity data and federal contract data to make a 
determination of whether federal contractors and other businesses are 
liable for filing tax returns.  

Comment:  

The Treasury Inspector General for Tax Administration (TIGTA) made a 
similar recommendation involving the use of private sector data to 
identify potential nonfilers. In FY 2009, the IRS initiated a study to 
address the feasibility of using private data sources to identify non-
filers not captured by other systems. The IRS' Office of Research 
looked into what would be required should the IRS decide to purchase 
private data, and attempts were made to determine what benefits the 
IRS might realize. They concluded that it is difficult to quantify the 
benefits because IRS would be purchasing data from information 
resellers without assurance that the IRS would not receive duplicate 
records or that the data purchased would produce revenue-generating 
casework. The most exhaustive marketing data companies have over 14 
million listings available. Most IRS data are set up to match on 
Taxpayer Identification Numbers (TINs), and an automated process to 
effectively match purchased lists of business names to TINs in IRS 
systems does not currently exist. A new study involving the use of 
private sector data will likely produce the same results as the IRS 
study initiated in FY 2009 and completed March 2010. With regard to 
using federal contractor data to make a determination for filing tax 
returns, the IRS will evaluate the effectiveness of data mining using 
the Central Contractor Registration database maintained by the General 
Services Administration.  

Recommendation 8:  

Establish a process similar to the FERDI program for federal workers 
and retirees that will give a high priority to businesses identified 
as potential nonfilers that have federal contracts.  

Comment:  

We will explore the feasibility of establishing a system for 
prioritizing and routing federal contractor nonfiler cases (i.e., 
leverage the federal contractor indicator in the nonfiler process 
through our Inventory Delivery System (IDS). We continue to believe 
that the IDS is the most cost-effective and efficient way to ensure 
that high priority cases are brought into active inventory. 

[End of section]  

Appendix V: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

James R. White, (202) 512-9110 or whitej@gao.gov: 

Acknowledgments: 

In addition to the contact named above, Ralph Block, Assistant 
Director; Linda Baker; Amy Spiehler; Donna Miller; Jeffrey Niblack; 
A.J. Stephens; James Ungvarsky; and John Zombro made key contributions 
to this report. 

[End of section]  

Footnotes:  

[1] IRS defines the tax gap as the difference between what taxpayers 
pay voluntarily and on time and what they should pay under the law. 
This is the gross tax gap. IRS also publishes an estimate net of all 
receipts. Unless noted, in this report the tax gap is defined as the 
gross tax gap. While IRS does not have an estimate of the business 
nonfiling tax gap, it does have an estimate for estate tax nonfiling. 

[2] See, for example, GAO, Tax Compliance: Better Compliance Data and 
Long-term Goals Would Support a More Strategic Approach to Reducing 
the Tax Gap, [hyperlink, http://www.gao.gov/products/GAO-05-573] 
(Washington, D.C.: July 18, 2005). 

[3] We judgmentally selected these two states to get a geographic mix 
of states that had sufficient cases that were closed as not liable to 
file tax year 2007 returns to test the viability of using private 
sector data. 

[4] A business may request an EIN on-line or by using Form SS-4.  

[5] IRS considers employers, sole proprietors, corporations, 
partnerships, tax-exempt organizations, trusts, estates of decedents, 
and other entities to be businesses. Sole proprietors, however, do not 
file business income tax returns. Rather, sole proprietors report the 
income and expenses of the business on a schedule attached to their 
individual tax returns but may be required to file other types of 
business tax returns, e.g., employment or excise taxes, for which they 
need an EIN.  

[6] This is the Servicewide definition of a nonfiler in IRS's Nonfiler 
Strategy, discussed later in this report. 

[7] A corporation is a legal construct (often a business entity) 
created in conformance with statutory requirements that acts as a 
separate and distinct legal entity apart from its owners and that has 
other legal rights such as the ability to own property, enter into 
contracts, and issue stock. Typically, a corporation's shareholders 
have limited liability, meaning they are not personally liable for the 
debts of the corporation beyond their investment. Under the Internal 
Revenue Code, corporations are classified as C corporations or S 
corporations. A corporation can elect to be treated as an S 
corporation for tax purposes if it meets certain eligibility 
requirements, including having no more than 100 shareholders. 26 
U.S.C. § 1361. In recent years S corporations have been one of the 
fastest growing business entity types. See GAO, Tax Gap: Actions 
Needed to Address Noncompliance with S Corporation Tax Rules, GAO-10-
195 (Washington, D.C.: Dec. 15, 2009). Any corporation not eligible or 
not electing to be treated as an S corporation is treated as a C 
corporation. Generally, income earned by C corporations is taxed at 
the corporate tax rate at the corporate level. In addition, 
distributions to stockholders are taxed as income at the shareholders' 
rates. 

[8] 26 U.S.C. § 6012(a)(2); 26 C.F.R. § 1.6012-2. 

[9] In general, all domestic partnerships that have income, 
deductions, or credits for federal income tax purposes during a tax 
year must file a return of partnership income (Form 1065) for that 
year. 26 U.S.C. § 6031(a); 26 C.F.R. § 1.6031(a)-1(a). This 
requirement encompasses entities such as limited liability 
corporations that are treated as partnerships for federal income tax 
purposes. Certain eligible syndicates, pools, or joint ventures, such 
as investing and operating agreement partnerships, may elect not to be 
treated as a partnership for federal income tax purposes and are not 
required to file a Form 1065, although their members must still report 
their share of the partnership's income. 26 C.F.R. §§ 1.761-2, 
1.6031(a)-1(c). Certain publicly traded partnerships are treated as 
corporations and file Form 1120. 26 U.S.C. § 7704. Foreign 
partnerships are generally only required to file if the partnership 
had gross income from a source within the United States or income 
effectively connected with the conduct of a trade or business within 
the United States. 26 U.S.C. § 6031(e); 26 C.F.R. § 1-6031(a)-1(b). 

[10] The information returns reporting income are known as Form K-1s. 
See GAO, Tax Administration: IRS Should Take Steps to Improve the 
Accuracy of Schedule K-1 Data, [hyperlink, 
http://www.gao.gov/products/GAO-04-1040] (Washington, D.C.: Sept. 30, 
2004) and Tax Administration: Changes to IRS's Schedule K-1 Document 
Matching Program Burdened Compliant Taxpayers, [hyperlink, 
http://www.gao.gov/products/GAO-03-667] (Washington, D.C.: May 30, 
2003). 

[11] These totals include information returns filed on sole 
proprietors where the sole proprietor withholds FICA and income tax 
under an EIN that is the tax identification number for the business.  

[12] Federal agencies use Form 8596 to report this information. See 
GAO, Tax Administration: More Can Be Done to Ensure Federal Agencies 
File Accurate Information Returns, [hyperlink, 
http://www.gao.gov/products/GAO-04-74] (Washington, D.C.: Dec. 5, 
2003). 

[13] See GAO, Tax Administration: Improving IRS' Business Nonfiler 
Program, [hyperlink, http://www.gao.gov/products/GAO/GGD-89-39] 
(Washington, D.C.: Mar. 8, 1989) and Tax Administration: IRS Could 
Reduce the Number of Unproductive Business Nonfiler Investigations, 
[hyperlink, http://www.gao.gov/products/GAO/GGD-88-77] (Washington, 
D.C.: May 24, 1988). 

[14] See Treasury Inspector General for Tax Administration, The 
Internal Revenue Service Needs a Coordinated National Strategy to 
Better Address an Estimated $30 Billion Tax Gap Due to Nonfilers 
(Reference No. 2006-30-006, Nov. 22, 2005) and Additional Steps Need 
to be Completed to Ensure the Success of the Service-wide Non-filer 
Strategy (Reference No. 2008-30-165, Sept. 22, 2008).  

[15] TIGTA's 2008 report following up on the implementation of IRS's 
Nonfiler Strategy found that Servicewide performance measures needed 
to be developed. 

[16] See GAO, The Merits of Establishing a Business Information Return 
Program, [hyperlink, http://www.gao.gov/products/GAO/T-GGD-87-4] 
(Washington, D.C.: Mar. 17, 1987); IRS Needs to Implement a Corporate 
Document Matching Program, [hyperlink, 
http://www.gao.gov/products/GAO/T-GGD-91-40] (Washington, D.C.: June 
10, 1991); and Tax Administration: Benefits of a Corporate Matching 
Program Exceed the Costs, [hyperlink, 
http://www.gao.gov/products/GAO/GGD-91-118] (Washington, D.C.: Sept. 
27, 1991). 

[17] See GAO, Tax Administration: IRS Needs to Strengthen Its Approach 
for Evaluating the SRFMI Data-Sharing Pilot Program, [hyperlink, 
http://www.gao.gov/products/GAO-09-45] (Washington, D.C.: Nov. 7, 
2008). Several pilot phases have been completed. As of January 2010, 
in response to our recommendation, IRS had completed a plan to 
evaluate the pilot. 

[18] IRS's National Research Program (NRP) updates the tax gap 
estimates. Its nonfiling estimates seek to estimate noncompliance by 
all nonfilers, both those known to IRS and those unknown. A 
comprehensive effort to measure compliance for different types of 
taxes and various sets of taxpayers, the NRP is intended to provide a 
statistically valid representation of the compliance characteristics 
of taxpayers.  

[19] See GAO, Tax Debt Collection: IRS Has a Complex Process to 
Attempt to Collect Billions of Dollars in Unpaid Tax Debt, [hyperlink, 
http://www.gao.gov/products/GAO-08-728] (Washington, D.C.: June 13, 
2008), appendix III.  

[20] An internal IRS research report done in 2001 on business 
nonfilers found that about 28 percent of businesses identified as 
nonfilers had more than 1 nonfiler module and some had up to 20 
nonfiler modules.  

[21] IRS recognized the importance of an evaluation plan by producing 
one for its State Reverse File Match Initiative (SRFMI) program. This 
evaluation plan was in response to our recommendation to develop such 
a plan. See GAO, Tax Administration: IRS Needs to Strengthen Its 
Approach for Evaluating the SRFMI Data-Sharing Pilot Program, 
[hyperlink, http://www.gao.gov/products/GAO-09-45] (Washington, D.C.: 
Nov. 7, 2008). 

[22] IRS data indicate that 96 percent of the cases were closed in 
2008 and 2009. The remaining 4 percent of the cases were closed in 
2007 and 2010. 

[23] All reference to cases in this section relate to unique 
businesses. 

[24] We eliminated all cases from our analysis that IRS closed as not 
liable to file a return because they were subsidiaries of other 
businesses. 

[25] Another 7 percent (2,941 cases) of the cases were closed as not 
liable to file a return because there was little or no tax due. 

[26] According to Internal Revenue Manual section 5.1.18.4, IRS has a 
contract with Accurint for its national asset locator tool and a 
contract with Smart.Alx, which is a Web browser used to access credit 
reports. 

[27] See appendix I for an explanation of the D&B data matching 
process. 

[28] Of the 7,688 cases, 3,960 cases had information return income of 
less than $1,000 while the remaining 3,728 cases had no information 
return income. 

[29] The CCR also contains data on federal assistance awards, which 
include grants, cooperative agreements, and other forms of federal 
assistance. 

[30] Federal contractors that owe delinquent taxes currently receive 
priority treatment. Under the Federal Payment Levy Program (FPLP) 
businesses and individuals who receive federal payments such as 
certain Social Security benefits, federal wages, and federal contract 
payments are subject to a continuous levy of up to 15 percent of 
individual and recurring specified payments. The American Jobs 
Creation Act of 2004 amended IRS's continuous levy authority by 
providing for a 100 percent levy on specified federal 
contractor/vendor payments.  

[31] For tax year 2008, IRS processed 116,148 Forms 8596 for 102,248 
taxpayer entities that had a valid EIN.  

[32] Where a subsidiary elects to have its income, losses, and 
deductions included in the parent business's consolidated income tax 
return, Form 1122 must be completed by the subsidiary and filed with 
the parent business's income tax return.  

[33] A corporation electing to be taxed as an S corporation notifies 
IRS by filing a Form 2553. For businesses ceasing to operate, IRS's 
Web site has a checklist of actions to be taken, including writing IRS 
a letter. See [hyperlink, 
http://www.irs.gov/businesses/small/article/0,,id=98703,00.html] and 
[hyperlink, 
http://www.irs.gov/businesses/small/article/0,,id=177073,00.html], 
downloaded on May 7, 2010. IRS's Web site and, in some cases, the tax 
forms themselves, provide information on how and what types of changes 
businesses must communicate to IRS. Once IRS has received notification 
of a change, it can update its record of the business's filing 
requirement on its Business Master File (BMF) as needed.  

[34] There is also a selection code of 00, which indicates cases that 
are "on hold." An example of such a case would be one that is being 
investigated as a criminal case.  

[35] Certain selection codes apply only to particular return types. 

[36] Primary codes are assigned to a case by the BMF CCNIP. However, 
these codes existed prior to the creation of BMF CCNIP and were 
assigned by the Business Master File.  

[37] Type Indicator Codes (TIC)--added with the establishment of the 
BMF CCNIP--are also applied to cases before they are placed on the 
nonfiler inventory. TIC codes may be used to accelerate a case 
directly to the collections function. For example, taxpayers that have 
filed an extension but still have not filed by the extension deadline 
receive an accelerated TIC code because they have shown the intention 
to file when they asked for the extension. While every case is 
assigned a TIC code, most cases receive one that directs a case 
through the normal process of the nonfiler inventory. Currently, 
accelerated TIC codes are rarely used.  

[38] The campuses that process business nonfiler cases are Brookhaven 
(NY), Cincinnati (OH), Memphis (TN), Ogden (UT), and Philadelphia (PA). 

[39] Case creation analysts also use a "default schedule" to guide 
their decisions. The default schedule is created annually and provides 
a guide for case creation analysts by setting weekly values for each 
of the variables that the analysts must choose. IRS officials told us 
that the default schedule is referred to on a weekly basis, but 
selections often vary from those proposed in the schedule.  

[40] When a case is in notice stage, TDI Analysis--a computer program--
periodically reexamines information on the case to determine whether a 
case will receive the second notice, be closed, or be directed onward. 
TDI Analysis also updates information on the Business Master File.  

[41] Revenue officers and some call-site operators have the ability to 
use the 6020(b) program to prepare a return for business nonfilers as 
well.  

[42] Cases can also be sent to CSCO or a6020(b) from the Queue, but 
these cases are relatively less frequent.  

[43] When employment tax delinquencies continue to accumulate after 
the taxpayer has been assigned to the field for pursuit, IRS considers 
the case to be "pyramiding." IRM Section 5.7.8 describes the 
pyramiding cases and the role of the field in pursuing them.  

[End of section] 

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