Small Businesses: IRS Considers Taxpayer Burden in Tax Administration, but Needs a Plan to Evaluate the Use of Payment Card Information for Compliance Efforts
Highlights
What GAO Found
According to estimates produced by government tax researchers using 2010 taxpayer data, small businesses (defined in the research as individuals or entities with substantive business activity but with less than $10 million in total income and deductions) make up 99 percent of all businesses. Approximately 69 percent of small businesses (about 16 million) are individual taxpayers who report business income and the remaining 31 percent (or roughly 7.3 million) are partnerships or corporations. Small businesses with at least one employee make up about 20 percent of the small business population, but produce about 71 percent of total small business income.
Small businesses undertake a number of tax compliance-related activities that create burden. These activities can be grouped into general categories such as income tax activities, employer-related tax activities, and third-party information reporting activities. The tax compliance burden associated with these activities varies depending on the businesses' asset size, filing entity type (e.g., sole proprietor, partnership), number of employees, and industry type. According to IRS research, compliance burden increases with the size of businesses, whether measured in terms of assets, receipts, or employment. IRS also measured money and time burden as a portion of total business receipts, total assets, and burden per employee. Across all three measures, IRS results were consistent with the assumption that small businesses face significant fixed compliance costs combined with decreasing marginal costs as the business grows.
IRS's decision-making framework for administering the tax system includes consideration of small business compliance burden. For example, IRS's strategic plan identifies reducing taxpayer burden as a strategic goal. IRS provided examples of how it works with internal and external stakeholders to reduce taxpayer burden on small businesses. For example, IRS collaborated with Treasury and external stakeholders to develop a simplified method for some small businesses to calculate a home office deduction, which was introduced in January 2013. Previously, businesses had to complete a complex property depreciation calculation.
To improve tax compliance among small businesses, in 2012, IRS began piloting a program that compares payment data from payment settlement entities (such as credit card companies) with income reported by small businesses. IRS is testing ways to use payment data to detect underreporting of taxable income while minimizing small business taxpayer burden. While IRS's plans for evaluating the pilot include many key evaluation elements that GAO identified, other elements are missing. For example, IRS has defined high level pilot goals such as improving voluntary compliance and reducing the tax gap, but has not established measures for determining progress against these goals. Additionally, the plan did not adequately document evaluative questions, data collection needs, or the evaluative criteria necessary to assess whether pilot activities produced the intended results. Without these and other elements, IRS cannot ensure it is making evidence-based decisions about expanding and integrating pilot activities into broader small business compliance improvement efforts.
Why GAO Did This Study
A challenge IRS faces is balancing efforts to minimize taxpayer burden with efforts to ensure compliance with the tax code. Small businesses are a vital source of economic growth in the United States. Reducing their costs for complying with the tax code may free up resources to expand, hire new employees, and contribute to the growth of the U.S. economy. GAO was asked to examine small business tax compliance burden and IRS's payment card pilot that addresses taxpayer non-compliance. This report: (1) describes characteristics of the small business population (2) describes how characteristics of a small business affect compliance burden; (3) describes how IRS integrates small business compliance burden considerations in decision-making; and (4) assesses IRS's plan for evaluating its payment card pilot. To answer these objectives, GAO analyzed Treasury and IRS data, research, and other documentation and interviewed agency officials. GAO used its guidance on program design evaluation to assess IRS's payment card pilot evaluation plan.
Recommendations
To improve the evaluation of the payment card pilot, GAO recommends that IRS clearly define the stages of the pilot and establish measurable goals for determining when the pilot progresses from one stage to the next and develop an evaluation plan for the overall pilot that includes evaluation questions, complete descriptions of needed data, and evaluation criteria. IRS agreed to take the recommended actions.
Recommendations for Executive Action
| Agency Affected | Recommendation | Status |
|---|---|---|
| Internal Revenue Service | To improve the evaluation of the payment card pilot, the Commissioner of Internal Revenue should clearly define the stages of the payment card pilot and establish measurable goals for determining when the pilot advances from one stage to the next. |
Through the development of three related documents in response to our recommendations, Internal Revenue Service (IRS) clearly defined the stages of the Payment Mix Methodology (PMM) payment card pilot and established measurable goals for determining when the pilot advances from one stage to the next. The documents outlined the stages of the payment card pilot's "Test and Learn" PMM Framework. The six steps of the pilot were (1) Create a hypothesis (research question); (2) Design the test; (3) Conduct the test; (4) Analyze the results and determine the impact of the treatment(s); (5) Document learnings; and (6) Learn and iterate. Further, the documents summarized the performance measures and goals that IRS used to assess the results of various work streams of the payment card pilot. After evaluating the results of the PMM activities, IRS decided to discontinue these pilot activities. However, IRS is still using aspects of the evaluation plan to assess a new set of pilot activities called "Next Best Case 2.0 Model" through which IRS will continue to test additional uses of payment card information to inform audit case selection. Overall, improving the evaluation plan can help IRS assess whether activities conducted under the pilot can be used to improve taxpayer compliance or should be discontinued.
|
| Internal Revenue Service | To improve the evaluation of the payment card pilot, the Commissioner of Internal Revenue should develop an evaluation plan for the overall pilot and building on pilot activities to inform decisions about whether, how, and when to integrate pilot activities into overall enforcement efforts. This plan should include evaluation questions. |
Through the development of three related documents in response to our recommendations, Internal Revenue Service (IRS) produced an improved evaluation plan for the overall payment card pilot, particularly the pilot's payment mix methodology (PMM) activities. The improved evaluation plan included evaluation questions. IRS developed a 'test and learn' methodology for the payment card pilot through which IRS could test a number of hypotheses and research questions in the early stages of the pilot. These hypotheses/research questions equate to evaluation questions to assess the performance of the PMM. The evaluation plan presents two hypotheses for assessing the PMM pilot over multiple years. Specifically, for tax years 2011 through 2013, the evaluation plan shows that IRS hypothesized it could identify underreported income for certain taxpayers by comparing gross payment card receipts reported on Form 1099-K for similar businesses. For tax year 2014, IRS documented its learnings from testing case selection processes to identify and select the most productive cases. After evaluating the results of the PMM activities, IRS decided to discontinue these pilot activities. However, IRS is still using aspects of the evaluation plan to assess a new set of pilot activities called "Next Best Case 2.0 Model" through which IRS will continue to test additional uses of payment card information to inform audit case selection. For the "Next Best Case 2.0 Model" IRS designed research questions to evaluate whether payment card information could improve audit case selection as compared to case selection methodologies that do not take payment card information into consideration. Overall, improving the evaluation plan can help IRS assess whether activities conducted under the pilot can be used to improve taxpayer compliance or should be discontinued.
|
| Internal Revenue Service | To improve the evaluation of the payment card pilot, the Commissioner of Internal Revenue should develop an evaluation plan for the overall pilot and building on pilot activities to inform decisions about whether, how, and when to integrate pilot activities into overall enforcement efforts. This plan should include evidence-based evaluative criteria. |
Through the development of three related documents in response to our recommendations, Internal Revenue Service (IRS) produced an improved evaluation plan for the overall payment card pilot, particularly the pilot's payment mix methodology (PMM) activities. The improved evaluation plan included evidence-based evaluative criteria. IRS used the criteria to inform what data it should gather during pilot testing to evaluate whether to continue 1099-K pilot activities in campus and field exam. These criteria included, for example, the time spent on each case; the rate at which all of the items being reviewed in an audit were substantiated and resulted in no changes; and the opportunity cost of diverting resources to PMM over other methods. After evaluating the results of the PMM activities, IRS decided to discontinue these pilot activities. However, IRS is still using aspects of the evaluation plan to assess a new set of pilot activities called "Next Best Case 2.0 Model" through which IRS will continue to test additional uses of payment card information to inform audit case selection. Overall, improving the evaluation plan can help IRS assess whether activities conducted under the pilot can be used to improve taxpayer compliance or should be discontinued.
|
| Internal Revenue Service | To improve the evaluation of the payment card pilot, the Commissioner of Internal Revenue should develop an evaluation plan for the overall pilot and building on pilot activities to inform decisions about whether, how, and when to integrate pilot activities into overall enforcement efforts. This plan should include an analysis plan. |
Through the development of three related documents in response to our recommendations, Internal Revenue Service (IRS) produced an improved evaluation plan for the overall payment card pilot, particularly the pilot's payment mix methodology (PMM) activities. The improved evaluation plan included an analysis plan. The evaluation plan explains activities IRS undertook that equate to an analysis plan for the payment card pilot, so that IRS could learn how to leverage Form 1099-K to reduce the tax gap. Those activities include test design, analysis of results, and learning and iteration. IRS provided support for analysis planning activities prior to the pilot (fiscal years 2008-2012), and for the first four years of the pilot (fiscal years 2013-2017). Specifically, when designing the test in 2008 to 2012, IRS developed its case selection methodologies and treatments, and back tested these using a sample of Forms 1099-K. After evaluating the results of the PMM activities, IRS decided to discontinue these pilot activities. However, IRS is still using aspects of the evaluation plan to assess a new set of pilot activities called "Next Best Case 2.0 Model" through which IRS will continue to test additional uses of payment card information to inform audit case selection. Overall, improving the evaluation plan can help IRS assess whether activities conducted under the pilot can be used to improve taxpayer compliance or should be discontinued.
|
| Internal Revenue Service | To improve the evaluation of the payment card pilot, the Commissioner of Internal Revenue should develop an evaluation plan for the overall pilot and building on pilot activities to inform decisions about whether, how, and when to integrate pilot activities into overall enforcement efforts. This plan should include a complete description of data to be collected. |
Through the development of three related documents in response to our recommendations, Internal Revenue Service (IRS) produced an improved evaluation plan for the overall payment card pilot, particularly the pilot's payment mix methodology (PMM) activities. The improved evaluation plan included a complete description of data to be collected. IRS explained that results of all returns closed in a given fiscal year would be fully reviewed and several key data characteristics about those returns would be documented and analyzed. Data characteristics included whether the audit resulted in the assessment of additional tax, the amount of additional tax, and the length of the audit. After evaluating the results of the PMM activities, IRS decided to discontinue these pilot activities. However, IRS is still using aspects of the evaluation plan to assess a new set of pilot activities called "Next Best Case 2.0 Model" through which IRS will continue to test additional uses of payment card information to inform audit case selection. Overall, improving the evaluation plan can help IRS assess whether activities conducted under the pilot can be used to improve taxpayer compliance or should be discontinued.
|
| Internal Revenue Service | To improve the evaluation of the payment card pilot, the Commissioner of Internal Revenue should develop an evaluation plan for the overall pilot and building on pilot activities to inform decisions about whether, how, and when to integrate pilot activities into overall enforcement efforts. This plan should include a data reliability assessment. |
Through the development of three related documents in response to our recommendations, Internal Revenue Service (IRS) produced an improved evaluation plan for the overall payment card pilot, particularly the pilot's payment mix methodology (PMM) activities. The improved evaluation plan included a data reliability assessment. The plan shows evidence of data reliability assessments both prior to and during the 'test and learn' process, which is a process/methodology IRS developed for the payment card pilot. Related assessment actions prior to the process include conducting background research and exploratory data analysis. This also included exploring the available data to identify data challenges, determining how to access the data, whether the data is relevant and credible, what data is missing, and ease of obtaining additional or new data. After evaluating the results of the PMM activities, IRS decided to discontinue these pilot activities. However, IRS is still using aspects of the evaluation plan to assess a new set of pilot activities called "Next Best Case 2.0 Model" through which IRS will continue to test additional uses of payment card information to inform audit case selection. Overall, improving the evaluation plan can help IRS assess whether activities conducted under the pilot can be used to improve taxpayer compliance or should be discontinued.
|
| Internal Revenue Service | To improve the evaluation of the payment card pilot, the Commissioner of Internal Revenue should develop an evaluation plan for the overall pilot and building on pilot activities to inform decisions about whether, how, and when to integrate pilot activities into overall enforcement efforts. This plan should include documentation of evaluation limitations. |
Through the development of three related documents in response to our recommendations, Internal Revenue Service (IRS) produced an improved evaluation plan for the overall payment card pilot?particularly the pilot?s payment mix methodology (PMM) activities. The improved evaluation plan included documentation of evaluation limitations. As part of its "Test and Learn" Framework, IRS discussed the need to be aware of internal and external data validity concerns. For internal validity concerns, IRS highlighted threats, including taxpayers dropping out of the test and control groups at different rates, behavior changing as a result of taxpayers communicating with each other, or after receiving the same treatment multiple times. IRS noted that these can arise due to differences in the characteristics of the individuals in the sample compared to the population, differences between the setting in which the test was conducted versus other settings, and unique characteristics of a time period in which the test took place. IRS officials highlighted that another evaluation limitation to take into consideration is data availability; some outcome metrics, such as those for field exam results, will only be available in the long term. To mitigate this, IRS highlighted that the project team should consider whether other metrics may serve as proxies or provide other useful information that is available more quickly, or measure outcomes for short-term or intermediate goals. After evaluating the results of the PMM activities, IRS decided to discontinue these pilot activities. However, IRS is still using aspects of the evaluation plan to assess a new set of pilot activities called "Next Best Case 2.0 Model" through which IRS will continue to test additional uses of payment card information to inform audit case selection. Overall, improving the evaluation plan can help IRS assess whether activities conducted under the pilot can be used to improve taxpayer compliance or should be discontinued.
|