Tax Administration: Costs and Uses of Third-Party Information	 
Returns (20-NOV-07, GAO-08-266).				 
                                                                 
One proven approach for improving tax compliance is information  
reporting to the Internal Revenue Service (IRS) by third parties 
about taxpayers' income and expenses. IRS matches information	 
returns with taxpayers' income tax returns to see if taxpayers	 
have filed returns and reported all their income. The		 
administration's fiscal year 2008 budget proposed requiring	 
information reporting on merchant payment card reimbursements and
on certain payments to corporations, raising an estimated $18.4  
billion over 10 years. This report's objectives are to (1)	 
identify, using case studies, the compliance costs of existing	 
information reporting; (2) determine the kinds of third-party	 
compliance costs that may result from the two budget proposals	 
and options for mitigating the costs; and (3) determine IRS's	 
ability to process and use additional information returns. GAO	 
did nongeneralizable structured interviews with four payers	 
volunteering information and with five companies filing a sizable
percentage of all information returns. GAO's work also included  
reviewing studies and documentation and contacting other	 
government and nongovernment parties.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-08-266 					        
    ACCNO:   A78291						        
  TITLE:     Tax Administration: Costs and Uses of Third-Party	      
Information Returns						 
     DATE:   11/20/2007 
  SUBJECT:   Administrative costs				 
	     Authorizing legislation				 
	     Federal taxes					 
	     Income taxes					 
	     Personal income taxes				 
	     Private sector					 
	     Reporting requirements				 
	     Tax administration 				 
	     Tax administration systems 			 
	     Tax evasion					 
	     Taxes						 
	     Taxpayers						 
	     Information management				 
	     Program implementation				 

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GAO-08-266

   

     * [1]Results
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Report to the Committee on Finance, U.S. Senate

United States Government Accountability Office

GAO

November 2007

TAX ADMINISTRATION

Costs and Uses of Third-Party Information Returns

GAO-08-266

Contents

Letter 1

[9]Results 3
[10]Agency Comments and Our Evaluation 5
[11]Appendix I Briefing Slides 6

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. However, 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.

United States Government Accountability Office
Washington, DC 20548

November 20, 2007

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

The tax year 2001 gross tax gap--the difference between what taxpayers
should have paid and what they actually paid--was an estimated $345
billion. One proven approach for improving tax compliance is information
reporting to the Internal Revenue Service (IRS) by third parties about
taxpayers' income and expenses. The administration's fiscal year 2008
budget contained information reporting proposals estimated to increase
federal revenue by about $29 billion over 10 years. Two of the proposals
would expand information reporting to cover (1) reimbursements by banks to
merchants for the merchants' payment card receipts and (2) payments by
businesses to corporations for services the corporations provided,
together raising an estimated $18.4 billion over 10 years. The tax year
2001 gross tax gap--the difference between what taxpayers should have paid
and what they actually paid--was an estimated $345 billion. One proven
approach for improving tax compliance is information reporting to the
Internal Revenue Service (IRS) by third parties about taxpayers' income
and expenses. The administration's fiscal year 2008 budget contained
information reporting proposals estimated to increase federal revenue by
about $29 billion over 10 years. Two of the proposals would expand
information reporting to cover (1) reimbursements by banks to merchants
for the merchants' payment card receipts and (2) payments by businesses to
corporations for services the corporations provided, together raising an
estimated $18.4 billion over 10 years.

IRS seeks to verify compliance by trying to compare the income or expenses
reported by third parties to the income or expenses taxpayers report on
their tax returns to see if taxpayers have filed returns and reported all
their income. Like all information reporting, the proposals would assign
some of the costs of tax administration to private sector parties who
would have to file information reports with IRS. The administration did
not estimate the costs of the information reporting proposals to
third-party payers. In addition, questions have been raised about IRS's
ability to process and use additional information returns. You asked us
for more details on the effects of expanding information return reporting
requirements. IRS seeks to verify compliance by trying to compare the
income or expenses reported by third parties to the income or expenses
taxpayers report on their tax returns to see if taxpayers have filed
returns and reported all their income. Like all information reporting, the
proposals would assign some of the costs of tax administration to private
sector parties who would have to file information reports with IRS. The
administration did not estimate the costs of the information reporting
proposals to third-party payers. In addition, questions have been raised
about IRS's ability to process and use additional information returns. You
asked us for more details on the effects of expanding information return
reporting requirements.

This report's objectives are to This report's objectives are to

* identify the compliance costs associated with existing information 
reporting requirements as reported by selected case study payer 
organizations, software vendors, service bureaus that transmit 
information returns to IRS on behalf of payers, and return preparers; 

* determine the kinds of third-party compliance costs that may result 
from two information reporting proposals--merchant payment card 
reimbursements and payments to corporations--and any options for 
mitigating the costs; and: 

* determine IRS's ability to process and use additional information 
returns. 

To identify compliance costs reported in selected cases, we used (1)
structured interviews, others' studies, and other interviews about factors
influencing costs; and (2) Web sites showing price information. We used
structured interviews to see how much selected payers spend in-house on
information reporting and how much selected parties charge for it. We
interviewed four organizations volunteered through International Accounts
Payable Professionals or the National Federation of Independent Business,
an organization of small businesses that is on record as finding the
information reporting proposals we are studying to be troublesome to small
businesses. Also, we selected five companies from lists of vendors,
IRS-approved e-filers, and Information Reporting Program Advisory
Committee members, enough to include representatives of software vendors,
service bureaus, and return preparers and cover a sizable percentage of
all information returns. These nine case studies provide examples of costs
but are not to be generalized to the entire population. We also examined
Web sites of the five vendors, service bureaus, and return preparers that
we interviewed and of others appearing on two IRS lists of e-filers.

To determine the kinds of third-party compliance costs that may result
from the two information reporting proposals and any options for
mitigating the costs, we reviewed studies and documentation, interviewed
government and nongovernment parties, and analyzed compliance costs and
mitigations related to any overlap among the proposals and an expanded
broker proposal. Nongovernment contacts included eight national
organizations representing small businesses, banking and electronic
transactions industries, and other interests; and companies in the payment
card industry. For the payments-to-corporations proposal, which is closer
to current requirements than the payment card proposal is, we used the
structured interviews for the first objective described earlier for
further insights into the compliance costs involved. Our lists of
compliance costs and mitigations may not be exhaustive, and we did not
evaluate (1) trade-offs that policymakers will have to make among items on
the lists or (2) projected benefits from the proposals. Mitigation ideas
are possible ways to reduce, not eliminate, costs, and their viability
depends on their own costs and benefits and accompanying facts and
circumstances.

To determine IRS's ability to process and use additional information
returns, we analyzed how IRS uses information returns and how many
information returns IRS processes and sends through its matching process.
We also asked how IRS checks that all information returns that should be
filed are filed. Finally, we interviewed IRS officials on how they would
accommodate additional information returns and assessed related IRS costs
and plans. We determined that the data used in this report to describe the
growing number of information returns filed and the disparity between the
numbers of tax underreporter and nonfiler cases identified and the numbers
pursued are sufficiently reliable for the purposes of the report; we
determined this after interviewing IRS officials and reviewing the
information's reasonableness against other information we had.

We did our work from April 2007 through October 2007 in accordance with
generally accepted government auditing standards. On November 6, 2007, we
briefed your staff on the results of our work. This report conveys the
information provided during that briefing. A copy of the briefing document
with slight revisions is included in appendix I.

Results

In our nine case studies, filers of information returns told us that
existing information return costs, both in-house and for external
payments, were relatively low. In-house compliance costs included the
costs of getting taxpayer identification numbers (TIN), buying software,
tracking reportable payments, filing returns with IRS, and mailing copies
to taxpayers. One small business employing under five people told us of
possibly spending 3 to 5 hours per year filing Form 1099 information
returns manually, using an accounting package to gather the information.
An organization with more than 10,000 employees estimated spending less
than .005 percent of its yearly staff time on preparing and filing Forms
1099, including recordkeeping. Two external parties reported prices for
preparing and filing Forms 1099 with IRS of about $10 per form for 5 forms
to about $2 per form for 100 forms, with one of them charging about $.80
per form for 100,000 forms. As expected, unit prices for services provided
to payers by selected software vendors, service bureaus, and return
preparers decreased as the number of forms handled increased.

New information reporting requirements for payment card reimbursements and
payments to corporations would impose new compliance costs, some of which
could be mitigated. For payment card reimbursements, compliance costs
would include (1) merging separately stored TINs and merchant
identification numbers, especially in the case of multiple locations or
franchises; and (2) more generally, new systems and added service
requirements. Mitigations could include (1) having the reporting party be
as close as possible to the merchant in a payment or reporting chain and
(2) extending current systems and procedures that, for instance, might
already generate and report related data for other purposes.

For payments to corporations for services, payer compliance costs would
include, for example, additional bookkeeping and postage, as well as the
need for TIN collection and distinguishing between payments for goods or
for services. Mitigations could include using or extending current
systems, limiting information return recipients to only some corporations,
and grandfathering ongoing relationships for TIN collection and other
purposes or specifying a lead time for collecting information on them.

IRS already receives and handles a growing number of information returns,
over 1.7 billion for tax year 2006. According to IRS officials, after
correction, about 98 percent of these information returns are potentially
usable for matching purposes. IRS uses about 90 percent of these
potentially usable information returns in its matching efforts for
individual taxpayers. The majority of the remaining 10 percent of
information returns cannot be used for individual matching efforts because
they are associated with business, not individual, tax returns. IRS
pursues millions of discrepancies, including both underreporting of income
and failure to file tax returns, discovered through its matching efforts.
According to IRS officials, millions of others are not pursued because of
resource constraints.

For the two proposals we studied, IRS budgeted $11.8 million in
programming and start-up costs for fiscal year 2008, with another $16.8
million expected in future administrative implementation costs, although
for the payments-to-corporations proposal, IRS said its cost estimates
could vary by an additional several million dollars. By design, it did not
estimate future enforcement costs because of uncertainty over whether
legislation would pass and how it would be implemented; for example, it
did not cost out the expected hundreds of staff years needed to use
payments-to-corporations information returns. Also for this proposal, it
conservatively estimated 60 million forms arriving annually, saying the
actual number could range into the billions. IRS will be in a better
position to estimate how many information returns, including those in
paper form, will be arriving if specific legislation is enacted. Any
enacted proposals would require IRS to address their benefits and costs
and minimize their burden on the public before the Office of Management
and Budget approves the information collection.

Agency Comments and Our Evaluation

We provided a draft of the briefing document in appendix I to the Acting
Commissioner of Internal Revenue for review and comment. IRS provided
technical written comments, which we incorporated as appropriate.

As agreed with your offices, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days from
its issue date. At that time, we will send copies to the Secretary of the
Treasury; the Acting Commissioner of Internal Revenue; and other
interested parties. In addition, this report will be available at no
charge on the GAO Web site at [12]http://www.gao.gov .

If you or your staffs have any questions, please contact me at (202)
512-9110 or at [13][email protected] . 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 were Kevin Daly, Evan
Gilman, George Guttman, Jyoti Gupta, Lawrence Korb, and Edward Nannenhorn.

James R. White
Director, Tax Issues Strategic Issues

Appendix I: Briefing Slides

Tax Administration: 

Costs and Uses of Third-Party Information Returns: 

November 6, 2007: 

Briefing to the Senate Committee on Finance: 

Briefing Contents: 

Introduction: 

Objectives: 

Results in Brief: 

Scope and Methodology: 

Background: 

Information Reporting Costs of Case Study Organizations: 

Payment Card Reimbursements: 

Payments to Corporations: 

The Internal Revenue Serviceï¿½s (IRS) Ability to Process and Use 
Information Returns: 

[End of section] 

Costs and Uses of Third-Party Information Returns: 

Introduction: 

The tax year 2001 gross tax gap--the difference between what taxpayers 
should have paid and what they actually paid--was an estimated $345 
billion. 

One proven approach for improving tax compliance is information 
reporting to IRS by third parties about taxpayersï¿½ income and expenses. 
IRS seeks to verify compliance by trying to compare the income or 
expenses reported by third parties to the income or expenses taxpayers 
report on tax returns. 

The administrationï¿½s fiscal year 2008 budget contained information 
reporting proposals estimated to increase federal revenue by about $29 
billion over 10 years. Two of the proposals would expand information 
reporting to cover: 

* reimbursements by banks to merchants for the merchantsï¿½ payment card 
receipts and: 

* payments by businesses to corporations for services the corporations 
provided.

Like all information reporting, the proposals would assign some of the 
costs of tax administration to private sector parties who would have to 
file information reports with IRS.

The administration did not estimate the costs of the information 
reporting proposals to third-party payer organizations, or payers, 
making various kinds of payments and filing information returns. 

In addition to the compliance costs of the proposals, questions have 
been raised by some opponents of the proposals about IRSï¿½s ability to 
process and use additional information reports. 

The Senate Committee on Finance asked us for more information on the 
effect of expanding information return reporting requirements. 

Objectives: 

Identify the compliance costs associated with existing information 
reporting requirements as reported by selected case study payer 
organizations, software vendors, service bureaus that transmit 
information returns to IRS on behalf of payers, and return preparers. 

Determine the kinds of third-party compliance costs that may result 
from two information reporting proposalsï¿½payments to corporations and 
merchant payment card reimbursementsï¿½and any options for mitigating the 
costs. 

Determine IRSï¿½s ability to process and use additional information 
returns. 

To address our objectives, we did nongeneralizable structured 
interviews with five companies appearing on various lists and filing a 
sizable percentage of all information returns and with four payers 
volunteered by associations; we also reviewed studies and documentation 
and contacted IRS and other government and nongovernment parties. 

Results in Brief: 

Information Reporting Costs of Case Study Organizations: 

In our nine case studies, filers of information returns told us that 
existing information return costs, both in-house and for external 
payments, were relatively low.

* One small business employing under five people told us of possibly 
spending 3 to 5 hours per year filing Form 1099 information returns 
manually, using an accounting package to gather the information. 

* An organization with more than 10,000 employees estimated spending 
less than .005 percent of its yearly staff time on preparing and filing 
Forms 1099, including recordkeeping. 

* Two external parties reported prices for preparing and filing Forms 
1099 with IRS of about $10 per form for 5 forms to about $2 per form 
for 100 forms, with one of them charging about $.80 per form for 
100,000 forms. 

As expected, unit prices for services provided by selected software 
vendors, service bureaus, and return preparers decreased as the number 
of forms handled increased.

Information Reporting Proposalsï¿½Compliance Costs and Mitigations: 

New information reporting requirements for payment card reimbursements 
and payments to corporations would impose new compliance costs, some of 
which could be mitigated.

* For example, for payment card reimbursements, compliance costs would 
include (1) merging separately stored taxpayer and merchant 
identification numbers, especially in the case of multiple locations or 
franchises; and (2) more generally, new systems and added customer 
service requirements. 

* Mitigations could include (1) having the reporting party be as close 
as possible to the merchant in a payment or reporting chain and (2) 
extending current systems and procedures that, for instance, might 
already generate and report related data used for other purposes. 

IRSï¿½s Ability to Process and Use Information Returns: 

According to IRS, after correction, about 98 percent of the information 
returns it receives are potentially usable for matching purposes; IRS 
uses about 90 percent of these potentially usable information returns 
in its matching efforts for individual taxpayers; of the remaining 10 
percent of information returns, the majority cannot be used for 
individual matching efforts because they are associated with business, 
not individual, tax returns. 

* After going through the matching process, IRS pursues millions of 
discrepancies above certain dollar thresholds; according to IRS 
officials, millions of other discrepancies above the thresholds are not 
pursued because of resource constraints. 

For the two information reporting proposals GAO studied, IRS budgeted 
$11.8 million in programming and start-up costs for fiscal year 2008, 
with another $16.8 million expected in future administrative 
implementation costs. 

* IRS did not estimate future enforcement costs because of uncertainty 
over whether legislation would pass and how it would be implemented; 
for example, it did not cost out the expected hundreds of staff years 
needed to use payments-to-corporation information returns. 

Any enacted proposals would require IRS to address their benefits and 
costs and minimize their burden on the public before the Office of 
Management and Budget approves the information collection.

Scope and Methodology: 

Objective 1: used (1) structured interviews, othersï¿½ studies, and other 
interviews about factors influencing costs; and (2) Web sites showing 
price information. 

* Used structured interviews to see how much selected (1) payer 
organizations spend in-house on information reporting and (2) software 
vendors, service bureaus, and return preparers charge for information 
reporting.

- Interviewed four organizations volunteered through International 
Accounts Payable Professionals or the National Federation of 
Independent Business, an organization of small businesses that is on 
record as finding the information reporting proposals we are studying 
to be troublesome to small businesses. 13

- Selected five companies from lists of vendors, IRS-approved e-filers, 
and Information Reporting Program Advisory Committee members, enough to 
include representatives of software vendors, service bureaus, and 
return preparers and cover a sizable percentage of all information 
returns. 

- These nine case studies provide examples of costs but are not to be 
generalized to the entire population; however, they do provide insights 
from the perspective of organizations of different sizes and from 
different industries and of organizations filing their own information 
returns and those filing on behalf of others. 

Examined Web sites of the above five vendors, service bureaus, and 
return preparers we interviewed and others appearing on two IRS lists 
of e-filers. 

Objective 2: for each of the two information reporting proposals, 
reviewed studies and documentation on compliance costs to implement the 
proposals and ways to mitigate those compliance costs; interviewed IRS, 
the Department of the Treasury, and nongovernment parties about 
compliance costs and mitigations; and analyzed compliance costs and 
mitigations related to any overlap among the proposals and an expanded 
broker proposal. 

* Nongovernment contacts included eight national organizations 
representing small businesses, banking and electronic transactions 
industries, and other interests; and companies in the payment card 
industry. 

* Limitations: Our lists of compliance costs and mitigations may not be 
exhaustive, and we did not evaluate (1) trade-offs that policymakers 
will have to make among items on the lists or (2) projected benefits 
from the proposals; mitigation ideas are possible ways to reduce, not 
eliminate, costs, and their viability depends on their own costs and 
benefits and accompanying facts and circumstances. 

For the payments-to-corporations proposal, which is closer to current 
requirements than the payment card proposal is, we used the structured 
interviews for objective 1 for further insights into compliance costs 
involved. 

Objective 3: analyzed how IRS uses information returns and how many 
information returns IRS processes and sends through the matching 
process. In addition, 

* asked how IRS checks that all information returns that should be 
filed are filed, and: 

* interviewed IRS officials on how they would accommodate additional 
information returns and assessed related IRS costs and plans. 

We determined that the data used in this report to describe the growing 
number of information returns filed and the disparity between the 
numbers of tax underreporter and nonfiler cases identified and the 
numbers pursued are sufficiently reliable for the purposes of the 
report; we determined this after interviewing IRS officials and 
reviewing the informationï¿½s reasonableness against other information we 
had. 

We did our work from April through October 2007 in accordance with 
generally accepted government auditing standards. 

Background: 

How Information Reporting Works and Why It Is Important: 

Information reporting involves third-party payers, such as employers or 
banks, filing returns with IRS and taxpayers after each calendar year 
that provide information on a variety of taxpayersï¿½ transactions and 
payments, such as wages and miscellaneous income. 

* IRS validates the accuracy of the names and taxpayer identification 
numbers (TIN) on the information returns; if accurate TINs are not 
provided, IRS can often require third parties to withhold taxes from 
payments to the taxpayers, a procedure known as backup withholding. 

* IRS tries to match information from information returns filed by 
third parties against taxpayersï¿½ income tax returns to see if taxpayers 
have filed returns and reported all their income. 

As the next slide shows, voluntary reporting compliance is 
substantially higher for income subject to withholding or information 
reporting than for other income. 

* For example, for wages and salaries, which are subject to withholding 
and substantial information reporting, taxpayers have consistently 
misreported only an estimated 1 percent of their income. 

* For income with little or no information reporting, the tax year 2001 
estimated percentage was about 54 percent. 

Figure: Individual Net Income Misreporting Categorized by the Extent of 
Income Subject to Withholding and Information Reporting, Tax Year 
2001:  

This figure is a bar graph showing individual net income misreporting 
categorized by the extent of income subject to withholding and 
information reporting, tax year 2001. 

Substantial information reporting and withholding: Wages and salaries: 
1.2; 
Substantial information reporting: Pensions and annuities: Dividend 
income: Interest income: Unemployment compensation: Social Security 
benefits: 4.5; 
Some information reporting: Deductions: Partnerships/S-Corp income: 
Exemptions: Capital gains: Alimony income: 8.6; 
Little or no reporting: Nonfarm proprietor income: Informal supplier 
income: Other income: Rents and royalties: Farm income: Form 4947 
income: Adjustments: 53.9. 

[See PDF for image] - graphic text: 

Source: IRS. 

[End of figure] 

Benefits and Costs of Information Reporting: 

Improved compliance with the tax laws due to information reporting 
increases tax revenue. Increased revenue is not itself a benefit to 
society as a whole because the increased revenue simply transfers 
resources from the private sector to the public sector. Benefits depend 
on what is done with the revenue. The increased revenue could be used 
to reduce tax rates, increase spending, or reduce deficits.

Increased compliance could provide benefits to society that include: 

* increased economic growth if, for example, the increased revenue is 
used to reduce large, long-term federal budget deficits; 

* increased taxpayersï¿½ perceptions of the fairness of the tax system; 
and: 

* increased economic efficiency by, for example, ï¿½leveling the playing 
fieldï¿½ for business, making it less likely that resources will be 
shifted into less productive activities simply because these activities 
present greater opportunities for noncompliance. 

The costs of information reporting include the in-house compliance 
costs of third parties, such as recordkeeping and employee time; third-
party external costs, such as their payments to vendors and return 
preparers; and the resources used by IRS to process and match the 
returns. 

In line with this discussion on benefits and costs, the Paperwork 
Reduction Act of 1995 requires IRS to get Office of Management and 
Budget approval that the benefits of collecting any new information 
outweigh the costs. 

Information Reporting Costs of Case Study Organizations: 

Third-Party Compliance Costs: 

To comply with information reporting requirements, third parties would 
incur costs internally or pay external parties. 

* In-house costs may involve additional recordkeeping costs beyond 
normal recordkeeping costs related to running a business, as well as 
the costs of preparing and filing the information returns themselves. 

* If the third parties go outside their organizations for help, they 
would incur out-of-pocket costs to buy software or pay for others to 
prepare and file their returns.

For Case Study Entities Reporting Current Cost Information to Us, Their 
IRS Form 1099 Costs Were Relatively Small: 

These case studies provided examples of in-house and external costs but 
are not to be generalized to the entire population. 

In-house Costs: 

In our case study payer organizations, current compliance costs 
included the costs of getting TINs, buying software, tracking 
reportable payments, filing returns with IRS, and mailing copies to 
taxpayers; organizations may file up to 16 kinds of Forms 1099, but the 
organizations we studied filed mostly Forms 1099-MISC reporting 
miscellaneous income, a category that includes nonemployee 
compensation. 

* One organization with employees numbering in the low thousands 
estimated that its current costs of preparing and filing a couple 
hundred Forms 1099, which include recordkeeping and distinguishing 
goods from services, are a minimal addition to its normal business 
costs. 

* An organization with more than five times the employees and Forms 
1099 of the last organization estimated spending less than .005 percent 
of its yearly staff time on preparing and filing the 1099 forms, 
including recordkeeping.

* One business with fewer than 5 employees and Forms 1099 but with 
people knowledgeable about accounting told us of possibly spending 3 to 
5 hours per year on filing 1099 forms manually, using an accounting 
package to gather the information. 

* Another small business--one employing about 20 to 25 people and 
filing almost as many Forms 1099--told us of spending a little over an 
hour a year retyping and filing 1099 forms generated by its accounting 
package. 

Payments to External Parties: 

Unit prices for services provided by outside organizations we examined 
decreased as the number of forms handled increased. 

* Selected software vendors, service bureaus, and return preparers, and 
various Web sites informed us that prices varied depending on the 
number of forms filed and the services performed. 

* For one outside organization, prices for printing, filing with IRS, 
and mailing decreased from between $3 and $4 per form for 5 forms, 
subject to an overall fixed minimum of under $100, to well under $1 per 
form for doing 100,000 forms.

- Prices for just filing with IRS fell to $.01 each after the first few 
thousand 1099 forms. 

* Prices from one vendor for off-the-shelf software for organizations 
to do their own preparation, filing, and mailing were in the low 
hundreds of dollars the first year and less afterwards for yearly 
updates. 

* Prices from two other companies for preparing and filing Forms 1099 
ranged from about $10 per form for 5 forms to about $2 per form for 100 
forms, with one of them charging about $.80 per form for 100,000 forms. 

Relationship to Studies That Have Been Done: 

This relationship of price to size for entities we studied is 
consistent with what studies that we have seen show about the role of 
fixed costs and economies of scale in complying with the tax code; we 
are familiar with no similar studies of information returns.

* According to Slemrod and Bakija, studies consistently found that the 
smaller the firm, the larger the cost of complying with the tax system 
per dollar of various measures of the size of the firm. (See Joel 
Slemrod and Jon Bakija, Taxing Ourselves: A Citizenï¿½s Guide to the 
Debate over Taxes, 3rd ed. (Cambridge, Mass.: The MIT Press, 2004). 

Payment Card Reimbursements: 

Description of Payment Card Reimbursement Proposal: 

* ï¿½Merchant acquiring banksï¿½ would report to IRS the gross 
reimbursement payments made to merchants in a calendar year. 

* Merchant acquiring banks (henceforth called banks) include 
organizations that process card payments for merchants that accept 
payment cards. 

* Payment cards include credit and debit cards. 

* The proposal was not detailed, with the overall cost and number of 
affected information return filers unknown and any resulting 
legislation still needing regulations to implement it. 

* Under the proposal, IRS and the Department of the Treasury could make 
exceptions from the requirements where compliance costs of information 
reporting outweighed benefits from improved compliance. 

IRS would compare reported amounts to the gross receipts that merchants 
reported on their tax returns. 

* When reimbursements differ from gross receipts in a way that 
indicates that income might be underreported, IRS could use the 
information in selecting and conducting audits of taxpayers. 

Revenue Estimate for the Payment Card Reimbursement Proposal: 

The administrationï¿½s fiscal year 2008 budget estimated that the payment 
card reimbursement proposal would raise about $10.7 billion over 10 
years. 

Compliance Costs: 

Merging separately stored TINs and other merchant information would add 
compliance costs, especially in the case of multiple locations or 
franchises.

* For example, different hotels in the same chain may have the same TIN 
but different merchant identification numbers for payment card purposes.

Mitigations: 

The proposal could be made flexible so that parties reporting to IRS 
could be banks or an unknown number of other entities, such as parent 
corporations, that are as close as possible to the merchant in the 
payment or reporting chain and, thus, knowledgeable about the merchant; 
regulations could assure that the party actually (1) paying the 
merchant or (2) preparing the report on which the payment is based is 
the one reporting to IRS.

Compliance Costs: 

Costs would be incurred if the reporting requires that banks and others 
have their current merchants get TINs certified on an IRS form.

Mitigations: 

Current merchant accounts that have already supplied uncertified TINs 
could be grandfathered, although this may mean that many could be 
grandfathered for many years or even indefinitely. 

Certified TINs could be required at a specific future date, but TINs 
could change and need to be monitored over time.

Compliance Costs: 

Costs would be incurred if procedures and systems are established to 
insert backup withholding into ongoing, complicated relationships to 
increase the probability of getting accurate TINs.

Mitigations: 

Legislation could be passed without a backup withholding provision, but 
this mitigation would limit the potential effectiveness of the proposal 
and risk losing revenue due to invalid TINs.

Compliance Costs: 

Banks and others may need to field questions when cash versus accrual 
and calendar year versus fiscal year information reporting do not match 
merchantsï¿½ accounting systems and uncertainty is created.

Mitigations: 

Since:  

* IRS is not planning an exact match anyway but only a trigger for 
questions, 
* almost all entities are on the calendar year basis, 
* large percentages are on the cash basis, and: 
* accrual taxpayers might be more sophisticated than others, 

IRS could let banks and others know that, possibly by analyzing 
multiple yearsï¿½ data, it would work from the knowledge that years can 
differ for tax and accounting purposes. 

Compliance Costs: 

Because transactions involve cash backs, returns, tips, fees, gift 
cards, and other items, payment reimbursements may not match merchant 
receipts, creating costs for banks and others to the extent they have 
to address these discrepancies. 

Mitigations: 

Since IRS is not planning an exact match anyway, it could announce it 
was developing industry norms of net-to-gross ratios to evaluate 
information, although norms may not be foolproof or always possible.

IRS could deal with part of the compliance cost by modeling the 
reporting form after the Form 1099-B for brokers and giving the 
information return preparer a choice on the form for gross or net 
information, although this mitigation could create inconsistencies 
across payers. 

To the extent that gross and net amounts might even out over time, 
concern could center on any that do not.

Compliance Costs: 

Information on TINs in addition to merchant identification numbers 
flowing through the payment card system would increase the amount of  
confidential information that could be disclosed if a security breach 
occurred, creating clean-up and customer relations costs. 

Legal liabilities related to payment card operating rules may change.

Mitigations: 

The number of links in banksï¿½ and othersï¿½ systems between TINs, 
merchant identification numbers, and merchant payment card receipts 
could be minimized. 

Various parties could be involved in considering legislative and 
regulatory details. 

Compliance Cost: 

Overall, because of issues mentioned previously, software, hardware, 
systems, processes, and training would need to be developed, involving 
an uncertain amount of time and cost; banks and others would need to 
add service people to handle questions and inadvertent errors. 

Mitigations: 

To limit overall compliance costs, banks and others could extend 
systems and procedures already in place that, for instance, might 
already generate and report related data used for other purposes.

Congress or IRS could provide adequate lead time to allow banks and 
others to develop any needed software, etc.

Payments to Corporations: 

Payments to Corporations Description of Payments-to-Corporations 
Proposal: 

Today, businesses paying corporations for services generally do not 
have to send IRS information returns covering the payments. 

* Payments to corporations are generally not covered by an overall 
requirement that taxpayers paying a total of $600 or more for services 
in the course of a trade or business send IRS an information return 
showing the dollar amount and the payee. 

Most payments requiring information reporting today are subject to 
backup withholding if the payee has not provided a valid TIN. 

To address compliance issues and improve voluntary compliance, the 
administration proposed requiring information returns for payments to 
corporations for services totaling $600 or more in a calendar year. 

* It did not specify much detail. 

Revenue Estimates for the Payments-to-Corporations Proposal: 

The administrationï¿½s fiscal year 2008 budget estimated that the 
payments-to- corporations proposal would raise about $7.7 billion over 
10 years, a greater amount than the Joint Committee on Taxationï¿½s 
revenue estimate of $1.7 billion. 

* The Joint Committeeï¿½s estimate was footnoted to say that it was very 
preliminary and subject to change upon clarification of the proposal. 

Our Previous Work: 

In 1991, we suggested that Congress needed to pass legislation to 
require that payments to corporations be reported on information 
returns (GAO/GGD-91- 118).

In 1992, we recommended that federal agencies issue information returns 
on payments to corporations providing services (GAO/GGD-92-130). 

* Federal executive agencies are now required to file information 
returns on payments to corporations for services provided. 

Compliance Costs: 

Payers would face additional costs for each additional Form 1099ï¿½costs 
for bookkeeping, dealing with IRS, postage, and outside help maybe for 
the first time; payers using payment cards may have to make changes to 
accounting systems if the systems do not show all qualifying payments 
to corporations but instead show payments only to the payment card 
industry.

Mitigations: 

Payers would face additional costs, but other costs may be reduced 
because the need to distinguish corporate from other payees for tax 
reasons could disappear.

With adequate lead time, many payers could limit costs by using or 
extending current systems and procedures for paying noncorporate 
entities, including procedures for recording payment card payments.

With the risk of allowing noncompliance by some payees and gaming of 
the system, Congress or IRS could exempt small payer businesses based 
on their revenues or other factors. 

Compliance Costs: 

Payers may have to file Forms 1099 for payments to about 6 million 
corporations, including S corporations, regardless of size, and some of 
the corporations would have many addresses. 

Mitigations: 

At the risk of extra complexity, Congress could require that Forms 1099 
be sent to only some corporations, such as those privately held or 
below a certain size, for instance, smaller than the Fortune 500.

* To reduce payersï¿½ burden of determining which corporations are 
exempt, exempt corporationsï¿½ invoices could show the exemption.

Congress could raise the $600 reporting floor, although compliance by 
current and future filers could suffer.

Compliance Costs: 

Payers may have to incur the costs of reporting payments for outsourced 
daily operations, such as overnight mail delivery.

Mitigations: 

IRS could extend existing exemptions for payments like freight, 
effectively exempting certain categories of corporations.

Compliance Costs: 

Start-up costs would be incurred to collect TINs and to determine which 
corporations predominantly provide goods and which predominantly 
provide services. 

Mitigations: 

IRS could issue guidance to require that TINs and goods versus services 
information be provided immediately on starting a business 
relationship, for example, on the invoice.

IRS could grandfather ongoing relationships or specify a lead time for 
collecting information on them.

Compliance Costs: 

Costs may be incurred when cash versus accrual and calendar year versus 
fiscal year information reporting do not match taxpayersï¿½ accounting 
systems and business uncertainty is created. 

Mitigations: 

Since: 

* IRS is not planning an exact match anyway but only a trigger for 
questions, 

* almost all entities are on the calendar year basis, 

* large percentages are on the cash basis, and: 

* accrual taxpayers might be more sophisticated than others, 

IRS could let payers know that, possibly by analyzing multiple yearsï¿½ 
data, it would work from the knowledge that years can differ for tax 
and accounting purposes.

Compliance Costs: 

Added compliance costs would be imposed if more than one partyï¿½for 
instance, a bank and a payer to a service providerï¿½is required to 
report information covering the same merchant transactions. 

Mitigations: 

Inefficient reporting could be avoided if IRS provides ordering rules 
or unified reporting rules so that the same transactions are not 
covered more than once.

Proposals other than the payment card proposal could exempt 
transactions involving payment cards, as an administration proposal to 
expand broker information reporting does; that proposal, estimated to 
raise about $2.0 billion over 10 years (about $2.5 billion according to 
the Joint Committee on Taxation), would require brokers, such as 
auction houses, to file information returns for certain customers 
showing gross proceeds from the sale of tangible personal property; 
however, it  would exempt sales that otherwise need to be reported, for 
instance, under the payment card reporting proposal.

Proposals could cover different kinds of transactions, such as payments 
to corporations continuing to focus on services and the broker proposal 
continuing to focus on tangible goods. 

IRS Processing of Information Returns: 

As shown on the next slide, IRS receives and handles a growing number 
of information returns from payers, reaching over 1.7 billion returns 
for tax year 2006.

Upon receipt, IRS puts them into a format that allows IRS to attempt to 
match information return information with tax return information. 

According to IRS officials, IRS has the capacity to process the 
information returns it currently receives electronically, but large 
files may take a few hours to upload from the receiving server to the 
main systems. 

* Delays in uploading files near the March 30 deadline may occur 
because this is the peak time for receipts. 

Table: Receipt of Information Returns (Number in Millions): 

Type of information return: Electronic; 
Tax year 2003: 485; 
Tax year 2004: 685; 
Tax year 2005: 847; 
Tax year 2006: 1,163. 

Type of information return: Magnetic tape; 
Tax year 2003: 583; 
Tax year 2004: 473; 
Tax year 2005: 368; 
Tax year 2006: 250. 

Type of information return: Paper; 
Tax year 2003: 47; 
Tax year 2004: 49; 
Tax year 2005: 56; 
Tax year 2006: 50. 

Type of information return: Other (including wage and tax statements 
from the Social Security Administration); 
Tax year 2003: 275; 
Tax year 2004: 280; 
Tax year 2005: 290; 
Tax year 2006: 299 (as of October 2007). 

Total;  
Tax year 2003: 1,390; 
Tax year 2004: 1,487; 
Tax year 2005: 1,561; 
Tax year 2006: 1,762. 

Source: IRS Data Books for tax years 2005 and IRS for tax year 2006. 

Note: Numbers include such information returns as mortgage interest, 
broker proceeds, interest, and dividend distributions, and individual 
retirement arrangements. 

[End of table] 

According to IRS officials, once formatted by IRS, 97 percent of 
information returns received can potentially be used for matching 
purposes. 

Thus, about 3 percent of information returns received need a TIN 
supplied or corrected.

According to IRS officials, IRS can supply or correct TINs for 35 to 40 
percent of this 3 percent.

Therefore, about 98 percent of information returns are potentially 
usable for matching purposes.

According to IRS officials, IRS uses about 90 percent of the 
potentially usable information returns in its matching efforts for 
individual taxpayers. Discrepancies between what is reported on a 
taxpayerï¿½s information returns and tax return may be referred to the 
Automated Underreporter (AUR) program. Information returns that cannot 
be matched to a filed individual tax return may be referred to the 
nonfiler program. Of the 10 percent of information returns that cannot 
be used in the matching efforts for individual taxpayers, over 90 
percent are associated with businesses that are not sole proprietors 
(businesses that do not file a Schedule C). 

* IRS may not use each line on each type of usable information return 
for matching purposes. 

According to IRS officials, IRS does not know the total number of 
discrepancies that its matching efforts discover because discrepancies 
under certain dollar thresholds are not tracked. 

Above these dollar thresholds, as the next slide shows, the AUR and 
nonfiler programs pursue millions of discrepancies; according to IRS 
officials, millions of other discrepancies above the thresholds are not 
pursued because of resource constraints. 

Table: Use of Information Returns (Numbers in Millions): 

Type of cases: AUR cases (above IRS's dollar threshold): Identified; 
Tax year 2003: 14.5; 
Tax year 2004: 15.0; 
Tax year 2005: 15.0. 

Type of cases: AUR cases (above IRS's dollar threshold): Pursued; 
Tax year 2003: 4.1; 
Tax year 2004: 4.6; 
Tax year 2005: 4.5. 

Type of cases: AUR cases (above IRS's dollar threshold): Percentage 
pursued; 
Tax year 2003: 28%; 
Tax year 2004: 31%; 
Tax year 2005: 30%. 

Type of cases: Nonfiling of tax return cases (above IRS's dollar 
threshold): Identified; 
Tax year 2003: 7.4; 
Tax year 2004: 7.5; 
Tax year 2005: 7.9. 

Type of cases: Nonfiling of tax return cases (above IRS's dollar 
threshold): Pursued; 
Tax year 2003: 4.4; 
Tax year 2004: 3.1; 
Tax year 2005: 2.8. 

Type of cases: Nonfiling of tax return cases (above IRS's dollar 
threshold): Percentage pursued; 
Tax year 2003: 59%; 
Tax year 2004: 41%; 
Tax year 2005: 35%. 

Source: IRS. 

[End of table] 

Criteria Used to Select AUR Cases to Be Pursued: 

Dollars by category: 

* Generally, AUR pursues the higher dollar cases after categorizing the 
cases based on the type of income or expenses involved and the 
potential extra tax that might be assessed. 

Coverage: 

* However, regardless of dollars, AUR usually pursues a small number of 
cases in most categories to maintain a presence. 

High risk: 

* AUR also pursues cases in certain high-risk areas regardless of 
dollars and coverage (e.g., stock and bond sales and Schedule C 
returns). 

Other Uses of Matching Data: 

According to IRS officials, non-IRS requesters of information return 
data matched to tax return data use it for nontax purposes, such as 
determining eligibility for veterans and welfare benefits. 

Also, according to IRS officials, IRS functions such as Examination, 
Collection, and Criminal Investigation also use the data. 

IRS Efforts to Find Nonreporters and Underreporters of Information 
Returns: 

IRS has a program to contact federal government entities that do not 
file any required information returns. 

As part of taxpayer audits and collection compliance checks, IRS 
officials are required to check if required information returns are 
filed. 

IRS Costs and Plans to Accommodate More Information Reporting: 

In costing out its various fiscal year 2008 legislative proposals, IRS 
said that it assumed 100 percent electronic filing for most proposals. 
It added, however, that it would be reasonable to assume that about 15 
to 20 percent of information returns would actually be on paper. 

For fiscal year 2008, programming and start-up costs were budgeted at 
$8 million for the payment card proposal and $3.8 million for the 
payments-to- corporations proposal; after fiscal year 2008, IRS 
estimated administrative implementation costs at another $12.7 million 
and $4.1 million, respectively. Overall for the payments-to-
corporations proposal, IRS said its cost estimates could vary by an 
additional several million dollars. 

According to the fiscal year 2008 budget proposal, IRS expected about 
125 million payment card returns annually associated with small 
business and self- employed taxpayers.

For the payments-to-corporations proposal, IRS conservatively estimated 
60 million forms arriving annually, saying the actual number could 
range into the billions.

If specific legislation is enacted and IRS and Treasury are formulating 
regulations, IRS will be in a better position to estimate how many 
information returns, including those in paper form, will be arriving. 

By design, IRS estimated only the costs it did because of the 
uncertainty of whether legislation would pass and how it would be 
implemented, and it did not cost out enforcement estimates. 

* For instance, it did not cost out the hundreds of full-time 
equivalent staff years that it expected to be needed on an ongoing 
basis to use information gained from the payments-to-corporations 
proposal. 

If information reporting proposals are passed, IRS would be responsible 
for addressing the benefits and costs of the resulting information 
collections as part of its responsibilities under the Paperwork 
Reduction Act of 1995. 

* Under the act, agencies are responsible for ensuring that information 
collections are implemented to minimize the burden on the public while 
maximizing utility.

* In addition, the Office of Management and Budget is responsible for 
reviewing and approving proposed information collections. 

(450582)

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Highlights of [21]GAO-08-266 , a report to the Committee on Finance, U.S.
Senate

November 2007

TAX ADMINISTRATION

Costs and Uses of Third-Party Information Returns

One proven approach for improving tax compliance is information reporting
to the Internal Revenue Service (IRS) by third parties about taxpayers'
income and expenses. IRS matches information returns with taxpayers'
income tax returns to see if taxpayers have filed returns and reported all
their income. The

administration's fiscal year 2008 budget proposed requiring information
reporting on merchant payment card reimbursements and on certain payments
to corporations, raising an estimated $18.4 billion over 10 years.

This report's objectives are to (1) identify, using case studies, the
compliance costs of existing information reporting; (2) determine the
kinds of third-party compliance costs that may result from the two budget
proposals and options for mitigating the costs; and (3) determine IRS's
ability to process and use additional information returns.

GAO did nongeneralizable structured interviews with four payers
volunteering information and with five companies filing a sizable
percentage of all information returns. GAO's work also included reviewing
studies and documentation and contacting other government and
nongovernment parties.

[22]What GAO Recommends

GAO makes no recommendations in this report. IRS provided technical
comments, which GAO incorporated as appropriate.

In nine case studies, filers of information returns told GAO that existing
information return costs were relatively low. One small business employing
under five people told GAO of possibly spending 3 to 5 hours per year
filing Form 1099 information returns manually, using an accounting package
to gather the information. Two parties selling services reported prices
for preparing and filing Forms 1099 with IRS of about $10 per form for 5
forms to about $2 per form for 100 forms, with one of them charging about
$.80 per form for 100,000 forms. As expected, unit prices for services
provided to payers by selected software vendors, service bureaus, and
return preparers decreased as the number of forms handled increased.

The two information reporting proposals studied would impose new
compliance costs, some of which could be mitigated. For payment card
reimbursements, compliance costs would include (1) merging separately
stored taxpayer and merchant identification numbers, especially in the
case of multiple locations or franchises; and (2) more generally, new
systems and added service requirements. Mitigations could include (1)
having the reporting party be as close as possible to the merchant in a
payment or reporting chain and (2) extending current systems and
procedures that, for instance, might already generate and report related
data used for other purposes. For payments to corporations for services,
payer compliance costs would include, for example, additional bookkeeping,
and mitigations could include limiting information return recipients to
only some corporations.

IRS already receives and handles a growing number of information returns,
over 1.7 billion for tax year 2006. According to IRS officials, IRS uses
about 90 percent of potentially usable information returns in its matching
efforts for individual taxpayers. IRS pursues millions of discrepancies,
including both underreporting of income and failure to file tax returns,
discovered through its matching efforts. According to IRS officials,
millions of others are not pursued because of resource constraints. For
the two proposals studied, IRS budgeted $11.8 million in programming and
start-up costs for fiscal year 2008, with another $16.8 million expected
in administrative implementation costs after 2008. It did not estimate
future enforcement costs.

IRS Receipt of Information Returns (Numbers in Millions)

References

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  20. http://www.gao.gov/cgi-bin/getrpt?GAO-08-266
  21. http://www.gao.gov/cgi-bin/getrpt?GAO-08-266
*** End of document. ***