Tax Gap: Many Actions Taken, But a Cohesive Compliance Strategy Needed
(Chapter Report, 05/11/94, GAO/GGD-94-123).

Despite new compliance tools provided by Congress, the gross "tax
gap"--the difference between what corporations and individuals owe and
what they voluntarily pay--has continued to grow, from $76 billion in
1981 to $127 billion in 1992.  The Internal Revenue Service (IRS)
further estimates that its enforcement programs failed to collect about
three-quarters of the gross tax gap.  Such annual tax losses intensify
pressures in funding necessary programs.  This report analyzes the
composition of the tax gap, congressional and IRS prior efforts to
reduce the tax gap, IRS' ongoing and planned efforts to improve
compliance, and what more could be done to close the tax gap.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  GGD-94-123
     TITLE:  Tax Gap: Many Actions Taken, But a Cohesive Compliance 
             Strategy Needed
      DATE:  05/11/94
   SUBJECT:  Tax administration
             Tax returns
             Federal agency reorganization
             Tax nonpayment
             Reporting requirements
             Noncompliance
             Law enforcement
             Income taxes
             Tax administration systems
             Government collections
IDENTIFIER:  IRS Taxpayer Compliance Measurement Program
             IRS Compliance 2000 Initiative
             IRS Tax System Modernization Program
             IRS Integrated Case Processing System
             Earned Income Tax Credit
             IRS Compliance Research Information System
             IRS Corporate Files On-Line Project
             IRS Automated Inventory Control System
             IRS Automated Underreporter System
             IRS Integrated Collection System
             IRS Totally Integrated Examination System
             IRS Automated Criminal Investigation System
             IRS Payor Master File
             TSM
             
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Cover
================================================================ COVER


Report to the Honorable
John W.  Olver,
House of Representatives

May 1994

TAX GAP - MANY ACTIONS TAKEN, BUT
A COHESIVE COMPLIANCE STRATEGY
NEEDED

GAO/GGD-94-123

Tax Gap


Abbreviations
=============================================================== ABBREV

  BMF - Business Master File
  CRIS - Compliance Research Information System
  DEFRA - Deficit Reduction Act
  EITC - Earned Income Tax Credit
  EIN - Employer Identification Number
  ERA - Economic Recovery Act
  IRS - Internal Revenue Service
  MSSP - Market Segment Specialization Program
  TCMP - Taxpayer Compliance Measurement Program
  TEFRA - Tax Equity and Fiscal Responsibility Act
  TIN - Taxpayer Identification Number
  TSM - Tax Systems Modernization

Letter
=============================================================== LETTER


B-256512

May 11, 1994

The Honorable John W.  Olver
House of Representatives

Dear Mr.  Olver: 

This report responds to your request for information on the income
tax gap and the efforts of the Internal Revenue Service (IRS) and
Congress to reduce it.  The report also offers other ideas for
reducing this tax gap.  We have not offered new recommendations;
rather, we have updated information related to our past
recommendations that have not been implemented. 

We are sending copies of this report to the Commissioner of Internal
Revenue, the Chairman of the Senate Committee on Finance, the
Chairman of the House Committee on Ways and Means, the Chairman of
the Joint Committee on Taxation, and other interested parties. 

This report was prepared under the overall direction of Natwar M. 
Gandhi, Associate Director, Tax Policy and Administration Issues. 
Ralph Block from our San Francisco Regional Office was the project
manager.  Other major contributors are listed in appendix V.  Please
call me on (202) 512-5407 if you or your staff have any questions. 

Sincerely yours,

Jennie S.  Stathis
Director, Tax Policy and
 Administration Issues


EXECUTIVE SUMMARY
============================================================ Chapter 0


   PURPOSE
---------------------------------------------------------- Chapter 0:1

The Internal Revenue Service (IRS) has estimated that individual and
business taxpayers owed but did not voluntarily pay over $100 billion
in 1992 income taxes (i.e., gross tax gap).  IRS further estimated
that its enforcement programs did not collect about three-quarters of
the gross tax gap (i.e., net tax gap).  Such annual tax losses
intensify pressures in funding necessary programs. 

This report responds to a request by Representative John Olver as a
member of the House Appropriations Subcommittee that oversees IRS. 
It analyzes the composition of the tax gap, congressional and IRS
prior efforts to reduce the gap, IRS' ongoing and planned efforts to
improve compliance, and what more could be done to reduce the gap. 


   BACKGROUND
---------------------------------------------------------- Chapter 0:2

IRS last estimated the gross tax gap in 1988 and net tax gap in 1990. 
Both estimates were projected through tax year 1992.  Since then, IRS
has updated statistical compliance data through detailed audits of
randomly selected tax returns in its Taxpayer Compliance Measurement
Program (TCMP).  IRS is using the TCMP and other data to update its
tax gap estimates during 1994. 

IRS has various enforcement efforts to reduce the gross tax gap.  IRS
audits tax returns, collects delinquent taxes and returns, and
computer matches amounts reported on tax returns to amounts reported
on third-party information returns. 

IRS is developing new approaches to reduce the tax gap.  Under its
Compliance 2000 strategy, IRS assumes that most taxpayers want to
comply.  It is looking at nonenforcement methods such as education to
increase compliance, particularly if the noncompliance appears to be
unintentional. 

IRS is reorganizing to become more cross-functional.  The collection
and audit functions will fall under the compliance group.  At the
same time, IRS is upgrading its computer systems under its Tax
Systems Modernization (TSM), which it plans to finish by 2008.  As
TSM comes on-line, IRS is exploring how to retrain staff whose work
will be automated. 

GAO developed this report by tracking its past recommendations on
reducing the tax gap.  In summarizing past recommendations, GAO also
updated information relating to those recommendations. 


   RESULTS IN BRIEF
---------------------------------------------------------- Chapter 0:3

IRS' estimates showed that in current dollars, the gross income tax
gap is large and has grown--from $76 billion in 1981 to $127 billion
in 1992.  While imprecise, these estimates provide useful indicators
of taxes that are not voluntarily paid and the composition of the
gap. 

Since the early 1980s, Congress has given IRS tools to help it reduce
the tax gap.  Tax laws have subjected more income and deductions to
information returns reporting and increased penalties for
noncompliance.  Congress has also given IRS additional funds for
specific compliance initiatives to increase its enforcement presence. 

IRS has used these tools but still has not been able to increase its
enforcement presence.  Audit rates in fiscal year 1992 were more than
50 percent lower than in fiscal year 1981.  Enforcement staffing has
been declining since fiscal year 1988 and is about what it was in
fiscal year 1987.  Because of overall budget shortfalls, IRS has
reallocated funds from compliance initiatives to nonenforcement
efforts, such as returns processing. 

Ongoing changes at IRS offer new ways to reduce the gap. 
Implementation of Compliance 2000, TSM, and the reorganization is
ongoing, but progress has been slow.  Also, IRS does not yet know how
many displaced staff can be retrained for compliance work.  As a
result, it is too early to tell how these changes will improve
compliance.  IRS must ensure that it accounts for these changes as it
develops its compliance strategy. 

One key to a comprehensive compliance strategy is having data that
identify noncompliance and the reasons for it.  IRS is developing
these data, which will not be available for several years.  In the
interim, IRS could use existing compliance data to focus more of its
enforcement resources on such highly noncompliant taxpayers as small
corporations and sole proprietors. 

As reported in the past, GAO believes that IRS should not reduce its
current levels of audit coverage, computer matching caseload, and
collection activities.  Further, IRS could attack more noncompliance
through computer matching.  To do this, IRS needs to better ensure
that information returns are filed timely and accurately. 

Congress could help by requiring information reporting on payments
made to corporations and requiring withholding on payments made to
independent contractors.  Congress also could act on IRS' suggestion
to allow IRS to reinvest productivity gains from TSM projects. 
Before doing so, Congress may want assurance that IRS will use the
funds for compliance purposes. 


   GAO'S ANALYSIS
---------------------------------------------------------- Chapter 0:4


      NONCOMPLIANCE THREATENS OUR
      TAX SYSTEM
-------------------------------------------------------- Chapter 0:4.1

Our income tax system funds many government programs and relies on
taxpayers to comply voluntarily.  However, our tax system loses
billions of dollars each year because taxpayers do not comply.  As a
result, the burden of funding these programs shifts to taxpayers who
comply. 

Estimating the tax gap is an imprecise science.  Even so, IRS'
estimates provide a useful indicator of the extent of tax losses from
types of noncompliance across the country.  Such knowledge can help
IRS to better target compliance resources. 

IRS' estimates show that the gross tax gap is large and growing.  For
1992, IRS estimated that it had reached $127 billion for corporations
and individuals--including sole proprietors of a business.  Of this
$127 billion gross tax gap, IRS estimated that $94 billion was caused
by individuals and $33 billion by corporations.  Across all
individual taxpayers, the largest part of the tax gap arose from
unreported income--$63 billion.  Overall, IRS estimated that
taxpayers voluntarily paid 82 percent of their income tax
liabilities.  IRS' goal is for voluntary compliance to reach 90
percent by 2000.  (See pp.  10-15.)

The tax gap can rise or fall depending on changes in tax law,
economic conditions, and IRS' tax administration.  For example, a
more global economy creates problems in determining the tax
liabilities of multinational corporations.  More electronic filing
creates new ways to claim false tax refunds on fraudulent returns. 
(See pp.  16-19.)


      TAX GAP REMAINS LARGE
      DESPITE PAST ACTIONS
-------------------------------------------------------- Chapter 0:4.2

Both Congress and IRS have tried since the early 1980s to reduce the
tax gap.  Even so, the tax gap is still large.  Without these
efforts, however, it is likely that the gap would be even larger. 

Beyond funding IRS' ongoing enforcement programs, Congress helps
reduce the tax gap through tax law changes.  Congress expanded the
filing requirements for information returns as well as the penalties
for not filing.  Information returns are a proven way to promote
compliance and help IRS find noncompliance.  Congress also closed the
door on various ways to shelter income from taxation, which can add
to the tax gap if abused.  Also, Congress eliminated some individual
tax deductions, such as for consumer interest, which reduced the
opportunity for noncompliance by taxpayers who claim too much
interest.  (See pp.22-23.)

Congress funded compliance initiatives in the late 1980s to help IRS
enforce tax laws.  However, time lags in hiring, training, and
assigning new staff prevented IRS from achieving projected revenue
gains.  Also, because of overall budget shortfalls, IRS redirected
compliance initiative funds to nonenforcement areas and to offset
unfunded labor costs.  As a result, IRS has not been able to maintain
the increased staffing levels sought through the compliance
initiatives.  After enforcement staff increased by 6,700 from fiscal
years 1987 to 1988, it decreased by 6,200 by fiscal year 1992.  (See
pp.  24-25.)

IRS' major enforcement activities have not grown over the past
decade.  Audits of corporations have decreased from over 5 percent in
fiscal year 1981 to less than 3 percent in fiscal year 1992.  During
the same period, audits of individuals decreased from 1.8 percent to
less than 1 percent.  (See pp.  26-28.)

Collection of delinquent taxes has not kept pace with increases in
collection inventory.  From fiscal years 1988 to 1992, the collection
of delinquent taxes increased 6 percent--from $22.9 billion to $24.2
billion.  Over this time, the collection inventory increased about 55
percent, going from $75.6 billion in fiscal year 1988 to $117 billion
in fiscal year 1992.  (See pp.  28-29.)

Computer matching has been reduced in recent years to absorb some of
IRS' budget shortfalls.  For example, in fiscal year 1992, to pay for
unfunded labor costs IRS reduced the budget for the matching program
that identifies taxpayers who underreport their income.  As a result,
underreporter assessments in fiscal year 1992 were about the same as
in fiscal year 1986--$1.8 billion.  (See pp.  29-30.)

While the specific effects are unknown, nonenforcement activities
such as customer service can affect the tax gap.  For example,
taxpayers who receive prompt and correct answers from IRS about
whether they are entitled to a deduction are more likely to claim the
proper amount of that deduction.  The accuracy rate of IRS' toll-free
telephone assistance increased from 63 percent in fiscal year 1989 to
89 percent in fiscal year 1994.  However, during the same period, the
telephone accessibility rate decreased from 58 percent to 21 percent. 
(See pp.  30-32.)


      IRS PLANS CHANGES TO REDUCE
      THE TAX GAP
-------------------------------------------------------- Chapter 0:4.3

IRS now does much of its compliance work under its Compliance 2000
strategy.  IRS wants to encourage taxpayers to keep complying, help
well-intentioned but noncompliant taxpayers to strive toward full
compliance, and pursue taxpayers who did not intend to comply. 

This new IRS strategy faces barriers.  IRS still is seeking data to
objectively sort out who is not complying and how.  Making the
transition from enforcement to a mindset that targets enforcement,
education, and tax simplification to specific taxpayer groups has
been uneven.  IRS has not fully developed a system to know whether
the strategy is on track or needs midcourse corrections.  (See pp. 
34-36.)

IRS' plans for computer systems to identify and correct noncompliance
rely on TSM.  Under TSM, IRS is developing an Integrated Case
Processing system, which is supposed to allow authorized IRS staff
access to all the information they need to work their assigned cases. 
However, that system is not expected to be available before 1997. 
Also, the success of merging the audit and collection functions into
a compliance group depends on whether IRS can mold its compliance
efforts into a comprehensive strategy. 

It is too soon to determine whether IRS' new computer systems and
organization will work.  If they do not work, IRS' goal to increase
voluntary compliance to 90 percent by 2000 will be difficult to meet. 
(See pp.36-38.)


      GAO'S VIEWS ON REDUCING THE
      TAX GAP
-------------------------------------------------------- Chapter 0:4.4

While eliminating the tax gap is unlikely, striving toward this end
is worthwhile.  GAO supports IRS' efforts to develop a compliance
strategy and new systems.  In doing so, IRS must ensure that its
compliance programs continually improve, making them as
cost-effective as possible. 

A compliance strategy begins with having statistical data to identify
the nature of the noncompliance.  IRS has used TCMP data in this way
but is looking for new sources.  GAO supports IRS efforts to improve
TCMP or replace it with better systems.  However, IRS does not know
when such systems will be ready. 

Until it develops new compliance data, IRS could continue to use
existing tax gap and TCMP data in developing an interim compliance
strategy.  As a starting point, IRS could focus more of its efforts
on highly noncompliant groups, such as small corporations and sole
proprietors, who make up 29 percent of the tax gap.  Until IRS sees
improved compliance in each group, it should continue the increased
focus.  (See pp.  40-42.)

If the budget allows, IRS also needs to increase computer matching in
areas of known noncompliance, such as income from partnerships and
erroneous dependent claims, which represent a tax gap of over $4
billion.  For any computer match to be effective, IRS needs to
receive all required information returns in a timely fashion.  (See
pp.  42-45.)

GAO believes that IRS can increase its collection of delinquent
taxes.  For example, GAO recommended that IRS restructure its
collection organization to support earlier telephone contact with
delinquent taxpayers.  (See p.  45.)

One way Congress could help IRS is to give it more compliance tools. 
For example, simplifying the definition of independent contractors,
withholding on payments made to independent contractors, and
requiring information reporting on payments made to corporations
would help reduce the gap associated with these taxpayers.  IRS
believes these tools would help it to better attack the gross tax
gap.  (See pp.  46-48.)

IRS also believes Congress can help by allowing it to reinvest some
of its productivity gains from TSM into compliance efforts.  GAO does
not oppose this concept.  However, GAO points out that in the past
IRS' use of compliance initiative funds has not resulted in
additional enforcement presence.  IRS has either had problems in
garnering the expected productivity gains or experienced budget
shortfalls.  If Congress were to give IRS additional funding for
compliance activities, Congress may want some assurance that IRS uses
the funds to increase its enforcement presence.  (See pp.  49-50.)


   RECOMMENDATIONS
---------------------------------------------------------- Chapter 0:5

GAO is not making any new recommendations in this report. 


   AGENCY COMMENTS
---------------------------------------------------------- Chapter 0:6

GAO requested written comments, but IRS chose not to comment because
this report summarized past GAO reports and offered no new
recommendations. 


INTRODUCTION:  THE TAX GAP
CHALLENGE
============================================================ Chapter 1

One of the biggest challenges facing the Internal Revenue Service
(IRS) is finding ways to reduce the gross income tax gap--the
difference between income taxes owed and voluntarily paid.\1 IRS
estimated that this gap was about $127 billion in 1992--a 67- percent
increase over the estimated $76 billion gap for 1981,\2 which was the
year that the first of several major tax compliance legislative
measures were enacted.\3

Tax gap estimates are important.  They indicate the amount of
taxpayer noncompliance and IRS' ability to reduce noncompliance over
time.  For example, IRS estimated that its enforcement programs
reduced the gross tax gap for 1992 by about 23 percent, leaving a net
tax gap of about $100 billion.  Regardless of the adequacy of these
IRS programs, the tax gap could continue to grow in current dollars
because of economic growth and changes in tax laws that increase
opportunities for noncompliance.  Tax gap estimates also indicate the
potential tax revenues that could be used to help reduce the federal
deficit, which is estimated to be about $200 billion in 1994. 

We have been concerned with the increase in the tax gap.  We have
made a number of recommendations to IRS and Congress on ways to
reduce the tax gap, such as by improving IRS' enforcement programs. 
Representative John W.  Olver is also concerned about the size of the
tax gap.  He asked us to analyze the nature and importance of the tax
gap and actions for reducing the gap.  These actions include those
that Congress and IRS have already taken or that IRS is now
developing, as well as additional actions that either Congress or IRS
could take in the future. 


--------------------
\1 Throughout this report, references to the "gross tax gap," "tax
gap," or "gap" mean the gross income tax gap. 

\2 IRS stated its tax gap estimates in current dollars.  We used IRS'
estimates throughout the chapters of this report.  For a different
perspective, the gross tax gap in 1992 dollars increased 8.7 percent
from $117 million in 1981 to $127 million in 1992.  We created two
tables that convert IRS estimates into constant dollars.  Appendix I
has these tables. 

\3 At the time we did our work, IRS had updated tax gap estimates,
but these were still in draft form so IRS officials would not release
the estimates to us. 


   TAX GAP ESTIMATES AND TRENDS
---------------------------------------------------------- Chapter 1:1

IRS first estimated the tax gap in 1979.  Since then, it estimated
the gross income tax gap in 1983 and 1988, projecting the estimates
to future tax years up through 1992.  These estimates covered the
amount of income taxes that individuals and corporations did not
voluntarily pay because of noncompliance, such as unreported income
and overstated exemptions and deductions. 

During 1988, IRS estimated that the tax year 1992 gross tax gap would
be $82.6 billion for individuals and $31.1 billion for corporations. 
In 1990, IRS added an estimated $13.3 billion to account for the 1992
gross remittance gap--the amount of income taxes that taxpayers
report as owed but do not pay voluntarily.  Figure 1.1 shows these
three major components of the $127 billion gross income tax gap for
1992.\4

   Figure 1.1:  Major Components
   of the Tax Year 1992 Gross
   Income Tax Gap

   (See figure in printed
   edition.)

Sources:  Income Tax Compliance Research, IRS Publication 1415, July
1988; and Income Tax Compliance Research:  Net Tax Gap and Remittance
Gap Estimates, IRS Research Division, Publication 1415, April 1990. 

IRS has also estimated the net income tax gap, which is the gross
income tax gap less the estimated amount of income taxes collected
through IRS' enforcement.  IRS' enforcement consists of auditing tax
returns, computer matching tax return data against third-party
information returns to find unreported income, collecting overdue
taxes, obtaining delinquent returns, and correcting math errors on
tax returns.  IRS has estimated the net tax gaps for 1981, 1984, and
1987. 

For 1987, IRS estimated that its enforcement actions reduced the
$94.2 billion gross tax gap by $21.9 billion (23 percent), leaving a
net tax gap of $72.3 billion.  This was a slight improvement over the
estimated 20-percent reduction in the 1981 gross tax gap--from $76
billion to $60.7 billion.  Figure 1.2 shows the size of the net tax
gap for 1987. 

   Figure 1.2:  Net Income Tax Gap
   for 1987

   (See figure in printed
   edition.)

Sources:  Income Tax Compliance Research, IRS Publication 1415, July
1988; and Income Tax Compliance Research:  Net Tax Gap and Remittance
Gap Estimates, IRS Research Division, Publication 1415, April 1990. 


--------------------
\4 IRS also estimated the gross tax gap on the basis of the taxes
that would actually be assessed after all appeals and litigation of
the recommended assessments.  For 1992, this estimate totaled $110.1
billion--$91 billion for individuals and their remittance gap and
$19.1 billion for corporations and their remittance gap, including
fiduciaries and exempt organizations. 


      LIMITATIONS OF TAX GAP
      ESTIMATES
-------------------------------------------------------- Chapter 1:1.1

Tax gap estimates give useful indicators of noncompliance, but a
number of factors limit their preciseness.  The first two deal with
the scope--or what IRS attempts to measure.  The other three factors
deal with potential measurement errors. 

  First, the tax gap estimates covered just legally earned income of
     individuals and corporations and not taxes owed from illegal
     source income (e.g., drugs or prostitution). 

  Second, the 1992 tax gap estimates did not include other types of
     taxes, such as excise, employment, and gift taxes. 

  Third, estimates for individuals and small corporations (i.e.,
     assets of $10 million or less) are based on IRS' Taxpayer
     Compliance Measurement Program (TCMP).  Under TCMP, IRS
     examiners do line-by-line audits of income tax returns.  For
     each return type, IRS audits a probability sample taken for the
     entire population.  This allows IRS to do population estimates
     for each line item on the return, covering many compliance
     issues.  However, even these audits do not detect all overstated
     deductions or unreported income.\5 To account for undetected
     income, IRS multiplies the detected amounts by a factor derived
     from a special study.\6

  Fourth, the estimates are necessarily based on earlier compliance
     data and do not reflect IRS' latest compliance data.  The 1988
     tax gap study used TCMP results for tax year 1982 and earlier
     years on individuals and tax year 1980 on small corporations. 
     Since then, IRS has done TCMP surveys of individuals for tax
     years 1985 and 1988 and small corporations for tax year 1987. 
     As a result, IRS' tax gap estimates could change.  For example,
     small corporations' compliance dropped 20 percentage points
     between 1980 and 1987--from 81 percent to 61 percent. 

  Finally, the estimates for large corporations (i.e., those with
     assets over $10 million) are based on IRS' operational audits,
     which are not randomly selected.  As a result, they are less
     precise than estimates for individuals and small corporations,
     which used TCMP results.  Also, unlike TCMP audits, IRS'
     operational audits do not cover each line of the tax return and
     thus cannot lead to estimates for each item. 


--------------------
\5 See Tax Administration:  Overstated Real Estate Tax Deductions
Need To Be Reduced (GAO/GGD-93-43, Jan.  19, 1993). 

\6 The study calculated multipliers based on additional income
reported on information returns but not discovered during tax year
1976 audits. 


      GROWTH OF THE TAX GAP
-------------------------------------------------------- Chapter 1:1.2

IRS' estimates show that the gross tax gap has grown about 67
percent--from $76 billion for tax year 1981 to $127 billion for tax
year 1992.  Figure 1.3 shows this growth for selected years. 

   Figure 1.3:  Gross Income Tax
   Gap, Selected Years

   (See figure in printed
   edition.)

Sources:  Income Tax Compliance Research, IRS Publication 1415, July
1988; and Income Tax Compliance Research:  Net Tax Gap and Remittance
Gap Estimates, IRS Research Division, Publication 1415, April 1990. 

Specific tax gap components have also grown considerably.  Table 1.1
shows the growth in tax gap components for 1981 and 1992. 



                          Table 1.1
           
           Gross Tax Gap Estimates by Source of Tax
             Gap for Tax Years 1981 and 1992, in
                       Current Dollars

                    (Dollars in millions)

                            1981 tax    1992 tax     Percent
Source of tax gap         gap amount  gap amount    increase
------------------------  ----------  ----------  ----------
Individual tax gap           $61,900     $93,994        51.8
Unreported income             40,433      62,759        55.2
Sole proprietors              18,714      30,173        61.2
All other income              21,719      32,586        50.0
Overstated deductions\a        7,449       8,081         8.5
Individual nonfiler            5,231      10,233        95.6
Individual remittance          8,300      11,400        37.3
 gap
Math errors                      487       1,521       212.3
Corporate tax gap             14,066      33,135       135.6
Small corporation              4,461       6,999        56.9
Large corporation              8,638      23,716       174.6
Others\b                         167         420       151.5
Corporate remittance gap         800       2,000       150.0
============================================================
Total tax gap                $75,966    $127,129      67.2\c
------------------------------------------------------------
\a Includes subtractions for erroneous deductions, exemptions,
credits, and other adjustments. 

\b Includes unreported income and overstated deductions for exempt
organizations' unrelated business income and for fiduciaries. 

\c As shown in appendix I, table I.2, the gross tax gap in 1992
dollars increased 8.7 percent from $117 million in 1981 to $127
million in 1992. 

Source:  Income Tax Compliance Research, IRS Publication 1415 (7-88);
and Income Tax Compliance Research:  Net Tax Gap and Remittance Gap
Estimates, IRS Publication 1415 (4-90). 

Table 1.1 shows that the tax gap created by individuals' unreported
income rose over $22 billion between 1981 and 1992.  About half of
this increase as well as half of the total $63 billion gap came from
unreported sole proprietor (i.e., self-employed individuals) income. 
Such income is generated by "informal suppliers" (proprietors who
operate their businesses informally, usually on a cash basis), farm
proprietors, and nonfarm proprietors. 

Many types of unreported self-employment income are difficult to
detect.  Some skilled and professional employees may "moonlight" on a
cash basis as informal suppliers.  Or, the self-employed individual
may keep two sets of books, only reporting from the books with the
lowest amount of income.  Appendix I gives a more detailed breakdown
of the tax gaps for tax years 1981 and 1992. 


      IMPORTANCE OF TAX GAP
      ESTIMATES
-------------------------------------------------------- Chapter 1:1.3

In spite of the limitations of the tax gap estimates, the estimates
reflect additional tax revenues the federal government might be able
to apply to the deficit if ways can be found to reduce the gap. 
Because of this level of noncompliance, tax rates paid by compliant
taxpayers have to be higher to raise the desired level of tax
revenue. 

Tax gap estimates also indicate the major types of taxpayer
noncompliance.  Knowing this, IRS has some idea of where to target
enforcement resources and whether that targeting had some positive
effect.  Without such guideposts from the gross and net tax gap
estimates, IRS is more likely to direct resources at taxpayers whose
compliance is relatively high.  Similarly, knowing whether the
noncompliance is intentional or unintentional can provide IRS with
insight on how to close portions of the gross tax gap.  Given
intentional noncompliance, IRS would be more likely to use
enforcement over taxpayer service and seek tax law changes that
reduce opportunities to not comply. 

Unintentional noncompliance suggests the need to identify reasons and
appropriate countermeasures such as clearer or simpler rules. 
Noncompliance is more likely when complex tax laws or rules confuse
taxpayers about when and how to comply.  Fewer and simpler tax laws
reduce the amount of information that taxpayers need to comply and
reduce the opportunity to not comply.  Tax withholding and
information return reporting help taxpayers to comply by providing
the information they need and the incentive to use it. 


   EMERGING TAX GAP ISSUES
---------------------------------------------------------- Chapter 1:2

In addition to known tax gap issues, IRS must also be in a position
to handle emerging compliance issues that could increase the tax gap. 
Changes in tax laws, economic conditions, and tax administration can
affect the tax gap.  For example, health care reform, if financed by
businesses on the basis of the number of employees, may tend to
increase the number of businesses that misclassify employees as
independent contractors, who tend to have lower compliance.  A more
global economy creates problems in determining tax liabilities of
multinational corporations.  Adverse economic conditions could
increase the number of bankruptcies as well as the remittance gap. 
Changes in IRS operations could increase the tax gap if, for example,
questionable refund schemes increased with the growth in
electronically filed returns. 


      EARNED INCOME TAX CREDIT
-------------------------------------------------------- Chapter 1:2.1

The Earned Income Tax Credit (EITC) is a refundable tax credit
payable to working lower income families with children.  It has been
a source of considerable noncompliance, and IRS estimated that the
EITC tax gap for 1992 would be about $1.3 billion.  After IRS made
this estimate, tax law changes in 1990 made it easier for taxpayers
to comply with EITC requirements, which could have reduced this tax
gap.  But the Omnibus Budget Reconciliation Act of 1993 significantly
expanded this credit, which could increase the opportunity and
incentive for noncompliance. 

The 1993 act increased the maximum credit for working families with
one child from $1,434 to about $2,038, or 42 percent, in 1994.  For
families with two or more children, the maximum credit will increase
from $1,511 to about $2,527, or 67 percent, in 1994.  Also, for the
first time, this credit will be available to workers over the age of
22 who do not have any qualifying children, who cannot be claimed as
a dependent on another return, and who earn less than $9,000.  The
maximum credit for these individuals will be $306 in 1994.  Such
substantial increases could lead to increased noncompliance if IRS
does not develop programs that readily detect and correct improper
EITC claims. 


      MISCLASSIFIED INDEPENDENT
      CONTRACTORS
-------------------------------------------------------- Chapter 1:2.2

IRS estimated that the 1992 tax gap from sole proprietors (including
independent contractors) not filing tax returns or not reporting
income on filed returns was about $33 billion.  IRS officials had no
estimate of how many sole proprietors are independent contractors,
but they are concerned about employees being misclassified as
independent contractors. 

For 1984, IRS estimated that about 750,000 of 5.2 million employers
had misclassified about 3.4 million employees as independent
contractors.  Assuming no increase, such misclassification led to an
estimated $2 billion tax loss for tax year 1992.  However, IRS
officials believe that misclassification has been increasing. 

Increased misclassification has raised concerns because independent
contractors tend to have lower tax compliance compared to employees. 
For example, one IRS study of tax year 1974 found that independent
contractors reported just 74 percent of their business income.  On
the other hand, employees subject to withholding generally have been
reporting over 99 percent of their wages. 

This compliance difference can be explained.  IRS has continually
found lower compliance in the absence of withholding or another form
of information reporting.  Unlike payments to employees, payments to
independent contractors are not subject to income tax withholding. 
Instead, businesses they serve generally should report their payments
on information returns.  Although such information reporting helps
induce compliance, gaps exist in this reporting for independent
contractors.  Neither businesses using incorporated independent
contractors nor nonbusiness individuals using any contractors are
required to file the returns. 

Health care reform could also affect the classification of employees
as independent contractors.  Part of the President's reform proposal
is to have employers pay up to 80 percent of employees' health
insurance.  They would not be required to make this payment for
workers that they classify as independent contractors.  As a result,
they may classify more workers as independent contractors. 

On the other hand, the President's proposal contains a provision that
could clarify the vague classification rules.  This proposal would
authorize the Secretary of the Treasury to prescribe rules for
determining who is an employee for purposes of withholding and health
care.  If the rules established by Treasury tighten the requirements
for independent contractor status, the number of workers who would be
classified as employees could increase. 


      MULTINATIONAL CORPORATE
      TAXATION
-------------------------------------------------------- Chapter 1:2.3

Multinational corporations are becoming an increasingly larger part
of the U.S.  and world economy.  For example, from 1980 to 1989,
foreign direct investment in the United States increased almost
fivefold (from $83 billion to an estimated $401 billion).  This
growth should continue with the move toward a global economy. 

This trend presents a challenge to IRS because of the potential for
corporations to transfer their income, through intercompany pricing
of goods and services, to other countries with lower tax rates.  The
extent to which corporations avoid U.S.  taxes by manipulating the
prices of intercompany goods and services is unknown.  However, IRS
has identified billions of dollars of proposed changes to
corporations' income due to what it considers to be improper transfer
pricing.  In fiscal year 1990, for example, IRS tracked 73 major
examinations of international tax issues with proposed adjustments to
income of $11.9 billion. 


      INCREASES IN BANKRUPTCIES
-------------------------------------------------------- Chapter 1:2.4

The gross remittance gap for tax year 1992 was $13.3 billion.  This
gap could increase if the trend in bankruptcy filings continues. 
Since 1985, bankruptcy filings have increased 167 percent.  Over
970,000 individuals and businesses filed for bankruptcy in the year
ending June 30, 1992--an increase of 10.5 percent over the previous
year.  Business bankruptcies accounted for about 8 percent of these
filings and the rest were consumer cases, 35 percent of which were
joint filings by a husband and wife. 

In many bankruptcy cases, federal taxes are a major debt.  Since
1986, the number of bankruptcy cases about which IRS has been
notified has doubled.  Over the same time, the dollars collected from
bankrupt taxpayers have increased 165 percent.  Even so, the
collection rate is low.  For example, just $526 million of the $7.2
billion of the total taxes assessed against bankrupt taxpayers in
1992 has been collected. 


      ELECTRONIC FILING OF TAX
      RETURNS
-------------------------------------------------------- Chapter 1:2.5

In 1993, over 12 million individuals filed their tax returns
electronically.  By the year 2001, IRS estimates that about 80
million returns will be filed electronically.  Electronic filing has
advantages and disadvantages.  One advantage is that IRS can process
electronically filed returns more easily than paper returns. 

At the same time, electronic filing can result in more fraudulent
refunds because of the expedited processing of returns and refunds
given fewer established controls.  Through October 1993, IRS
identified 25,633 electronically filed returns involving fraudulent
refunds of $53 million; 45 percent of those refunds were issued
before IRS could stop them.  Noncompliance associated with
electronically filed returns could pose a larger problem in the
future as more and more taxpayers file this way. 


   PRIOR GAO RECOMMENDATIONS ON
   WAYS TO REDUCE THE TAX GAP
---------------------------------------------------------- Chapter 1:3

Since 1982, we have made many recommendations on ways that IRS could
better address tax gap components.  Many of them dealt with IRS
better using information returns in computer matching to identify
taxpayers who underreport income; overstate exemptions, deductions,
and credits; or fail to file information returns.  For example: 

  In 1987, we recommended that IRS establish an information returns
     program to identify businesses that underreported their income
     or failed to file tax returns. 

  In 1989, we recommended that IRS use information returns to
     identify employers who misclassified their workers as
     independent contractors. 

  In 1991, we recommended changes to IRS' nonfiler and underreporter
     programs to allow for more efficient use of information returns. 

  In 1993, we recommended that IRS use information return data to
     detect small businesses that overstated expense deductions or
     failed to file required information returns. 

We also made recommendations on collection actions, which would
reduce the remittance gap.  For example: 

  In 1990, we reported several times on the need for IRS to establish
     internal controls and information systems to determine how much
     of the accounts receivable inventory can be collected. 

  In 1993, we reported that IRS could collect more delinquent taxes
     if it made earlier telephone contact with delinquent taxpayers,
     customized its collection procedures, rewarded its collection
     staff, supplemented its efforts with private collection
     companies' services, and cooperated more with state governments. 

Other recommendations targeted the effectiveness and efficiency of
IRS' compliance programs.  In 1991, we recommended that IRS improve
its audits to check for information returns compliance. 
Recommendations in 1993 focused on improving the data used by IRS to
make tax gap estimates. 

We also made legislative recommendations directed at reducing the
income tax gap.  For example, Congress recently enacted legislation
to implement our recommendations on information returns reporting for
bad debts and for seller finance mortgages. 

Appendix II summarizes the work we have done and recommendations we
have made on tax gap issues since 1982. 


   OBJECTIVES, SCOPE, AND
   METHODOLOGY
---------------------------------------------------------- Chapter 1:4

The objectives of this assignment were to analyze the nature and
importance of the tax gap and actions for reducing the gap.  These
actions include those that Congress and IRS have already taken, that
IRS is now developing, and that Congress or IRS could take in the
future. 

To meet our objectives, we summarized our findings and
recommendations in previous reports and testimonies that dealt with
tax gap issues.  We issued these reports during 1982 through 1993. 
Using these past recommendations, we updated some of the related
information and analyzed whether these recommendations still could
apply. 

We also analyzed IRS' tax gap studies, budget data, annual reports,
and related studies.  We discussed these documents with responsible
National Office officials at IRS, focusing on issues related to the
tax gap.  Specifically, we analyzed IRS' tax gap studies done in
1979, 1983, 1988, and 1990 as well as IRS documents on its Tax
Systems Modernization (TSM), organizational changes, and operating
plans.  We also reviewed legislative provisions that have affected
tax gap components since 1981. 

We requested written comments from IRS on a draft of this report. 
IRS officials told us they chose not to comment because the report
summarized past GAO reports and offered no new recommendations.  We
did our work in accordance with generally accepted auditing standards
between April and December 1993. 


ACTIONS TAKEN TO REDUCE THE TAX
GAP
============================================================ Chapter 2

Almost every year since 1981 has witnessed legislation to address tax
gap issues.  These legislative actions generally required information
returns reporting on income and deductions, imposed penalties for tax
noncompliance, or reduced the opportunity for noncompliance by
eliminating certain tax write-offs.  IRS estimated that some of these
provisions resulted in additional 1990 tax revenue of $3.4 billion. 
Even so, IRS' estimated tax gap increased $50.7 billion in current
dollars from tax years 1981 to 1992.  However, the growth of the gap
could have been higher without these legislative actions. 

Congress has also appropriated additional funds for specific
compliance initiatives to help IRS reduce the tax gap.  However, IRS
was not able to use all the funds for enforcement because of budget
shortfalls.  Instead, funds were shifted to nonenforcement activities
such as processing tax returns.  In some cases, IRS overestimated the
revenues that the additional resources for specific compliance
initiatives would generate and underestimated the time needed to
fully implement the initiatives.  As a result, these additional funds
did not allow IRS to make a more significant dent in the tax gap. 

IRS' enforcement programs have not prevented the tax gap from
growing, even with bigger budgets.  In fact, between fiscal years
1987 and 1992, the estimated tax gap grew at a faster pace than IRS'
enforcement budget and estimated enforcement revenues. 
Nonenformcement programs such as customer service may help taxpayers
to comply, which would reduce the tax gap.  However, IRS' data did
not measure how these programs affected compliance. 


   TAX LAW CHANGES HAVE HELPED IRS
   ADDRESS TAX GAP ISSUES
---------------------------------------------------------- Chapter 2:1

Many legislative actions since the early 1980s were aimed at reducing
the tax gap.  Most tax law changes dealt with reporting information
to IRS that would allow it to more easily detect unreported income or
overstated deductions.  For example: 

  The Economic Recovery Act (ERA) of 1981 increased penalties for
     negligence, filing false withholding certificates, and failure
     to file information returns.  It also required that a copy of an
     information return be furnished to the person who received the
     payment to induce reporting the income. 

  The Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982
     imposed information reporting on proceeds from stock sales,
     state income tax refunds, and bearer obligations; increased
     penalties for failure to file information returns; and expanded
     the requirement for employers to report employees' tip income. 

  The Deficit Reduction Act (DEFRA) of 1984 required information
     reporting on mortgage interest payments and cash payments of
     more than $10,000 received during the course of a trade or
     business. 

  The Tax Reform Act (TRA) of 1986 eliminated or restricted many
     deductions, offsets, and exclusions to income.  These changes
     had substantial impacts on compliance.  By eliminating certain
     deductions and exclusions, TRA also eliminated any related
     noncompliance.  Specifically, TRA reduced the opportunity for
     taxpayers to be noncompliant by restricting abusive tax shelters
     and eliminating itemized deductions for interest expenses and
     sales taxes.  The act required information returns for real
     estate transactions and for contracts from certain federal
     agencies and required that taxpayers report the Social Security
     numbers of dependents claimed on tax returns. 

  The Omnibus Budget Reconciliation Act of 1993 required certain
     lenders to report any discharge of indebtedness of over $600 to
     IRS. 

Appendix III gives a summary of legislative actions from 1981 through
1993 that addressed taxpayer compliance issues. 

The tax gap increased $51 billion from tax years 1981 to 1992, rising
from $76 billion to $127 billion in current dollars.  Yet the gap
could have been higher if not for these legislative changes,
especially those requiring information reporting.  As discussed in
chapter 1, taxpayers are more prone to report income that is also
reported on information returns to IRS.  IRS estimated that tax
legislation from 1981 through 1986 generated $3.4 billion in
additional revenue for 1990.  Table 2.1 shows IRS' estimates. 



                          Table 2.1
           
           Estimates of Increased Revenues in 1990
            Resulting From Tax Law Changes Between
                        1981 and 1986

                    (Dollars in millions)

Tax Gap Component                 Amount  Tax Law
------------------------------  --------  ------------------
Interest income                    $ 233  TEFRA, TRA
Taxable dividends                    154  TEFRA
State/local refunds                  152  TEFRA
Self-employment income               215  ERA, TEFRA, TRA
Capital gains/losses               1,226  TEFRA
Pension income                       764  TEFRA
Deductions                           296  DEFRA
Exemptions                           381  TRA
============================================================
Total                             $3,421
------------------------------------------------------------
Source:  Income Tax Compliance Research, IRS Publication 1415 (7-88). 


   APPROPRIATIONS GIVEN TO IRS TO
   ADDRESS TAX GAP ISSUES
---------------------------------------------------------- Chapter 2:2

Additional appropriations given to IRS for specific compliance
initiatives have not had the intended effect.  Some funds intended
for compliance initiatives were redirected to nonenforcement
activities because of budgetary shortfalls.  Several examples of
these shortfalls follow. 

  Through a supplemental appropriation for fiscal year 1986 and a
     continuing resolution for fiscal year 1987, Congress provided
     IRS with funds to increase its audit staff by 2,500
     positions--1,618 revenue agents, 175 tax auditors, and 707
     support personnel.\1 IRS projected that this increased staffing
     would enable it to audit 113,000 additional tax returns, adding
     $593 million in collections during fiscal year 1987.  IRS did
     not achieve the anticipated gain in revenue agent staffing for
     fiscal year 1987.  Many of the agents hired through the
     initiative filled attrition vacancies that had gone unfilled
     because IRS diverted resources from enforcement to returns
     processing. 

  IRS' fiscal year 1991 appropriation included $191 million for 3,476
     additional staff years to implement 9 compliance initiatives. 
     These initiatives were expected to produce an additional $5.7
     billion in enforcement revenues during the 5-year period ending
     in fiscal year 1995.  We reviewed 3 of the 9 initiatives, which
     accounted for $140 million of the appropriation, 2,226 of the
     additional staff, and $3.2 billion of the estimated revenue.\2
     We found that IRS later lowered this $3.2 billion estimate to
     $2.4 billion.  According to IRS, this reduction resulted from a
     combination of staff reductions, changes in productivity
     assumptions, and failure to account for the opportunity costs of
     taking experienced staff away from their jobs to train new
     hires.  As a result, delinquent tax collections failed to keep
     pace with the growth in the accounts receivable inventory and
     actually declined by 5 percent from fiscal year 1990 to fiscal
     year 1991. 

  IRS' fiscal year 1993 budget included about $43 million for eight
     compliance initiatives dealing with collecting delinquent taxes,
     auditing high-income/high-asset individual and corporate
     returns, and increasing criminal investigations and
     international compliance efforts.  These initiatives were not
     fully implemented because IRS had to redirect resources to
     offset budget shortfalls.  IRS scaled back staffing and
     redirected resources for such activities as training and travel
     to offset unfunded labor costs of over $200 million. 

The outlook is bleak for completing fiscal year 1994 compliance
initiatives.  Congress has authorized about $115 million to fund 11
compliance initiatives (e.g., for increasing delinquent tax
collections, international tax compliance, and audit coverage, as
well as for reducing electronic fraud).  However, IRS will spend only
about $10 million on the initiatives; the other $105 million will be
diverted to pay for unfunded locality pay. 

Despite the various compliance initiatives that were intended to
increase enforcement staffing since fiscal year 1986, IRS has not
been able to maintain enforcement staffing levels.  As shown in table
2.2, IRS enforcement staffing peaked in fiscal year 1988 after
experiencing an increase of 6,703 full-time equivalent staff from
fiscal year 1987.  However, between fiscal years 1988 and 1992,
full-time equivalent staff decreased by 6,165.  Decreased enforcement
staffing is one reason why IRS has been unable to stem the growth of
the tax gap. 



                          Table 2.2
           
             Number of Full-Time Equivalent Staff
                Positions for the Examination,
              Collection, and Computer Matching
                          Functions


              Examinatio                Computer
Fiscal year            n  Collection    matching       Total
------------  ----------  ----------  ----------  ==========
1986              26,120      15,571       4,844      46,535
1987              29,243      16,265       5,259      50,767
1988              31,895      18,546       7,029      57,470
1989              31,315      18,470       5,691      55,476
1990              28,788      18,034       5,683      52,505
1991              28,592      18,605       5,609      52,806
1992              28,393      18,518       4,394      51,305
------------------------------------------------------------
Source:  IRS Annual Reports (1986 to 1992). 


--------------------
\1 See Tax Administration:  IRS' Implementation of the 1987 Revenue
Initiative (GAO/GGD-88-16, Dec.  2, 1987). 

\2 Tax Administration:  Congress Needs More Information on Compliance
Initiative Results (GAO/GGD-92-118, July 31, 1992). 


   IRS ENFORCEMENT PROGRAMS THAT
   AFFECT THE TAX GAP
---------------------------------------------------------- Chapter 2:3

IRS' major enforcement programs for addressing tax gap issues are its
examination, collection, and computer matching programs.\3 As
discussed in chapter 1, IRS estimated that these programs reduced the
gross tax gap for tax year 1987 by $21.9 billion, or 23 percent--from
$94.2 billion to $72.3 billion.  Table 2.3 shows how much each of
IRS' enforcement programs reduced the gross tax gap for tax year
1987.  IRS did not have estimates for more recent years. 



                          Table 2.3
           
           Reductions to Tax Year 1987 Tax Gap as a
              Result of IRS Enforcement Programs

                    (Dollars in billions)

Enforcement program               Amount             Percent
--------------------  ------------------  ------------------
Examination                        $12.0                54.8
Collection                           5.7                26.0
Computer matching                    2.3                10.5
Other\a                              1.9                 8.7
============================================================
Total                              $21.9               100.0
------------------------------------------------------------
\a Includes $1.2 billion for math error corrections and $.7 billion
for delinquent tax returns obtained without computer matching. 

Source:  Income Tax Compliance Research:  Net Tax Gap and Remittance
Gap Estimates, IRS Research Division, Publication 1415 (4-90). 


--------------------
\3 IRS' Criminal Investigations Division can affect the tax gap
because some of its investigations deal with legal-source income. 
However, much of its resources focus on illegal source income from
narcotics, money laundering, and the like, which are not part of the
tax gap.  IRS did not have data on how its legal-source
investigations affect the tax gap. 


      EXAMINATION PROGRAM
-------------------------------------------------------- Chapter 2:3.1

Examination is the backbone of IRS' enforcement activities.  It
audits filed tax returns to address that portion of the gross tax gap
created by unreported income and overstated exemptions, deductions,
and credits.  IRS estimates that for tax year 1987 these types of
noncompliance accounted for about $76.7 billion of the $94.2 billion
gross tax gap.  As shown in table 2.3, IRS estimates that the
Examination Program reduced the $76.7 billion gap by about 16
percent, or $12 billion--$7.3 billion from auditing corporations and
$4.7 billion from auditing individuals. 

Even though audits are the primary enforcement tool for identifying a
wide variety of noncompliance, audit rates have decreased over 50
percent between fiscal years 1981 and 1992.  As shown in table 2.4,
the corporate audit rate decreased from 5.07 percent to 2.99 percent,
or 41 percent, while the audit rate for individuals decreased from
1.77 percent to 0.91 percent, or 48 percent, between fiscal years
1981 and 1992. 



                          Table 2.4
           
            Corporate and Individual Audit Rates,
                Fiscal Years 1981 Through 1992

Fiscal year               Corporate rate     Individual rate
--------------------  ------------------  ------------------
1981                                5.07                1.77
1982                                4.74                1.55
1983                                3.66                1.50
1984                                2.67                1.27
1985                                2.40                1.31
1986                                2.25                1.12
1987                                1.58                1.09
1988                                1.32                1.03
1989                                2.02                0.92
1990                                2.59                0.80
1991                                2.36                1.00
1992                                2.99                0.91
------------------------------------------------------------
Source:  IRS Annual Reports. 

IRS data show that audit rates for certain types of taxpayers have
increased in recent years.  For example, the audit rate for small
corporations (those with less than $10 million in assets) more than
doubled between 1987 and 1992, increased from 1.07 percent to 2.6
percent--an increase of over 37,000 audited returns.  Similarly, the
audit rate grew for the least compliant group of individual
taxpayers--nonfarm sole proprietors.  This audit rate increased from
2.2 percent in fiscal year 1987 to 2.7 percent in fiscal year 1992,
an increase of over 35,000 audits. 

Even with these recent increases, overall audits for individuals and
corporations decreased from 1.21 million in 1987 to 1.16 million in
1992.  Moreover, the recommended assessments from income tax audits
failed to keep pace with increases in the estimated income tax gap
between fiscal years 1987 and 1992.  Comparing year-end totals for
these years, assessments increased 46 percent while the tax gap
increased 76 percent. 

IRS' audit rate should be viewed with caution.  IRS classifies
certain taxpayer contacts as audits when in fact the taxpayers' books
and records were not examined.  Instead, IRS sent notices of proposed
tax assessments to taxpayers, using information from third-party
sources. 

For example, when an audit of a partnership return results in tax
assessments for individual partners, IRS counts each assessment as an
audit of the individual, even though the individual tax returns were
not audited.  When IRS prepares a substitute tax return based on
information returns for nonfilers who fail to file after being
notified by IRS, IRS has counted the substitute return as an audit. 
In fiscal year 1991, about 370,000 such contacts were included in
IRS' audit rate.  If these items are subtracted from the 1.1 million
individual audits that IRS data showed as completed in fiscal year
1991, the audit rate would be 0.67 percent instead of 1.00 percent. 


      COLLECTION PROGRAM
-------------------------------------------------------- Chapter 2:3.2

As shown in table 2.3, IRS estimated that for tax year 1987
collection work reduced the remittance gap by $5.7 billion--from $9.3
billion to $3.6 billion--a 61-percent decrease.  IRS estimated that
it also decreased the 1992 remittance gap by 61 percent, or $8.1
billion--from $13.3 billion to $5.2 billion. 

From fiscal year 1987 through fiscal year 1992, the collection budget
grew from $661 million to $922 million, a 40-percent increase; and
the number of collection staff grew from 16,265 to 18,605, a
14-percent increase.  Even with increased resources, IRS gained
little ground in collecting delinquent taxes. 

For example, over the same time period, IRS delinquent collections
increased just 6 percent--from $22.9 billion to $24.2 billion. 
Further, between fiscal years 1988 and 1992, collections of
delinquent taxes did not keep pace with the growth in the collections
workload, as figure 2.1 shows.\4

   Figure 2.1:  Comparison of
   Total Accounts Receivable and
   Collection of Delinquent
   Accounts, Fiscal Years 1988
   Through 1992

   (See figure in printed
   edition.)

Note 1:  Accounts receivable values for fiscal years 1991 and 1992
have been adjusted from a 10-year to a 6-year statutory collection
period. 

Note 2:  In 1992, IRS redefined the gross accounts receivable
inventory by excluding certain amounts previously included.  The 1992
inventory value was calculated on the basis of the old definition and
is therefore comparable to prior years. 

Source:  IRS data. 

IRS estimated that about $52 billion of the 1992 accounts receivable
inventory is currently not collectible.  Given the greater growth of
the accounts receivable inventory relative to collections, much time
could pass before IRS puts a dent in the collectible portion of the
inventory. 


--------------------
\4 Comparable accounts receivable data for fiscal year 1987 were not
available. 


      COMPUTER MATCHING PROGRAM
-------------------------------------------------------- Chapter 2:3.3

IRS considers the computer document matching program to be its
primary enforcement tool for dealing with nonbusiness individual
taxpayers.  Compared with its audit program, this matching program is
less intrusive on taxpayers and more cost effective.  As shown in
table.  2.3, IRS estimated that its computer document matching
program for individuals reduced the gross tax gap for tax year 1987
by 2.4 percent or $2.3 billion--$1.2 billion for unreported income
and $1.1 billion for nonfilers. 

In fiscal year 1992, IRS spent about $169 million on the program and
recommended additional assessments of $4.3 billion in taxes,
penalties, and interest on 5.3 million taxpayers who either
underreported their income or failed to file tax returns.  IRS
estimates that information returns partially cover 99.5 percent of
the total income among individual taxpayers.  Further, IRS estimates
that between 35 percent and 45 percent of the income reported on all
individual income tax returns is based solely on data that are (or
should be) reflected on information returns. 

The number of information returns processed by IRS has substantially
increased.  In fiscal year 1992, IRS processed over 1 billion
information returns compared to 492 million in fiscal year 1980. 
However, budget constraints in recent years have prevented IRS from
taking full advantage of these information returns to reduce the
gross tax gap.  Faced with recent budget shortfalls, the
underreporter portion of the matching program has been one of the
first programs to be cut.  For example, to make up for fiscal year
1992 shortfalls, IRS reduced its underreporter workload to 5.6
million cases from the 9 million cases it worked in 1991.  This means
that 3.4 million fewer cases were worked to assess additional taxes
owed; we estimate that these cases could have contributed as much as
$1 billion in revenue.\5

IRS' matching program has great potential for attacking the
unreported income portion of the tax gap.  Budget cuts that decrease
the matching program's workload could erode the high compliance
levels found for income that is subject to information reporting and
increase the tax gap. 


--------------------
\5 IRS data for fiscal year 1992 show that about 3.8 million or 68
percent of the 5.6 million underreporter cases resulted in taxpayer
contact, and the taxpayers were assessed about $1.8 billion for an
average of $474 in additional taxes, penalties, and interest.  If IRS
could have worked the 3.4 million underreporter cases and obtained
results similar to those of the 5.6 million cases, additional tax,
penalties, and interest assessments could have been as high as $1
billion. 


   IRS' NONENFORCEMENT EFFORTS TO
   REDUCE THE TAX GAP
---------------------------------------------------------- Chapter 2:4

IRS has not estimated how much its nonenforcement efforts, such as
taxpayer service, have reduced the tax gap.  IRS' customer service
activities generally account for about 40 percent of its budget. 
These activities include taxpayer service, returns processing, and
the issuance of tax forms and publications. 

Even though IRS has no specific estimates, customer service
activities can play an important role in reducing the tax gap.  IRS'
1988 TCMP data suggested that many taxpayers may not comply because
of confusion about tax laws.  The 1988 TCMP sample included audits of
over 54,000 individual taxpayers, which represents 104 million
taxpayers.  TCMP data showed that if all 104 million taxpayers were
audited, the tax liabilities reported by an estimated 42 million
taxpayers, or 40 percent, would have increased. 

The TCMP data showed that an estimated 33 million of the 42 million
taxpayers (82 percent) were not assessed a fraud or negligence
penalty, suggesting that much of their noncompliance was
unintentional.  This is the type of noncompliance more susceptible to
customer service activities.  Table 2.5 shows the primary reasons,
according to the TCMP data, that tax liability increased for 33
million taxpayers. 



                          Table 2.5
           
            Primary TCMP Reasons for Tax Increase
              When Taxpayers Were Not Assessed a
            Negligence or Fraud Penalty for 1988.

                    (Dollars in millions)

                                 Number of         Amount of
Reason for noncompliance         taxpayers      tax increase
------------------------  ----------------  ----------------
Multiple interpretations         1,230,202            $1,237
 of tax
 law
Lack of substantiation           9,074,690             3,765
Incorrect accounting or
 computational                   5,215,212             2,710
 procedures
Relied on a return
 preparer and                    4,964,121             3,166
 did not help with
 preparation
Lacked knowledge of tax
 laws to                         7,648,492             3,259
 prepare accurate return
Other\a                          5,004,042             1,549
============================================================
Totals                          33,136,759           $15,686
------------------------------------------------------------
\a IRS' TCMP data did not explain these "other" reasons. 

Source:  IRS 1988 TCMP data. 

As shown in table 2.5, the 33 million individuals had a total
estimated tax change of $15.7 billion.  To the extent that these
individuals can be helped through IRS' customer service, the tax gap
could be reduced.  For example, expanding outreach programs and
simplifying tax return instructions could help the 7.6 million
taxpayers who lacked the knowledge of tax laws to prepare accurate
returns.  Also, spending more customer service resources to ensure
that tax preparers are familiar enough with the tax laws could reduce
noncompliance among the 5 million taxpayers who relied on such
preparers for accurate returns. 

Our analysis of the 1988 TCMP data for individuals also raised
questions about IRS' over-the-counter taxpayer assistance and its
telephone service function.  Of the 33 million taxpayers, about 2
million, or 6 percent, had used these services in preparing their
returns.  Even so, these taxpayers owed an estimated $923 million in
taxes. 

Since the tax year 1988 TCMP survey, IRS data show that its customer
service activities are improving.  For example, the accuracy rate of
IRS' toll-free telephone assistance increased from 63 percent in 1989
to 89 percent in 1994.  However, this 26 percentage point increase in
the accuracy rate was accompanied by a 37 percentage point decrease
in the telephone accessibility rate, which went from 58 percent in
1989 to 21 percent in 1994. 

According to IRS officials, toll-free telephone accessibility was
lower in 1993 primarily because the demand for telephone assistance
increased sharply while resources available to provide it decreased. 
The resulting reduction in accessibility meant that more callers
received busy signals or were placed on hold and hung up before IRS
could assist them.  IRS appears to be getting better at answering
taxpayers' questions, which should help taxpayers to file complete
and accurate tax returns.  However, if taxpayers cannot get through
to IRS to get their questions answered, overall taxpayer compliance
may not improve. 


   CONCLUSIONS
---------------------------------------------------------- Chapter 2:5

Tax law changes have given IRS more enforcement tools to better
detect noncompliance and have deterred taxpayers from misreporting
their income and deductions.  Congress has also given IRS additional
appropriations for specific compliance initiatives, but the funds
have had little impact on the tax gap.  Budget shortfalls have
prevented IRS from taking full advantage of these additional funds or
the new enforcement tools.  Revenues generated by IRS' ongoing
enforcement programs have not kept pace with the growth in the tax
gap.  Congressional actions and IRS' enforcement activities, however,
have likely prevented the tax gap from growing larger. 

IRS has no data on the extent to which IRS' customer service
activities affect the tax gap.  IRS' tax year 1988 TCMP data did
indicate that almost 9 million noncompliant taxpayers needed more
assistance in understanding tax laws and in preparing accurate tax
returns.  However, in 1994 only 21 percent of the taxpayers who tried
to get such assistance from IRS' toll-free telephone service were
able to get through.  The good news is that when they did get
through, IRS answered 89 percent of their questions correctly. 


IRS' CURRENT AND PLANNED EFFORTS
TO REDUCE THE TAX GAP
============================================================ Chapter 3

IRS is making and planning dramatic changes in the way it does
business and addresses noncompliance.  It has adopted a compliance
strategy called Compliance 2000, which relies more on education and
assistance to improve compliance.  Through Tax Systems Modernization
(TSM), IRS is developing new computer systems while reorganizing its
work to take advantage of this new technology.  IRS expects these
changes to improve overall compliance levels from 83 percent in 1992
to 90 percent by the year 2000. 

Once all of these changes are implemented, IRS' vision of how it will
then operate calls for (1) shifting from a paper-based to an
electronic tax processing system; (2) consolidating fragmented
telephone assistance into fewer locations that can handle almost all
taxpayer calls; and (3) developing a database that contains all
pertinent account information and is readily available to all
employees who need it. 

IRS' reorganization and computer upgrades, together with the
compliance strategies and systems, will not be fully operational
before 2000.  By then, IRS' goal to increase voluntary compliance to
90 percent will be difficult to meet if these new tools experience
delays. 


   COMPLIANCE 2000
---------------------------------------------------------- Chapter 3:1

To help achieve the goal of increasing taxpayer compliance from 83
percent to 90 percent by the year 2000, IRS has embarked on a new
strategy called Compliance 2000.  This strategy recognizes that
education and assistance as well as enforcement are needed to reduce
the tax gap.  Compliance 2000 differs from the traditional compliance
approach by placing more emphasis on identifying the root causes of
noncompliance and moving to address these underlying problems. 
Compliance 2000 relies on identifying characteristics that
differentiate compliant from noncompliant taxpayers, enabling IRS to
find solutions before taxpayers make mistakes, help those having
difficulty complying, and focus enforcement resources in the most
productive fashion on those whose noncompliance is intentional. 

On the surface, the Compliance 2000 strategy is sound.  However, it
depends on having valid systematic data that can be used to target
the most noncompliant areas.  Since 1963, TCMP has provided such
data.  However, IRS has criticized TCMP data for not being detailed
enough on the specific location and causes for each type of
noncompliance.  Actually, TCMP has captured such data in narrative
form through the TCMP workpapers.  IRS has not extracted such data to
determine the specific nature of the noncompliance because of
concerns about cost and missing data. 

Recognizing the need for more detailed, systematic compliance data,
IRS is developing new methods for measuring compliance, identifying
noncompliant taxpayers, and allocating compliance resources.  For
example, the Compliance Research Information System (CRIS) will
attempt to measure compliance by compiling IRS and non-IRS data into
a comprehensive database and performing various analyses to identify
noncompliant taxpayer segments.  IRS envisions that TCMP data will be
the foundation for CRIS.  It plans to do a new comprehensive TCMP
survey in 1996 for tax year 1994 returns. 

IRS plans to manage CRIS at its new National Office of Research and
Analysis.  It also plans to have a network of 31 District Offices of
Research and Analysis, which will use a local version of CRIS to
identify compliance issues related to specific geographic areas. 
CRIS is scheduled to be ready by 1996.  In fiscal year 1997, the
compliance data from CRIS will be used to develop an Annual
Compliance Plan.  This will be a multiyear, multifunctional plan that
will define the compliance issues to be addressed and will allocate
national and field resources to priority compliance areas. 

IRS is not waiting for new compliance data to become available before
it changes the way it looks at compliance and audits taxpayers. 
Under a newly developed Market Segment Specialization Program (MSSP),
IRS studies and analyzes market segments to determine levels of
noncompliance.  A market segment can be an industry, profession, or
issue (e.g., truck drivers, garment contractors, the construction
industry, passive losses).  IRS is assessing noncompliance in the
market segments by analyzing data from filed returns, state/federal
exchange programs, and industry sources. 

Under MSSP, district office staff are to (1) identify, research, and
develop market segments; (2) audit returns in the segments to
determine levels of compliance; and (3) produce audit guides to be
used when auditing specific market segments.  As of September 1993,
IRS had completed 21 MSSP projects and developed 14 audit guides. 
Projects have covered such market segments as attorneys, mortuaries,
and restaurants.  Appendix IV lists the MSSP projects. 

IRS' market segment approach suffers from the lack of detailed,
systematic compliance data.  IRS does not know whether the market
segments it is developing are the most noncompliant segments among
taxpayers.  IRS will not have this data until it completes its
planned TCMP survey as well as CRIS.  Until then, resources may not
be targeted at areas that would significantly reduce the tax gap. 


   TAX SYSTEMS MODERNIZATION
---------------------------------------------------------- Chapter 3:2

IRS is counting on CRIS to provide the data it needs to measure and
identify the most noncompliant areas so that IRS can effectively
employ its Compliance 2000 strategy.  In concert with developing
compliance data and strategies, IRS hopes to make its compliance
programs more effective and efficient. 

TSM is scheduled to become fully operational by the year 2008 at an
estimated cost of $23 billion.  TSM is being designed to use new
technology that will enable employees to serve taxpayers more quickly
and efficiently than now.  Through TSM, IRS expects to use new
processes that will enable it to meet its strategic
objectives--reduce taxpayer burden, improve voluntary compliance, and
increase productivity and efficiency.  IRS expects such productivity
and efficiency to come from switching its reliance on paper filings
and manual processing of tax returns and other documents to
electronic filing and automated processing.  In addition, IRS plans
to move toward more (1) automated access to taxpayer information by
IRS staff, (2) electronic transfer of data between IRS locations, and
(3) reliance on telephone contacts with taxpayers to resolve
problems. 

One of the major initiatives under TSM that affects compliance
activities is to have systems that will process information returns
quicker so that potential underreporter cases can be identified at
the time tax returns are processed.  Currently, IRS underreporter
cases are not developed and pursued until 12 to 18 months after
returns are required to be filed. 

Another major TSM initiative for compliance purposes will be the
Integrated Case Processing system.  This system is supposed to allow
authorized employees, using a universal workstation, to assemble all
the information they need to do their work in an electronic case
folder.  With all this information available, employees are supposed
to be able to resolve most issues and concerns of taxpayers at
initial contact. 

Included in the Integrated Case Processing system will be the
following TSM projects: 

  Corporate Files On-Line:  Some IRS master file data is placed
     on-line, facilitating accessibility by employees who can use the
     data to resolve taxpayer inquiries more quickly. 

  Automated Inventory Control System:  Now being tested at the Fresno
     Service Center, this will be used to track taxpayer
     correspondence and reduce delays in responding to taxpayer
     inquiries. 

  Automated Underreporter System:  Information returns are
     automatically associated to tax return data to facilitate the
     determination of whether taxpayers reported their income
     correctly. 

  Integrated Collection System:  The assignment and management of
     active collection are automated. 

  Totally Integrated Examination System:  Taxes, interest, and
     penalties on audit cases are automatically computed. 

  Automated Criminal Investigation System:  Criminal investigators
     are able to use information from sources throughout the law
     enforcement community. 

If all of these and other planned systems work, administration of the
tax system should improve.  However, it is still too soon to
determine whether IRS can successfully merge these different systems
into one workable integrated system. 

As TSM automates manual processes, IRS hopes to reinvest displaced
staff by training them to assume higher level duties.  This staff do
such work as processing tax returns.  IRS envisions many of them
being trained to do compliance duties, such as assisting taxpayers or
helping with audits.  IRS' reinvestment plan has merit; however, IRS
does not yet know how many staff will be displaced, how many can be
retrained to handle new duties, and whether this number will be
enough. 


   CORE BUSINESS SYSTEMS
---------------------------------------------------------- Chapter 3:3

IRS is reorganizing its operations to better address tax gap issues
and help taxpayers comply.  It is implementing a systems management
approach, which it calls core business systems, to improve its work
systems, products, and services.  This approach to management is
designed to help break down the walls between functions such as
Examinations, Collections, and Taxpayer Service by looking at the
organization as an integrated process rather than a series of
functions.  To do this, IRS' business functions have been reorganized
into six core business systems that integrate related activities. 
These six systems include one on educating and assisting taxpayers
and one on ensuring compliance. 

IRS is also changing its organizational structure to better implement
these new systems and IRS' new approach.  It has established chief
officers for carrying out IRS' program objectives and strategies
under these systems.  For example, the Chief Compliance Officer is
the principal advisor to the Commissioner on policy and operational
matters affecting compliance functions.  These functions include
compliance research, examinations, collections, and criminal
investigations.  Specifically, this officer will focus on continually
measuring the degree of compliant behavior, identifying
noncompliance, determining the causes of noncompliance, and proposing
actions to improve compliance. 

IRS plans to also decrease staff positions in the national and
regional offices and put more staff on-line to address compliance
issues.  Finally, in its new organization, IRS plans to have

  5 submission processing sites, which will receive, control, image,
     and process paper tax returns, information returns, Form W-2s,
     and correspondence;

  3 computing centers, which will maintain the tax account and
     case-related data and receive all electronically filed tax
     returns and payments through electronic funds transfer; and

  23 customer service sites, which will handle taxpayer questions;
     problems; and issues not requiring face-to-face interaction,
     such as tax law and procedural questions, forms requests,
     installment agreements, adjustments, and nonfiler and
     underreporter issues. 

These organizational changes are just under way and it is too early
to determine whether they will create a multifunctional compliance
strategy and organization at all levels of IRS or whether they will
help IRS to reduce the tax gap. 


   CONCLUSIONS
---------------------------------------------------------- Chapter 3:4

For the Compliance 2000 strategy to work, IRS needs valid compliance
data and the technology and organizational structure to make it
effective.  However, many of the current and planned changes have not
been fully implemented.  As a result, IRS does not know what effect,
if any, the changes will have on reducing the tax gap.  For example,
IRS is already well on its way to instituting a market segment
approach to selecting returns for audit.  Without detailed,
systematic compliance data, IRS does not know whether this approach
is targeting the least compliant taxpayers.  Because TSM initiatives
are still being developed, their impact on compliance will not be
known for a few years.  Finally, it is too early to tell whether IRS'
reorganization into its core business systems will prove more
effective in addressing tax gap issues. 


ACTIONS THAT CAN BE TAKEN TO
REDUCE THE TAX GAP
============================================================ Chapter 4

While eliminating the tax gap is unlikely, working toward this end is
worthwhile.  In doing so, IRS must continually improve its compliance
programs to make them as cost-effective as possible.  Such
improvements can come from better using existing compliance data to
develop a strategy that focuses on noncompliant taxpayers who make up
major portions of the tax gap.  Part of this strategy could be to
maintain, if not increase, audit coverage.  Further, if the budget
allows, IRS could increase computer matching and better ensure that
all required information returns are filed. 

Other actions to help IRS reduce the tax gap would require
congressional action.  Congress could pass legislation to require
information reporting on payments made to corporations and income tax
withholding on payments made to independent contractors.  IRS also
believes Congress can help by allowing IRS to reinvest--rather than
give up--the productivity gains from implementing TSM into its
compliance activities. 

IRS also could start acting on a number of matters as it moves into
TSM.  Most important is cleaning up its tax records so that it can
more readily determine all compliance issues associated with each
taxpayer. 


   WHAT IRS CAN DO TO REDUCE THE
   GAP
---------------------------------------------------------- Chapter 4:1

Before IRS can effectively attack the tax gap, it needs a
comprehensive compliance strategy and sound tax compliance data to
target its resources.  The first step toward achieving this goal is
the comprehensive TCMP survey planned for tax year 1994.  Until IRS
completes this survey, some known compliance issues can be addressed
but may require additional resources or a redirection of existing
resources.  For example, resources could be used to do more computer
matching and to better ensure that computer matching covers all
required information returns.  Also, IRS could address the remittance
gap by increasing the efficiency, productivity, and quality of its
collection function. 


      IRS NEEDS BETTER DATA TO
      TARGET EXAMINATION RESOURCES
-------------------------------------------------------- Chapter 4:1.1

Unlike the $13.3 billion remittance gap, which consists of known tax
debts, the remaining $113.7 billion of the gross income tax gap for
tax year 1992 is more difficult to find.  IRS has to find this
noncompliance, which includes unreported income and overstated
exemptions, deductions, and credits, and decide how best to target
its resources on such noncompliance.  The key to identifying and
correcting such noncompliance is to know the (1) taxpayers most
likely to be noncompliant; (2) income or expense in which
noncompliance is most likely; and (3) reasons or causes for the
noncompliance (e.g., intentional versus unintentional).  With a
process to capture and analyze such information, IRS can effectively
allocate the right resources to the right compliance problem. 

For about 30 years IRS has relied on TCMP to identify compliance
issues, measure taxpayer compliance, and help allocate examination
resources.  TCMP also has been the primary source for making tax gap
estimates.  We reported in April 1993 that IRS was planning major
changes that would greatly reduce TCMP's value in making compliance
and tax gap estimates.\1 Since then, IRS officials have told us that
they will conduct a comprehensive TCMP survey without making the
changes that would undercut its value. 

The planned TCMP survey for tax year 1994 will consist of about
150,000 individual, corporate, and partnership returns.  The survey
will be directed at about 30 market segments, such as taxpayers
engaged in retail industries.  This approach differs from prior TCMP
surveys, which examined taxpayers by type of return filed and amount
of income reported on their returns.  Also, unlike prior surveys, IRS
plans on collecting data to more specifically identify the tax issues
and reasons associated with any tax changes. 

As of February 10, 1994, IRS had not made a final decision on whether
the audits for this TCMP survey will be as detailed as in prior TCMP
audits.  As previously reported, we believe IRS should ensure that
the survey is conducted in a manner that provides valid statistical
data.  In particular, IRS needs to audit every tax return line item
on the selected returns so that it can properly identify compliance
levels and trends as well as emerging noncompliance.  This detailed
level of audit is important for identifying the most noncompliant tax
gap areas so that IRS can prioritize its use of enforcement
resources. 

We acknowledge that IRS is attempting to develop new systems, such as
CRIS, to provide these benefits.  But these systems will not be ready
during the next few years.  Until they are, valid TCMP data for more
recent years are critical in order for IRS to develop the
comprehensive compliance strategy that it envisions and needs.  The
last TCMP surveys covered tax year 1988 for individuals, tax year
1987 for small corporations, and tax year 1982 for partnerships. 
While the data for the small corporation and individual surveys are
still useful, their usefulness decreases with every major tax law and
economic change. 


--------------------
\1 Tax Administration:  IRS' Plans to Measure Tax Compliance Can Be
Improved (GAO/GGD-93-52, Apr.  5, 1993). 


      AUDIT COVERAGE NEEDS TO BE
      MAINTAINED
-------------------------------------------------------- Chapter 4:1.2

Audits of taxpayers' books and records are the only way IRS can
detect noncompliance not covered by information returns.  For
example, payments made to corporations are not covered by information
returns reporting; thus, audits are necessary for detecting
unreported corporate income.  Similarly, to detect overstated
business expense deductions, such as depreciation and inventory
costs, IRS needs to audit taxpayers' records. 

IRS estimates that sole proprietors report about 80 percent of their
taxes while small corporations report 61 percent.  Further, the audit
rate for small corporations was 2.6 percent and 2.3 percent for sole
proprietors in 1992.  While these audit rates have increased in the
last 5 years, they are still about half of what they were in 1981. 
As part of any short-term compliance strategy to reduce the tax gap,
IRS cannot afford to allow current audit coverage to decrease,
particularly for taxpayer groups with compliance problems.  Audit
levels for other taxpayers, such as large corporations and
nonbusiness individuals, also need to be maintained. 

Existing TCMP data, including the audit workpapers, often provide
additional audit leads.  Currently, under its MSSP, IRS is developing
specialized audit programs by using more subjective data, such as the
judgment and experience of IRS examiners in a particular market
segment.  While this approach may identify some noncompliant
taxpayers, IRS does not know if other types of taxpayers are more
noncompliant. 

For example, IRS has created special audit guides to examine bed and
breakfast establishments.  However, IRS does not know whether these
establishments are more noncompliant than other types of hotel and
lodging places.  Given its limited audit resources, IRS needs to be
diligent in using these resources. 


      INCREASE COMPUTER MATCHING
-------------------------------------------------------- Chapter 4:1.3

IRS can reduce the tax gap by computer matching more of the tax data
it receives.  For example, IRS estimated that the 1992 tax gap for
income individuals received from partnerships, S corporations, and
estates and trusts exceeded $3 billion.  These types of tax entities
are required to submit Schedules K-1, which show each partner's,
shareholder's, or beneficiary's distributive share of the business's
or estate's income and expenses.  These distributions are reported by
recipients on their individual income tax returns.  According to IRS
data, about 31.5 million Schedules K-1 for tax year 1991 were
submitted.  However, data from less than 13 percent of them were
entered into IRS' computer for use in detecting potential nonfilers
or underreporters. 

Similarly, IRS could expand its computer matching of information that
taxpayers report on income tax returns when claiming dependent
exemptions.  IRS estimates that the tax gap for erroneous exemptions
for tax year 1992 exceeded $2 billion.  We reported in March 1993
that IRS does not enter in its computer all dependents' Social
Security numbers as reported on the tax returns.\2 As a result, IRS
cannot readily detect unallowable claims for dependent exemptions,
including erroneous Earned Income Tax Credit claims.  We estimated
that IRS could have increased tax year 1988 revenues by about $750
million if it had transcribed and matched Social Security numbers to
tax returns. 

We also believe that the tax gap associated with overstated business
expenses could be reduced if IRS computer-matched information returns
it receives.  IRS' most recent TCMP data show that small corporations
in 1987 and sole proprietors in 1988 overstated all business
deductions by an estimated $40 billion.  In an August 1993 report, we
found that if IRS were to match wages that employers reported on
Forms W-2 to the wage expenses deducted on small business income tax
returns, it could have identified some overstated wage expense
deductions, which IRS estimated to be $3.2 billion.\3 Given the $40
billion in overstated deductions from just small businesses,
significant benefits would likely emerge from expanding this reverse
matching concept beyond wages to include services and other
deductions--such as for forgiven debts. 

For each of these and other examples, the additional data
transcription, matching, and follow-up required will strain IRS'
existing budget and computer capacity to some extent.  However, as
TSM begins to increase IRS' computer capacity and more tax documents
are filed electronically, these pressures should be alleviated. 


--------------------
\2 Tax Administration:  Erroneous Dependent and Filing Status Claims
(GAO/GGD-93-60, Mar.  19, 1993). 

\3 Tax Administration:  Computer Matching Could Identify Overstated
Business Deductions (GAO/GGD-93-133, Aug.  13, 1993). 


      ESTABLISH COMPREHENSIVE
      PAYER COMPLIANCE PROGRAMS
-------------------------------------------------------- Chapter 4:1.4

Computer matching, as just discussed, is vital to detecting
noncompliance and reducing the need to do intrusive audits.  To be
effective, all required information returns need to be filed timely
and be complete and accurate.  To ensure that information returns are
filed, IRS needs a comprehensive and effective payer compliance
program. 

IRS' most recent TCMP data showed that sole proprietors and small
corporations failed to submit about 3.5 million Forms 1099
(Miscellaneous Income) totaling $16.4 billion for tax years 1988 and
1987, respectively.  These information returns are used for reporting
such income as nonemployee compensation (income received by certain
types of sole proprietors, such as independent contractors), rents,
royalties, and crop insurance proceeds.  IRS estimated that the 1992
tax gap associated with all types of sole proprietors, rents, and
royalties exceeded $34 billion. 

Some of this tax gap could be more readily identified if required
information returns were filed.  For example, for the tax year 1989
underreporter program, the most recent data available, matching
information returns on just one type of income--nonemployee
compensation payments--to individual tax returns produced $400
million in additional recommended tax assessments on 280,000
taxpayers. 

In 1984, IRS established a Payer Master File, which contains
information on the payer's name, address, and taxpayer identification
number, which is the Social Security number for an individual
taxpayer and an Employer Identification Number for a business
taxpayer.  It also shows the types of information returns filed and
whether the payer filed on paper or used magnetic media.  The purpose
of this file was to help IRS advise and educate payers about filing
requirements as well as identify payers who failed to file
information returns. 

IRS has used data from this file to identify payer noncompliance in
its audits.  For example, Payer Master File data that indicates that
a business did not file information returns provides the examiner
with a lead to examine business expenses for potential noncompliance
with the information returns filing requirements.  We reported in
1989 that examiners were not doing a very good job of identifying
unfiled information returns.\4 In about 50 percent of the 932
completed business return audits we reviewed, examiners did not
identify businesses that failed to file information returns. 

We believe that IRS could use the Payer Master File to establish an
ongoing computerized payer compliance program as we discussed in our
August 1993 reverse document matching report.\5 This report describes
how IRS could develop a computer matching program to identify
businesses that overstated business expense deductions, such as
wages.  We also noted that the match could identify businesses that
had not filed information returns on those expense deductions.  IRS
could then contact the business to determine whether information
returns should have been filed.  We believe that this could be a very
cost-effective way to identify noncompliant payers so that more
information returns can be used in computer matching programs. 


--------------------
\4 Tax Administration:  Missing Independent Contractors' Information
Returns Not Always Detected (GAO/GGD-89-110, Sept.  8, 1989). 

\5 GAO/GGD-93-133. 


      IMPROVE USE OF COLLECTION
      RESOURCES
-------------------------------------------------------- Chapter 4:1.5

IRS estimated that its enforcement programs have annually reduced the
gross remittance gap by 61 percent since 1981.  In other words, IRS
collects 61 cents of every delinquent tax dollar.  We believe that
IRS can further reduce this gap by adopting recommendations we made
in a May 1993 report.\6 For example, we pointed out that today's
competitive collection environment forces IRS to consider new
enforcement techniques, such as those used by private sector firms
and state tax departments. 

We recommended that IRS restructure its collection organization to
support earlier telephone contact with delinquent taxpayers and
determine how to use current collection staff in earlier, more
productive stages of the collection process.  We also recommended
that IRS develop detailed information on delinquent taxpayers to be
used to customize its collection procedures.  Lastly, IRS needs to
further cooperate with state tax departments to collect delinquent
taxes faster.\7

In another May 1993 report, we noted that collection staffing
imbalances kept IRS from maximizing its collection of delinquent tax
accounts or stemming the growth of its accounts receivables.\8 We
recommended that IRS develop a plan for ensuring that the collection
staff in field offices is balanced to maximize the assessment and
collection of delinquent accounts. 


--------------------
\6 Tax Administration:  New Delinquent Tax Collection Methods for IRS
(GAO/GGD-93-67, May 11, 1993). 

\7 We made similar recommendations in other reports.  See IRS'
Accounts Receivable Inventory (GAO/T-GGD-90-19, Feb.  20, 1990); and
Tax Administration:  Improving IRS' Business Nonfiler Program
(GAO/GGD-89-39, Mar.  8, 1989). 

\8 Tax Administration:  Improved Staffing of IRS' Collection Function
Would Increase Productivity (GAO/GGD-93-97, May 5, 1993). 


      VERIFY EARNED INCOME TAX
      CREDIT CLAIMS
-------------------------------------------------------- Chapter 4:1.6

In the past, the Earned Income Tax Credit (EITC) has been a
compliance problem.  The 1992 tax gap for EITC exceeded $1 billion. 
However, this gap could grow because of increases in the amount of
credit that taxpayers with children will be able to receive in
1994--up to $2,527 from $1,511 in 1993. 

To develop safeguards for the early identification of erroneous EITC
claims, IRS could determine the types of compliance problems that it
can expect.  To do this, IRS officials said they are doing a study in
which a random sample of EITC claims is audited early in the filing
season.  The results of this study should reveal whether taxpayers'
errors are unintentional (because they do not understand the
requirements) or intentional.  Once the results are known, IRS may be
able to change its processing procedures to better detect erroneous
claims. 

As noted earlier, one way IRS could detect erroneous claims is to
transcribe qualifying children's Social Security numbers into its
computers and cross-check to determine whether the numbers are valid
and the qualifying children are young enough. 


   WHAT CONGRESS CAN DO TO REDUCE
   THE TAX GAP
---------------------------------------------------------- Chapter 4:2

Several enforcement tools that IRS could use to address tax gap
issues require legislation.  The most important tools address
compliance among sole proprietors, primarily independent contractors,
and small corporations.  Together, these types of businesses
accounted for at least $37 billion, or 29 percent, of the estimated
$127 billion tax year 1992 tax gap.  Further, changes in information
reporting of capital gain income would help to reduce the estimated
$11.5 billion tax gap for this type of income.  Finally, changing the
definition of dependents will increase taxpayer compliance and help
reduce the $2.2 billion tax gap related to erroneous exemptions. 

In the past, Congress has given IRS additional resources to reduce
the tax gap, but these resources have not increased IRS' compliance
presence.  Even if Congress were to give IRS more enforcement
resources, IRS would still need better compliance data to know where
it can best use not only these additional resources but also existing
resources.  One approach, suggested by IRS, to funding compliance
efforts is to allow IRS to reinvest productivity gains from TSM into
its enforcement programs.  If IRS is allowed to do so, Congress may
want some assurance that IRS uses the productivity gains for
compliance. 


      CLARIFY INDEPENDENT
      CONTRACTOR ISSUES
-------------------------------------------------------- Chapter 4:2.1

IRS estimated that the $127 billion tax gap for 1992 included $30.2
billion created by unincorporated sole proprietors (informal
suppliers) that did not report all their business income.  Some part
of this segment of the tax gap is attributable to independent
contractors.  We have recommended that Congress consider requiring
tax withholding on payments made to independent contractors and more
information returns reporting on these payments.\9 IRS data show that
independent contractors report 97 percent of the income that appears
on information returns, while contractors who do not receive these
returns report only 83 percent. 

We also suggested that Congress could reduce some of this
noncompliance by simplifying the rules for determining whether
workers can be classified as employees or as independent contractors. 
The President's health care proposal contains a provision to allow
the Secretary of the Treasury to prescribe classification rules. 


--------------------
\9 Tax Administration:  Approaches for Improving Independent
Contractor Compliance (GAO/GGD-92-108, Jul.  23, 1992). 


      REQUIRE INFORMATION RETURN
      REPORTING ON PAYMENTS MADE
      TO CORPORATIONS
-------------------------------------------------------- Chapter 4:2.2

IRS estimated that the corporate portion of the $127 billion gross
tax gap was about $33 billion in tax year 1992, including about $7
billion for small corporations.  Since these estimates were made in
1988, IRS completed its small corporation TCMP, which showed that the
compliance level for small corporations decreased from 81 percent in
1980 to 61 percent in 1987.  Compliance of small corporations engaged
in service industries fell from 69 percent to 48 percent between 1980
and 1987.  In contrast, sole proprietors in the service sector had a
compliance level of over 85 percent. 

IRS officials contend, and we agree, that the primary reason for
these different compliance rates is that unlike payments made to sole
proprietors, payments made to corporations for services are not
required to be reported on information returns.  We have also
reported on the need for information reporting on payments of
investment-type income (e.g., interest and dividends) made to
corporations.\10

In 1993, the administration submitted legislation that would have
required information returns on payments made to service
corporations.  Treasury estimated that this legislative proposal
would increase revenues by about $5 billion over a 5-year period. 
However, the Joint Committee on Taxation estimated that the proposal
would raise about $365 million over 5 years.  The Senate did not pass
the proposed legislation because of the burden businesses said it
would impose on them. 

Requiring information return reporting on payments made to
corporations would impose additional costs on businesses.  No
estimates of these costs have been done.  However, compliant
businesses now either (1) issue information returns for all payments
or (2) assume some costs and burdens to track whether a payment
recipient is incorporated.  If the law were changed, some compliant
businesses would no longer have to do this tracking.  Instead, they
would use their existing information reporting systems to file
information returns on all corporate payments. 


--------------------
\10 Tax Administration:  Benefits of a Corporate Document Matching
Program Exceed the Cost (GAO/GGD-91-118, Sept.  27, 1991). 


      REQUIRE MORE DATA ON
      INFORMATION RETURNS DEALING
      WITH CAPITAL GAIN INCOME
-------------------------------------------------------- Chapter 4:2.3

IRS' TCMP data show that individuals and small corporations
significantly underreported their capital gains income by $25
billion.  In addition, capital gains represented an $11.5 billion
portion of the $127 billion tax gap for 1992.  IRS studies indicated
that much of this compliance problem comes from taxpayers overstating
their "basis" in the asset, which is the amount of money they
originally paid for it. 

Currently, businesses are required to report the sales price but not
the purchase price of stocks and bonds on information returns. 
However, IRS would need the purchase price of stock transactions to
cost effectively determine whether taxpayers properly reported their
capital gain income from these transactions.  This information would
allow IRS to establish a nonintrusive computer matching program to
check for compliance.  In order to verify capital gain income, IRS
currently has to audit taxpayers' books and records.  The downside to
requiring information returns reporting on the purchase price of
stocks and bonds is the additional burden this reporting requirement
may place on businesses. 


      CHANGE THE DEFINITION OF
      DEPENDENT
-------------------------------------------------------- Chapter 4:2.4

The tax gap associated with erroneous exemptions was $2.2 billion in
tax year 1992.  We found that the primary source of erroneous
dependent claims was the taxpayer's failure to meet the dependent
support test, which requires a taxpayer to provide over 50 percent of
a dependent's support to claim the exemption.\11 We believe that
replacing the support test with a much simpler residency test, which
is used to qualify children for the EITC, would substantially reduce
this noncompliance.  This change would also decrease taxpayer burden
and generally make the tax law conform with current taxpayer
behavior. 


--------------------
\11 GAO/GGD-93-60. 


      MORE DATA AND ASSURANCES
      COULD HELP MAKE COMPLIANCE
      RESOURCE DECISIONS
-------------------------------------------------------- Chapter 4:2.5

Each year Congress considers the level of resources IRS should
receive to improve compliance and stem the tax gap.  If IRS receives
the resources, the question becomes where should IRS invest them most
cost effectively. 

We asked IRS officials this question.  We received a range of general
ideas for using more resources, including hiring staff to audit more
tax returns and collect more delinquent accounts.  However, we
concluded that no one knows the relative priorities for investing
more compliance resources to reduce the tax gap.  IRS needs detailed
data on the types and amounts of noncompliance that contribute most
heavily to the tax gap.  Once IRS has such data, it can begin to
figure out what causes the noncompliance in an effort to devise
appropriate solutions.  To the extent that such data are consistently
and systematically collected across the country, IRS could enhance
its ability to sort out relative compliance priorities and decide
whether more resources are needed in the highest priority areas. 

As discussed earlier, IRS already has valid compliance data through
its TCMP surveys and is planning on doing a more comprehensive
survey.  To get more specific, detailed data on compliance to
supplement TCMP, IRS is attempting to develop CRIS as a computer
system for storing and analyzing compliance data from various
sources.  If IRS succeeds in getting more and better data and
developing CRIS, it will have the foundation we believe is needed for
making decisions on whether more resources are necessary and on where
such resources should be targeted. 

One approach suggested by IRS officials to providing more compliance
resources is to allow IRS to reinvest some gains in productivity from
implementing new computer systems through TSM.  As discussed earlier,
as TSM begins to allow IRS to automate work that has been done
manually, the affected staff will no longer be needed to do that
work.  In the past several years, the proposed budget for IRS assumed
reduced resources because of TSM productivity gains but requested
additional resources for compliance initiatives. 

For example, IRS' fiscal year 1994 budget included decreases of $55
million and 1,219 full-time equivalent positions because of
productivity gains from implementing systems as part of TSM.\12 The
same budget requested an additional $150 million for compliance
initiatives in an attempt to redirect resources to address tax gap
issues.  In essence, the decrease in the budget for productivity
gains offset a large part of the increase requested for compliance
initiatives. 

In our April 1993 testimony on IRS' fiscal year 1994 budget, we
cautioned that the estimated productivity gains may not be realized
and IRS' operating base may erode if the compliance initiatives are
not funded.  We cited staffing needs in IRS' computer matching
program as an example of a program harmed when implementation of a
new computer system led to the loss of staff due to unrealized
productivity savings. 

The persistent decline in audits and computer match cases and
increases in known tax delinquents may suggest that IRS needs more
compliance staffing.  IRS' suggestion that it be allowed to reinvest
productivity savings from TSM is one way to get additional
enforcement resources.  However, if Congress allows IRS to do this,
it should make sure that IRS uses the reinvested resources for
compliance purposes. 


--------------------
\12 Tax Administration:  IRS' Budget Request for Fiscal Year 1994
(GAO/T-GGD-93-23, Apr.  28, 1993). 


   WHAT IRS MUST DO TO REDUCE THE
   TAX GAP UNDER TSM
---------------------------------------------------------- Chapter 4:3

As IRS modernizes its computers and changes its way of doing
business, several actions would help it to take advantage of its new
capabilities in reducing the tax gap.  IRS could clean up its master
file records to help ensure that the data used in the new computer
systems are complete and accurate.  IRS could also review its tax
returns to determine whether the data necessary to cost effectively
identify noncompliance are captured. 


      CLEAN UP MASTER FILE RECORDS
      TO CREATE CROSS-REFERENCE
      FILES
-------------------------------------------------------- Chapter 4:3.1

An effective and efficient enforcement program needs accurate,
comprehensive, and readily accessible tax data.  The types of tax
data available dictate the compliance strategies that can be
effectively employed.  IRS currently has separate databases for each
particular type of tax entity.  For example, if a taxpayer is a sole
proprietor with several employees and has a pension plan, then the
taxpayer will have income tax return data on the Returns Transaction
File, tax account data on the Individual Master File, information
return data on the Payer and Information Returns Master Files,
employment tax data on the Business Master File, and pension data on
the Employee Plans Master File. 

Currently, these files have errors.  Further, IRS cannot
cross-reference these files to determine all compliance issues
associated with a taxpayer.  IRS believes that TSM can give it this
capability.  As discussed in chapter 3, IRS envisions having an
integrated case processing system that will allow the computer to
make various compliance checks (e.g., underreporter and nonfiler). 
This will allow all compliance issues for a taxpayer to be handled at
the same time.  However, IRS needs valid taxpayer data and
cross-reference files to do these checks.  To our knowledge IRS is
doing little to ensure that each taxpayer record has a valid taxpayer
identification number and that these records can be cross-referenced
to each other. 

Without clean taxpayer records and cross-reference files, IRS will
not have an effective integrated case processing system.  IRS will be
unable to create a comprehensive compliance case on the taxpayer,
making separate audits of a taxpayer's individual, corporate, and
partnership returns more likely.  An integrated system will enable
IRS to audit the taxpayer rather than the return, resulting in more
effective and timely audits. 


      DETERMINE DATA NEEDED FROM
      TAX RETURNS TO IDENTIFY
      NONCOMPLIANCE MORE READILY
-------------------------------------------------------- Chapter 4:3.2

Under TSM, IRS envisions entering all tax return data onto its
computers.  According to IRS, most returns will be either
electronically filed or scanned in order to convert the data into
computer-readable language by the turn of the century.  Currently,
about 50 percent of the tax return data on individual tax returns and
15 percent of business return data are manually transcribed on to
computers.  As a result, paper returns have to be reviewed to
determine whether enforcement action is warranted. 

One step that IRS should be taking now is to ensure that tax returns
capture the data needed for effective enforcement efforts.  Without
such data, IRS' enhanced data capabilities under TSM will be less
cost-effective.  For example, as we reported in July 1992, IRS does
not require sole proprietors to indicate on the Schedule C (Profit or
Loss From Business) the amount of payments they receive as
independent contractors.\13 Payers are required to report these
payments on Form 1099 (Miscellaneous Income).  If this information
were reported on Schedule C, IRS could computer match the total
amount of payments that independent contractors reported on Schedule
C with the information return amount to identify any unreported
income. 

A similar line could be added to partnership returns (Form 1065) to
verify nonemployee compensation these businesses receive.  If
Congress required information returns on payments made to
corporations, the corporate tax return would also need to be
modified. 

IRS could also have business taxpayers, including corporations,
indicate on their tax returns the number and amounts of information
returns they issued to noncorporate businesses for service payments
and other payments, such as for rent and interest.  This information
would serve as a reminder of the need to issue information returns on
certain types of payments.  The information would also help IRS check
business returns for payer compliance. 

IRS is reviewing tax returns and schedules to identify data now
required to be reported on returns but that can be eliminated from
the returns.  While making this review, IRS also needs to determine
whether collecting other data could help IRS detect noncompliance and
help taxpayers to comply. 


--------------------
\13 GAO/GGD-92-108. 


      VALIDATE TAXPAYERS'
      IDENTIFICATION NUMBERS
      SOONER
-------------------------------------------------------- Chapter 4:3.3

The tax gap for sole proprietors, many of whom are independent
contractors, is about $30 billion.  One way to reduce the sole
proprietor tax gap would be to quickly identify independent
contractors who give payers an incorrect TIN.  Quickly identifying
TINs would also be valuable for other payers, such as banks and
brokerage houses, that submit information returns on interest and
dividends paid to individuals.  These payments account for an
additional $4 billion of the tax gap. 

In fiscal year 1988, IRS received almost 1 billion information
returns.  Over 6 million of these were unmatchable because no TIN was
present or the TIN on the information return did not match the name. 
Currently, it takes IRS about 1 year to notify a payer that the wrong
TIN was submitted on an information return.  After this amount of
time, the independent contractor may no longer work for the business,
making it difficult or impossible for IRS to use the information
return in its underreporter or nonfiler programs. 

As we reported in September 1992, independent contractor TINs could
be verified more quickly if IRS had a system that would allow payers
to validate TINs via telephone, using technology similar to that used
to validate credit card purchases.\14 IRS is currently exploring a
limited application of this concept. 


--------------------
\14 Tax Administration:  Federal Agencies Should Report Service
Payments Made to Corporations (GAO/GGD-92-130, Sept.  22, 1992). 


      MORE USE OF STATE DATA
-------------------------------------------------------- Chapter 4:3.4

Since we issued our December 1985 report on IRS' use of state tax
data, IRS has been working with state tax administration offices to
make better use of state data.\15 For example, IRS' Fresno Service
Center is using California sales tax data to identify businesses that
failed to file federal tax returns.  In the past, IRS could not
efficiently use these records because the state sales tax records did
not contain taxpayers' Employer Identification Numbers (EIN).  Now
they do.  IRS officials told us that since 1992 the sales tax data
have helped IRS identify over 4,600 potential taxpayers who failed to
file federal returns with tax assessments of $81.5 million. 

By continuing to seek out compatible state and local databases, IRS
should be able to improve its ability to detect potential federal tax
noncompliance such as corporate nonfilers.  For example, one
potential data source is that maintained by state offices that
register corporations to do business in the state. 


--------------------
\15 Tax Administration:  The Federal/State Tax Information Exchange
Program (GAO/GGD-86-8, Dec.  13, 1985). 


   CONCLUSIONS
---------------------------------------------------------- Chapter 4:4

Just as the tax gap comprises many elements, strategies for reducing
it are many as well.  And while IRS needs more updated and precise
data to better target its resources, existing compliance data suggest
the relative sizes of various tax gap components.  Using these data,
we have issued many reports that recommended a number of approaches. 

Until IRS produces new compliance data and a comprehensive compliance
strategy, existing data could be used as part of an interim
compliance strategy that directs resources at the most noncompliant
taxpayers.  This interim strategy could, at a minimum, be geared to
maintaining current levels for audits, computer matching, and
delinquent tax collection.  The tax system cannot afford to have IRS
misdirect its enforcement resources to areas that will not improve
compliance. 

According to IRS' tax gap estimates and TCMP data, areas in which
substantial compliance improvements are possible include small
corporations and sole proprietors.  These businesses represent 29
percent or $37 billion of the $127 billion tax gap.  Their compliance
levels are also low--small corporations report about 61 percent of
the taxes they owe while sole proprietors report about 80 percent. 

IRS should focus resources on computer matching more tax return data. 
IRS data shows a $3 billion tax gap associated with individuals who
receive income from partnerships and similar tax entities.  IRS
should consider more computer matching of the documents received on
this type of income.  More computer matching for erroneous dependent
and Earned Income Tax Credit claims as well as certain business
deductions could also be done.  To make its document matching program
more effective, IRS could expand its use of the Payer Master File to
better ensure that all required information returns are filed. 

IRS can begin now to develop data to properly allocate its
collections resources and to try different collection techniques. 
For example, making earlier telephone contact with delinquent
taxpayers should speed up collections and prevent some accounts from
becoming uncollectible. 

If Congress required information returns on payments made to
corporations and simplified the independent contractor definition,
IRS could better attack business noncompliance.  Congress can also
help IRS reduce the tax gap by making sure IRS has appropriate and
accurate data on how to target compliance resources.  Further,
Congress could also act on IRS' suggestion to reinvest productivity
gains from TSM.  Before doing so, Congress may want assurance that
IRS will use these reinvested resources for compliance purposes. 

IRS could take several steps to take full advantage of TSM.  IRS
could clean up its taxpayer records and better integrate use of them
in enforcement efforts.  IRS could also review tax returns to ensure
that the data necessary to effectively and efficiently detect
noncompliance are collected. 


   RECOMMENDATIONS
---------------------------------------------------------- Chapter 4:5

This report makes no new recommendations.  Rather, this report
highlights prior recommendations that would help to reduce the income
tax gap. 


ESTIMATES OF THE TAX GAP AND
ENFORCEMENT REVENUE
=========================================================== Appendix I

This appendix shows estimates of individual and corporate tax gap
components for tax years 1981 and 1992 in both current and constant
dollars.  It also compares the overall tax gap estimate to IRS'
enforcement revenue for fiscal years 1987 through 1992. 



            Table I.1 Estimated Tax Gap by Source
            for 1981 and 1992, in Current Dollars

                    (Dollars in millions)

                              1981 tax gap      1992 tax gap
Description                         amount            amount
------------------------  ----------------  ----------------
Individual filers
 Wages and salaries                 $2,378            $1,919
Interest                             1,969             1,891
Dividends                            2,075             2,142
State tax refund                       127               102
Alimony                                124               253
Capital gains                        1,822            11,535
Form 4797                              217             1,264
Pensions and annuities                 456               144
Taxable unemployment                   107               388
Farm income                          2,350             1,909
Partnership income                   2,755             2,246
Small business                         912               729
 corporation
Estates and trusts                      49                73
Rents and royalties                  2,012             4,481
Nonfarm sole proprietors            18,714            30,173
Other income                         4,366             3,465
Taxable Social Security                  0                44
Adjustments to income                  752               694
Deductions                           3,540             3,889
Exemptions                           1,844             2,224
Credits                              1,313             1,274
Math errors                            487             1,521
Individual nonfiler tax              5,231            10,233
 gap
Individual remittance                8,300            11,400
 gap
============================================================
Total individual tax gap           $61,900           $93,994
Small corporation tax                4,461             6,999
 gap
Large corporation tax                8,638            23,716
 gap
Unrelated business
 income                                 56               218
 tax gap
Fiduciary tax gap                      111               202
Corporate remittance gap               800             2,000
============================================================
Total corporate tax gap            $14,065           $33,135
============================================================
Total tax gap\a                    $75,966          $127,129
------------------------------------------------------------
\a Totals may not add due to rounding. 

Source:  Income Tax Compliance Research, IRS Publication 1415. 



                          Table I.2
           
           Gross Tax Gap Estimates by Source of Tax
           Gap for Tax Years 1981 and 1992, in 1992
                           Dollars

                    (Dollars in millions)

                            1981 tax    1992 tax     Percent
Source of tax gap         gap amount  gap amount    increase
------------------------  ----------  ----------  ----------
Individual tax gap           $94,851     $93,994        -0.9
Unreported income             61,956      62,759         1.3
Sole proprietors              28,676      30,173         5.2
All other income              33,280      32,586        -2.1
Overstated deductions\a       11,414       8,081       -29.2
Individual nonfiler            8,016      10,233        27.7
Individual remittance         12,718      11,400       -10.4
 gap
Math errors                      746       1,521       103.9
Corporate tax gap             21,552      33,135        53.7
Small corporation              6,836       6,999         2.4
Large corporation             13,236      23,716        79.2
Others\b                         256         420        64.1
Corporate remittance gap       1,226       2,000        63.1
============================================================
Total tax gap\c             $116,988    $127,129         8.7
------------------------------------------------------------
\a Includes subtractions for erroneous deductions, exemptions,
credits, and other adjustments. 

\b Includes unreported income and overstated deductions for exempt
organizations' unrelated business income and for fiduciaries. 

\c Totals may not add due to rounding. 

Sources:  Income Tax Compliance Research, IRS Publication 1415
(7-88); and Income Tax Compliance Research:  Net Tax Gap and
Remittance Gap Estimates, IRS Research Division, Publication 1415
(4-90). 



                          Table I.3
           
            Tax Gap Estimates and Assessments and
             Collections by IRS, in 1992 Dollars

                    (Dollars in millions)

                          Examinatio  Collection    Computer
Year           Tax gap\a         n\b          \c  matching\c
------------  ----------  ----------  ----------  ----------
1987            $113,855     $19,754     $27,668      $3,914
1988             112,629      19,581      27,122       3,662
1989             114,483      17,843      26,176       5,490
1990             117,687      19,938      27,196       2,875
1991             122,418      27,961      24,920       3,007
1992             127,029      24,125      24,235       4,259
------------------------------------------------------------
\a Tax dollars only. 

\b Includes additional taxes and penalties. 

\c Includes additional taxes, interest, and penalties

Sources:  IRS Annual Report for 1992; Income Tax Compliance Research,
IRS Publication 1415 (7-88); and Tax Administration:  Trends for
Certain IRS Programs (GAO/GGD-93-102FS, May 26, 1993). 


SUMMARY OF SELECTED TAX
GAP-RELATED PRODUCTS ISSUED BY GAO
SINCE 1982
========================================================== Appendix II

This appendix summarizes the findings and recommendations from some
of the reports and congressional testimonies that we have published
since 1982 on issues related to the tax gap.  Our summary focuses on
our more recent products. 


      FURTHER RESEARCH INTO
      NONCOMPLIANCE IS NEEDED TO
      REDUCE GROWING TAX LOSSES
      (GAO/GGD-82-34, JULY 23,
      1982)
------------------------------------------------------ Appendix II:0.1

IRS estimated that the total tax revenue loss due to individual
noncompliance may have been as much as $97 billion for 1981.  We
found that IRS' audit program was not having the results intended. 
IRS had sacrificed substantial tax revenue in the audit and other
enforcement programs because of efforts to stimulate voluntary
compliance.  Also, IRS' management information systems did not
provide adequate data to optimally allocate resources within and
among its various compliance programs.  We recommended that IRS
provide cost and revenue data on compliance programs, identify
techniques for measuring and analyzing the effects of the compliance
programs, determine the overall effectiveness of its current
approach, reallocate compliance program resources using cost/revenue
data, and plan and budget each compliance program to maximize
revenue. 


      IRS NEEDS TO IMPROVE ITS
      EXAMINATION SELECTION
      PROCESS FOR EXEMPT
      ORGANIZATIONS HAVING
      UNRELATED BUSINESS INCOME
      (GAO/GGD-85-64, JULY 8,
      1985)
------------------------------------------------------ Appendix II:0.2

We found that IRS could have better identified and examined unrelated
business income (UBI) returns having the most potential for
noncompliance.  More revenue with fewer examinations could have
resulted.  We found that IRS lacked information to fully understand
the nature and magnitude of UBI tax noncompliance.  We recommended
that IRS take the necessary action to further analyze existing data
on UBI tax examinations and that information on all types of UBI
organizations and specific UBI activities be developed, collected,
and analyzed. 


      IRS NEEDS TO IMPROVE ITS
      REPORTING PROCEDURES FOR
      COMMODITY CREDIT LOAN AND
      CROP INSURANCE INCOME
      (GAO/GGD-86-69, JULY 22,
      1986)
------------------------------------------------------ Appendix II:0.3

We found that an estimated $53 million in crop loans and insurance
indemnity payments were not reported by the recipients on their 1982
and/or 1983 tax returns.  We recommended that IRS incorporate
commodity credit loan and crop insurance income into its document
matching program. 


      IRS NEEDS AN OVERALL
      STRATEGY FOR ADDRESSING TIP
      INCOME REPORTING
      (GAO/GGD-86-119, SEPT.  30,
      1986)
------------------------------------------------------ Appendix II:0.4

IRS estimated that the highest nonreporting rate among all legal
income areas was $8.5 billion in unreported tip income, with an
estimated revenue loss of $2.3 billion.  We recommended that IRS
identify and evaluate detection techniques and tools that have proven
effective in tip income reporting projects and design and implement
an overview and evaluation process to monitor the progress of tip
reporting enforcement activities. 


      IRS SHOULD ESTABLISH A
      BUSINESS INFORMATION RETURNS
      PROGRAM (GAO/T-GGD-87-4,
      MAR.  17, 1987)
------------------------------------------------------ Appendix II:0.5

We found that a document matching program could identify businesses
that underreport their income and/or fail to file tax returns.  We
recommended that IRS establish an information returns program within
existing IRS systems to identify businesses that underreport income
and/or do not file tax returns. 


      THE TAX GAP--DEFINITION,
      STUDIES, ASSUMPTIONS, AND
      COMPONENTS (GAO/GGD-88-66BR,
      MAR.  25, 1988;
      GAO/T-GGD-88-22, MAR.  31,
      1988)
------------------------------------------------------ Appendix II:0.6

Our overall analysis of IRS' 1988 tax gap study showed that IRS
excluded tax estimates for illegal source income and remittance
problems, changed the method for computing taxes on unreported
income, and assumed that compliance rates would remain constant.  We
showed a higher gap for 1987 than for 1973, a decreased tax gap from
1986 to 1987, and an increased tax gap from 1987 through 1992.  While
the tax gap is difficult to measure precisely, IRS' estimates showed
that it remained substantial.  We pointed out that in some of our
prior reports we found that IRS could help reduce the tax gap by
implementing a business document matching program, more actively
pursuing tax collection from closed criminal investigations, and
using better tip income detection methods. 


      OPPORTUNITIES EXIST FOR
      IMPROVING IRS'
      ADMINISTRATION OF ALIEN
      TAXPAYER PROGRAMS
      (GAO/GGD-88-54, APR.  11,
      1988)
------------------------------------------------------ Appendix II:0.7

Certain aliens are statutorily required to obtain compliance
certificates before leaving the country to document that they have
met their U.S.  tax responsibilities.  We found that IRS did not have
aggregate information on the number of certificates issued or amount
of tax collected.  We recommended that IRS collect information on the
number of certificates issued, the amount of tax collected, the
number of leads obtained from the Immigration and Naturalization
Service and results obtained, and the cost of administering alien
compliance efforts.  In addition, we recommended that IRS arrange to
have embassies distribute information on the potential tax
obligations of aliens, designate district office personnel to be
responsible for coordinating nonresident alien compliance efforts,
and revise the letter used to contact agents responsible for
withholding taxes from foreign entertainers to bring it into
conformity with current IRS forms and information. 


      INVESTIGATING ILLEGAL
      INCOME:  SUCCESS UNCERTAIN,
      IMPROVEMENTS NEEDED
      (GAO/GGD-88-61, APR.  25,
      1988)
------------------------------------------------------ Appendix II:0.8

For tax year 1981, IRS estimated that drug trafficking, gambling, and
prostitution accounted for $34 billion in unreported income and $9
billion in unpaid taxes.  IRS' Criminal Investigation Division did
not have information on key objectives, such as investigating major
criminals and pursuing tax revenues from completed cases.  We
recommended that IRS collect data on cases referred for tax
assessment or collection and tax revenues generated, require special
agents to consult with attorneys at the close of grand jury cases to
determine where information may be forwarded for civil action, and
establish district office programs to monitor the civil actions taken
by various IRS components on closed criminal cases. 


      IRS COULD REDUCE THE NUMBER
      OF UNPRODUCTIVE BUSINESS
      NONFILER INVESTIGATIONS
      (GAO/GGD-88-77, MAY 24,
      1988)
------------------------------------------------------ Appendix II:0.9

About 73 percent of the business nonfiler investigations in 1986 were
unproductive because IRS had issued more than one EIN, businesses did
not file required employment returns, and IRS did not update its
records on business filing requirements.  We recommended that IRS
adopt additional research techniques to identify businesses with
previously issued EINs, emphasize to businesses the importance of
filing quarterly employment tax returns, modify criteria for deleting
invalid employment tax filing requirements, and ensure that the
filing status determined from nonfiler investigations is accurately
recorded on the Business Master File. 


      IRS' EFFORTS TO ESTABLISH A
      BUSINESS INFORMATION RETURNS
      PROGRAM (GAO/GGD-88-102,
      JULY 22, 1988)
----------------------------------------------------- Appendix II:0.10

We found that a program that would match information returns for
income such as interest and dividend to tax returns filed by sole
proprietors, partnerships, and corporations was feasible.  We
recommended that IRS proceed as rapidly as possible with its efforts
to develop a business document matching program. 


      INFORMATION ON IRS' COMBINED
      ANNUAL WAGE REPORTING
      RECONCILIATION PROGRAM
      (GAO/GGD-89-21, DEC.  14,
      1988)
----------------------------------------------------- Appendix II:0.11

The purpose of the Combined Annual Wage Reporting Reconciliation
Program is to ensure that employers submit correct wage and tax
information to both IRS and the Social Security Administration.  IRS
identified 791,000 discrepancies with potential tax implications
between 1981 and 1986, of which 54 percent were resolved.  From 1981
to 1984, IRS assessed employers additional taxes, interest, and
penalties of $2.7 billion.  However, IRS abated almost $1.4 billion
of those assessments and collected almost $500 million, leaving an
uncollected amount of $800 million at the time of this report.  We
made no recommendations. 


      PERIODIC EVALUATION NEEDED
      IF IRS USES LEVIES TO
      COLLECT DEFERRED ACCOUNTS
      (GAO/GGD-89-34, FEB.  14,
      1989)
----------------------------------------------------- Appendix II:0.12

We found that in 1988, IRS developed a plan for taking a more active
approach to resolving deferred individual taxpayer accounts that
would involve annually levying taxpayer assets.  We also found
insufficient information for evaluating the cost-effectiveness of the
plan, which had not considered business deferred accounts.  We
recommended that IRS establish procedures for periodically evaluating
the program's effectiveness if IRS implements a levy program for
deferred accounts. 


      IMPROVING IRS' BUSINESS
      NONFILER PROGRAM
      (GAO/GGD-89-39, MAR.  8,
      1989)
----------------------------------------------------- Appendix II:0.13

We found that state employment tax information could be used to
identify erroneous taxpayer statements and to close investigations
involving businesses that owed no taxes.  We recommended that IRS
explore opportunities to use state employment tax information in
business nonfiler investigations and correct computer coding problems
so that employment tax publications are not sent to invalid
addressees.  IRS implemented these recommendations. 


      STATE AND LOCAL COMPLIANCE
      WITH IRS' INFORMATION
      REPORTING REQUIREMENTS
      (GAO/GGD-89-63, MAY 4, 1989)
----------------------------------------------------- Appendix II:0.14

We found that state and local governments were not complying with
IRS' requirements for filing information returns to report payments
made to independent contractors.  They often were not in compliance
because they did not understand IRS' requirements.  We recommended
that IRS establish an IRS focal point to assist state and local
governments and develop a program for monitoring and enforcing state
and local governments' information returns compliance.  IRS
implemented these recommendations. 


      IRS CAN IMPROVE THE PROCESS
      FOR COLLECTING 100-PERCENT
      PENALTIES (GAO/GGD-89-94,
      AUG.  21, 1989)
----------------------------------------------------- Appendix II:0.15

We found that IRS can assess 100-percent penalties more efficiently
and effectively.  We recommended that IRS improve the processing of
100-percent penalty cases and improve internal controls. 


      OPTIONS FOR CIVIL PENALTY
      REFORM (GAO/GGD-89-81, SEPT. 
      6, 1989)
----------------------------------------------------- Appendix II:0.16

We provided information on various civil tax penalties and analyzed
proposals to respond to concerns about those penalties.  We
recommended that Congress establish a time-sensitive failure to file
penalty for all delinquent taxpayers.  We also recommended that
Congress should (1) ensure that any legislation enacted should
maintain and enhance the value of penalties in deterring
noncompliance, (2) consider setting higher penalty rates, and (3)
increase return preparer penalties. 


      MISSING INDEPENDENT
      CONTRACTORS' INFORMATION
      RETURNS NOT ALWAYS DETECTED
      (GAO/GGD-89-110, SEPT.  8,
      1989)
----------------------------------------------------- Appendix II:0.17

We found that IRS audits of business tax returns did not effectively
identify businesses that failed to file information returns for
payments made to independent contractors.  In the closed audits,
revenue agents did not identify 1,261 information returns that 467
businesses should have filed, involving $6.2 million in payments. 
IRS procedures for doing compliance checks were vague, and data that
could help check compliance were not used. 

We recommended that IRS improve compliance checks of information
reporting by (1) requiring that field managers and quality reviewers
stress the importance of compliance checks, enforce workpaper
standards, and assess the effectiveness of the checks; (2)
establishing minimum requirements for agents in doing compliance
checks; and (3) requiring that businesses' information return filings
be made available to agents.  IRS agreed to stress the importance of
the checks as well as provide more information to the revenue agents. 


      INFORMATION RETURNS CAN BE
      USED TO IDENTIFY EMPLOYERS
      WHO MISCLASSIFY WORKERS
      (GAO/GGD-89-107, SEPT.  25,
      1989)
----------------------------------------------------- Appendix II:0.18

We found that IRS needs a system for identifying employers who
misclassify employees as independent contractors.  We recommended
that IRS identify employers who are misclassifying employees as
independent contractors.  To target audit resources better, IRS
should match independent contractors' information returns with their
tax returns.  We also suggested that Congress may want to consider
repealing the restriction against requiring employers to
prospectively reclassify employees who have been misclassified as
independent contractors.  IRS adopted our recommendation. 


      IRS CAN USE TAX GAP DATA TO
      IMPROVE ITS PROGRAMS FOR
      REDUCING NONCOMPLIANCE
      (GAO/GGD-90-53BR, APR.  4,
      1990; AND GAO/T-GGD-90-32,
      APR.  19, 1990)
----------------------------------------------------- Appendix II:0.19

IRS estimated the gross tax gap to be $85 billion in 1987 and
projected that it would reach $114 billion by 1992.  Sole
proprietors, informal suppliers, small corporations, and large
corporations accounted for over half of IRS' estimate.  We found that
sole proprietors underpaid 23 percent of their tax liability, income
from informal suppliers was not documented, and noncompliance by
small corporations was equally divided between underreported income
and overstated deductions.  Noncompliance among large corporations
involved improper accounting of reported income and deductions. 

We also found that IRS did not design its major enforcement programs
to specifically reduce the tax gap.  As a result, such programs had
limited impact in reducing the tax gap.  Further, IRS examined only 1
percent of individual returns and 2 percent of corporate returns,
could not match all information returns, and lacked resources to
investigate all underreporting identified by matching.  We cited
several ideas for improving enforcement:  Use information returns to
identify employers who misclassify workers as independent
contractors, develop a business document matching program, get help
from state and local authorities to verify that federal tax returns
have been filed by informal suppliers, and expand the use of
information reporting and withholding. 


      ERRONEOUS PENALTIES FOR
      FAILURE TO FILE RETURNS OR
      PAY TAXES CAN BE REDUCED
      (GAO/GGD-90-80, APR.  13,
      1990)
----------------------------------------------------- Appendix II:0.20

We found that statistics on assessment and abatement decisions
relating to civil tax penalties for failing to file a timely tax
return and failing to pay taxes due overstated the number and dollar
value of actual abatements.  We recommended that IRS tax examiners
document their penalty abatement cases, isolate and delete changes
that are merely computer adjustments, and clarify the requirements
for coding tax returns. 


      STATUS OF IRS' TEST OF A
      BUSINESS INFORMATION RETURNS
      PROGRAM GAO/GGD-90-38, MAY
      29, 1990
----------------------------------------------------- Appendix II:0.21

IRS developed an action plan to test the feasibility of developing a
business document matching program similar to its program for
individual taxpayers.  At the conclusion of IRS' test, we found a
slight variance in the "success rate" for identifying delinquent
returns.  As a result, IRS agreed to explore how to use information
returns to supplement its current program to identify business
nonfilers. 


      CORRECTING TAXPAYER
      IDENTIFICATION IS POSSIBLE
      WITHOUT DISCLOSING TAX DATA
      (GAO-GGD-90-90, JUNE 5,
      1990)
----------------------------------------------------- Appendix II:0.22

As part of IRS' Information Returns Program, banks and other
financial institutions file information returns reporting interest
and dividend income paid to individuals.  IRS was unable to match
over $10 billion of interest and dividend information returns for
calendar year 1988 because the name and/or identification number did
not match information in either Social Security or IRS files.  We
recommended that IRS encourage financial institutions to obtain
information about name changes not reported to Social Security. 


      IRS NEEDS MORE RELIABLE
      INFORMATION ON ENFORCEMENT
      REVENUES (GAO/GGD-90-85,
      JUNE 20, 1990)
----------------------------------------------------- Appendix II:0.23

We found that IRS did not know how much revenue its enforcement
programs actually generated.  The Enforcement Resource Allocation
Model was not being used as intended.  We recommended that Congress
monitor IRS' progress in improving its enforcement revenue data.  We
also recommended that IRS provide Congress with information on actual
revenues generated by its enforcement programs and explore ways to
link revenue data with proposed staffing increases. 


      MANAGEMENT MISTAKES CAUSED
      DELAYS IN AUTOMATED
      UNDERREPORTER SYSTEM
      (GAO/IMTEC-90-51, JULY 10,
      1990)
----------------------------------------------------- Appendix II:0.24

IRS' Automated Underreporter System was intended to help IRS process
cases in which taxpayers underreported their income.  We found that
IRS officials' haste to complete the system led them to use
incomplete system designs and shortcut important system development
steps.  These problems, compounded by a lack of technical expertise,
delayed the implementation of the system.  To compensate for delays,
IRS developed an interim system to track the locations of
underreporters and planned to deploy the system to all service
centers by the end of 1990.  We recommended that IRS might want to
use the interim system as the starting point for completing the full
system.  In addition, IRS needed to verify staffing needs, establish
realistic milestones, and assign experienced technical staff to key
positions. 


      INFORMATION ON IRS' ACCOUNTS
      RECEIVABLE INVENTORY
      (GAO/T-GGD-90-19, FEB.  20,
      1990; GAO/GGD-90-111FS, JULY
      30, 1990; AND
      GAO/T-GGD-90-60, AUG.  1,
      1990)
----------------------------------------------------- Appendix II:0.25

IRS' accounts receivable grew three times faster than collections of
delinquent taxes and twice as fast as total net tax receipts.  We
found that IRS lacked internal controls and information systems to
determine how much of the inventory could be collected.  We discussed
the need for IRS to focus on existing accounts, possibly increase
collection staffing levels, and improve human resources. 


      IRS PREPARER PENALTY DATA
      INACCURATE AND MISLEADING
      (GAO/GGD-90-92, AUG.  15,
      1990)
----------------------------------------------------- Appendix II:0.26

We found that statistics on return preparer penalties did not
accurately reflect preparer noncompliance with the tax laws.  The
data understated the number of penalties, did not distinguish among
penalties assessed for different types of noncompliance, and
contained erroneous data.  We recommended that IRS ensure that its
statistics more accurately reflect preparer penalty activity. 


      IRS' IMPROVED ESTIMATES OF
      TAX EXAMINATION YIELD NEED
      TO BE REFINED
      (GAO/GGD-90-119, SEPT.  5,
      1990)
----------------------------------------------------- Appendix II:0.27

We found problems with the methodology that IRS used to estimate the
additional revenues generated from increasing examination staff.  We
recommended that IRS develop empirical data to show whether hiring
new staff allows more experienced staff to work on high-yield cases. 


      IRS' ACCOUNTS RECEIVABLE
      INVENTORY (GAO/GGD-91-2,
      OCT.  18, 1990; AND
      GAO/GGD-91-45, APR.  16,
      1991)
----------------------------------------------------- Appendix II:0.28

We found that taxpayer or IRS errors accounted for a high number of
erroneous receivables from federal agencies in its accounts
receivable inventory.  Erroneous receivables could be reduced through
improvements to the tax deposit system and IRS' accounting and
information processing systems.  We recommended that Treasury
undertake a governmentwide program to improve federal agency tax
processing and develop methods to improve accountability among top
agency management. 


      EXTENT AND CAUSES OF
      ERRONEOUS LEVIES
      (GAO/GGD-91-9, DEC.  21,
      1990)
----------------------------------------------------- Appendix II:0.29

We found that IRS had initiated more than 16,000 erroneous levies and
erroneously levied the assets of businesses to a much greater extent
than those of individuals.  We recommended that IRS establish a
nationwide levy verification program. 


      EFFECTIVENESS OF IRS' RETURN
      PREPARER PENALTY PROGRAM IS
      QUESTIONABLE (GAO/GGD-91-12,
      JAN.  7, 1991)
----------------------------------------------------- Appendix II:0.30

We found that IRS examiners were reluctant to pursue return preparer
penalties because of the low dollar value of the penalties, and cases
were often not opened when potential preparer misconduct was evident
on returns.  We recommended that IRS be more diligent in opening
preparer penalty cases, assess them appropriately and consistently,
and make referrals when required. 


      IRS' COMPLIANCE PROGRAMS TO
      REDUCE THE TAX GAP
      (GAO/T-GGD-91-11, MAR.  13,
      1991)
----------------------------------------------------- Appendix II:0.31

IRS estimated the gross tax gap to be $85 billion for 1987 and
projected that it would reach $114 billion by 1992.  IRS' estimates
showed that nonfilers and underreporters accounted for $7 billion and
$48 billion, respectively, of the 1987 tax gap.  We found that IRS
could use information returns better to pursue people who do not file
a tax return or who underreport income.  IRS could also improve its
computer matching of information returns with tax returns to reduce
unproductive underreporter cases. 


      IRS DOES NOT INVESTIGATE
      MOST HIGH-INCOME NONFILERS
      (GAO/GGD-91-36, MAR.  13,
      1991)
----------------------------------------------------- Appendix II:0.32

We found that IRS could investigate high-income nonfilers and could
do so more effectively by using the Substitute for Return Program. 
We recommended that IRS estimate tax yields for high-income
nonfilers, modify the Substitute for Return Program to include
high-income nonfilers, and develop a system to check delinquent
high-income returns.  IRS took actions on all of our recommendations. 


      IRS CAN IMPROVE ITS PROGRAM
      TO FIND TAXPAYERS WHO
      UNDERREPORT THEIR INCOME
      (GAO/GGD-91-49, MAR.  13,
      1991)
----------------------------------------------------- Appendix II:0.33

We found that IRS' underreporter program had been cost-effective but
could have been more so.  From 1982 to 1988, the percent of
nationwide underreporter cases that were unproductive had increased
from 54 percent to 66 percent.  We recommended that IRS make its
computer matching more effective. 


      IRS' BUDGET REQUEST FOR
      FISCAL YEAR 1992
      (GAO/T-GGD-91-17, MARCH 20,
      1991)
----------------------------------------------------- Appendix II:0.34

The fiscal year 1992 budget request for IRS totaled $6.73 billion, a
net increase of $622 million over the authorized level for fiscal
year 1991.  Because of the more stable fiscal condition in 1991, IRS
would be able to more fully implement congressionally authorized
compliance initiatives.  The most significant compliance initiative
proposed in the budget request for fiscal year 1992 provided an
additional $34 million for IRS to collect delinquent accounts. 
Another initiative provided $5.5 million to increase the number of
audits of high-dollar returns. 


      EXPANDED REPORTING ON
      SELLER-FINANCED MORTGAGES
      CAN SPUR TAX COMPLIANCE
      (GAO/GGD-91-38, MAR.  29,
      1991)
----------------------------------------------------- Appendix II:0.35

As much as $200 million in 1989 federal taxes may not have been
reported because of noncompliance in reporting seller-financed
mortgage interest income and deductions.  We found that third-party
information reports might help increase taxpayer compliance with the
requirements for reporting interest payments made under
seller-financed mortgages.  We recommended that Congress enact
legislation to require buyers who deduct seller-financed mortgage
interest to report the name and Social Security number of the seller,
and authorize IRS to penalize buyers and sellers who do not
cooperate.  Congress enacted this legislation. 


      IRS' EFFORTS TO ENSURE
      CORPORATE TAX COMPLIANCE
      (GAO/T-GGD-91-21, APR.  17,
      1991)
----------------------------------------------------- Appendix II:0.36

The corporate tax gap has grown three times faster than that for
individuals.  IRS estimated that corporations accounted for $31
billion of the $114 billion estimated tax gap for 1992. 
Long-standing problems have challenged IRS' ability to check
voluntary compliance among large corporations through audits. 


      REFUND OFFSET PROGRAM
      BENEFITS APPEAR TO EXCEED
      COSTS (GAO/GGD-91-64, MAY
      14, 1991)
----------------------------------------------------- Appendix II:0.37

We found that IRS offset about $4 billion in taxpayer refunds during
1982 through 1990 for the nonpayment of child and spousal support
payments and student loans.  We evaluated the effects of the refund
offset program on filing behavior of student loan defaulters and
compared the program's benefits resulting from increased debt
collection with the program's costs of increased noncompliance.  The
refund offset program had a less adverse effect on tax compliance
than suggested by IRS studies.  The debt collected from the offset
was at least four times greater than the potential revenue loss.  We
recommended that IRS carry out its plans for future studies of the
refund offset program. 


      IRS NEEDS TO IMPLEMENT A
      CORPORATE DOCUMENT MATCHING
      PROGRAM (GAO/T-GGD-91-40,
      JUNE 10, 1991); AND
      (GAO/GGD-91-118, SEPT.  27,
      1991)
----------------------------------------------------- Appendix II:0.38

In 1987, small corporations reported only 61 percent of the taxes
they owed--a 25-percent drop from 1980, when they reported 81
percent.  Audit coverage also declined.  In 1990, IRS audited about
2.6 percent of all corporations compared with 6.5 percent in 1980. 
We found that a limited corporate document matching program involving
interest, dividends, rents, royalties, and capital gains would
generate about $1 billion in revenue.  We said that Congress needs to
pass legislation that would require payments to corporations be
reported on information returns and to appropriate the necessary
funds for IRS to implement the program.  Congress has considered but
has not enacted this legislation. 


      COLLECTING BACK TAXES:  IRS
      PHONE OPERATIONS MUST DO
      BETTER (GAO/IMTEC-91-39,
      JUNE 18, 1991)
----------------------------------------------------- Appendix II:0.39

We found that Automated Collection Sites (ACS) were not working as
well as they should have been.  Specifically, calls were not placed
to taxpayers when they might be at home, and ACS staff spent too much
time on things other than working on tax cases.  We recommended that
at all ACS call sites IRS automate outgoing calls, automate receiving
and directing incoming calls, and standardize hours of operation.  We
also recommended that IRS evaluate the performance of call sites. 


      MANAGEMENT CHALLENGES FACING
      IRS (GAO/T-GGD-91-20, JUNE
      25, 1991)
----------------------------------------------------- Appendix II:0.40

We found that IRS' workload has continued to grow each year.  It
included assisting over 70 million taxpayers, processing over 200
million tax returns and related documents, collecting and accounting
for over $1 trillion in revenues, narrowing a $100 billion a year tax
gap, and dealing with a growing accounts receivable inventory that
was pushing $100 billion.  We concluded that a new balance could be
struck between traditional compliance activities and more
preventative approaches, such as tax law simplification and expanded
information reporting, to improve compliance in a more cost-effective
manner. 


      NEGLIGENCE AND SUBSTANTIAL
      UNDERSTATEMENT PENALTIES
      POORLY ADMINISTERED
      (GAO/GGD-91-91, JULY 3,
      1991)
----------------------------------------------------- Appendix II:0.41

We found that about one-third of penalties for negligence and
substantial understatement contained erroneous penalty determinations
because IRS generally was too lenient.  We recommended that IRS
establish a National Quality Improvement Project to examine problems
we identified; determine the effectiveness of solutions through a
subsequent review of audit cases both with and without penalty
assessments; and take actions to ensure that taxpayers are provided
with explanations of penalties assessed. 


      EFFORTS TO PREVENT,
      IDENTIFY, AND COLLECT
      EMPLOYMENT TAX DELINQUENCIES
      (GAO/GGD-91-94, AUG.  26,
      1991)
----------------------------------------------------- Appendix II:0.42

Over two-thirds of all federal tax revenue is collected through
employment taxes ($707 billion of the $1 trillion in federal gross
tax receipts).  We found that at the end of fiscal year 1990,
delinquent employment taxes accounted for about $29.7 billion, or 31
percent, of the $96.3 billion accounts receivable balance.  We
recommended that IRS develop a comprehensive plan to prevent,
identify, and collect employment tax delinquencies.  We also said
that IRS should designate an official to oversee the function. 


      OPPORTUNITIES TO INCREASE
      REVENUE BEFORE EXPIRATION OF
      THE STATUTORY COLLECTION
      PERIOD (GAO/GGD-91-89, SEPT. 
      30, 1991)
----------------------------------------------------- Appendix II:0.43

Annual write-offs of assessed taxes and assessed interest and
penalties from IRS' two major master files--individual and
business--grew from $2.3 billion to $4.6 billion between fiscal years
1986 and 1990.  We found a substantial amount of accounts receivable
that remained outstanding at the end of each year.  We recommended
that IRS develop more specific information on accounts written off,
systematically collect and analyze review results on accounts
classified as uncollectible, and send reminder notices to taxpayers
with accounts in the queue awaiting investigation. 


      EARNED INCOME CREDIT: 
      ADVANCE PAYMENT OPTION IS
      NOT WIDELY KNOWN OR
      UNDERSTOOD BY THE PUBLIC
      (GAO/GGD-92-26, FEB.  19,
      1992)
----------------------------------------------------- Appendix II:0.44

Congress enacted EITC to assist low-income wage earners, offset the
effects of Social Security taxes they paid, and encourage these
workers to seek employment.  When advance payments were made, they
did not appear to impose a major burden on employers.  We found that
out of an estimated 8,000 individuals who filed returns and received
the advance payment, almost half did not report that receipt on their
tax returns.  We recommended that IRS send a notice to individuals
who did not file a return, explaining their requirement to file.  We
also recommended that IRS explore ways to identify those individuals
who claim EITC in advance, but do not report it, to keep them from
receiving additional credit amounts. 


      FEDERAL CONTRACTOR TAX
      DELINQUENCIES
      (GAO/T-GGD-92-23, MAR.  17,
      1992)
----------------------------------------------------- Appendix II:0.45

IRS records showed that federal contractors owed $773 million in
taxes as of July 1991.  Over one-quarter of the 26,000 federal
contractors we reviewed were delinquent on IRS' records either for
the payment of taxes or the filing of tax returns.  IRS had not
developed procedures to fully use the information received on federal
contracts and had no procedure to ensure all required information was
properly reported.  We found that IRS had not fully used contract
payments as a means to collect delinquent taxes. 

We recommended that IRS establish a mechanism to ensure that federal
agencies report all required information on federal contracts, work
with federal agencies to ensure all information is shared, and
complete the project that shows IRS staff how to use federal contract
information.  We also recommended that Congress expressly authorize
IRS to use administrative offsets and consider whether tax compliance
should be made a prerequisite to the award of federal contracts. 


      COMPLIANCE 2000:  A WORTHY
      IDEA THAT NEEDS EFFECTIVE
      IMPLEMENTATION
      (GAO/T-GGD-92-48, JUNE 3,
      1992)
----------------------------------------------------- Appendix II:0.46

Compliance 2000 is IRS' most recent effort to improve voluntary
compliance with the tax laws.  However, IRS has not yet developed a
structure for planning, managing, and monitoring the program to
ensure it remains focused and objective.  TCMP has not been
integrated with Compliance 2000 to provide objective data on
noncompliance and measure IRS' effectiveness, and IRS has not yet
determined how Compliance 2000 will affect the already low audit
rates.  We recommended that IRS develop a structure for planning,
managing, and evaluating Compliance 2000; integrate Compliance 2000
efforts with TCMP to ensure statistically based measures of
compliance; and ensure that Compliance 2000 efforts do not erode
already low audit rates. 


      MONEY LAUNDERING FORMS COULD
      BE USED TO DETECT NONFILERS
      (GAO/T-GGD-92-56, JUNE 23,
      1992)
----------------------------------------------------- Appendix II:0.47

Businesses must file Form 8300 with IRS for any cash payment received
that exceeds $10,000.  The forms include the name, address, and tax
identification number of the purchaser.  We tested a sample of 1,000
forms.  Over one-third were of little or no use for identifying
nonfilers because they either had no tax identification number or a
number that may have been incorrect.  IRS did not use the forms to
identify potential nonfilers until tax year 1991. 


      INDEPENDENT CONTRACTOR
      COMPLIANCE (GAO/GGD-92-108,
      JULY 23, 1992); AND
      GAO/T-GGD-92-63, JULY 23,
      1992)
----------------------------------------------------- Appendix II:0.48

IRS' Employment Tax Examination Program focuses on small business
compliance with the common law rules for classifying workers as
either "employees" or "independent contractors" (self-employed
individuals who provide services).  We found that common law rules
for classifying workers remain unclear and subject to conflicting
interpretations.  IRS estimated that self-employed individuals
(including independent contractors) would underpay $20.3 billion in
1992 taxes by not reporting income.  We recommended that Congress
clarify the rules for classifying workers.  We also recommended that
Congress should consider legislation to improve independent
contractor compliance through withholding and/or improved information
reporting.  Congress has considered various legislative proposals
along these lines but has not enacted any of them. 


      FEDERAL AGENCIES SHOULD
      REPORT SERVICE PAYMENTS MADE
      TO CORPORATIONS
      (GAO/GGD-92-130, SEPT.  22,
      1992)
----------------------------------------------------- Appendix II:0.49

Federal agencies awarded $68 billion for service contracts.  Because
information reporting generally excludes payment to corporations,
federal agencies did not have to inform IRS of $61 billion in
payments.  We recommended that the Office of Management and Budget
(OMB) require that agencies issue information returns on payments to
corporations providing services, validate TINs of those contractors
before the first payment is made, withhold 20 percent of contract
payments to contractors providing invalid TINs, and certify annually
that the required information returns on payment have been issued. 
OMB established a pilot test, in concert with IRS and other federal
agencies, to improve federal compliance in issuing information
returns and validating TINs. 


      IRS CAN IMPROVE CONTROLS
      OVER ELECTRONIC FILING FRAUD
      (GAO/GGD-93-27, DEC.  30,
      1992)
----------------------------------------------------- Appendix II:0.50

IRS can improve its screening of electronic filing applicants by
using a national database that has information on federal, state, and
local criminal convictions.  We found that IRS has problems detecting
questionable returns and stopping fraudulent refunds.  We recommended
that IRS improve the processes for preventing the filing of
fraudulent electronic tax returns and for detecting fraudulent
returns during service center processing. 


      OPPORTUNITIES TO INCREASE
      THE USE OF ELECTRONIC FILING
      (GAO/GGD-93-40, JAN.  22,
      1993)
----------------------------------------------------- Appendix II:0.51

We found that IRS needs to develop a strategy for making electronic
filing more appealing and available to a wider population.  We also
found that IRS needs to address various operational issues that could
enhance the appeal of electronic filing and help taxpayers more fully
realize its available benefits.  We recommended that IRS take steps
to increase electronic filing of individual income tax returns by
assessing the feasibility of letting taxpayers file through their
personal computers.  We also recommended that IRS should determine
tax forms and schedules that could be added to the list of documents
that can be filed electronically. 


      INFORMATION RETURNS CAN
      IMPROVE REPORTING OF
      FORGIVEN DEBTS
      (GAO/GGD-93-42, FEB.  17,
      1993)
----------------------------------------------------- Appendix II:0.52

We found that 1 percent of taxpayers voluntarily reported forgiven
debts when they had no information returns compared to 48 percent
when they had information returns.  By matching the information
returns, IRS determined that another 20 percent failed to report
their forgiven debt income and owed taxes for 1986.  We recommended
to Congress that it require the Federal Deposit Insurance Corporation
and Resolution Trust Corporation to issue information returns on
forgiven debts that exceed $600 and include the date of the
compromised or charged-off debt on the return.  We also recommended
that if Congress enacts related legislation, IRS should use the
information returns on forgiven debts in its enforcement programs. 
Both Congress and IRS acted on our recommendations. 


      ERRONEOUS DEPENDENT AND
      FILING STATUS CLAIMS
      (GAO/GGD-93-60, MAR.  19,
      1993)
----------------------------------------------------- Appendix II:0.53

We found that the dependent support test was too complex and
burdensome for many taxpayers to voluntarily comply with; about 73
percent of dependent claims failed to meet the dependent support
test.  We recommended that Congress consider enacting legislation
that would substitute a residency test for the support test and
consider eliminating the household maintenance test from head of
household filing status.  We recommended that IRS correct the
problems in its limited matching program and implement a 100-percent
computer matching program to identify erroneous dependent claims. 
Neither Congress nor IRS has yet implemented our recommendations. 


      IRS' PLAN TO MEASURE TAX
      COMPLIANCE CAN BE IMPROVED
      (GAO/GGD-93-52, APR.  5,
      1993)
----------------------------------------------------- Appendix II:0.54

IRS was planning to change the scope of TCMP audits, which would have
reduced TCMP's value.  We found that if IRS did fewer audits and did
not examine every tax return line, estimates of voluntary compliance
would be less precise.  We recommended that IRS not implement the
proposed TCMP changes; ensure that any proposed changes to TCMP meet
four criteria (measure compliance, allow IRS to select returns for
audit, support enforcement programs, and meet the needs of various
users); shorten the time needed to produce final TCMP results; and
not postpone the next TCMP beyond tax year 1993 returns.  IRS agreed
to postpone the changes we reviewed and to ensure that any changes to
TCMP will meet our four criteria.  IRS plans to do the next TCMP for
tax year 1994. 


      IMPROVED STAFFING OF IRS'
      COLLECTION FUNCTION WOULD
      INCREASE PRODUCTIVITY
      (GAO/GGD-93-97, MAY 5, 1993)
----------------------------------------------------- Appendix II:0.55

IRS has faced a continually growing workload of delinquent taxpayers
but has not allocated its Collection field staff to ensure that each
field office has the appropriate number of staff.  While IRS
recognized that some offices have staffing imbalances, it has not
identified the full extent of the imbalances and has not been able to
rectify those imbalances because of its informal policies.  We
recommended that IRS develop a plan for ensuring that the Collection
staff in field offices is balanced to maximize the assessment and
collection of delinquent taxes.  We also recommended that IRS
reconsider its decision to not transfer Collection staff among field
offices. 


      IMPROVEMENTS FOR MORE
      EFFECTIVE TAX-EXEMPT BOND
      OVERSIGHT (GAO/GGD-93-104,
      MAY 10, 1993)
----------------------------------------------------- Appendix II:0.56

We found that IRS has not used tax-exempt bond return information to
monitor issuers' compliance and IRS' plan for improving its
tax-exempt bond oversight does not provide a clear direction for
integrating tax-exempt bond efforts throughout IRS.  We recommended
that IRS partially redirect existing Expanded Bond Audit Program
efforts to include active testing of current market compliance,
identify and make better use of information to detect noncompliance,
and develop and implement a plan to guide efforts throughout IRS to
make more effective use of resources to promote voluntary compliance
in the tax-exempt bond industry. 


      NEW DELINQUENT TAX
      COLLECTION METHODS FOR IRS
      (GAO/GGD-93-67, MAY 11,
      1993)
----------------------------------------------------- Appendix II:0.57

We found that IRS and state tax departments currently cooperate in
many tax administration projects, but only 10 percent of these
projects are directly related to tax collection.  We also found that
IRS competes with private collection companies and state governments
for payments from debtors.  We recommended that IRS restructure its
collection organization to support earlier telephone contact, develop
detailed information on delinquent taxpayers, use the information to
customize collection procedures, and identify and implement ways to
increase cooperation with state governments in collecting delinquent
taxes. 


      IRS ACTIVITIES TO INCREASE
      COMPLIANCE OF OVERSEAS
      TAXPAYERS (GAO/GGD-93-93,
      MAY 18, 1993)
----------------------------------------------------- Appendix II:0.58

We found that IRS still cannot measure the full extent of overseas
noncompliance because it has limited information about Americans
living overseas.  IRS did not collect significant additional federal
tax revenues in three overseas enforcement initiatives that we
studied. 


      TRENDS FOR CERTAIN IRS
      PROGRAMS (GAO/GGD-93-102FS,
      MAY 26, 1993)
----------------------------------------------------- Appendix II:0.59

We found that (1) resource, workload, and output indicators reflect
the level of performance at IRS as opposed to program results or
program impact; (2) IRS has started to develop performance measures
for increasing voluntary compliance, reducing taxpayer burden, and
improving productivity and customer satisfaction; (3) IRS plans to
measure how its components contribute to mission accomplishment; (4)
IRS has traditionally relied on voluntary compliance and the tax gap
to measure its progress; (5) the Enforcement Management Information
System is generating various management information reports on
revenue generated from each IRS enforcement program, but IRS is not
using the data for management decisionmaking; (6) IRS is trying to
prevent erroneous receivables from being added to the accounts
receivable inventory; (7) IRS needs to develop impact measures for
some of its collections activities; (8) IRS has improved its taxpayer
assistance activities since the 1991 filing season, but taxpayers are
having trouble getting through to IRS over the telephone; and (9) IRS
publishes numerous forms, publications, and instructions to help
taxpayers understand tax laws and meet their filing requirements.  We
did not make any recommendations. 


      MANY BENEFITS AND FEW COSTS
      TO REPORTING NET OPERATION
      LOSS CARRYOVER
      (GAO/GGD-93-131, SEPT.  23,
      1993)
----------------------------------------------------- Appendix II:0.60

We found that IRS instructions on the amounts that corporations
should report on the net operating loss deduction line were
incomplete and confusing.  We also found that three of every four of
the nation's corporations that claimed the deduction in 1989 did just
the opposite--they reported this deduction even when they had no
taxable income or reported more of this deduction than taxable
income.  We recommended that IRS revise its instructions on reporting
the deduction to clarify amounts that can be deducted, clearly define
net operating loss carryover, require corporations to annually report
their carryovers, and use the reported amounts to track corporate
deductions of these losses.  IRS has implemented our recommendations. 


      EARNED INCOME TAX CREDIT: 
      DESIGN AND ADMINISTRATION
      COULD BE IMPROVED
      (GAO/GGD-93-145, SEPT.  24,
      1993)
----------------------------------------------------- Appendix II:0.61

We found that EITC appears to be achieving its goals.  Those workers
who receive the credit and are below the poverty line have their
overall federal tax burden substantially reduced, while those
qualified workers who are above the poverty line have their taxes
reduced somewhat.  Also, work incentives for some workers appear to
be enhanced by the credit.  However, we also found that one-third of
the taxpayers who received the credit were not entitled to it.  This
occurred primarily because tax filers claimed the wrong filing
status.  We recommended that IRS modify the tax return to capture all
the requisite qualifications information, send nonfiler notices that
explain credit requirements to nonfilers with low earned incomes, and
modify returns processing procedure to ensure that all potentially
eligible taxpayers who submit similar information are treated
consistently. 


SUMMARY OF MAJOR TAX COMPLIANCE
LEGISLATION ENACTED SINCE 1981
========================================================= Appendix III

This appendix summarizes some major tax law provisions that deal with
taxpayer compliance and that were enacted between 1981 and 1993. 


   ECONOMIC RECOVERY ACT OF 1981
   (P.L.  97-34)
------------------------------------------------------- Appendix III:1


      INFORMATION REPORTING
----------------------------------------------------- Appendix III:1.1

A copy of an information return must be furnished to the person who
received the payment reported on the return. 


      PENALTIES
----------------------------------------------------- Appendix III:1.2

A new penalty was imposed for underpayment of income tax resulting
from overstatement of value of property by an individual, a closely
held corporation, or a personal services corporation. 

A specific civil penalty was created for persons who overstate their
tax deposit claims.  This penalty equals 25 percent of the overstated
deposit claim. 

The penalty was increased from $50 to $500 for any individual who
files false information in connection with wage withholding. 

The negligence penalty was increased by an amount equal to 50 percent
of the interest payable on the underpayment caused by the negligence. 
This new penalty adds to the 5-percent negligence penalty already in
effect. 

The penalty for failure to file most information returns was
increased from $1 per return up to a maximum of $1,000, to $10 per
return up to a maximum of $25,000. 


      INTEREST
----------------------------------------------------- Appendix III:1.3

The interest rate for tax deficiencies (and overpayments) was tied
more closely to the actual cost of borrowing by setting it annually
at the average prime rate for the month of September. 


      ESTIMATED TAXES
----------------------------------------------------- Appendix III:1.4

The portion of the current year's tax liability that corporations
whose taxable income exceeds $1 million must pay as estimated tax was
increased. 


   TAX EQUITY AND FISCAL
   RESPONSIBILITY ACT OF 1982
   (P.L.  97-248)
------------------------------------------------------- Appendix III:2


      INFORMATION REPORTING
----------------------------------------------------- Appendix III:2.1

A separate provision was added on the reporting requirements of
persons engaged in a trade or business for payments made to any
persons for services performed. 

The definition of reportable interest was expanded to include
interest on all obligations issued to the public.  This included
obligations issued by state and local governments. 

Information reporting imposed on brokers was modified to permit
regulatory requirements on reporting gross proceeds from customer
transactions, require brokers to furnish statements of the
information filed with IRS to customers, and clarify the definition
of broker. 

An information reporting requirement was imposed on certain direct
sellers of consumer goods.  This requirement applied to any person
who, in the course of trade or business, sells consumer products on a
buy-sell basis, deposit-commission basis, or any similar basis to any
buyer who sells the products in a home or other nonpermanent retail
establishment. 

This legislation required information reporting of state and local
income tax refunds. 

Information reporting requirements for tip income were expanded. 
Large food or beverage establishments must report aggregate amounts
of tips shown on charge receipts and reported tip amounts together
with mandatory service charges of less than 10 percent. 

This legislation required information reporting by employers and
administrators of pension plans that permit designated distributions. 


      PENALTIES
----------------------------------------------------- Appendix III:2.2

The penalty for failure to file an information return was increased
from $10 per failure, not to exceed $25,000, to $50 per failure, not
to exceed $50,000. 

The category of information returns subject to the general penalty
for failure to file timely was expanded to include returns for
transactions carried out by brokers for their customers, returns
filed by direct sellers, and returns for withholding. 

The penalty for failure to provide information statements to
taxpayers was increased from $10 per statement to $50 per statement,
not to exceed $50,000 per calendar year. 

The penalty for failure to file information returns for certain
deferred compensation plans, and certain term, annuity, and bond
purchase plans was increased from $10 to $25 for each day the failure
continues.  The maximum penalty increased from $5,000 to $15,000. 

The penalty for failure to furnish a taxpayer identification number
(TIN) was increased from $5 per failure to $50 per failure, not to
exceed $50,000 in any calendar year. 

A minimum penalty was established for the extended failure to file
any income tax return if the tax is underpaid.  The penalty will be
imposed if the return is not filed within 60 days of the due date
(with extensions). 

A new penalty was established for promoting abusive tax shelters. 

A penalty was established for substantial understatement of income
tax.  An understatement of income tax is substantial if the
understatement exceeds the greater of 10 percent of the tax required
to be shown on the return or $5,000 ($10,000 for corporations other
than S corporations and personal holding companies). 

A new penalty was established for aiding and abetting the
understatement of tax liability. 

A penalty for frivolous returns was created. 


      INTEREST
----------------------------------------------------- Appendix III:2.3

Daily compounding of interest payable was required. 

A rate of interest must be determined semiannually and based on
average adjusted prime rate for the 6-month period. 


      WITHHOLDING
----------------------------------------------------- Appendix III:2.4

Withholding was imposed at the source where the taxpayer fails to
provide a TIN or provides an incorrect TIN to a person who must file
an information return for the payment to the taxpayer. 

Withholding was imposed on designated distributions from pensions,
annuities, and certain other plans. 

Withholding was imposed at a rate of 10 percent on payments of
dividends, interest, and certain patronage dividends paid to
individuals. 


      PARTNERSHIPS
----------------------------------------------------- Appendix III:2.5

The tax treatment of partnerships items must be established at the
partnership level in a unified proceeding rather than in separate
proceedings with each partner. 


   INTEREST AND DIVIDEND TAX
   COMPLIANCE ACT OF 1983 (P.L. 
   98-67)
------------------------------------------------------- Appendix III:3


      BACKUP WITHHOLDING
----------------------------------------------------- Appendix III:3.1

Backup withholding was established on reportable payments, including
situations in which IRS notifies the payor that the payee's TIN is
incorrect, the payee has been notified by IRS of an underreporting of
interest or dividends, or the payee fails to certify to the payor
that he/she is not subject to withholding.  The amount of withholding
increased to 20 percent of payment. 


      RETURNS ON MAGNETIC TAPE
----------------------------------------------------- Appendix III:3.2

Payers of interest and dividends who file at least 50 information
returns are required to file the returns on magnetic media. 


   DEFICIT REDUCTION ACT OF 1984
   (P.L.  98-369)
------------------------------------------------------- Appendix III:4


      INFORMATION REPORTING
----------------------------------------------------- Appendix III:4.1

Taxpayers who, in the course of their trade or business, receive
mortgage interest are required to issue an information return to the
payor of the mortgage interest, and a penalty was established for
failure to do so. 

A taxpayer operating a trade or business who receives more than
$10,000 in cash in one transaction (or two or more related
transactions) was required to file an information return reporting
the transaction, and a penalty was established for failure to do so. 

A taxpayer who acquires an interest in secured property through
foreclosure or abandonment was required to report such acquisition,
and a penalty was established for failure to do so. 

Reporting of certain sales or exchanges of partnership interests was
required.  A partnership must file an information return reporting an
exchange, described in section 751(a), of any interest in the
partnership. 


      TAX SHELTERS
----------------------------------------------------- Appendix III:4.2

A statutory definition of tax shelter was created. 

A registration requirement for tax shelters was created. 

A penalty was created for failure to register a tax shelter or
provide a tax shelter identification number. 

The penalty that can apply to a tax shelter promoter who makes false
or fraudulent statements or gross valuation overstatements was
increased. 


   TAX REFORM ACT OF 1986 (P.L. 
   99-514)
------------------------------------------------------- Appendix III:5


      INFORMATION RETURNS
----------------------------------------------------- Appendix III:5.1

Gross proceeds from certain real estate transactions must be
reported. 

Heads of federal executive agencies must report the name, address,
and TIN of persons receiving federal contracts. 

A new provision was created requiring reporting of royalties to any
person aggregating more than $10 per calendar year. 


      PENALTIES
----------------------------------------------------- Appendix III:5.2

The maximum penalty for failure to file an information return was
increased to $100,000 and consolidated with the penalty for failure
to supply a copy of the return to the payee. 

A new penalty was created for providing incorrect information on
information returns filed with IRS or provided to a taxpayer. 

The penalty for failure to pay tax increased from .5 percent per
month, up to a maximum of 25 percent, to 1 percent per month when IRS
has notified the taxpayer that IRS will impose a levy upon the
taxpayer's assets. 

The fraud penalty was modified by increasing the rate but applying it
only to the amount of underpayment attributable to the fraud. 

The scope of the negligence penalty was expanded to include all
taxes. 

The penalty for substantial understatement of tax liability increased
from 10 percent to 20 percent of the underpayment of tax attributable
to the understatement. 

The accuracy-related, failure to file, and fraud penalties were
coordinated. 

The penalty for failure to make timely deposits of tax was modified
by establishing a 4-tiered penalty structure. 


      INTEREST
----------------------------------------------------- Appendix III:5.3

A differential rate was created for interest paid by a taxpayer to
the Treasury and for interest paid by the Treasury to a taxpayer. 
The taxpayer pays a higher rate of interest. 


      DEPENDENT SOCIAL SECURITY
      NUMBER
----------------------------------------------------- Appendix III:5.4

Taxpayers were required to provide a Social Security number for each
dependent claimed who is at least 5 years old. 


      TAX EXEMPT INTEREST
----------------------------------------------------- Appendix III:5.5

Taxpayers were required to show on their returns the amount of
tax-exempt interest received during the year. 


      TAX SHELTERS
----------------------------------------------------- Appendix III:5.6

The definition of tax shelter subject to registration requirements
was altered, and the penalty for failure to register was increased. 

The penalty for failure to register a tax shelter increased from the
lesser of $10,000 or 1 percent of the aggregate amount invested in
the tax shelter, to the latter amount.  The $10,000 cap was therefore
deleted. 

The penalty for failure to report a tax shelter identification number
on a tax return was increased from $50 to $250. 

The maximum penalty for failure by organizers to maintain a list of
investors for any calendar year was increased from $50,000 to
$100,000. 


      ESTIMATED TAX PAYMENTS
----------------------------------------------------- Appendix III:5.7

The proportion of current year's tax liability a taxpayer must make
as estimated tax payments in order to avoid a penalty was increased
from 80 percent to 90 percent. 

Private foundations are required to make quarterly estimated tax
payments of the excise tax due on net investment income. 

Tax-exempt organizations are required to make quarterly estimated tax
payments of tax on unrelated business income. 


      COLLECTIONS
----------------------------------------------------- Appendix III:5.8

The statute of limitations on collection after assessment was
extended from 6 years to 10 years. 


   REVENUE RECONCILIATION ACT OF
   1989 (P.  L.  101-239)
------------------------------------------------------- Appendix III:6


      PENALTIES
----------------------------------------------------- Appendix III:6.1

Uniform penalties for failure to comply with certain information
reporting requirements were established.  A three-tier penalty
structure was established for failure to file an information return
on time in which the penalty varies depending on when, if at all, the
taxpayer corrects the failure. 

The accuracy-related penalties were consolidated, and a general 20-
percent rate was established for negligence or disregard of the
rules, substantial understatement of tax, and over/undervaluation
penalties. 

The penalties for professionals who prepare tax returns were modified
to include a penalty of $250 per return if any part of a return or
claim for refund is based on an unreasonable position. 

The penalty for negligent or fraudulent failure to file a return was
increased from 5 percent to 15 percent of the net amount of tax due
per month.  The maximum penalty increased from 25 percent to 75
percent. 


   REVENUE RECONCILIATION ACT OF
   1990 (P.L.  101-508)
------------------------------------------------------- Appendix III:7


      DEPENDENT SOCIAL SECURITY
      NUMBER
----------------------------------------------------- Appendix III:7.1

Taxpayers are required to provide a Social Security number for each
dependent claimed who is at least 1 year old. 


      LARGE CASH TRANSACTIONS
----------------------------------------------------- Appendix III:7.2

Cash transactions of more than $10,000 must be reported to IRS by
those operating a trade or business.  The definition of "cash"
subject to information reporting was expanded to include "case
equivalent monetary instrument" (e.g., checks, travelers' checks,
drafts, money orders). 

The penalty was increased for intentional disregard by a recipient of
the requirement to report receipt of more than $10,000 in cash or
cash equivalent. 


   OMNIBUS BUDGET RECONCILIATION
   ACT OF 1993 (P.L.  103-66)
------------------------------------------------------- Appendix III:8


      INFORMATION REPORTING
----------------------------------------------------- Appendix III:8.1

Certain financial entities are required to file information returns
with IRS and provide debtors with statements for any discharged
indebtedness of $600 or more.  Entities include the Federal Deposit
Insurance Corporation, the Resolution Trust Corporation, and the
National Credit Union Administration, as well as other federal
agencies, banks, and credit unions.  A penalty for failure to furnish
information returns was established. 


      PENALTIES
----------------------------------------------------- Appendix III:8.2

The standard for the accuracy-related penalty was raised, and the
"not frivolous" standard was replaced with the stricter "reasonable
basis" standard.  To avoid the penalty, a taxpayer must have at least
a reasonable basis for the position taken on his/her return. 


      WITHHOLDING
----------------------------------------------------- Appendix III:8.3

The withholding rate on supplemental wage payments (bonuses,
commissions, and overtime pay) was increased from 20 to 28 percent. 


MARKET SEGMENT SPECIALIZATION
PROGRAM
========================================================== Appendix IV

This appendix lists the 21 market segments that IRS has developed as
of September 30, 1993, as part of its Market Segment Specialization
Program.  The listing indicates the market segments for which IRS has
developed or has under development audit guides. 


      MARKET SEGMENTS WITH AUDIT
      GUIDES RELEASED
------------------------------------------------------ Appendix IV:0.1

Air charters
Attorneys
Bed and breakfasts
Gas retailers
Mortuaries
Taxicabs
Trucking


      MARKET SEGMENTS WITH AUDIT
      GUIDES UNDER DEVELOPMENT
------------------------------------------------------ Appendix IV:0.2

Auto dealerships
Construction
Entertainment
Fishing
Garment contractors
Garment manufacturing
Health care
Laundromats
Oil and gas operators
Reforestation
Rehabilitation tax credit
Restaurants
Travel agencies
Wineries


--------------------
\1 IRS also has 66 research and development projects underway that
may result in audit guides in additional market segments. 


MAJOR CONTRIBUTORS TO THIS REPORT
=========================================================== Appendix V


   GENERAL GOVERNMENT DIVISION,
   WASHINGTON, D.C. 
--------------------------------------------------------- Appendix V:1

Tom Short, Assignment Manager


   SAN FRANCISCO REGIONAL OFFICE
--------------------------------------------------------- Appendix V:2

Ralph Block, Project Manager
Lou Roberts, Senior Evaluator
George Zika, Senior Evaluator
Suzy Foster, Senior Evaluator
Kit Seymour, Senior Evaluator
Samuel H.  Scrutchins, Technical Advisor
Arthur Davis, Report Referencer
