Tax Gap
A Strategy for Reducing the Gap Should Include Options for Addressing Sole Proprietor Noncompliance
Gao ID: GAO-07-1014 July 13, 2007
The Internal Revenue Service (IRS) estimates that $68 billion of the annual $345 billion gross tax gap for 2001 was due to sole proprietors, who own unincorporated businesses by themselves, underreporting their net income by 57 percent. A key reason for this underreporting is well known. Unlike wage and some investment income, sole proprietors' income is not subject to withholding and only a portion is subject to information reporting to IRS by third parties. GAO was asked to (1) describe the nature and extent of sole proprietor noncompliance, (2) how IRS's enforcement programs address it, and (3) options for reducing it. GAO analyzed IRS's recent random sample study of reporting compliance by individual taxpayers, including sole proprietors.
Based on what IRS examiners could find, most sole proprietors, at least an estimated 61 percent, underreported net business income, but a small proportion of them accounted for the bulk of understated taxes. Both gross income and expenses were misreported. Most of the resulting understated taxes were in relatively small amounts. Half the understatements that IRS examiners could find were less than $903. However, 10 percent of the tax understatements, made by over 1 million sole proprietors, were above $6,200. In this top group, the mean understatement of tax was $18,000. IRS's two main sole proprietor enforcement programs--the Automated Underreporter Program, which computer matches information on a tax return with information submitted to IRS by third parties, and examinations (audits)--have limited reach. The two programs each annually contact less than 3 percent of estimated noncompliant sole proprietors. The limited reach exists for a variety of reasons. In 2001, about 25 percent of sole proprietor gross income was reported on information returns by third parties; expenses generally are not subject to such reporting. Even when required, various barriers make information reporting inconvenient. Examinations of sole proprietors yield less in additional tax assessed and cost more to conduct than examinations for other taxpayers. However, because of the extent of sole proprietor noncompliance, any effect that examinations have on voluntary compliance by other sole proprietors could result in significant revenue. The Treasury Department's recently released tax gap strategy discusses neither sole proprietor noncompliance specifically nor the many options that could address it. GAO has reported on the need for such a detailed strategy for years. Specific options that address issues including sole proprietor recordkeeping, underreporting of gross income, overreporting of expenses, information reporting, and IRS's enforcement programs are listed in appendix II.
Recommendations
Our recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director:
Team:
Phone:
GAO-07-1014, Tax Gap: A Strategy for Reducing the Gap Should Include Options for Addressing Sole Proprietor Noncompliance
This is the accessible text file for CG speech number GAO-07-1014
entitled 'Tax Gap: A Strategy for Reducing the Gap Should Include
Options for Addressing Sole Proprietor Noncompliance' which was
released on August 14, 2007.
This text file was formatted by the U.S. Government Accountability
Office (GAO) to be accessible to users with visual impairments, as part
of a longer term project to improve GAO products' accessibility. Every
attempt has been made to maintain the structural and data integrity of
the original printed product. Accessibility features, such as text
descriptions of tables, consecutively numbered footnotes placed at the
end of the file, and the text of agency comment letters, are provided
but may not exactly duplicate the presentation or format of the printed
version. The portable document format (PDF) file is an exact electronic
replica of the printed version. We welcome your feedback. Please E-mail
your comments regarding the contents or accessibility features of this
document to Webmaster@gao.gov.
This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed
in its entirety without further permission from GAO. Because this work
may contain copyrighted images or other material, permission from the
copyright holder may be necessary if you wish to reproduce this
material separately.
Report to the Committee on Finance, U.S. Senate:
United States Government Accountability Office:
GAO:
July 2007:
Tax Gap: A Strategy for Reducing the Gap Should Include Options for
Addressing Sole Proprietor Noncompliance:
GAO-07-1014:
GAO Highlights:
Highlights of GAO-07-1014, a report to the Committee on Finance, U.S.
Senate
Why GAO Did This Study:
The Internal Revenue Service (IRS) estimates that $68 billion of the
annual $345 billion gross tax gap for 2001 was due to sole proprietors,
who own unincorporated businesses by themselves, underreporting their
net income by 57 percent. A key reason for this underreporting is well
known. Unlike wage and some investment income, sole proprietors‘ income
is not subject to withholding and only a portion is subject to
information reporting to IRS by third parties.
GAO was asked to (1) describe the nature and extent of sole proprietor
noncompliance, (2) how IRS‘s enforcement programs address it, and (3)
options for reducing it. GAO analyzed IRS‘s recent random sample study
of reporting compliance by individual taxpayers, including sole
proprietors.
What GAO Found:
Based on what IRS examiners could find, most sole proprietors, at least
an estimated 61 percent, underreported net business income, but a small
proportion of them accounted for the bulk of understated taxes. Both
gross income and expenses were misreported. Most of the resulting
understated taxes were in relatively small amounts. Half the
understatements that IRS examiners could find were less than $903.
However, 10 percent of the tax understatements, made by over 1 million
sole proprietors, were above $6,200. In this top group, the mean
understatement of tax was $18,000.
IRS‘s two main sole proprietor enforcement programs”the Automated
Underreporter Program, which computer matches information on a tax
return with information submitted to IRS by third parties, and
examinations (audits)”have limited reach. The two programs each
annually contact less than 3 percent of estimated noncompliant sole
proprietors. The limited reach exists for a variety of reasons. In
2001, about 25 percent of sole proprietor gross income was reported on
information returns by third parties; expenses generally are not
subject to such reporting. Even when required, various barriers make
information reporting inconvenient. Examinations of sole proprietors
yield less in additional tax assessed and cost more to conduct than
examinations for other taxpayers. However, because of the extent of
sole proprietor noncompliance, any effect that examinations have on
voluntary compliance by other sole proprietors could result in
significant revenue.
The Treasury Department‘s recently released tax gap strategy discusses
neither sole proprietor noncompliance specifically nor the many options
that could address it. GAO has reported on the need for such a detailed
strategy for years. Specific options that address issues including sole
proprietor recordkeeping, underreporting of gross income, overreporting
of expenses, information reporting, and IRS‘s enforcement programs are
listed in appendix II.
Figure: Sole Proprietor's Estimated Understated Tax by Percentile for
Tax Year 2001.
[See PDF for image]
Source: GAO analysis of IRS data.
[End of figure]
What GAO Recommends:
GAO recommends that the Secretary of the Treasury ensure that the tax
gap strategy (1) covers sole proprietor compliance and is coordinated
with broader tax gap reduction efforts and (2) includes specific
proposals, such as the options in this report. GAO is not making
recommendations regarding specific options. IRS and the Department of
the Treasury provided technical comments on a draft of this report,
which we incorporated as appropriate.
[hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-1014].
To view the full product, including the scope and methodology, click on
the link above. For more information, contact James R. White at (202)
512-9110 or whitej@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Most Sole Proprietors Underreported Business Income, but a Small
Proportion Accounted for the Bulk of Unpaid Taxes:
Enforcement Programs Have Limited Reach over Sole Proprietors but Still
Make Billions of Dollars in Recommended Assessments:
Current Treasury Tax Gap Strategy Discusses Neither Sole Proprietor
Noncompliance nor the Many Options That Could Address It:
Conclusions:
Recommendation for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: Scope and Methodology:
Appendix II: Options to Address Problems with the Tax Compliance of
Sole Proprietors:
Appendix III: IRS Form 1040 Schedule C, Tax Year 2001:
Appendix IV: Independent Contractors and Section 530 of the Revenue Act
of 1978:
Appendix V: Backup Withholding Rules:
Appendix VI: Comments from the Department of the Treasury:
Appendix VII: GAO Contact and Staff Acknowledgments:
Related GAO Products:
Tables:
Table 1: Percentage of Recommended Assessments and Limitations of IRS
Enforcement Programs for Detecting Sole Proprietor Reporting
Noncompliance:
Table 2: Options to Improve Sole Proprietor Tax Compliance:
Table 3: Confidence Intervals for Summary of Schedule C Misreporting
for Tax Year 2001:
Table 4: Confidence Intervals for Estimated Understated Tax Amounts by
Percentile for Individual Income Tax Returns with Schedule Cs Attached,
Tax Year 2001.
Table 5: Confidence Intervals for Estimated Cumulative Understated
Taxes by Percentile for Individual Income Tax Returns with Schedule Cs
Attached, Tax Year 2001:
Figures:
Figure 1: Distribution of Sole Proprietors and Their Gross Receipts by
Size of Proprietorship, Tax Year 2003:
Figure 2: IRS's Nonemployee Compensation Information Returns Matching
Process:
Figure 3: Summary of Unadjusted NRP Population Estimates for Schedule C
Misreporting, Tax Year 2001:
Figure 4: Estimated Understated Tax Amounts by Percentile for Form
1040s with Schedule Cs Attached, Tax Year 2001:
Figure 5: Estimated Cumulative Understated Taxes by Percentile for Form
1040s with Schedule Cs Attached, Tax Year 2001:
Figure 6: Number of AUR NEC Contacts Made and Total Recommended
Assessments, Tax Years 1999-2003:
Figure 7: Examinations of Returns with Schedule C Attachments and
Recommended Tax Assessments, Fiscal Years 2001-2006:
Figure 8: Recommended Penalties for Sole Proprietors and Non-Sole
Proprietors in NRP Examinations with a 100 Percent or Greater
Recommended Tax Change by Dollar Value of Tax Change in Tax Year 2001:
Abbreviations:
AGI: adjusted gross income:
AUR: Automated Underreporter Program:
EIN: employer identification number:
FIRE: Filing Information Returns Electronically:
IRS: Internal Revenue Service:
NEC: nonemployee compensation:
NMA: net misreported amount:
NRP: National Research Program:
SOI: IRS Statistics of Income Division:
TIN: taxpayer identification number:
United States Government Accountability Office:
Washington, DC 20548:
July 13, 2007:
The Honorable Max Baucus:
Chairman:
The Honorable Charles Grassley:
Ranking Member:
Committee on Finance:
United States Senate:
Voluntary compliance with federal tax laws is a critical component of
the federal tax system. Each year, however, a gap arises between tax
amounts that were voluntarily reported and paid on time and those that
should have been paid. The Internal Revenue Service's (IRS) most recent
estimate is that the gross federal tax gap for tax year 2001 was $345
billion.
Sole proprietors, who own unincorporated businesses by themselves, have
a relatively high rate of tax noncompliance and account for a
significant portion of the tax gap. IRS estimates that sole proprietors
misreported 57 percent of their business income in 2001 and that $68
billion of the tax gap is attributable to sole proprietors
underreporting such income.[Footnote 1] Key reasons for sole
proprietors' relatively high tax noncompliance are well known. Sole
proprietors are not subject to tax withholding, and only a portion of
their net business income is reported to IRS by third parties. By
comparison, misreporting rates for wage and interest income, which are
subject to withholding or information reporting by financial
institutions, are low (about 1 and 4 percent, respectively).
Congress has been encouraging IRS to develop an overall tax gap
reduction plan or strategy that could include a mix of approaches, like
simplifying tax law, increasing enforcement tools, and reconsidering
the level of resources devoted to enforcement. On September 26, 2006,
the Department of the Treasury (Treasury), Office of Tax Policy, issued
"A Comprehensive Strategy for Reducing the Tax Gap." At the time,
Treasury officials said that a more detailed strategy would be
forthcoming.
Because of your concern about the tax gap and the importance of sole
proprietor compliance, you asked us to identify steps that might
improve that compliance. Our objectives were to (1) describe the nature
and extent of the noncompliance associated with sole proprietors, (2)
describe the extent to which IRS's enforcement programs address the
types of sole proprietor noncompliance found by IRS's most recent
research, and (3) identify options to close the tax gap related to sole
proprietors that could be included in the tax gap strategy being
developed by Treasury. To describe the nature and extent of sole
proprietor noncompliance, we analyzed IRS's National Research Program
(NRP) results on the reporting compliance of individual taxpayers in
tax year 2001, IRS's tax gap estimates, and IRS's Statistics of Income
(SOI) data to develop a profile of sole proprietors and related tax
compliance issues.[Footnote 2] To determine the extent to which IRS's
compliance programs address sole proprietor noncompliance, we reviewed
filing guidance and compliance program procedures and analyzed program
results. We interviewed IRS staff on the operations and results of the
Automated Underreporter Program (AUR), which tests for underreporting
by computer matching information returns reporting selected payments
made to sole proprietors with income tax returns. We also interviewed
staff in IRS's correspondence, office, and field examination (or audit)
programs. In addition, we reviewed NRP examination cases to identify
examples of barriers when examining sole proprietors.
We used several approaches to identify options for closing the sole
proprietor tax gap that could fit into the tax gap strategy. We focused
on options that could address the types of sole proprietor
noncompliance profiled by IRS's research and the limitations of IRS's
enforcement programs that address sole proprietors. We also reviewed
existing recommendations from the President's Budget, President's
Advisory Panel on Federal Tax Reform, our previous recommendations and
reports of the Treasury Inspector General for Tax Administration, IRS's
Taxpayer Advocate, and IRS advisory groups. We discussed the options
with experts on sole proprietor compliance, including persons who have
experience with IRS or other federal programs related to sole
proprietors or who published related research. We met with officials
from various small business organizations, professionals who provide
tax advice to small businesses, and tax professional organizations.
Further, we reviewed Treasury's tax gap strategy. A more detailed
description of our methodology is in appendix I. This report contains
estimates which have associated confidence intervals that are conveyed
in the body or discussed in the appendix. We conducted our review from
July 2006 through June 2007 in accordance with generally accepted
government auditing standards.
Results in Brief:
Most sole proprietors underreported net business income for tax year
2001, but a small proportion of them accounted for the bulk of
understated taxes. This underreported income was caused by misreporting
of both gross income and expenses. Based on what was detected in NRP
reviews, at least 61 percent of sole proprietors underreported their
net income by $93.6 billion in 2001. IRS recognizes that these are
underestimates because detecting underreported income is difficult,
especially cash receipts. After upward adjustment, IRS estimated that
underreported net income resulted in sole proprietors understating
their taxes by $68 billion. Although most sole proprietors had
understated taxes, the amounts were skewed. Of all sole proprietors who
understated taxes, the lower half understated them by less than an
estimated $903. Over 1 million sole proprietors had tax understatements
above $6,200, which accounted for the upper 10 percent of
understatements. These understatements averaged an estimated $18,000
and accounted for 61 percent of all understated taxes on returns filed
by sole proprietors.
IRS's main programs to check sole proprietor tax compliance--AUR and
the Examination program--have a limited reach. AUR annually contacts
about 3 percent of the estimated population of noncompliant sole
proprietors while Examination reaches less than 2 percent of them.
Information returns that AUR uses to verify sole proprietor income only
cover about 25 percent of sole proprietor gross receipts and generally
few of their expenses. Barriers to submitting information returns,
including complex requirements and lack of convenient electronic
filing, also limit AUR's reach. Examinations of sole proprietors' tax
returns are more costly and recommend lower additional tax assessments
than some other examinations. However, examinations (like other
enforcement programs) may have a deterrent effect and increase
voluntary compliance by other sole proprietors. Because the rate of
noncompliance of sole proprietors is so high, any change in their
compliance rate from more enforcement activity could result in
significant revenue increases. Even without taking into account any
effect on voluntary compliance, IRS's enforcement programs annually
make contact with hundreds of thousands of sole proprietors and
recommend billions of dollars in additional tax assessments. Finally,
IRS did not always apply negligence penalties during NRP for sole
proprietors with large tax changes.
Since the mid-1990s, we have reported on the need for a strategy to
address the overall tax gap as well as the part caused by sole
proprietors. That need still exists. Treasury's recently released tax
gap strategy discusses neither sole proprietor noncompliance nor the
many options that could address it. Although the fiscal year 2008
budget request had legislative proposals on the tax gap, including some
related to sole proprietors, these proposals do not make up a long-
term, comprehensive strategy. Because no single approach is likely to
cost effectively reduce the tax gap by sole proprietors, various
options could be considered as part of the overall tax gap strategy and
would require IRS, Treasury, or legislative action. These options
include enhancing assistance to taxpayers, making information return
submission more convenient, requiring more information reporting, and
increasing IRS enforcement. Each option has pros and cons. In general,
the pros include increasing voluntary compliance, enhancing IRS's
ability to detect noncompliance, and reducing the burden of complying.
The cons include additional burdens imposed on sole proprietors and
third parties as well as costs imposed on IRS. We do not rank the
options or recommend particular ones because IRS has other compliance
objectives in addition to sole proprietor compliance, some options may
be substitutes for each other, and quantitative information about the
pros and cons is often lacking. Details on all of our options,
including some of the pros and cons, are included in appendix II.
We recommend that the Secretary of the Treasury ensure that the tax gap
strategy includes (1) a segment on improving sole proprietor compliance
that is coordinated with broader tax gap reduction efforts and (2)
specific proposals, such as the options we identified, that constitute
an integrated package. In commenting on a draft of this report,
Treasury said that although not addressed specifically, the seven
elements of the department's strategy are intended to apply broadly to
all types of businesses and individual taxpayers, including sole
proprietorships. Treasury also stated that this report provides
valuable insight for applying the strategy to the tax gap. IRS and
Treasury also provided technical comments on a draft of this report,
which we incorporated as appropriate. IRS did not provide written
comments.
Background:
Sole proprietors own unincorporated businesses by themselves. As such,
they are distinct from corporations and partnerships. In this report,
the term sole proprietors refers to both the owners of the businesses
and the category of business. In tax year 2003, 20.6 million sole
proprietors filed tax returns (the latest year for which detailed IRS
data were available). Sole proprietors constitute about 72 percent of
all businesses in the United States but are small; they have only 4.8
percent of all business receipts. Sole proprietors include a wide range
of businesses, including those that provide services, such as doctors
and accountants; produce goods, such as manufacturers; or sell goods at
fixed locations, such as car dealers and grocers. These activities may
be full time or part time and may be all or part of an individual's
income. Figure 1 shows the distribution of sole proprietors and their
gross receipts by the size of the proprietorship.
Figure 1: Distribution of Sole Proprietors and Their Gross Receipts by
Size of Proprietorship, Tax Year 2003:
[See PDF for image]
Source: GAO analysis of IRS data.
[End of figure]
Sole proprietors report their business-related net profit or loss on
IRS Form 1040, U.S. Individual Income Tax Return, through their
Schedule C Profit or Loss from Business (see app. III). The Schedule C
requires sole proprietors to classify their type of business or
profession, report gross receipts and income, place expenses in 23
categories, and provide additional data on vehicle expenses. Sole
proprietors with expenses up to $5,000 may qualify for simplified tax
reporting on Schedule C-EZ, which allows them to report all expenses on
one line. Sole proprietors combine their business profits or losses,
reported on Schedule C, with income, deductions, and credits from other
sources that are reported elsewhere on the Form 1040 to compute their
overall individual tax liability.
In addition to income tax obligations, sole proprietors have other tax
requirements. If they have employees, sole proprietors are responsible
for withholding and paying Social Security, Medicare, and federal
income tax, and paying federal unemployment tax under an employer
identification number (EIN) that is the tax identification number (TIN)
for the business. Whether they have employees or not, sole proprietors
are required to pay self-employment tax, which is similar to the Social
Security and Medicare tax for wage earners.
Information Reporting:
Sole proprietors may prepare and receive information returns for
payments made to them or made by them for services, known as
nonemployee compensation (NEC), on an IRS Form 1099-MISC.[Footnote 3]
IRS uses the NEC data in its matching programs, such as AUR, to help
verify a sole proprietor's receipts. Generally, a Form 1099-MISC needs
to be filed with IRS and the recipient of the payment for:
* payments of $600 or more for services performed for a trade or
business, including a sole proprietor, by people who are not employees,
such as contractors;[Footnote 4]
* rent payments of $600 or more, other than rents paid to real estate
agents;[Footnote 5] and:
* sales of $5,000 or more of consumer goods to persons for resale
anywhere other than in a permanent retail establishment.
Payments for purchases of goods and service to corporations generally
are not required to be reported.[Footnote 6]
Based on these rules, organizations (including sole proprietors) that
make NEC payments for services provided may be required to submit
information returns to IRS and the payee. For example, a store owner (a
sole proprietor) who hires a self-employed computer programmer (another
sole proprietor) to design the business Web site for $10,000 must
submit a Form 1099-MISC information return to report the $10,000
payment made to the computer programmer. However, if the programmer is
hired to design a personal, non business Web site for the store owner,
no information return is required.
Completing a Form 1099-MISC requires the payer to determine whether the
payee is an independent contractor or an employee. To determine
independent contractor status, payers are to use 20 common law
rules.[Footnote 7] Numerous controversies over interpretation of the
common law rules led to the enactment of Section 530 of the Revenue Act
of 1978, which stops IRS and Treasury from issuing new interpretations
of these rules.[Footnote 8] In 1996, we characterized these rules as
confusing and resulting in many misclassifications. If the
determination results in an employee-employer relationship, the
organization is required to prepare a Form W-2 and withhold tax from
each payment to the employee.
Similarly, the payer must determine if the payee is a corporation,
since such payments generally are not subject to Form 1099-MISC
reporting. To determine if the service is provided by a corporation,
service providers are asked to declare their corporation status and, if
not a corporation, provide a TIN. To ensure that payees provide correct
TINs on information returns filed with IRS, NEC payments may be subject
to backup withholding. Independent contractors and Section 530 are
discussed in appendix IV, and backup withholding rules are discussed in
appendix V.
IRS Enforcement Programs:
IRS's two main programs for ensuring compliance among sole proprietors
are AUR and Examination. AUR matches the NEC income reported on the
Schedule C of the sole proprietor's tax return with the NEC income
reported on Form 1099-MISC. AUR may send a notice to the sole
proprietor if the AUR matching identifies a discrepancy between the NEC
reported. The notice proposes adjustments to the tax return filed and
requests payment of additional tax, interest, or penalties related to
the discrepancy. If the taxpayer disagrees with the notice, the
taxpayer is requested to explain the difference and provide any
supporting documents. Figure 2 describes the NEC information reporting
process.
Figure 2: IRS's Nonemployee Compensation Information Returns Matching
Process:
[See PDF for image]
Source: GAO analysis of IRS information, Art Explosion (images).
[End of figure]
Examinations may address any type of noncompliance issue and come in
three forms. Correspondence examinations are conducted through the mail
and usually cover a narrow issue or two. Office examinations are also
limited in scope but involve taxpayers going to an IRS office. For
field examinations, IRS will send a revenue agent to a taxpayer's home
or business to examine the compliance problem that IRS suspects.
Compliance Measurement and the Tax Gap:
IRS estimates the gross tax gap--the difference between what taxpayers
actually paid and what they should have paid on a timely basis--to be
$345 billion for tax year 2001, the most recent estimate made. IRS also
estimates that it will collect $55 billion, leaving a net tax gap of
$290 billion. IRS estimates that a large portion of the gross tax gap,
$197 billion, is caused by the underreporting of income on individual
tax returns. Of this, IRS estimates that $68 billion is caused by sole
proprietors underreporting their net business income. This estimate
does not include other sole proprietor contributions to the tax gap,
including not paying because of failing to file a tax return,
underpaying the tax due on income that was correctly reported, and
underpaying employment taxes. According to IRS, estimates for some
parts of the tax gap are more reliable than those for others. For both
these reasons, the precise proportion of the overall tax gap caused by
sole proprietors is uncertain. What is certain is that the dollar
amount of the tax gap associated with sole proprietors is significant.
IRS bases its estimates of the tax gap caused by underreporting of
individual income on its compliance research program--NRP. The
individual reporting compliance study was a detailed review and
examination of a representative sample of 46,000 individual tax returns
from tax year 2001. IRS generalized from the NRP sample results to
compute estimates of underreporting of income and taxes for all
individual tax returns. Because even the detailed NRP reviews could not
detect all noncompliance, IRS adjusted the NRP estimates to develop
final estimates of income misreporting and the resulting tax gap. IRS
did not adjust all the NRP population estimates, only those necessary
for developing its final tax gap estimates. However, NRP population
estimates are a rich source of data about the nature and extent of sole
proprietor noncompliance. Consequently, our report sometimes presents
NRP population estimates and sometimes final tax gap estimates.
Most Sole Proprietors Underreported Business Income, but a Small
Proportion Accounted for the Bulk of Unpaid Taxes:
The significant amount of sole proprietor noncompliance reported in
IRS's tax gap estimates is caused by underreporting of net business
income, including the misreporting of both gross business income and
expenses. The distribution of the resulting unpaid taxes is uneven. A
small proportion of sole proprietors, but still a significant number,
has relatively large amounts of unpaid taxes.
Most Sole Proprietors Underreported Net Business Income, Misreporting
Both Gross Income and Expenses:
Based on the unadjusted NRP results, an estimated 70 percent of
Schedule C filers in 2001 (about 12.9 million) made an error when
reporting net business income (that is, net profit or loss on line 31
of Schedule C). Most of the misreporting was underreporting. These NRP
results showed that an estimated 61 percent of Schedule C filers
underreported their net income and 9 percent overreported.
These reporting errors resulted in $93.6 billion, before adjusting, of
misreported net business income as shown in figure 3. This misreporting
included an estimated $99 billion of underreported and $5.4 billion of
overreported net income.
The underreporting of net business income was caused by misreporting of
both gross income and expenses, as shown in figure 3. An estimated 39
percent of sole proprietors (6.9 million) made an error on the gross
income line of Schedule C and underreported about $53 billion net after
subtracting overstatements from understatements. An estimated 73
percent of sole proprietors (10.9 million) made an error on the total
expense line of the Schedule C and overreported about $40 billion net
after subtracting understatements from overstatements.[Footnote 9]
Overstating expenses reduces net business income and thus taxes.
However, understating expenses may also contribute to understated tax
if it is done to disguise understating higher amounts of gross income.
The misreporting of expenses was spread over all the 23 expense
categories on the Schedule C. However, 55 percent of expense
misreporting was concentrated in four categories: car and truck,
depreciation, supplies, and other.
Figure 3: Summary of Unadjusted NRP Population Estimates for Schedule C
Misreporting, Tax Year 2001:
[See PDF for image]
Source: GAO presentation of IRS information.
Notes: Each line estimate is computed separately. For example, the
estimate of total expenses is based on a different number of tax
returns than for net profits. For this reason, in part, the percentage
of returns with errors for total expenses is greater than those for net
profits. The computations and confidence intervals are discussed in
app. I.
[A] A positive NMA refers to misreporting that could understate tax.
Therefore, the NMA for income items is understatements minus
overstatements, and the NMA for expense items is overstatements minus
understatements.
[End of figure]
The unadjusted NRP results underestimate the amount of misreporting.
The estimates in figure 3 are based on errors detected in the NRP
reviews. IRS knows that not all misreporting is detected during its
examinations, including NRP reviews. Unreported cash receipts, for
example, are difficult to detect. IRS uses various methodologies and
other sources of data (on cash transactions, for example) to adjust the
aggregate NRP results (but not individual line items) to estimate
misreporting. The NRP data limitations are more fully described in
appendix I.
After these adjustments, IRS estimates that sole proprietors
misreported 57 percent of their net business income in 2001 and that
the tax gap caused by this misreporting of sole proprietor net business
income in 2001 was $68 billion. This is a substantial upward adjustment
from the estimated $36.9 billion in understated taxes from all sources
on returns with a Schedule C attached based on what NRP
detected.[Footnote 10]
Taxpayers misreport income and expenses for a variety of reasons. Some
misreporting is intentional; some is unintentional. How much
misreporting is in each category is not known. IRS refers some
misreporting for criminal prosecution, but often it is impossible to
tell from a tax return whether errors are intentional. Beyond
intentional misreporting, reasons for errors include transcription
mistakes, misunderstanding of the relevant tax laws or regulations, and
poor recordkeeping. Examples from our review of NRP examination case
files illustrate some of these types of reporting errors:
* The sole proprietor operated a cash-card business and reported about
$900,000 in gross receipts on the Schedule C. The business is largely
done with cash transactions. The examiner found evidence of more than
$1 million in additional sales income, as well as additional expenses
from purchases, leading to an adjustment of about $30,000 for Schedule
C net income. The adjustment contributed to a total proposed additional
tax assessment of about $8,000.
* The sole proprietor owned a construction business and reported
Schedule C losses of over $30,000. The examiner found that that the
sole proprietor had poor business skills and shoddy records. Organizing
the documentation to support the Schedule C required over 25 hours of
examiner time and resulted in net adjustments to receipts and expenses
on the Schedule C of over $45,000.
* The sole proprietor owned a retail business and reported Schedule C
gross income of almost $250,000. The examiner proposed adjustments of
about $9,000 to Schedule C expenses because the expenses were
undocumented or were personal living expenses not associated with the
business. In protesting the related assessment to IRS Appeals, the
taxpayer's representative said that the taxpayer's records were spread
across several store accounts, several accounts for rental properties,
and two personal accounts. Eventually, Appeals identified additional
records and sent the case back to Examination.
* The taxpayer was selling craft-related items and admitted to the IRS
auditor that the sales were not engaged in for profit. Accordingly, the
taxpayer should not have filed a Schedule C, and several thousand
dollars of expenses reported by the taxpayer on Schedule C were
disallowed.
* The taxpayer was a minister and filed a schedule C. The examiner
explained that although the taxpayer was self-employed in performing
ministerial services for Social Security purposes, the taxpayer was
considered an employee for income tax purposes. The taxpayer should not
have filed a Schedule C.
Although a Small Proportion of Sole Proprietors, More Than 1 Million
Accounted for the Majority of Understated Taxes:
Understated taxes are spread unevenly among the population of sole
proprietors, and slightly more than 1 million sole proprietors
accounted for most of the understatements. On one hand, the amount of
tax understatement caused by underreported net Schedule C income cannot
be calculated precisely. Understated taxes on a return could result
from the misreporting of multiple items, and the tax calculations
depend on all such misreporting rather than just one item.[Footnote 11]
On the other hand, using the best available data on underreporting
detected by NRP, we estimate that 72 percent of the underreported
adjusted gross income (AGI) on income tax returns filed by sole
proprietors was caused by changes in Schedule C income.[Footnote 12] As
a result, it is likely that most of the NRP-estimated $36.9 billion
(unadjusted) in understated taxes on these returns can be attributed to
underreported net business income on Schedule C.
Although most sole proprietors had understated taxes, the amounts were
skewed. Based on NRP estimates, half of sole proprietors who
understated taxes on their individual income tax returns, understated
less than an estimated $903 (the 50th percentile amount), as shown in
figure 4. Above the 50th percentile, the amount of tax understatement
significantly increased to an estimated $2,527 at the 75th percentile,
$6,210 at the 90th percentile, and $20,387 at the 98th percentile.
About 1.25 million sole proprietors accounted for the largest 10
percent of understatements for which the mean was about $18,000; for
the largest 5 percent, the mean understatement was about $27,000. By
comparison, as will be discussed further in the next sections, IRS's
field examiners assessed on average $27,800 of additional tax for
examinations of individual returns without Schedule Cs.
Figure 4: Estimated Understated Tax Amounts by Percentile for Form
1040s with Schedule Cs Attached, Tax Year 2001:
[See PDF for image]
Source: GAO analysis of IRS data.
Notes: Figure 4 excludes returns with no understatement and is based on
unadjusted NRP results. Confidence intervals are discussed in app. I.
[End of figure]
Most of the aggregate $36.9 billion of understated taxes (unadjusted
NRP estimate) on returns filed by sole proprietors was concentrated in
a small proportion of sole proprietors. As shown in figure 5, the 11.2
million sole proprietors at and below the 90th percentile understated
their taxes by a cumulative $14.3 billion. The remaining 10 percent
(1.25 million) above the 90th percentile understated a cumulative $22.6
billion in taxes, accounting for 61 percent of the total.
Figure 5: Estimated Cumulative Understated Taxes by Percentile for Form
1040s with Schedule Cs Attached, Tax Year 2001:
[See PDF for image]
Source: GAO analysis of IRS data.
Notes: Figure 5 excludes returns with no understatement and is based on
unadjusted NRP results. Confidence intervals are discussed in app. I.
[End of figure]
When arrayed by the size of the sole proprietor and based on reported
gross receipts, understated taxes are less skewed. Based on Schedule C
gross receipts, those sole proprietors at or below the 90th percentile
($127,462) accounted for 65 percent of cumulative understated taxes
($23.9 billion of $36.9 billion).[Footnote 13] Those with the largest
10 percent of gross receipts accounted for the other 35 percent or
$12.9 billion of the understated taxes.
Enforcement Programs Have Limited Reach over Sole Proprietors but Still
Make Billions of Dollars in Recommended Assessments:
IRS's two main programs for addressing sole proprietor reporting
compliance[Footnote 14]--AUR and Examination--have limited reach over
noncompliant sole proprietors, although they annually contact hundreds
of thousands of taxpayers and recommend billions of dollars in
assessments. Table 1 shows the types of sole proprietor noncompliance
that AUR and Examination investigate, the percentage of the
noncompliant sole proprietor population with recommended assessments,
and the limitations of the programs.
Table 1: Percentage of Recommended Assessments and Limitations of IRS
Enforcement Programs for Detecting Sole Proprietor Reporting
Noncompliance:
IRS program: AUR;
Sole proprietor noncompliance addressed: Inaccurately reported gross
receipts;
Percentage of noncompliant population with recommended assessments:
2.7[A];
Program limitations:
* Form 1099-MISC is not required to be filed on all gross receipts
(e.g., sales of goods);
* Form 1099-MISC is not always filed as required because of various
barriers;
* Does not address sole proprietor expenses;
* Does not follow up on all the mismatches identified;
* Some information submitted by taxpayers is not verified.
IRS program: Examination;
Sole proprietor noncompliance addressed: Receipts and expense
noncompliance;
Percentage of noncompliant population with recommended assessments:
1.4[B]; [Empty];
Program limitations:
* Most examinations are not designed to address sole proprietor tax
issues;
* Examinations can take a lot of time;
* Recommended assessments are lower from examining sole proprietor
issues compared to examining other types of tax return issues.
Source: GAO analysis of IRS data.
[A] Tax year 2003, the most recent year for which the appropriate AUR
data were available.
[B] Examinations conducted in fiscal year 2005 on calendar year 2004
returns, the most recent year for which the appropriate Schedule C
filing data were available.
[End of table]
Assuming that Schedule C filers would misreport net income at the same
rate in subsequent years as they did in 2001, AUR recommended that
additional tax be assessed on about 2.7 percent of noncompliant sole
proprietors for tax year 2003.[Footnote 15] Similarly, Examination
recommended that additional tax be assessed on about 1.4 percent of
noncompliant sole proprietors for returns from tax year 2004.[Footnote
16]
AUR Is Restricted by Limits on Information Reporting and Other Program
Constraints but Still Identifies Significant NEC Noncompliance:
AUR cannot detect all sole proprietor misreporting because the third-
party information returns used for matching do not report all sole
proprietor receipts or expenses. One quarter of sole proprietor
receipts reported on a Schedule C in 2001 also appeared on a Form 1099-
MISC that year. Since not all receipts are reported on a Schedule C,
the true percentage would be lower. Exemptions to information reporting
requirements prevent greater coverage of sole proprietor receipts. Most
merchandise sales, nonbusiness services (such as construction or
repairs for homeowners), and payments of less than $600 are exempt from
Form 1099-MISC reporting. Additionally, because payments to
corporations are generally exempt, sole proprietors that want to avoid
information reporting of their receipts could incorporate.
Several barriers may inhibit information return filing on NEC payments.
First, preparing a Form 1099-MISC to report NEC payments can be a
complex process.[Footnote 17] The general instructions for filling out
any information return are 21 pages long, and the instructions for Form
1099-MISC are 8 pages long. Payers must figure out whether the
businesses they have hired are independent contractors or exempt
corporations and whether the payments meet other exemption criteria as
well as acquire the payees TINs or EINs.
Second, submitting Form 1099-MISC returns is not convenient. In its
instructions, IRS requires payers to use forms printed with red,
magnetic ink so that IRS scanners can more easily process the forms;
payers are instructed not to print Form 1099-MISC off of IRS's Web
site. However, we observed plain paper Form 1099-MISC returns being
scanned in IRS's Ogden, Utah, processing center. Furthermore, payers
must submit Form 1099-MISC returns separately from their tax returns.
There is $50 penalty, as the instructions prominently remind payers,
for failing to use the correct form. In practice, IRS may not assert
the penalty for every violation because of the administrative and
collection costs.
IRS has an Internet-based system for submitting information returns
called Filing Information Returns Electronically (FIRE), but barriers
exist to the use of that system. FIRE requires payers to put return
information in a particular format that IRS can use, which requires
appropriate software that payers must purchase. Payers cannot simply
call up a Web site and fill out an online form, and they need to
register with IRS before using the system.[Footnote 18] The likelihood
that a payer would submit a Form 1099-MISC return electronically
decreases as the number of forms that the payer files decreases. For
example, IRS data from tax year 2005 show that 93 percent of paper Form
1099-MISC returns were filed by payers with 24 or fewer submissions.
One common tax preparation software package allows users to print Form
1099-MISC and submit them to IRS on paper, but the users cannot
transmit Form 1099-MISC returns electronically as they can income tax
returns. This software vendor said that it had a special arrangement
with IRS for its users to print Form 1099-MISC on plain paper.
Paper forms are more costly for IRS to process than electronically
filed forms. With paper, IRS workers scan forms into a database and
visually verify that the information was scanned correctly, a labor-
intensive process. A substantial number of Form 1099-MISC returns are
filed on paper. For filing year 2005, the Form 1099-MISC constituted 87
percent of all the paper information returns submitted that IRS could
scan. Nearly 40 percent of Form 1099-MISC returns (31.5 million) were
submitted via paper that year.
AUR Is Limited by a Lack of Resources, Expense Matching, and
Examination Authority:
Because of resource constraints, IRS officials said they do not contact
taxpayers in all cases where AUR finds a mismatch between what was
reported on an information return and what was reported on a tax
return. The annual average of NEC-related contacts for tax years 1999
through 2003 is much less than half of the roughly 2 million cases that
AUR officials say they annually identify for taxpayer contacts caused
by potential NEC underreporting.[Footnote 19]
Also, AUR matching generally does not address misreported Schedule C
expenses. First, according to IRS, AUR does not match sole proprietors'
Schedule C expenses with the information returns they file for their
own payments. Second, third-party information generally is not required
on sole proprietor expenses.[Footnote 20]
AUR reviewers are directed to consider the reasonableness of the
taxpayers' responses to notices but generally do not examine the
accuracy of the information in the responses because they do not have
examination authority.[Footnote 21] IRS officials said that addressing
larger issues raised in the returns would take more time and possibly
reduce the productivity of AUR overall. Consequently, taxpayers could,
after being contacted by AUR about underreported NEC, create fictitious
expenses to offset the underreported NEC.
AUR does not systematically check for related parties trying to shift
income from a tax return in a high-rate bracket to another return with
a lower bracket. Related parties may include taxpayers who own multiple
businesses, husbands and wives who file separate tax returns, unmarried
couples, siblings, or parents and their children. IRS data showed that
3 percent of all Form 1099-MISC returns had the same address for the
payer and the payee--one indicator that a related-party transaction
might exist. A nonrandom file review of 55 Form 1099-MISC filings at
IRS's Ogden, Utah, campus found 8 examples in which the payer and payee
had similar addresses or names. We did not determine the
appropriateness of the apparent related-party transactions in the IRS
Form 1099-MISC data based on the incidence of name and address matches.
Two NRP cases are illustrative of apparent related-party transactions
involving Form 1099-MISCs. In one case, a couple shared a financial
account, and one of them was a sole proprietor. The sole proprietor,
who earned more than $450,000 as an executive at a separate company,
paid the other individual to run the sole proprietorship and deducted
the payment on a Schedule C. The sole proprietorship had over $100,000
in losses and less than $1,000 in revenue. In the case file, an
examiner noted that a Form 1099-MISC was filed on the NEC income paid
from the executive to the person at the same address. This case file
did not note whether the payment inappropriately shifted income to
lower the couple's overall tax liability or whether the payment was an
allowable business deduction for services actually rendered as an
ordinary and necessary expense of carrying out a business, as required
by the Internal Revenue Code.[Footnote 22] In another case, however,
IRS disallowed deductions for wages that a psychiatrist paid to his
children because the taxpayer did not show that the children had
rendered services or even that the wages were paid--only that the
deductions were taken.
Despite Limitations, AUR Annually Recommends Hundreds of Millions of
Dollars in Assessments on NEC Misreporting:
Annually, AUR receives more than 80 million 1099-MISC forms. From those
submissions, AUR contacts hundreds of thousands of taxpayers about
potential sole proprietor misreporting on those forms and makes
billions of dollars in recommended assessments. From tax years 1999
through 2003,[Footnote 23] AUR annually, on average, sent 371,989
notices on NEC cases and recommended $666 million in tax assessments.
Figure 6 shows the trends in NEC contacts and total recommended
assessments that AUR made from 1999 through 2003.
Figure 6: Number of AUR NEC Contacts Made and Total Recommended
Assessments, Tax Years 1999-2003:
[See PDF for image]
Source: GAO analysis of IRS data.
[End of figure]
Contacts and assessments related to underreported NEC make up a
significant portion of the AUR caseload. Of more than 60 categories
that AUR uses to sort income data, the two NEC categories combined rank
first in the number of contacts with taxpayers and in the dollars of
recommended assessments made from tax year 1999 through tax year 2003.
NEC cases constituted 17 percent of all AUR contacts and 21 percent of
all AUR assessments for tax years 1999 through 2003.
Examination Program Is Not Geared toward Schedule C Issues but Still
Finds Significant Noncompliance:
Most of IRS's examinations do not focus on noncompliance by sole
proprietors.[Footnote 24] Correspondence examinations account for the
majority of IRS's examinations that IRS did in fiscal year 2006 and
generally take the least amount of time to conduct, typically an hour
or less, because they deal with simple, limited issues. Schedule C tax
issues are generally too complex to make an examination through
correspondence practical. For example, in our review of NRP files, we
found a case in which an examiner manually sorted through a taxpayer's
records and organized them to accurately calculate the taxes owed--a
task that could not occur through correspondence. In any case, IRS's
correspondence tax examiners, the lowest-graded examiners, do not have
the training to examine many Schedule C issues, such as business
depreciation or accounting methods.
Schedule C tax issues typically must be addressed in field
examinations. Field examinations took 20 hours on average to complete
in fiscal year 2006. Furthermore, field examinations of returns with
Schedule C forms took about 50 percent longer per return (7.2 hours
more) to complete than those not categorized as Schedule C returns in
that year.
Among field examinations, the recommended additional tax assessed for
examinations of returns with attached Schedule C forms tended to be
smaller than for other types of examinations. For example, the average
recommended assessment for revenue agents examining returns with
attached Schedule C forms (the employees most likely to do these
examinations) was $24,000 in fiscal year 2006. This was $3,800 less
than examinations of returns without Schedule C attachments and was
less than the average dollars per return for 18 other types of returns
without Schedule C attachments, such as tax-shelter program cases.
The relatively higher costs and lower yields for Schedule C
examinations do not necessarily mean than Schedule C examinations are
not cost-effective. The statistics reported above include only the
additional taxes expected from the taxpayer who was examined.
Examinations may have a deterrent effect on other taxpayers and
increase the rate of voluntary compliance.[Footnote 25] Because the
rate of noncompliance is so high for sole proprietors, any change in
their voluntary compliance from doing more examinations could result in
significant revenue increases.
IRS has been examining more tax returns with attached Schedule C forms,
resulting in billions of dollars in recommended tax assessments. From
fiscal years 2001 through 2006, the number of examinations of returns
that IRS categorized as Schedule C returns increased by 132 percent,
from 128,062 to 297,626, as shown in figure 7.[Footnote 26] In fiscal
year 2006, IRS examined about 3 percent of the Schedule C categorized
returns. Recommendations of additional tax assessments also increased
each year. The large increase in these assessments in 2005 was
primarily for returns reporting income greater than $100,000. IRS
officials also cited Son of Boss fraud cases from fiscal years 2005 and
2006 and increased examination efficiency as causes for the upward
trends.[Footnote 27] Assessments do not reflect amounts actually
collected. Amounts ultimately collected are not yet known from the
examinations closed in 2005 and 2006.
Figure 7: Examinations of Returns with Schedule C Attachments and
Recommended Tax Assessments, Fiscal Years 2001-2006:
[See PDF for image]
Source: GAO analysis of IRS data.
[End of figure]
IRS Did Not Always Apply Negligence Penalties during NRP:
IRS did not apply negligence penalties in a substantial portion of NRP
cases with a tax change. IRS uses negligence penalties[Footnote 28] to
encourage compliance and to assure compliant taxpayers that the tax
system is fair.
Although sole proprietors were more frequently penalized than non-sole
proprietors, just 62 percent of the sole proprietors who had a 100
percent or more tax change in their tax liability after the NRP
examination and had a tax change of $10,000 or more were penalized. For
smaller tax changes, the percentage penalized was lower. Figure 8
summarizes the penalty results from the NRP examinations for tax
returns with a 100 percent or more change for sole proprietors and non-
sole proprietors.
Figure 8: Recommended Penalties for Sole Proprietors and Non-Sole
Proprietors in NRP Examinations with a 100 Percent or Greater
Recommended Tax Change by Dollar Value of Tax Change in Tax Year 2001:
[See PDF for image]
Source: GAO analysis of IRS information.
[End of figure]
Our NRP case file review provided some examples in which penalties were
not assessed at all or seemed to be assessed inconsistently.
* A sole proprietor reported AGI of about $10,000 and zero tax
liability on the return. An examiner proposed total adjustments of
about $3,000, which included unreported Schedule C receipts and
overstated expenses resulting in additional tax of about $450. The
examiner proposed a negligence penalty of about $90, explaining that
the taxpayer did not take reasonable care in preparing the tax return,
which was done by a tax preparer.
* A sole proprietor reported AGI of about $90,000 and a tax liability
of about $16,000. An examiner proposed total adjustments of about
$35,000, based on unreported Schedule C receipts and overstated
expenses, and a tax increase of $15,000. The examination workpapers
explained that no negligence penalty was proposed since the tax
preparer was responsible for most of the adjustments.
The differences in individual cases might be caused in part by IRS
procedures that give revenue agents discretion on whether to pursue a
penalty, even when the tax change is substantial.[Footnote 29]
Recommended penalties must be reviewed by the examiner's manager.
Explanations ranging from a lack of knowledge to reliance on a paid
preparer can lead some examiners to mitigate a penalty but not others.
IRS officials said the application of penalties in NRP cases should be
similar to that for operational examinations because NRP examiners were
required to follow IRS's standard guidance for penalties. We have
started work on a study that will more fully analyze the use of
penalties in IRS's operational examinations.
Current Treasury Tax Gap Strategy Discusses Neither Sole Proprietor
Noncompliance nor the Many Options That Could Address It:
The tax gap strategy issued by Treasury in September 2006 does not
discuss sole proprietor noncompliance or specific options to address
it. A number of options to improve sole proprietor compliance exist and
could be considered as part of the overall tax gap strategy. Each
option has both pros (such as improved compliance) and cons (such as
burdens on taxpayers or third parties).
Tax Gap Strategy Does Not Specifically Discuss Sole Proprietor
Noncompliance:
Treasury's tax gap strategy does not discuss specific options to
address the tax gap overall or sole proprietor noncompliance in
particular. As we discussed in February 2007 testimony,[Footnote 30]
the strategy generally does not identify specific steps that Treasury
and IRS[Footnote 31] will undertake to reduce the tax gap, the related
time frames for such steps, or explanations of how much the tax gap
would be reduced. Rather, the strategy broadly discusses opportunities
for tax evasion and the preventive role of tax research, information
technology, compliance activities, taxpayer service, tax law
simplification, and working with stakeholders. For example, the portion
on improving compliance activities generally discusses initiatives on
expanded information reporting, improved document matching, refined
detection programs, and increased examinations in selected areas.
However, no specifics are provided. Without specifics, the strategy
does not include actions that potentially would reduce the tax gap.
Since the mid-1990s, we have reported on the need for a strategy to
address the federal tax gap as well as sole proprietor noncompliance.
In May 1994, we summarized many ideas on reducing the tax gap,
including ideas on information reporting, tax withholding, and tax
simplification.[Footnote 32] In August 1994, we reported on the lack of
a comprehensive linkage between IRS's compliance strategy and
compliance efforts for sole proprietors and on the need for better
systems to identify the causes of noncompliance and target enforcement
resources.[Footnote 33] More recently, in July 2005, we reported that
IRS needed a results-oriented approach to reduce the tax gap based on
long-term, quantitative voluntary compliance goals and performance
measures to determine the success of its strategies and adjust as
necessary.[Footnote 34] In April 2006, we testified that IRS had
established such compliance goals but lacked a data-based plan for
achieving the goals.[Footnote 35] In February 2007, we testified on the
need for multiple approaches to reduce the tax gap, including improved
taxpayer services, tax code simplification, more information reporting,
and an appropriate level of resources for tax enforcement.[Footnote 36]
Our products related to the tax gap are listed in the Related GAO
Products section at the end of this report.
IRS is not without some of the elements of a tax gap strategy. IRS's
management continually makes decisions about reallocating resources and
has taken steps that demonstrate an understanding of the value of a
more strategic approach. One important step is NRP, which gives IRS
management more information about the nature of noncompliance and is
being used to better target examinations on noncompliant taxpayers.
IRS's annual budget requests include specific compliance program
proposals. For example, the fiscal year 2008 budget submission had 16
legislative proposals on tax gap reduction. Some of these proposals
related to sole proprietors, such as those requiring information
reporting on certain government payments made for the procurement of
property and services and on merchant card payment reimbursements.
Several IRS and Treasury experts, and other knowledgeable individuals
also commented that many of these options would be applicable to any
small business regardless of its organizational form (such as
partnerships, limited liability companies, and corporations). However,
these elements do not make up the type of long-term, comprehensive
strategy, described above, that provides an overall rationale and
specific steps, time frames, and predicted impact on the tax gap.
Many Options for Improving Sole Proprietor Compliance Exist and Could
Be Considered for the Tax Gap Strategy, But All Have Trade-offs:
Many options exist that could help reduce sole proprietor
noncompliance. These options range from enhancing IRS's assistance to
taxpayers to instituting tax withholding on payments made to all or
certain types of sole proprietors. Each option has pros and cons.
We identified options and their pros and cons by reviewing our reports
and the reports of others on sole proprietor compliance as well as
through extensive conversations with experts and knowledgeable
individuals inside and outside of IRS. Consistent with our previous
reports, we tried to identify options that represented a range of
approaches, such as improving taxpayer service, more information
reporting, and various enforcement actions. Many of the options are
directed at the specific sole proprietor compliance problems and IRS
program limitations described earlier in this report. We placed the
options into broad categories of problems, such as poor recordkeeping,
unreported business income, and overstated business expenses. Our list,
in table 2, is not exhaustive and not ranked in any order. Appendix II
contains a longer description of each option, including pros and cons.
Table 2: Options to Improve Sole Proprietor Tax Compliance:
A. Recordkeeping and complexity:
1. Work with small business representatives to improve instructions for
keeping records and completing the Schedule C;
A. Recordkeeping and complexity:
2. Provide assistance to first-time Schedule C filers;
a. Target outreach to sole proprietors filing their first Schedule C--
IRS could provide guidance to help them keep records and report
accurately on their Schedule C forms;
b. Notify first time Schedule C filers who did not use a paid tax
preparer and who reported on certain Schedule C lines known to generate
more noncompliance about guidance on IRS's Web site;
A. Recordkeeping and complexity:
3. Separate business and personal records and transactions;
a. Require sole proprietors to include all business transactions in a
financial account or accounts used only for business purposes;
b. Require sole proprietors to obtain TINs for business transactions in
lieu of using their Social Security numbers.
A. Recordkeeping and complexity:
4. Repeal certain limitations in section 530 of the Budget Act of 1978
involving guidance on rules on classifying workers.
B. Burdens and problems for third parties in filing information
returns:
5. Clarify Schedule C instructions to indicate that an information
return may be required from sole proprietors who are deducting expenses
for wages, fees, and commissions;
B. Burdens and problems for third parties in filing information returns:
6. Ensure that IRS's Web-based system for filing information returns
can accommodate those filing information returns on payments made to
sole proprietors;
B. Burdens and problems for third parties in filing information returns:
7. Create a new Form 1099-NEC to segregate the NEC from the various
boxes on the existing Form 1099-MISC.
C. Unreported sole proprietor income:
8. Expand gross receipts reporting on the Schedule C;
C. Unreported sole proprietor income:
9. Close gaps in existing information reporting on payments made to
sole proprietors, for example, by requiring information reporting on
annual service payments that are;
a. made to all corporations or to some subset, such as small
corporations, non-publicly held corporations, or noncompliant
corporations, or;
b. less than $600, which is the current trigger for information
reporting;
C. Unreported sole proprietor income:
10. Require new information reporting by organizations on payments to
sole proprietors;
a. Require businesses that process credit (and debit) card payments to
report on the amount of payments made to sole proprietors for a tax
year;
b. Require federal, state, and local governments to file information
returns on all nonwage payments made to procure property and services
from businesses;
c. Require financial institutions to file information returns on
business deposits and withdrawals by sole proprietors;
C. Unreported sole proprietor income:
11. Require new information reporting on consumer payments to sole
proprietors for property owners who pay contractors for improvements,
if the payments will be used to adjust the basis of the property.
D. Overstated deductions for sole proprietor expenses:
12. Expand expense reporting on the Schedule C;
D. Overstated deductions for sole proprietor expenses:
13. Match information returns filed by sole proprietors with related
expenses on their Schedule C forms;
D. Overstated deductions for sole proprietor expenses:
14. Expand information reporting on the expenses of sole proprietors
under two options;
a. Require businesses that receive certain types of payments from sole
proprietors in large amounts (i.e., thousands of dollars) to file
information returns to report those amounts;
b. Require businesses that process credit (and debit) card payments to
report information on the amount of payments by sole proprietors for
each tax year;
D. Overstated deductions for sole proprietor expenses:
15. Verify additional expenses claimed to offset unreported income.
E. Nonpayment of tax:
16. Deny benefits/payments until tax obligations are met, for example,
by requiring that;
a. sole proprietors pay their self-employment tax obligations in order
to receive credit for Social Security benefits and;
b. federal agencies do a tax compliance check with IRS before providing
a government benefit to a sole proprietor;
E. Nonpayment of tax.
17. Withhold tax to encourage compliance through situational or
universal means by requiring those who are to file information returns
on payments made to sole proprietors to;
a. withhold a small amount from payments until the sole proprietor's
TIN is certified through an IRS system that is quick and accurate and;
b. withhold a very small percentage of the payments made to sole
proprietors in all cases or in limited situations, such as when the
sole proprietor voluntarily consents.
F. IRS management of limited resources:
18. Improve IRS's audit selection of sole proprietor tax returns in at
least two ways;
a. Use more advanced automated systems to update the current manual
system;
b. Improve the ability of AUR to refer cases for audit;
F. IRS management of limited resources:
19. Enhance data sharing with the states;
F. IRS management of limited resources:
20. Use informational notices to encourage compliance;
F. IRS management of limited resources:
21. Revise the rules for penalties to improve consistency and
compliance under two options;
a. Simplify the process for assessing penalties and develop standards
on using penalties;
b. Increase the penalty for subsequent failures to file required
information returns.
Source: GAO analysis and interviews with tax experts and knowledgeable
individuals.
[End of table]
All the options have pros and cons. Because the options are presented
as concepts, rather than as detailed plans ready for implementation,
the pros and cons could vary with such detail. In most cases, pros and
cons are described qualitatively and are not intended to be exhaustive;
additional analysis might find others. In general, the pros include
helping sole proprietors to comply voluntarily, helping IRS detect and
prevent underreporting of income and understatement of taxes, and
reducing the burden on taxpayers or third parties for filing tax
returns and information returns. The cons include the costs and burdens
imposed on sole proprietors, third parties, and IRS.
We are not recommending particular options for a number of reasons:
* Trade-offs. IRS has other compliance objectives in addition to sole
proprietor compliance. Devoting more IRS staff and other resources to
close the sole proprietor tax gap means that fewer resources are
available for combating other types of noncompliance, such as
corporate, individual, or tax-exempt entity noncompliance. Forgoing
enforcement revenue elsewhere is an opportunity cost of devoting more
resources to sole proprietor noncompliance. Also, the resources and
management capacity devoted to sole proprietor noncompliance may not be
sufficient to implement all the options. Priorities would need to be
established.
* Interaction between options. Some of the options may be substitutes
for each other. Others may be complements. Improving assistance to
taxpayers might reduce the need for some enforcement actions. Some of
the options may reinforce each other--such as expanded information
reporting and more convenient filing options--making it desirable to
package them together.
* Policy judgments. Some of the options involve policy judgments about
how the options would affect different groups of people. For example,
information reporting invariably imposes some costs on the third
parties required to report, but no objective criteria exist for
assessing when third-party costs are excessive. In many cases,
quantitative information about the effects is not available. Judgments
would have to be made based on qualitative information.
For all of these reasons, we are not ranking or otherwise making
recommendations on the value of each option, nor are we opining on
which options should be packaged together and in what manner. The
options could be considered as part of an overall Treasury and IRS tax
gap strategy. For most options, Treasury and IRS would need to develop
the details on how the options would work both singly and as part of a
coordinated strategy. Issues that could be considered in an overall
strategy include how much emphasis should be placed on:
* sole proprietor noncompliance versus other types of noncompliance,
* efforts to help sole proprietors voluntarily comply versus efforts to
help IRS detect noncompliance after it occurs,
* the reporting requirements and added burden placed on sole
proprietors versus the reporting requirements and burden placed on
third parties, and:
* legislative changes versus administrative changes at IRS.
Conclusions:
The tens of billions of dollars in tax revenue lost annually because
sole proprietors under report over half of their aggregate net income
contribute to the nation's long-term fiscal challenge. This
underreporting is also unfair to compliant taxpayers. Because
underreporting is spread among more than 12 million sole proprietors,
much of it in small amounts, because the underreporting is for both
gross income and expenses, and because IRS's enforcement programs are
limited and costly, the sole proprietor tax gap cannot be closed by IRS
enforcement alone. As we have said before, improving compliance will
require a variety of new approaches.
Many options exist for improving sole proprietor compliance; however,
they all have individual pros and cons, some may be substitutes for
each other and some may reinforce each other. Trade-offs also exist at
a broader level. Devoting more IRS resources to sole proprietor
compliance must be judged relative to what those resources could
accomplish in IRS's other programs. Furthermore, IRS's resources are
not the only ones devoted to tax administration. Taxpayers and third
parties spend their time and money to make our tax system work. For
these reasons, the options are best considered as part of an overall
strategy. Such a strategy would provide more assurance that taxpayer,
third party, and IRS resources are being used efficiently to promote
compliance.
Recommendation for Executive Action:
We recommend that the Secretary of the Treasury ensure that the tax gap
strategy includes (1) a segment on improving sole proprietor compliance
that is coordinated with broader tax gap reduction efforts and (2)
specific proposals, such as the options we identified, that constitute
an integrated package.
Agency Comments and Our Evaluation:
We requested written comments from the Secretary of the Treasury and
received comments on behalf of the Treasury from its Tax Legislative
Counsel (see app. VI). In commenting on a draft of this report, the
Treasury said that although not addressed specifically, the seven
elements of the department's strategy are intended to apply broadly to
all types of businesses and individual taxpayers, including sole
proprietorships. Treasury also stated that this report provides
valuable insight for applying the strategy to the tax gap. IRS and
Treasury also provided technical comments on a draft of this report,
which we incorporated as appropriate. IRS did not provide written
comments.
As agreed with your offices, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days
after its date. At that time, we will send copies to the Secretary of
the Treasury, the Commissioner of Internal Revenue, and other
interested parties. This report will also be available at no charge on
GAO's Web site at [hyperlink, http://www.gao.gov].
If you or your staff have any questions about this report, 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 VII.
Signed by:
James R. White:
Director, Tax Issues:
Strategic Issues:
[End of section]
Appendix I: Scope and Methodology:
To describe the nature and extent of the noncompliance associated with
sole proprietors, we analyzed the Internal Revenue Service's (IRS)
National Research Program (NRP) results, tax gap estimates, and
Statistics of Income (SOI) data, and interviewed IRS officials. The NRP
data are IRS estimates of individual tax reporting compliance based on
reviews and examinations of filed tax returns. IRS randomly selected
the returns for tax year 2001, which were filed with IRS during
calendar year 2002. To compute the percentage of returns with an
understatement or overstatement on a Schedule C line and the net
misreported amounts, IRS used the following definitions, including
related limitations:
Percentage of returns with an error: This ratio is the weighted number
of taxpayers that have a non-zero net misreported amount divided by the
weighted number of returns that should have reported the amount. For
some items, taxpayers may have errors that exactly offset each other
resulting in no net tax change. For example, a taxpayer may have
reported a transaction as an "office expense," but an examiner
reclassified the same amount as "repairs and maintenance." NRP did not
consider these offsetting changes as errors for those line items.
Net misreported amounts (NMA): The NMA is the sum of all amounts
underreported minus the sum of all amounts overreported for an item.
The NMA does not include adjustments between schedules of the return.
For example, the NRP examiner may disallow reported amounts for expense
deductions on Schedule C that should have been reported on Schedule A
and increase the deductions on Schedule A by the same amounts. Neither
adjustment would be in IRS's NMA. However, the adjustments would be
included in IRS's definition of the amounts that should have been
reported, which are reflected in the denominator of the net
misreporting percentage. The NMA does not include adjustments that were
made because the taxpayer used the wrong form or line item.
Because the percentage of returns with an error and the NMA are derived
from samples, table 3 lists the confidence intervals for each amount.
IRS did not compute confidence intervals for its estimates. When we
calculated confidence intervals, we got slightly different point
estimates than IRS. The difference appears to arise from varying
definitions of sole proprietors. We are 95 percent confident that the
percentages and amounts reported are between the low estimate and the
high estimate. In the body of this report, we present IRS's point
estimates.
Table 3: Confidence Intervals for Summary of Schedule C Misreporting
for Tax Year 2001:
Dollars in billions.
Schedule C line: Gross income, line 7;
Percentage of returns with an error: Low estimate: 38;
Percentage of returns with an error: GAO calculated percentage: 40;
Percentage of returns with an error: High estimate: 42;
Percentage of returns with an error: IRS percentage reported: 39;
Net misreported amount: Low estimate: $52.8;
Net misreported amount: GAO calculated amount: $56.8;
Net misreported amount: High estimate: $60.8;
Net misreported amount: IRS reported amount: $52.6.
Schedule line C: Car and truck expenses, line 10;
Percentage of returns with an error: Low estimate: 44;
Percentage of returns with an error: GAO calculated percentage: 46;
Percentage of returns with an error: High estimate: 48;
Percentage of returns with an error: IRS percentage reported: 50;
Net misreported amount: Low estimate: 6.9;
Net misreported amount: GAO calculated amount: 7.5;
Net misreported amount: High estimate: 8.1;
Net misreported amount: IRS reported amount: 7.8.
Schedule line C: Depreciation and section 179 expense deduction, line
13;
Percentage of returns with an error: Low estimate: 36;
Percentage of returns with an error: GAO calculated percentage: 38;
Percentage of returns with an error: High estimate: 41;
Percentage of returns with an error: IRS percentage reported: 42;
Net misreported amount: Low estimate: 2.0;
Net misreported amount: GAO calculated amount: 2.4;
Net misreported amount: High estimate: 2.8;
Net misreported amount: IRS reported amount: 2.7.
Schedule line C: Supplies, line 22;
Percentage of returns with an error: Low estimate: 34;
Percentage of returns with an error: GAO calculated percentage: 36;
Percentage of returns with an error: High estimate: 38;
Percentage of returns with an error: IRS percentage reported: 41;
Net misreported amount: Low estimate: 2.4;
Net misreported amount: GAO calculated amount: 2.8;
Net misreported amount: High estimate: 3.2;
Net misreported amount: IRS reported amount: 2.9.
Schedule line C: Other expenses, line 27;
Percentage of returns with an error: Low estimate: 50;
Percentage of returns with an error: GAO calculated percentage: 52;
Percentage of returns with an error: High estimate: 54;
Percentage of returns with an error: IRS percentage reported: 55;
Net misreported amount: Low estimate: 7.2;
Net misreported amount: GAO calculated amount: 8.5;
Net misreported amount: High estimate: 9.8;
Net misreported amount: IRS reported amount: 9.0.
Schedule line C: Total expenses, line 28;
Percentage of returns with an error: Low estimate: 67;
Percentage of returns with an error: GAO calculated percentage: 69;
Percentage of returns with an error: High estimate: 71;
Percentage of returns with an error: IRS percentage reported: 73;
Net misreported amount: Low estimate: 36.4;
Net misreported amount: GAO calculated amount: 38.6;
Net misreported amount: High estimate: 40.8;
Net misreported amount: IRS reported amount: 40.4.
Schedule line C: Net profit or loss, line 31;
Percentage of returns with an error: Low estimate: 68;
Percentage of returns with an error: GAO calculated percentage: 70;
Percentage of returns with an error: High estimate: 72;
Percentage of returns with an error: IRS percentage reported: 70;
Net misreported amount: Low estimate: 91.7;
Net misreported amount: GAO calculated amount: 95.8;
Net misreported amount: High estimate: 99.9;
Net misreported amount: IRS reported amount: 93.6.
Source: GAO analysis of IRS data.
[End of table]
Estimated understated tax amounts, as shown in figure 4, were derived
from NRP sample data. Table 4 lists the estimated percentile amount and
confidence intervals for each percentile. We are 95 percent confident
that the percentages and amounts reported are between the low and high
estimates.
Table 4: Confidence Intervals for Estimated Understated Tax Amounts by
Percentile for Individual Income Tax Returns with Schedule Cs Attached,
Tax Year 2001.
Percentile: 25th;
Percentile lower confidence interval amount: $255;
Estimated percentile amount: $273;
Percentile upper confidence interval amount: $294.
Percentile: 50th;
Percentile lower confidence interval amount: 859;
Estimated percentile amount: 903;
Percentile upper confidence interval amount: 956.
Percentile: 75th;
Percentile lower confidence interval amount: 2,422;
Estimated percentile amount: 2,527;
Percentile upper confidence interval amount: 2,674.
Percentile: 90th;
Percentile lower confidence interval amount: 5,976;
Estimated percentile amount: 6,210;
Percentile upper confidence interval amount: 6,766.
Percentile: 95th;
Percentile lower confidence interval amount: 10,635;
Estimated percentile amount: 11,081;
Percentile upper confidence interval amount: 12,353.
Percentile: 98th;
Percentile lower confidence interval amount: 19,631;
Estimated percentile amount: 20,387;
Percentile upper confidence interval amount: 64,075.
Source: GAO analysis of IRS data.
[End of table]
Estimated cumulative understated tax amounts, as shown in figure 5,
were derived from NRP sample data. Table 5 lists the estimated
percentile amount and confidence intervals for each percentile. We are
95 percent confident that the percentages and amounts reported are
between the low and high estimates.
Table 5: Confidence Intervals for Estimated Cumulative Understated
Taxes by Percentile for Individual Income Tax Returns with Schedule Cs
Attached, Tax Year 2001:
Dollars in billions.
Percentile: 25th;
Percentile lower confidence interval amount: 0.30;
Estimated percentile amount: 0.36;
Percentile upper confidence interval amount: 0.44.
Percentile: 50th;
Percentile lower confidence interval amount: 1.84;
Estimated percentile amount: 2.05;
Percentile upper confidence interval amount: 2.35.
Percentile: 75th;
Percentile lower confidence interval amount: 6.31;
Estimated percentile amount: 6.93;
Percentile upper confidence interval amount: 7.65.
Percentile: 90th;
Percentile lower confidence interval amount: 13.47;
Estimated percentile amount: 14.26;
Percentile upper confidence interval amount: 15.64.
Percentile: 95th;
Percentile lower confidence interval amount: 18.24;
Estimated percentile amount: 19.37;
Percentile upper confidence interval amount: 21.08.
Percentile: 98th;
Percentile lower confidence interval amount: 23.68;
Estimated percentile amount: 24.91;
Percentile upper confidence interval amount: 33.06.
Percentile: 100th;
Percentile lower confidence interval amount: 34.77;
Estimated percentile amount: 36.86;
Percentile upper confidence interval amount: 38.95.
Source: GAO analysis of IRS data.
[End of table]
According to IRS Research officials, NRP results are not tax gap-
related estimates since they do not account for misreporting that the
auditors did not detect. Typically, the undetected misreporting of
Schedule C net income likely takes the form of understated gross
receipts and overstated expenses, for which IRS did not prepare
separate tax gap estimates. Overstated expenses tend to be detected
since the burden of proof is on the taxpayer to justify them. However,
when taxpayers intentionally understate gross receipts, they may also
understate expenses to hide the gross-receipt underreporting from IRS.
Also, NRP includes estimates of some net business income that is not
reported on Schedule C. These amounts are not added to the line-item
detail and are not included in the analyses for this report. We could
not estimate the amount of tax change that would result from NRP's
examinations of Schedule C income because it must be combined with the
taxpayer's filing status, exemptions, other types of income,
deductions, credits, and other taxes.
To analyze the extent to which IRS's enforcement programs address the
types of sole proprietor noncompliance found by IRS's most recent
research, we used several data sources. We reviewed instructions for
tax and information returns and filing guidance as well as program
procedures. We analyzed program results data collected from the
Automated Underreporter Program (AUR) and Examination officials, and
interviewed IRS staff on the operations and results of AUR and the
correspondence, office and field examination programs. We reviewed
examination plans and Internal Revenue Manual procedures and other
instructions to IRS staff describing program procedures. We analyzed
data on examination results and numbers of Schedule C forms filed from
the IRS Data Book, and data on paper Form 1099-MISC returns published
by IRS's Office of Research for 2006. We did not analyze IRS's math
error program since all NRP-examined returns were reviewed by this
program, which is an integral part of IRS's returns processing
function.
To calculate the percentage of noncompliant sole proprietors on which
AUR and Examination made recommended assessments, we first multiplied
the percentage of noncompliant sole proprietors found in NRP data by
the number of Schedule C returns for the most recent years that we had
available from the IRS Data Book that matched the most recent years for
which we had complete AUR and Examination data (tax year 2003 for AUR
and tax year 2004 returns for work Examination did in fiscal year
2005). Then we divided the number of recommended assessments made in
each program by the number of noncompliant sole proprietors to arrive
at the percentage of noncompliant sole proprietors on which the
programs made recommended assessments.
We reviewed a sample of completed NRP examination case files to
understand the types of sole proprietor noncompliance being detected.
We selected the sample using the NRP case results database to identify
all NRP cases with adjustments to Schedule C items for sole proprietor
tax returns. We then selected a nonestimation sample of NRP examination
cases with adjustments to gross receipts or sales, total expenses, net
profit or loss on the Schedule C, and the business income line on the
Form 1040 return, because these lines summarize the sole proprietor's
operations. We also randomly selected some Schedule C adjustment cases.
We also used NRP data and the NRP case file sample to analyze IRS's use
of penalties in NRP examinations. The analysis describes the proportion
of NRP cases closed with adjustments and the proportion closed with a
penalty recommended by the NRP examination. Because the cases with
adjustments and penalties were not drawn from the population of all
individual returns, they cannot be used to estimate a penalty
assessment rate and other characteristics for all individual taxpayers.
Even with these limitations, this analysis provides useful information
on the outcome of the NRP sample.
To estimate the percentage of reported Schedule C receipts that were on
a Form 1099-MISC, we compared amounts reported on the Form 1099-MISC
and on Schedule C (line 1 total gross receipts or sales). This analysis
used SOI data on individual tax returns for tax year 2001, which
included a sample of information returns. We found that three Form 1099-
MISC items could be reported on a Schedule C, including nonemployee
compensation (NEC), medical payments, and fish sales. According to IRS,
these Form 1099-MISC items could also be reported on two other IRS
forms--Schedule F, Profit and Loss From Farming, and Form 4835, Farm
Rental Income and Expenses--other than the Schedule C. We found that
about 4 percent of the amounts reported on the Form 1099- MISC were
reported on Schedule F or Form 4835. This difference was not material
to our computation. Further, our analysis did not consider several
sources of noncompliance that could affect the computation, such as the
nonfiling of the required Schedule C or Form 1099-MISC or the
underreporting of Schedule C or Form 1099-MISC amounts.
To estimate the percentage of Form 1099-MISC returns where the payer
and the payee have the same address, we used an SOI data file with tax
year 2001 individual income tax return information. We compared the
postal codes and the numeric portion of street addresses reported by
the payer and payee to identify whether they had the same address. For
those who did, we reviewed a sample to verify that the addresses were
the same. We also reviewed 55 Form 1099-MISC filings at the Ogden,
Utah, campus, which provided 8 examples in which a payer and payee had
similar addresses or names. We did not review other IRS records to
determine whether these Form 1099-MISC filers were related parties.
To assess the likelihood of being assessed a penalty, controlling for
other factors, we used logistic regression analysis, an econometric
method appropriate for analyzing variables with dichotomous outcomes.
We used the deciles of the continuous variables as the independent
variables in the model. We did not weight the NRP returns or
incorporate the NRP stratification because penalties are a function of
the audit and the NRP returns are not representative of audited
returns.
Controlling for use of a paid preparer, adjusted gross income, Schedule
C amount, and total tax as reported by the taxpayer, a logistic
regression was used to predict a penalty based on the absolute value of
the difference between the total tax reported on the Form 1040 and the
total tax after the NRP audit and the percentage of tax change (the
difference in total tax divided by the total tax reported on the Form
1040). We found a significant effect of the percentage change in tax
owed and the absolute value of the tax change on the likelihood of
receiving a penalty. That is, individuals in higher deciles (5th
through 10th deciles) of the percentage increase in tax were generally
more likely than those in the lowest decile to be recommended for a
penalty. Additionally, taxpayers in higher deciles of the absolute
value of the tax change (4th through 10th deciles) were more likely
than those in the lowest decile to be recommended for a penalty
controlling for other factors. We also found that the odds of a penalty
decreased with each decile increase in the taxpayer's reported total
tax liability.
Although we did not test for interactions that could mitigate this
effect, we found our results to be robust across a variety of model
specifications. We did not control for other potentially relevant
variables, such as differences among examiners, and did not test for
whether the case was abated.
We used several approaches to identify options to close the tax gap
related to sole proprietors that could be included in the tax gap
strategy being developed by the Department of the Treasury (Treasury).
First, we sought ways to address the gaps between the nature of sole
proprietor tax noncompliance and existing IRS programs. Second, we
reviewed various research publications on sole proprietors and our
recommendations, as well as those from the President's Budget,
President's Advisory Panel on Federal Tax Reform, Treasury Inspector
General for Tax Administration, IRS's Taxpayer Advocate, and IRS
advisory group reports. Third, we identified and discussed options and
their the pros and cons with experts and knowledgeable individuals on
sole proprietor compliance issues, including former Commissioners of
Internal Revenue; persons who have experience with IRS or other federal
programs related to sole proprietors; representatives for various
national organizations representing sole proprietors, tax return
preparers, or tax lawyers; tax staff working for Congress; and relevant
staff at IRS and Treasury. All of the national organizations
representing sole proprietors had large memberships and we contacted
each organization's committee which focuses on small business issues.
From this work, we consolidated the list of options and pros and cons.
We excluded a few options that were raised near the end of our work,
lacked details, or generated comments or questions from experts and
knowledgeable individuals on how the options would work.
The list of options is not exhaustive and has limitations. Since data
did not exist for analyzing the effect on the tax gap, taxpayers, or
IRS for each option, we could not independently validate or weigh the
pros or cons suggested by our experts and knowledgeable individuals.
Because the experts and knowledgeable individuals had competing
interests on questions of tax policy and administration, we did not
seek consensus on the "best" options or on the pros and cons. Experts
had limited time to discuss all the options and pros and cons. Thus, we
did not discuss each option in detail in each interview, but overall,
the interviews provided enough details for the options in our report.
As a result of such limitations, we did not try to rank the options.
Instead we described the options based on input from the literature and
experts. More detailed proposals could raise other pros or cons not
listed in our report.
We used several approaches to assess data reliability. We assessed
whether the examination results and data contained in the NRP database
were sufficiently reliable for the purposes of our review. For this
assessment, we interviewed IRS officials about the data, collected and
reviewed documentation about the data and the system used to capture
the data, and completed testing of relevant data fields for obvious
errors in accuracy and completeness. We completed analytic testing to
ensure that tax return items that should logically be equal were equal.
For example, the net profit and loss line on Schedule C should be
accurately transferred and equal to the similar line on the individual
income tax return. We also compared the information we collected
through our case file review to corresponding information in the NRP
database to identify inconsistencies. This testing found that the NRP
results for Form 1040 returns with Schedule C forms were sufficiently
reliable for our review.
The tax gap, SOI, AUR, and Examination data are all from sources that
we used in previous reports. Based on assessments done for those
reports, the fact that the sources are public and widely used, and
additional testing we did to ensure that we were properly interpreting
individual data elements, the data were sufficiently reliable for our
review.
We conducted our review at IRS Headquarters in Washington, D.C., and at
IRS's Ogden, Utah, campus from July 2006 through June 2007 in
accordance with generally accepted government auditing standards.
[End of section]
Appendix II: Options to Address Problems with the Tax Compliance of
Sole Proprietors:
We have developed a list of options for reducing the tax gap for sole
proprietors by reviewing our past reports as well as other related
literature and by talking to experts and knowledgeable persons about
sole proprietors' tax compliance. As we built the list of options, we
discussed the options and the related pros and cons with these experts,
including past and current IRS and Treasury staff; former IRS
Commissioners; congressional staff; representatives of organizations
representing sole proprietors, tax preparers, and tax lawyers; and
others who have working knowledge of tax compliance and IRS programs.
This list is not exhaustive nor is the list of the pros and cons
associated with each option. Many of the options are concepts rather
than fully developed proposals with details of how they would be
implemented. Additional detail could bring more pros and cons to light.
The pros and cons are not weighted, and options should not be judged by
the number of pros and cons. We are not making recommendations about
the options or ranking their desirability. Rather, we have aligned
these options with a series of known problems with sole proprietor tax
compliance. Some of the options overlap, covering more than one problem
while other options only deal with specific aspects of a problem.
A. Recordkeeping and Complexity:
For our system of voluntary compliance to work, taxpayers must keep
appropriate records. Our work on sole proprietors has raised issues
about incomplete or inaccurate recordkeeping by sole proprietors as
well as about the difficulties they face in dealing with complex tax
rules. The options in this section look for ways to improve
recordkeeping, simplify some of the rules, or provide more guidance and
education to sole proprietors to reduce their burden.
1. Work with small business representatives on their ideas for
improving the instructions for keeping records and meeting their
Schedule C filing obligations:
More education and better guidance could help sole proprietors comply
with the complex tax rules for reporting on the Schedule C. IRS could
work with small business and trade representatives to determine whether
and how specific changes to IRS's existing education and guidance would
help those filing the Schedule C.
Pro:
* Helping educate sole proprietors on their recordkeeping requirements
and filing obligations (Schedule C and information returns) could
reduce noncompliance.
* The costs to update the instructions is probably minimal, while the
cost for the education would not be.
Con:
* Getting specific ideas that would help sole proprietors might take
some time and effort, depending on the extent to which IRS tests these
ideas.
* It may be difficult to target the education and guidance and improve
instructions for the sole proprietors who need them the most, that is,
those who keep poor records or make errors on the Schedule C. These
sole proprietors may not have the time or incentive to pay attention.
* Changes may not help those who rely on a paid tax return preparer or
bookkeeper because of IRS's tendency to forward tax information to the
taxpayer but not to the tax return preparer.
* Some education efforts could be costly to IRS, such as efforts to
contact taxpayers individually.
2. Provide assistance to first-time Schedule C filers:
IRS could consider at least two broad approaches that would:
a) specifically target outreach to sole proprietors filing their first
Schedule C to inform them about the option to receive regular e-mails
on topics of interest, the small business hotline, the resource guide,
and other services specifically targeted to help small businesses and:
b) automatically send computer-generated notices (i.e., soft notices)
to first-time Schedule C filers who did not use a paid tax preparers
(to reduce the number of notices) and who reported on certain Schedule
C lines that involve more complexity or higher noncompliance (e.g.,
accounting method, depreciation, travel, or home office) about guidance
on IRS's Web site on reporting such issues.
Pro:
* This would provide new sole proprietors with the specific information
that they need to comply.
* It would also help new sole proprietors avoid "bad habits" before
they become rooted.
* Using e-mail would reduce IRS's costs.
* Using automated screening and soft notices would increase IRS's
"presence" without the costs of an enforcement contact (e.g., audit).
Con:
* There is no assurance that sole proprietors will read the information
and comply.
* Some sole proprietors may not use e-mail or want to provide an e-mail
address to IRS.
* IRS would incur some costs for the outreach and notices.
* Soft notices may not boost compliance if they are too vague or if
sole proprietors perceive that IRS will not follow up in future tax
years on the soft notices.
* Waiting to act until after the first Schedule C filing may be too
late to change the behavior of some sole proprietors.
3. Separate business and personal records and transactions:
Two requirements could help sole proprietors distinguish their business
transactions and records from personal ones. Details would need to be
worked out on any exceptions or tolerances; on offering incentives
rather than requirements; and on enforcing and penalizing any
noncompliance with the requirements, which follow.
a) Require sole proprietors to include all business transactions in a
business bank account or accounts used only for business purposes. Such
transactions would include deposits of business receipts and payments
of business expenses. Receipts or expenses generated outside of the
business would not be part of these business accounts. Further,
financial institutions could provide sole proprietors with an annual
summary of inflows and outflows for the business account(s).
b) Require each sole proprietor to obtain a taxpayer identification
number (TIN) for a business. Currently, sole proprietors generally are
required to obtain business TINs, known as employer identification
numbers (EIN), when they have wage-earning employees for filing certain
types of returns. In this option, sole proprietors could use EINs for
their business transactions in lieu of using their Social Security
numbers.
Pro:
* Recordkeeping could improve, which would reduce the time and burden
of preparing returns and responding to IRS's inquiries.
* IRS could save money if its computer matching and audits could be
done more quickly and with more certainty.
* Retroactively creating fictitious business expenses after the tax
year would be easier to detect.
* Tax compliance would improve to the extent that sole proprietors
would weed out personal expenses from their business expenses.
Con:
* Financial institutions may charge fees for separate business accounts
and statements.
* Taxpayers who want to evade may not deposit all their income in the
business accounts or still could run personal expenses through their
business accounts.
* It might be unnecessary or burdensome for Schedule C filers who are
not regularly operating a business but have intermittent Schedule C
receipts and expenses.
* IRS may have difficulty enforcing such a requirement.
4. Repeal certain limitations in section 530 of the Budget Act of 1978
involving guidance on rules for classifying workers:
Lift the limitations on IRS issuing rules and guidance on the criteria
to determine whether a worker is to be treated as an employee or an
independent contractor for tax purposes as well as on the related safe
harbors for employers that classified workers as independent
contractors.
Pro:
* Guidance and rules might help clarify confusion in the myriad of
employment relationships that have evolved since 1978.
* Clarification might help ensure that the correct amounts of taxes are
being paid.
Con:
Some types of sole proprietors might prefer:
* legislative clarification rather than trusting IRS to lead the
efforts to clarify and:
* living with the current confusion rather than opening the door to
changes, particularly if they do not trust IRS to make equitable
decisions about the proper classification or the existing safe harbors.
B. Burdens and Problems for Third Parties in Filing Information Returns:
Information reporting offers a way to cover more of the income of sole
proprietors who do not report all of their gross receipts. However,
information reporting suffers when the information returns are not
filed or are filed erroneously and late. Those filing the information
returns may face difficulties or burdens in filing information returns
on paper or when a sole proprietor does not provide a valid TIN. A
number of options exist to better ensure that IRS receives the required
information returns on payments made to sole proprietors while
minimizing the burden of those filing these information returns.
5. Clarify Schedule C instructions to indicate that information returns
may be required to be filed by sole proprietors who deduct expenses for
wages, fees, and commissions:
Pro:
* To the extent more Forms 1099-MISC are filed, sole proprietors are
likely to be more compliant in reporting business income.
* The instructions would provide another outlet for notifying taxpayers
of their Form 1099-MISC reporting obligations at a minimal cost.
Con:
* If those who are to file the required information returns do not read
or follow the instructions, the clearer instructions would not boost
required filings.
* If IRS receives more information returns, its costs to process and
use them would rise.
6. Change the IRS Web-based system for filing information returns to
accommodate those filing information returns on payments made to sole
proprietors, particularly those filing a smaller number of information
returns:
Pro:
* To the extent more Forms 1099-MISC are filed, sole proprietors are
likely to be more compliant in reporting business income.
* Web-based filing could reduce the costs, burdens, and errors for
everyone compared to filing/processing paper information returns. IRS
may be able to reduce its start-up costs by modifying its Filing
Information Returns Electronically system.
Con:
* If those who are to file the required information returns are not
comfortable filing information through the Web, do not have access to
computers, or do not want to file them at all, more filings of the
required returns may not occur.
* If IRS requires extensive registration steps in order to file on the
Web, some filers might find those steps too burdensome.
* IRS would incur start-up costs to create a new form and a Web-based
filing system.
* IRS would incur additional costs to process and use the information
from a significant increase in the number of filed information returns.
7. Create a new Form 1099-NEC to segregate NEC from the various boxes
on the existing Form 1099-MISC:
Although payment of NEC would trigger the requirement to file a Form
1099-NEC, IRS could request other summary information in the expanded
space on this separate form about payments to sole proprietors, such as
expenses reimbursed, noncash payments, type of services received, or
payments for goods.
Pro:
* To the extent more information returns are filed with the new form
and filed more clearly,
1. sole proprietors are likely to be more compliant in reporting
business income,
2. filing would be less confusing,
3. IRS could refine its computer matching to minimize "false" leads
that burden compliant taxpayers, and:
4. IRS would have better data to improve its research and case
selection for enforcement contacts to the extent that IRS requested
other information.
Con:
* IRS has no assurance that a new form would reduce taxpayers' burden
enough to lead to more filings of the required information returns.
* IRS would incur additional costs if it has to process a significant
increase in the number of filed information returns and if it has to
expand its existing enforcement activities to check compliance in
filing these types of required information returns.
C. Unreported Income for Sole Proprietors:
For tax year 2001, about 70 percent of the sole proprietors misreported
about 57 percent of their net business income. IRS's examinations are
limited in number and scope and do not find much of the unreported
income. Information reporting offers a way to cover more noncompliant
sole proprietors and focus on unreported gross receipts. However,
information reporting covered just a quarter of the gross receipts
reported on Schedule Cs. One reason for the gap is that current
information reporting focuses on payments for services and excludes
certain payments, such as those totaling below a certain threshold and
those to corporations. These options attempt to address these gaps in
information reporting for sole proprietors.
8. Expand gross receipts reporting on the Schedule C:
Sole proprietors would break out their total gross receipts on the
Schedule C to show the amount reported to them on information returns.
Other information could be required, such as the number of information
returns received and details on large payments.
Pro:
* Sole proprietors could be more sensitized to use the information
returns received and thus more accurately report gross receipts.
* IRS could be more productive in detecting unreported gross receipts
by matching the Schedule C and information returns filed or analyzing
the ratio of total gross receipts reported on the Schedule C and
information returns in audit selection.
* No additional burden would be placed on third parties.
Con:
* The reporting is unlikely to stop all businesses that wish to hide
payments.
* If their records do not account for whether the income was reported
on a Form 1099-MISC, sole proprietors may have an additional burden to
report the information.
* IRS would incur some costs to process and use the additional data.
9. Close gaps in existing information reporting on payments made to
sole proprietors:
Information returns are not required on all payments for services,
creating gaps when matching information returns that are filed to
determine if all the service payments received have been properly
reported. Two options to address these gaps include requiring
information reporting on annual service payments that (1) are made to
all corporations or to some subset , such as small corporations, non-
publicly held corporations, or noncompliant corporations (clear
definitions of exclusions would be needed), and (2) total less than
$600, which now triggers information reporting.
Pro:
* Sole proprietors who incorporate or receive payments below $600
should be more likely to comply in reporting business income.
* Sole proprietors would be less likely to structure payment amounts to
avoid information reporting.
* Businesses would not have to distinguish between incorporated and
unincorporated businesses in determining whether to file information
returns.
* IRS could improve the productivity of its computer matching for
unreported income.
Con:
* Businesses that file more information returns could incur significant
costs and burdens, particularly if they have to expand their
recordkeeping or make distinctions between small and large
corporations.
* IRS would incur costs to process and match more information returns,
and might not be able to use all of the new data if the number filed
increases significantly.
* The information returns would be unlikely to encourage larger
corporations that provide services to comply or help IRS find
unreported income among larger corporations.
* Those receiving payments that are less than $600 might not account
for much of the unreported income or might not be more noncompliant
than other sole proprietors.
10. Require new information reporting by organizations on payments to
sole proprietors:
These options would offer a way to get new information from
organizations about payments made to sole proprietors.
a) Require businesses that process credit card payments for merchants
to report information on the amount of payments made to sole
proprietors for a tax year. This reporting could be a summary or
include details for payments above some specified amount.
b) Require federal, state, and local governments to file information
returns on all nonwage payments made (or those above a threshold) for
property and services from corporate and noncorporate businesses.
Certain payments, such as those related to interest, real property, and
tax-exempt entities, would be excluded.
c) Require financial institutions to file information returns on
business deposits and withdrawals by sole proprietors, which would be
facilitated to the extent that business transactions are segregated in
business accounts under business TINs.
Pro:
* Sole proprietors covered by any of these options might be more
compliant in voluntarily reporting more business income on their
Schedule Cs.
* Each of the options would provide information that IRS could use to
select better enforcement cases or to be more productive in its
enforcement activities. For example, credit card reporting could allow
IRS to develop a ratio of credit card receipts to all receipts reported
by sole proprietors by type of industry, and knowing deposit and
withdrawal activity could allow IRS to better identify sole
proprietors' gross receipts through its bank deposit analysis method.
Similarly, the information can be used to avoid selecting a company for
audit if the information reports suggest that the taxpayer is
compliant.
Con:
* Credit card companies and financial institutions would have some
reporting costs.
* Governments would incur some reporting costs, but they already would
have to incur similar costs to meet the tax withholding requirement
that Congress approved for these payments starting in 2011, and federal
agencies are already required to file some of these data with IRS for
federal contracts.[Footnote 37]
* IRS would incur some costs to analyze the information from all the
options and to figure out its best uses to identify underreporters.
* IRS might find it hard to use the increased amount of information
returns at all or productively.
* If some businesses that use credit cards want to underreport income,
they might move more transactions to the cash economy.
* The information would not help identify unreported income among sole
proprietors who do not use credit cards, do not have accounts with
financial institutions, or do not contract with governments.
* To the extent that financial institutions are reporting deposits and
withdrawals related to nonbusiness activities, or that sole proprietors
move funds between multiple business accounts, the information could
create false leads for IRS that burden compliant taxpayers.
11. Require new information reporting on consumer payments to sole
proprietors:
This option envisions new information reporting by organizations but
also by consumers. It would require property owners to report on
payments made to contractors for improvements if the payments will be
used to adjust the basis of the property for depreciation or sales
purposes. Property owners would be required to report the contractors'
TINs. Absent the information return in their records, the property
owners could not adjust the basis for tax purposes.
Pro:
* Information reporting on such contracts could cover a substantial
dollar value.
* Sole proprietors may be more likely to report the payments on their
tax returns.
* The payment information could cover a larger portion of the gross
receipts than just service payments.
* Consumers would not have to be burdened with distinguishing the type
of business or type of payment in doing the reporting, and overall
burden would be limited by how often they contract for improvements.
* Property owners would have some incentive to report the contractor
payments and a defensible foundation for basis adjustments claimed in
the future.
Con:
* The incentive for property owners may dissipate if their basis
adjustments offer few tax benefits because they do not depreciate or
are not expected to have a taxable gain when they are sold, or because
property owners do not keep the information returns in their records in
order to compute and justify adjustments to basis many years later.
* Property owners would have some burden to track and report the
information and to deal with contractors that do not want to provide
their TINs, for which some recourse would be needed.
* If contractors want to avoid having these payments reported to IRS,
they could negotiate with property owners for a lower price in return
for property owners not filing the information returns.
* IRS would have to spend some time and money sorting the information,
particularly if the information is reported on paper rather than
electronically, and then using the information for research or
enforcement.
* IRS might find it hard to use all of the new information or to use it
productively.
* Some may view disallowing a basis adjustment as a harsh penalty for
failing to file an information return.
D. Overstated Deductions for Sole Proprietor Expenses:
A portion of the $68 billion sole proprietor tax gap arises from
overstating deductions for business expenses. Based on what NRP
detected, IRS has estimated for 2001 that about 73 percent of the sole
proprietors misreported about $40 billion in expense deductions.
Although IRS auditors find it easier to check claims for expense
deductions than to hunt for unreported income, IRS audits cover few of
the noncompliant sole proprietors who overstate business deductions.
And the information reporting system does not cover payments made by
sole proprietors that could be deductible business expenses. The
options in this section look to provide more information about expenses
to allow IRS to match or otherwise use to find overstated deductions.
12. Expand expense reporting on the Schedule C:
Sole proprietors would break out the amount of payments made for
services on the relevant expense lines of the Schedule C. Additional
information could be required, such as for payments above a specified
amount.
Pro:
* Sole proprietors might be more sensitized to the need to accurately
claim expense deductions on the Schedule C and the need to also report
them on required information returns.
* Tax preparers would have more incentive to check expense reporting
compliance.
* If adequate, IRS could use the data to detect overstated expenses by
matching amounts reported as expenses on the Schedule C lines with the
amounts reported on information returns filed by the sole proprietor or
by analyzing the ratio of total expenses to amounts reported on an
information return's audit selection.
* No additional burden would be placed on third parties.
Con:
* IRS might have difficulties processing and matching all of the new
expense data.
* IRS would incur difficulties, such as extra costs, to process and use
the additional data.
* If their records are incomplete on their expenses and information
returns or their accounting systems do not break out expenses by the
services provided, sole proprietors may have an additional burden to
report the information.
* This would not stop all reporting noncompliance.
13. Match information returns filed by sole proprietors with related
expenses on their Schedule Cs:
IRS would match the existing information returns filed by sole
proprietors to report their payments made for wages, services, and so
forth to the related lines of the Schedule C in order to see whether
the expenses claimed are consistent with the amounts reported on the
information returns. As with any computer match, IRS would need to
develop rules for doing the match and tolerances for contacting the
sole proprietors about discrepancies.
Pro:
* Such reverse matching could help identify excess deductions,
especially for wages, without incurring the costs of audits.
* If sole proprietors learn about the reverse matching, they may become
more compliant in reporting expenses:
* This matching would not impose any new burdens on third parties and
little burden on compliant sole proprietors if the matching criteria
are effective.
Con:
* Beyond wages and possibly some types of nonemployee compensation, IRS
may find it difficult to effectively match expenses in order to avoid
contacting compliant sole proprietors.
* If sole proprietors want to overstate deductions and know that IRS
can use the information returns they file to look for overstated
deductions, some of them may file fictitious information returns.
14. Expand information reporting on the expenses of sole proprietors:
The expanded information reporting to cover expenses claimed on the
Schedule C could include two options:
a) Businesses receiving certain types of payments from sole proprietors
in large amounts (i.e., thousands of dollars) would file information
returns to report those amounts by type of expense. Beyond limiting
such reporting to large dollar amounts (which would need to be set),
the reporting also could be limited to certain types of payments that
are easier to report or that tend to be overstated as expenses on the
Schedule C (e.g., rents, fees, insurance, and travel).
b) Businesses that process credit (and debit) card payments would be
required to report information on the amount of payments by sole
proprietors for each tax year. This reporting could be a summary total
or include more details for payments above some specified amount. IRS
would need to decide how it would use this information to check for
overstated expenses on the Schedule C.
Pro:
* Having the data might help IRS detect certain overstated expenses
without incurring the costs of an audit. Otherwise, IRS would have more
information on the expenses of sole proprietors for use in selecting
cases for auditing.
* Sole proprietors might report their expenses more accurately with
third-party data.
Con:
* Third-party businesses doing the reporting would have additional
costs to file the information returns or burdens to know whether the
payments are personal or business related.
* Some businesses might not want to report to IRS about payments they
receive from sole proprietors, particularly if those payments account
for most of their gross receipts and they underreport those payments on
their tax returns.
* Sole proprietors wishing to avoid the credit reporting may use more
cash purchases.
* If IRS were to use the information in a matching program, it would
incur costs to process and match it in order to avoid contacting
compliant sole proprietors and to identify personal expenses mixed in
with business expenses.
15. Verify additional expenses claimed to offset unreported income:
Through some form of review or audit of documentation, IRS could verify
additional business expenses in those cases where sole proprietors
claim additional expenses after IRS informs them that it has discovered
unreported business income.
Pro:
* IRS could improve the effectiveness of its AUR matching to the extent
that it stops sole proprietors from claiming unverified expense
offsets.
Con:
* If AUR staff do the verification, IRS would incur costs to train them
to do the verification and find additional staff to keep up the volume
of AUR contacts.
* If audit staff do the verification, IRS would have to make sure that
the return on investment justifies allocating more expensive, better-
trained staff to do the verification.
* If IRS develops some other verification program, it would incur start-
up and operational costs.
E. Nonpayment of Tax:
In addition to misreporting business income and expenses, the
noncompliant sole proprietors do not pay their tax liabilities. Even
so, they can receive government benefits, such as contract payments and
Social Security credits. And they are not subject to a proven tax
compliance technique for many individual taxpayers--tax withholding.
This section lists options that could help induce sole proprietors to
meet their tax obligations to receive benefits or avoid tax
withholding.
16. Deny benefits/payments until tax obligations are met:
One way to induce sole proprietors to pay their taxes owed is to deny
them government benefits unless they have paid the taxes. Federal
agencies that provide the benefits would need to check for tax
compliance with IRS, and the prohibitions against disclosing tax data
would need to be revised to ensure that the authority exists. Two
options for checking tax compliance before providing government
benefits are to:
a) require that sole proprietors pay their self-employment tax
obligations in order to receive credit for Social Security benefits or:
b) require federal agencies to do a tax compliance check with IRS
before making a contract payment or otherwise providing a government
benefit (certain loans or grants) to a sole proprietor (either all or
just contractors). At a minimum, a check would be made to see whether
the sole proprietor has unfiled tax returns or unpaid tax liabilities.
Pro:
* Sole proprietors would have an incentive to meet their tax
obligations.
* This would help ensure that compliant sole proprietors' competitors
pay their taxes.
Con:
* To the extent that sole proprietors are not motivated by the loss of
Social Security credits or government benefits, some of them may
continue to not pay their taxes.
* Sole proprietors could be unjustly denied credits or benefits because
of a systemic/human error and thus would need some venue for seeking an
administrative remedy.
* Federal agencies would incur costs to check compliance and might
incur some contracting delays if the compliance checks take a lot of
time.
* Denying some types of loans/grants (e.g., for disaster or poverty)
may be seen as harsh.
17. Withhold tax to encourage tax compliance:
Another way to induce sole proprietors to pay their taxes owed is to
require situational or universal tax withholding from the payments made
to them. Two basic options would require those who are to file
information returns (e.g., government and business entities) on
payments made to sole proprietors to do tax withholding:
a) Withhold a small amount from payments until the sole proprietor's
TIN is certified. This up-front withholding would replace "backup
withholding" in those cases where, over a year or more later, IRS
informs the sole proprietor that the TIN provided is invalid. IRS would
need a system for quickly and accurately certifying TINs, which can be
either EINs or Social Security numbers. Also, decisions would be needed
on how much to withhold and on what to do with the withheld amounts
(e.g., paid to the sole proprietor once the TIN is certified or
remitted to IRS and reconciled when the tax return is filed).
b) Withhold a small percentage of the payments made to sole proprietors
for services either in all cases or in limited situations, such as when
sole proprietors (1) voluntarily consent or (2) have a recent history
of tax noncompliance and IRS has not annually certified that they are
now tax compliant.
Pro:
* Sole proprietors would be more motivated to provide TINs that can be
certified, file their returns, report their income, and pay their
taxes.
* Those paying sole proprietors would probably have fewer burdens from
withholding the taxes up front compared to doing backup withholding
over a year later.
* Using a low rate could get the sole proprietors into the system
without necessarily creating an undue burden on their business
operations.
* IRS would have fewer information returns with erroneous TINs that it
spends resources trying to correct or that cannot be used in its
computer matching programs.
Con:
* Withholding would create an added burden for those doing business
with the sole proprietor, especially if they do not have systems for
doing withholding or periodically remitting tax amounts to IRS, or if
they would not have had to do backup withholding.
* Business relationships or operations might be disrupted if IRS's
system for validating TINs is slow or burdensome, or generates errors,
while some businesses may refuse to validate the TINs or to withhold
payments if requested to do so by the sole proprietor that they want to
use.
* Even with one low withholding rate, some sole proprietors may be
burdened if, for example, they operate on thin profit margins or have
limited working capital.
* If multiple, withholding rates or exceptions for withholding were
created by industry, location, years in business, compliance history,
and so forth to minimize the negative business impacts on sole
proprietors, questions might arise about complexity, equity, and
opportunities for "gaming" the system to have a lower or no withholding
rate.
* If withholding were limited to sole proprietors, some could
incorporate or claim to be a corporation to avoid withholding.
F. IRS Management of Limited Resources:
Following up on AUR mismatches and conducting examinations are costly.
Furthermore, some of IRS's compliance and enforcement actions
mistakenly select compliant, rather than noncompliant, taxpayers. This
section discusses options for more effectively using IRS's limited
resources by better using data and other tools.
18. Improve audit selection of sole proprietor tax returns:
IRS could explore opportunities for improving its selection of sole
proprietor tax returns and tax issues to be audited in at least two
ways.
a) IRS would use advanced automated selection systems to update the
current manual classification system to better select returns and tax
issues for audit.
b) IRS would improve the ability of AUR to refer cases for audit, such
as when unverified (e.g., oral) claims about income and expenses are
made. AUR is limited in pursuing such cases, and IRS Examination
already has selected many cases for audit by the time the referrals are
made.
Pro:
* IRS could select returns with a higher likelihood of tax changes at a
lower cost and with lower burden on compliant sole proprietors.
* More automation could free a number of experienced audit staff who
help select these returns and these tax issues for audit to do more
audits.
* IRS might be able to increase the dollar yield from finding
unreported income and denying unjustified claims for offsetting
deductions.
Con:
* IRS would incur costs to collect and test enough data to create an
effective automated system.
* IRS is likely to still need some manual intervention to account for
location-specific issues that cannot be programmed into the automated
system:
* IRS might find that these AUR cases are still less productive than
other audit cases.
19. Enhance data sharing with the states:
IRS would seek to improve data-sharing arrangements with the states.
State data could include using business licensing, ownership of real
estate or other large assets, sales receipts, and tax compliance data
to identify unfiled returns and underreported income.
Pro:
* IRS could cost effectively identify noncompliance, especially
nonfilers, that it otherwise would miss.
Con:
* State data may be difficult to match with federal data because states
impose different taxes than the federal government, may use a different
taxable base, and may report the data in a format that IRS cannot
easily use.
20. Use informational notices to encourage compliance:
IRS would send notices (soft notices) to Schedule C filers when it sees
potential compliance issues that it does not have the resources to
audit. These notices notify and educate the filers about a potential
problem with a tax reporting obligation, and suggest that they either
recheck their filed tax returns or change their reporting on future
returns.
Pro:
* IRS can expand its presence/education and sensitize sole proprietors
about tax obligations without the costs of enforcement contacts.
* Some sole proprietors may become more compliant voluntarily.
Con:
Some sole proprietors will ignore the soft notices, particularly if
they are received years after a return was filed or if IRS will not
take follow-up action regardless of what they do.
21. Revise the rules for applying penalties to improve consistency and
compliance:
One tool to increase compliance is to punish improper behavior with
penalties. Two options to remedy the inconsistent application of
penalties are to:
* simplify the process for assessing penalties and develop standards to
ensure the consistency of their application to sole proprietor errors
and misconduct and:
* make information return penalties scalable by increasing the dollar
amount of penalties for subsequent failures to file required
information returns (e.g., the penalty for the tenth failure to file an
information return may be significantly higher than the first).
Pro:
* Sole proprietors who are significantly noncompliant would be
penalized, and the equity and consistency of penalty application might
improve.
* Some sole proprietors might become more compliant if they are certain
that penalties will be applied.
* If IRS applies the penalties more consistently, fewer sole
proprietors may need to incur the burden of seeking abatements for
unnecessary penalties.
* IRS could receive more required information returns that are accurate
and timely.
Con:
* If the process becomes too rigid, some sole proprietors might resent
the perceived inequities. Some sole proprietors might have equity
concerns if IRS cannot reduce higher penalties caused by a systemic
glitch for many information returns (e.g., a computer error that
occurred over and over).
* If revised penalty rules go too far in accounting for inadvertent
actions, hardships, and other reasonable causes, the penalty
consistency may be hard to achieve.
* If many sole proprietors are required to file only a few information
returns, scaling penalties would have little impact, and if only a
small dollar amount of penalties is at stake, IRS procedures are likely
to continue authorizing abatement of the penalties.
[End of section]
Appendix III: IRS Form 1040 Schedule C, Tax Year 2001:
[See PDF for image]
Source: IRS.
[End of figure]
[End of section]
Appendix IV: Independent Contractors and Section 530 of the Revenue Act
of 1978:
With increased IRS enforcement of the employment tax laws beginning in
the late 1960s, controversies developed over whether employers had
correctly classified certain workers as independent contractors rather
than as employees. In some instances when IRS prevailed in
reclassifying workers as employees, the employers became liable for
portions of employees' Social Security and income tax liabilities (that
the employers had failed to withhold and remit), although the employees
might have fully paid their liabilities for self-employment and income
taxes.
In response to this problem, Congress enacted section 530 of the
Revenue Act of 1978 (Pub. L. No. 95-600). That provision generally
allows an employer who meets certain requirements (such as filing
required information returns) to treat a worker as not being an
employee for employment tax purposes (but not income tax purposes),
regardless of the individual's actual status under the common-law test,
unless the taxpayer has no reasonable basis for such treatment. Under
section 530, a reasonable basis is considered to exist if the taxpayer
reasonably relied on (1) past IRS audit practice with respect to the
taxpayer, (2) published rulings or judicial precedent, (3) long-
standing recognized practices in the industry of which the taxpayer is
a member, or (4) any other reasonable basis for treating a worker as an
independent contractor. Section 530 also prohibits the issuance of
Treasury regulations and revenue rulings on common-law employment
status.[Footnote 38] Congress intended that this moratorium to be
temporary until more workable rules were established but the moratorium
continues to this day. The provision was extended indefinitely by the
Tax Equity and Fiscal Responsibility Act of 1982.[Footnote 39]
The rules to classify a worker as an employee or an independent
contractor are still complex and often difficult to apply. The
determination of whether a worker is an employee or an independent
contractor is generally made under a facts and circumstances test that
seeks to determine whether the worker is subject to the control of the
employer, not only as to the nature of the work performed but the
circumstances under which it is performed. In general, the
determination of whether an employer-employee relationship exists for
federal tax purposes is made under a common-law test.
IRS has developed a list of 20 factors that may be examined in
determining whether an employer-employee relationship exists. The 20
factors were developed by IRS based on an examination of cases and
rulings considering whether a worker is an employee.[Footnote 40] The
degree of importance of each factor varies depending on the occupation
and the factual context in which the services are performed.[Footnote
41]
Misclassification of workers can be either inadvertent or deliberate.
Because the determination of classification is factual, reasonable
people may differ as to the correct result given a certain set of
facts. Thus, even though a taxpayer in good faith determines that a
worker is an independent contractor, an IRS agent may reach a different
conclusion by, for example, weighing some of the 20 factors
differently. The prohibition on issuance of general guidance by IRS may
make the likelihood of classification errors greater; IRS is not
permitted to publish guidance stating which factors are more relevant
than others. In the absence of such guidance, not only may taxpayers
and IRS differ, but different IRS agents may also reach different
conclusions, resulting in inconsistent enforcement.
A significant issue is the potential revenue loss to the federal
government when employees are misclassified as independent contractors.
An IRS survey of 1984 employment tax returns found that nearly 15
percent of employers misclassified employees as independent
contractors. When employers classified workers as employees, more than
99 percent of wage and salary income was reported. When workers were
misclassified as independent contractors, 77 percent of income was
reported when a Form 1099-MISC was filed and only 29 percent was
reported when no Form 1099-MISC was filed.
[End of section]
Appendix V: Backup Withholding Rules:
Persons (payers) making certain types of payments must withhold and pay
to IRS a specified percentage of those payments under certain
conditions. Related to sole proprietors, for example, both (1) the
commissions, fees, or other payments for work as an independent
contractor and (2) payments by fishing boat operators, but only the
part that is in money and that represents a share of the proceeds of
the catch, are reported on Form 1099-MISC. Other payments are not
subject to backup withholding, including wages, real estate
transactions, foreclosures and abandonments, and canceled debts. Also
corporations, governmental entities, and foreign governments generally
are exempt from backup withholding.
For backup withholding to be initiated on payments to sole proprietors,
a payment must be reportable and the payee must fail to furnish a
correct TIN.[Footnote 42] If an incorrect TIN is provided, IRS is to
notify the payer regarding the missing, incorrect, or not currently
issued payee TIN. At that time the payer is required to compare the
listing with his or her records and send a notice to the payee, asking
for the correct TIN. Under tax rules, if the payee refuses to provide a
TIN, the payer is required to immediately begin withholding 28 percent
of the amount of the payment and remit that amount to IRS. IRS
procedures describe how the payer is to verify the TIN and request that
the payee provide a correct TIN. The payer must make up to three
solicitations for the TIN (initial, first annual, and second annual) to
avoid a penalty for failing to include a TIN on the information return.
If the payer files an information return with a missing TIN or with an
incorrect name and TIN combination, or does not follow the procedure to
correct the TIN, the payer may be subject to a $50 penalty for each
incorrect return filed.
[End of section]
Appendix VI: Comments from the Department of the Treasury:
Department Of The Treasury:
Washington, D.C. 20220:
July 10, 2007:
Mr. James R. White:
Director, Tax Issues:
Strategic Issues:
United States Government Accountability Office:
Washington, DC 20548:
Dear Mr. White:
We appreciate the opportunity to review and provide comments on the
draft report titled "Tax Gap: A Strategy for Reducing the Gap Should
Include Options for Addressing Sole Proprietor Noncompliance (GAO-07-
1014)."
In addition to specific technical comments that we provided to your
staff, we would like to respond to the report's recommendation that
"the Secretary of the Treasury ensure that the tax gap strategy
includes (1) a segment on improving sole proprietor compliance that is
coordinated with broader tax gap reduction efforts and (2) specific
proposals such as the options, such we identified, that constitute an
integrated package." Although not addressed specifically, the seven
elements of the Treasury Department's strategy are intended to apply
broadly to all types of business and individual taxpayers, including
sole proprietorships. As we continue to consider application of the
strategy to the most significant elements of the tax gap, your report
will provide valuable insight.
Thank you for your analysis and suggestions on this important issue.
Sincerely,
Signed by:
Michael J. Desmond:
Tax Legislative Counsel:
[End of section]
Appendix VII: 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, Tom Short, Assistant Director;
Evan Gilman; Eric Gorman; Leon Green; George Guttman; Shirley Jones;
Donna Miller; Karen O'Conor; Anna Maria Ortiz; and Sam Scrutchins made
key contributions to this report.
[End of section]
Related GAO Products:
Tax Compliance: Multiple Approaches Are Needed to Reduce the Tax Gap.
GAO-07-488T. Washington, D.C.: February 16, 2007.
Tax Compliance: Multiple Approaches Are Needed to Reduce the Tax Gap.
GAO-07-391T. Washington, D.C.: January 23, 2007.
Tax Compliance: Opportunities Exist to Reduce the Tax Gap Using a
Variety of Approaches. GAO-06-1000T. Washington, D.C.: July 26, 2006.
Tax Gap: Making Significant Progress in Improving Tax Compliance Rests
on Enhancing Current IRS Techniques and Adopting New Legislative
Actions. GAO-06-453T. Washington, D.C.: February 15, 2006.
Tax Gap: Multiple Strategies, Better Compliance Data, and Long-Term
Goals Are Needed to Improve Taxpayer Compliance. GAO-06-208T.
Washington, D.C.: October 26, 2005.
Tax Compliance: Better Compliance Data and Long-term Goals Would
Support a More Strategic IRS Approach to Reducing the Tax Gap. GAO-05-
753. Washington, D.C.: July 18, 2005.
Tax Compliance: Reducing the Tax Gap Can Contribute to Fiscal
Sustainability but Will Require a Variety of Strategies. GAO-05-527T.
Washington, D.C.: April 14, 2005.
IRS Audits: Weaknesses in Selecting and Conducting Correspondence
Audits. GAO/GGD-99-48. Washington, D.C.: March 31, 1999.
Tax Administration: Billions in Self-Employment Tax Are Owed. GAO/GGD-
99-18. Washington, D.C.: February 18, 1999.
Tax Administration: Issues Involving Worker Classification. GAO/T-GGD-
95-224. Washington, D.C.: August 2, 1995.
Tax Administration: Estimates of the Tax Gap for Service Providers.
GAO/GGD-95-59. Washington, D.C.: December 28, 1994.
Tax Administration: IRS Can Better Pursue Noncompliant Sole
Proprietors. GAO/GGD-94-175. Washington, D.C.: August 2 1994.
Tax Gap: Many Actions Taken, But a Cohesive Compliance Strategy Needed.
GAO/GGD-94-123. Washington, D.C.: May 11, 1994.
Tax Administration: Approaches for Improving Independent Contractor
Compliance. GAO/GGD-92-108. Washington, D.C.: July 23, 1992.
FOOTNOTES
[1] In addition, sole proprietors contributed to an unmeasured extent
to the $54 billion in misreported employment taxes, the $34 billion
underpayment tax gap, and the $27 billion tax gap created by
individuals not filing required tax returns for tax year 2001.
[2] NRP studied reporting compliance (versus filing or payment
compliance) for a random sample of individual tax returns filed for tax
year 2001. In most cases, the returns were audited to determine whether
income, expenses, and other items were reported accurately by the
taxpayers.
[3] See IRS's Publication 334, Tax Guide for Small Business, and Form
1099-MISC instructions.
[4] Other reportable items include other income payments, medical and
health care payments, crop insurance proceeds, and gross proceeds to an
attorney.
[5] The real estate agent is responsible for reporting payments of rent
to the landlord. See Treasury Regulation 1.6041-3(d).
[6] Payments for merchandise, telegrams, telephone, freight, storage,
and similar items are also not reported nor are payments to informers
from government agencies about criminal activity.
[7] See GAO, Tax Administration: Issues in Classifying Workers as
Employees or Independent Contractors, GAO/T-GGD-96-130 (Washington,
D.C.: June 20, 1996).
[8] Pub. L. No. 95-600, November 16, 1978.
[9] IRS NRP and Research officials cited various reasons why a higher
percentage and number of sole proprietors misreported expenses compared
to overall net income. For example, some taxpayers who misreported
expenses were not counted as misreporting net income because of other
income or expense adjustments made during the examinations that
produced the correct net income amounts.
[10] The $36.9 billion estimate excludes returns with no understatement
and is based on unadjusted NRP results. We are 95 percent confident
that the actual estimate is between $34.7 billion and $39.0 billion.
[11] This tax calculation is difficult to do and requires assumptions
to account for how tax changes on one part of the income tax return
affect the rest of the tax return (including changes to other types of
wage, business, or investment income as well as to itemized deductions,
exemptions, and credits), and ultimately flow through to the final tax
liability and tax rate to be used.
[12] We are 95 percent confident that the actual estimate is between 68
percent and 76 percent.
[13] We are 95 percent confident that the actual 90th percentile amount
is between $124,720 and $134,263 and the cumulative amount is between
$22.1 billion and $25.8 billion.
[14] IRS also has programs for addressing nonpayment and nonfiling
types of noncompliance, as well as taxpayer service programs for
encouraging all types of tax compliance. Because this report focuses on
sole proprietor reporting noncompliance, references to "noncompliance"
refer to misreporting unless otherwise noted.
[15] This percentage should not be confused with IRS's "examination
coverage rate," which is merely the number of returns examined divided
by the number of returns filed.
[16] For both AUR and Examination, amounts of recommended assessments
should not be construed as amounts ultimately collected. For example,
recommended assessments could be abated in appeals or the amounts may
not be collectible.
[17] We have started work on a study that will more fully discuss
taxpayer burdens in filing 1099-MISC forms.
[18] Payers filing 250 or more information returns must use FIRE or
send IRS special cartridges with the data.
[19] UR contacts do not always lead to a tax change. For example, from
tax years 1999 through 2003, 26 percent of the NEC contacts did not
lead to a tax change.
[20] We have started work on a study that will more fully discuss
Schedule C expense reporting.
[21] AUR may refer suspicious cases to Examination, but IRS officials
have told us that historically, that happens infrequently. IRS started
a test in March 2007 on referring such suspicious cases to Examination
for questionable NEC income and expenses.
[22] I.R.C. § 162(a).
[23] Because IRS officials said data for 2004 were not complete when we
requested them, we used only data through 2003. It is possible that
contacts and assessments related to NEC are somewhat higher, but IRS
does not have the data to separate all contacts that included NEC as
well as other types of misreporting. NEC figures used here only refer
to those cases where 50 percent or more of the taxpayer's income was
NEC or where the tax change was 80 percent or greater than the original
tax reported.
[24] IRS Examination data treat a minority of Schedule C returns it
receives as business returns. This section deals only with returns IRS
has categorized as Schedule C business returns for Examination purposes
and will be referred to as returns with an attached Schedule C.
[25] GAO, Tax Compliance: Opportunities Exist to Reduce the Tax Gap
Using a Variety of Approaches, GAO-06-1000T (Washington, D.C.: July 26,
2006).
[26] IRS provided us examination data that did not differentiate
between examinations of returns that have Schedule C forms attached and
those that actually audited Schedule C issues. For example, a real
estate agent filing a Schedule C may also own rental real estate and
file a Schedule E. IRS may audit the real estate losses reported on the
Schedule E, but nothing on the Schedule C. Therefore, IRS's data may
overstate the number and amount of time that IRS spends auditing
Schedule C returns.
[27] Son of Boss was an abusive transaction aggressively marketed in
the late 1990s and 2000 primarily to wealthy individuals. IRS's
settlement initiative regarding Son of Boss required taxpayers to
concede 100 percent of the claimed tax losses and pay a penalty of
either 10 percent or 20 percent unless they previously disclosed the
transactions to IRS. We did not verify whether examinations were more
efficient in 2005 and 2006.
[28] The negligence penalties discussed in this section refer to those
in I.R.C. § 6662(b)(1).
[29] We used a statistical model to assess whether various factors are
related to the recommended assessment of penalties. Controlling for
other factors, we found that the dollar value of the tax change and the
percentage tax change are related to the recommendation to assess a
penalty. The relationship raises questions because the guidance about
assessing penalties does not provide a basis for considering the
percentage error or the dollar amount of the error, above a threshold,
when deciding to assess a penalty. App. I describes the model we used,
our analysis of the penalty-related data, and results.
[30] GAO, Tax Compliance: Multiple Approaches Are Needed to Reduce the
Tax Gap, GAO-07-488T (Washington, D.C.: Feb. 16, 2007).
[31] IRS is part Treasury, which is responsible for tax policy analysis
and formulation.
[32] GAO, Tax Gap: Many Actions Taken, But a Cohesive Compliance
Strategy Needed, GAO/GGD-94-123 (Washington, D.C.: May 11, 1994).
[33] GAO, Tax Administration: IRS Can Better Pursue Noncompliant Sole
Proprietors, GAO/GGD-94-175 (Washington, D.C.: Aug. 2, 1994).
[34] GAO, Tax Compliance: Better Compliance Data and Long-term Goals
Would Support a More Strategic IRS Approach to Reducing the Tax Gap,
GAO-05-753 (Washington, D.C.: July 18, 2005).
[35] GAO, Internal Revenue Service: Assessment of the Interim Results
of the 2006 Filing Season and Fiscal Year 2007 Budget Request, GAO-06-
615T (Washington, D.C.: Apr. 6, 2006).
[36] GAO, Tax Compliance: Multiple Approaches Are Needed to Reduce the
Tax Gap, GAO-07-391T (Washington, D.C.: Jan. 23, 2007).
[37] See section 511 of the Tax Increase Prevention and Reconciliation
Act of 2005, Pub. L. No. 109-222, May 17, 2006.
[38] A taxpayer may, however, request and obtain a written
determination from IRS regarding the status of a particular worker as
an employee or independent contractor.
[39] Pub. L. No. 97-248, September 3, 1982.
[40] IRS has also developed three categories of evidence that may be
relevant in determining whether a worker is a contractor or employee
under the common-law test. The three categories are behavioral control,
financial control, and type of relationship.
[41] For a list of the 20 factors and a discussion of their
application, see GAO, Tax Administration: Approaches for Improving
Independent Contractor Compliance, GAO/GGD-92-108 (Washington, D.C.:
July 23, 1992).
[42] Backup withholding also applies when the payee fails to certify,
under penalties of perjury, that the TIN provided is correct for
interest, dividend, and broker and barter exchange accounts opened or
instruments acquired after 1983.
GAO's Mission:
The Government Accountability Office, the audit, evaluation and
investigative arm of Congress, exists to support Congress in meeting
its constitutional responsibilities and to help improve the performance
and accountability of the federal government for the American people.
GAO examines the use of public funds; evaluates federal programs and
policies; and provides analyses, recommendations, and other assistance
to help Congress make informed oversight, policy, and funding
decisions. GAO's commitment to good government is reflected in its core
values of accountability, integrity, and reliability.
Obtaining Copies of GAO Reports and Testimony:
The fastest and easiest way to obtain copies of GAO documents at no
cost is through GAO's Web site [hyperlink, http://www.gao.gov]. Each
weekday, GAO posts newly released reports, testimony, and
correspondence on its Web site. To have GAO e-mail you a list of newly
posted products every afternoon, go to [hyperlink, http://www.gao.gov]
and select "Subscribe to Updates."
Order by Mail or Phone:
The first copy of each printed report is free. Additional copies are $2
each. A check or money order should be made out to the Superintendent
of Documents. GAO also accepts VISA and Mastercard. Orders for 100 or
more copies mailed to a single address are discounted 25 percent.
Orders should be sent to:
U.S. Government Accountability Office
441 G Street NW, Room LM
Washington, D.C. 20548:
To order by Phone:
Voice: (202) 512-6000
TDD: (202) 512-2537
Fax: (202) 512-6061
To Report Fraud, Waste, and Abuse in Federal Programs:
Contact:
Web site: [hyperlink, http://www.gao.gov/fraudnet/fraudnet.htm]
E-mail: fraudnet@gao.gov
Automated answering system: (800) 424-5454 or (202) 512-7470:
Congressional Relations:
Gloria Jarmon,
Managing Director, JarmonG@gao.gov (202) 512-4400
U.S. Government Accountability Office, 441 G Street NW, Room 7125
Washington, D.C. 20548:
Public Affairs:
Paul Anderson,
Managing Director, AndersonP1@gao.gov (202) 512-4800
U.S. Government Accountability Office, 441 G Street NW, Room 7149
Washington, D.C. 20548: