Tax Administration

GAO discovered that when information returns were issued, taxpayers had a significantly higher level of voluntary compliance in reporting forgiven debt income and were apparently able to pay taxes on that income. Furthermore, both GAO and the Internal Revenue Service (IRS) found that IRS could cost-effectively use the information returns to spot taxpayers who failed to comply. GAO believes that Congress should amend the tax code to extend formal information reporting to the Federal Deposit Insurance Corporation (FDIC) and the Resolution Trust Corporation (RTC). This move would significantly boost tax revenues even if future forgiven debt falls short of the 1990 level--more than $10 billion. It would also ensure that such reporting conforms to the law protecting consumers from privacy invasions and unwarranted government intrusions. If FDIC and RTC information reporting on forgiven debt proves to be cost-effective, Congress might consider extending this practice to other agencies. Otherwise, taxpayers with debts forgiven by FDIC or RTC will be subject to more IRS scrutiny than those with debts forgiven by other institutions. GAO found, for example, that private lending institutions forgive much higher amounts of debt than FDIC.

GAO found that: (1) in 1986, 1 percent of taxpayers who had not received information returns from FDIC and RTC voluntarily reported FDIC-forgiven debt and 48 percent of taxpayers who had received information returns voluntarily reported forgiven debt; (2) 20 percent underreported the forgiven debt income and owed additional taxes, 12 percent did not underreport income and did not owe additional taxes, and 20 percent may have underreported income but were not pursued because of limited IRS resources; (3) IRS estimated that in 1989 it lost about $78 million in potential revenues due to taxpayers failing to report forgiven FDIC debt; (4) in 1991, the combined FDIC- and RTC-forgiven debt totalled $10.9 billion; (5) IRS computer matching of 1986 information returns with other federal agencies' forgiven debt information yielded $37 in revenue for every $1 in costs and 83 percent of taxpayers subsequently paid the recommended taxes; (6) taxpayers who did not voluntarily report 1989 unforgiven debts had above average median incomes and had sufficient funds to pay the taxes; (7) FDIC and RTC believe that the benefits of taxpayer's filing information returns on forgiven debt outweighed the costs; (8) forgiven debt information reporting could increase recovery of unpaid social security taxes, assist IRS in locating individuals who had not filed tax returns, and assist taxpayers in meeting exceptions for not reporting forgiven debts; and (9) requiring lenders to file forgiven debt returns could increase IRS ability to collect additional revenue.

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.

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