Tax Administration: Estimates of the Tax Gap for Service Providers
(Letter Report, 12/28/94, GAO/GGD-95-59).

This report provides information on the tax gap for sole
proprietors--that is, self-employed persons.  The gross income tax gap
refers to the difference between the amount of income taxes owed and the
amount voluntarily paid.  GAO pegs the tax gap at $21 billion for 9.2
million nonfarm sole proprietors who claimed no cost of goods sold on
their returns.  GAO estimates the tax gap at $25.1 billion for 10.3
million nonfarm sole proprietors whose reported cost of goods sold, as a
percentage of gross receipts, were at or below the average reported by
all sole proprietors in the same industry.  GAO estimates the tax gaps
at $30.3 billion for 11.5 million nonfarm sole proprietors who were
primarily service providers.  This group includes all the sole
proprietors covered in the second group.  Of this $30.3 billion tax gap,
IRS also estimated that between $2 billion and $3.5 billion was
associated with potentially misclassified workers. These estimates
included only service providers who received all their self-employment
income from one business.  The $3.5 billion figure included all such
service providers.  The $2 billion figure included only those receiving
$20,000 or more from one payer.

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

 REPORTNUM:  GGD-95-59
     TITLE:  Tax Administration: Estimates of the Tax Gap for Service 
             Providers
      DATE:  12/28/94
   SUBJECT:  Tax administration
             Noncompliance
             Tax nonpayment
             Tax evasion
             Contractors
             Income taxes
             Service industry
             Tax law
IDENTIFIER:  IRS Taxpayer Compliance Measurement Program
             TCMP
             
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Cover
================================================================ COVER


Report to the Joint Committee on Taxation, Congress of the United
States

December 1994

TAX ADMINISTRATION - ESTIMATES OF
THE TAX GAP FOR SERVICE PROVIDERS

GAO/GGD-95-59

Estimates of the Tax Gap

(268590)


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

  COGS - Cost of Goods Sold
  IRMF - Information Returns Masterfile
  IRS - Internal Revenue Service
  PBA - Primary Business Activity
  TCMP - Taxpayer Compliance Measurement Program

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


B-259655

December 28, 1994

The Honorable Daniel Patrick Moynihan
Chairman, Joint Committee on Taxation

The Honorable Sam M.  Gibbons
Acting Vice Chairman, Joint Committee
 on Taxation
Congress of the United States

This report provides information about the tax gap for sole
proprietors (that is, self-employed individuals).  Specifically, it
presents estimates of the tax year 1992 gross income tax gap for
nonfarm sole proprietors who provided services.  It also includes
estimates of the tax gap attributable to service providers who may
have been employees, rather than self employed.  This report is part
of our response to your request that we analyze the noncompliance of
sole proprietors.  It represents the combined efforts of our staff
and analysts of the Internal Revenue Service (IRS). 


   BACKGROUND
------------------------------------------------------------ Letter :1

The gross income tax gap is the difference between the amount of
income taxes owed and the amount voluntarily paid.  Tax gap estimates
can be used to measure IRS progress in addressing particular types of
noncompliance and to help IRS allocate its compliance resources. 

IRS last published a tax gap estimate in 1988.\1 IRS projected that
the tax gap for all nonfarm sole proprietors who filed a return,
regardless of whether they provided goods, services, or both, would
be over $30 billion by 1992.\2 IRS split this estimate between two
sole proprietor groups.  About $20 billion was attributed to
individuals who formally organized their businesses as sole
proprietors.  The remaining $10 billion was associated with
individuals organized informally--informal suppliers--who provided
goods or services primarily through cash transactions.\3 IRS has not
yet published its new tax gap estimates based on Taxpayer Compliance
Measurement Program (TCMP) results for tax years 1985 and 1988. 

IRS did not segregate the portion of the sole proprietor tax gap
related to independent contractors.  If done, this independent
contractor portion might also be disaggregated into an estimate for
misclassified workers.  When hiring a worker to provide services, a
business may use an employee or an independent contractor.  Employers
must withhold taxes on employees but not on independent contractors. 
IRS has adopted 20 common-law rules for classifying workers as either
employees or independent contractors (see appendix II for a list of
these rules).  The degree of control, or right to control, that a
business has over a worker generally governs the classification. 
Misclassified workers are individuals who reported they were
self-employed but were actually employees of the businesses for which
they provided services.  The misclassification of workers as
independent contractors has plagued IRS and employers for many years
because of difficulties in applying the 20 common-law rules.\4


--------------------
\1 The 1988 estimate relied on TCMP data for tax years 1973, 1976,
1979, and 1982.  Under TCMP, IRS auditors do detailed audits of tax
returns for a random sample of taxpayers.  Since 1988, IRS has also
completed analysis of its TCMP surveys for tax years 1985 and 1988. 

\2 This $30 billion excludes an estimated $3.5 billion for sole
proprietors who did not file tax returns.  None of the tax gap
estimates in this report includes nonfilers. 

\3 A more complete discussion of the informal supplier tax gap can be
found in appendix I. 

\4 Our report Tax Administration:  Approaches for Improving
Independent Contractor Compliance (GAO/GGD-92-108, July 3, 1992)
summarizes the independent contractor classification issues. 


   OBJECTIVES, SCOPE, AND
   METHODOLOGY
------------------------------------------------------------ Letter :2

Our original objectives were to estimate the income tax gap for
independent contractors and the portion of that gap associated with
potentially misclassified employees.  We could do neither of these
estimates because no generally accepted definition of independent
contractor, such as from using the 20 common-law rules, could be
associated with data IRS used to calculate the tax gap. 

Because of uncertainty about who was an independent contractor, we
used service providers as surrogates since many are considered by IRS
and the business community to be independent contractors.  Also, IRS
data can be used in conjunction with some assumptions to make tax gap
estimates for sole proprietors who primarily provide services and for
that portion of the tax gap attributable to potentially misclassified
workers.  However, because the IRS data did not clearly define
service providers, we developed three definitions for service
providers using TCMP data and information reported on tax returns. 

The three definitions used the Cost of Goods Sold (COGS) information
and the IRS Primary Business Activity (PBA) codes that sole
proprietors claim on Schedule C, Profit or Loss From Business, of the
Form 1040, U.S.  Individual Income Tax Return.  We used the amount of
COGS claimed because sole proprietors who provide services generally
claim less COGS than those who manufacture or sell goods or mine
minerals.  The PBA codes categorize sole proprietors by their type of
business activity.  These codes can be used to identify service
providers.\5

Using the amount of reported COGS and PBA codes as criteria, we
analyzed the following three service provider groups:\6

  -- all sole proprietors who reported no COGS on their returns;

  -- all sole proprietors with no reported COGS plus those reporting
     COGS at or below their industry average, as a percentage of
     gross receipts--except for sole proprietors engaged in
     manufacturing, mining, or sales activities; and

  -- all sole proprietors in the first and second groups plus any
     remaining sole proprietors with service-related PBA codes. 

We analyzed the IRS 1988 TCMP data to obtain tax compliance data for
the sole proprietors who fell into each of the three groups.  At our
request, IRS used these data and its tax gap model to estimate the
1988 and 1992 tax gap for each group. 

To estimate the portion of tax gap related to misclassified workers,
we matched data from the TCMP file and the IRS tax year 1988
Information Returns Masterfile (IRMF) to identify service providers
who were potentially misclassified workers.  For this group, IRS then
used its tax gap model to estimate the portion of tax gap associated
with potentially misclassified workers.  At our request, IRS made tax
gap estimates for two categories of potentially misclassified
employees:  (1) service providers who received all of their income,
regardless of the amount, from one payer and (2) service providers
who received $20,000 or more from one payer.  We selected the $20,000
limit on the basis of discussions with the IRS employment tax staff. 

We received oral comments on a draft of this report from
representatives of the IRS Director of Research on December 12, 1994. 
These officials asked that we emphasize the weakness of the informal
supplier estimates and indicate that allocating this estimate among
business activities increases the uncertainty.  We agreed and
strengthened our caution about interpreting the allocated estimates
in table 2 and appendix VI.  Even though these allocations have
limitations, they provide some indication of the types of informal
suppliers who not only provide services but also add to the tax gap. 
These IRS officials agreed that our method of allocation was
reasonable.  We also updated the tax gap estimates to correspond to
IRS' most recent estimates. 

We did our work between October 1993 and November 1994 in accordance
with generally accepted government auditing standards. 


--------------------
\5 The PBA codes are defined under nine broad categories:  (1)
construction; (2) manufacturing; (3) mining; (4) agricultural
services; (5) wholesale trade; (6) retail trade; (7) real estate,
insurance, finance, and related services; (8) transportation,
communication, public utilities, and related services; and (9)
personal, business, and professional services. 

\6 Appendix I provides further details on our rationale and criteria
for the three definitions. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :3

Using three definitions of service providers and data available from
the IRS 1988 TCMP, we estimated that between 9.2 million and 11.5
million of the 13 million nonfarm sole proprietors might be
considered service providers.  IRS estimated that the 1992 tax gap
among these likely service providers ranged from $21 billion to $30.3
billion--that is, from 56 to 81 percent of the $37.2 billion tax gap
estimated by IRS for all nonfarm sole proprietors who filed a
return.\7 Specifically, the tax gap estimates for the three
definitions of service providers were

  -- $21 billion for 9.2 million nonfarm sole proprietors who claimed
     no COGS on their returns. 

  -- $25.1 billion for 10.3 million nonfarm sole proprietors whose
     reported COGS, as a percentage of gross receipts, were at or
     below the average reported by all sole proprietors in the same
     industry.  This group included all the sole proprietors covered
     in the first group. 

  -- $30.3 billion for 11.5 million nonfarm sole proprietors who, on
     the basis of IRS' PBA codes, were primarily service providers. 
     This group includes all the sole proprietors covered in the
     second group. 

Of this $30.3 billion tax gap, IRS also estimated that between $2
billion and $3.5 billion was associated with potentially
misclassified workers.  These estimates included only service
providers who received all their self-employment income from one
business.  The $3.5 billion estimate included all such service
providers.  The $2 billion estimate included only those receiving
$20,000 or more from one payer. 


--------------------
\7 The $37.2 billion sole proprietor tax gap estimate is from
unpublished data that we obtained from IRS.  IRS relied on tax years
1985 and 1988 TCMP results to make this estimate.  IRS has not
calculated a sampling error for its tax gap estimates. 


   INCOME TAX GAP ATTRIBUTABLE TO
   SERVICE PROVIDERS
------------------------------------------------------------ Letter :4

Using the IRS TCMP data, we estimated that for tax year 1988 about 13
million individuals filed Schedules C as nonfarm sole proprietors. 
We also estimated that between 68 percent (9.2 million) and 85
percent (11.5 million) of the nonfarm sole proprietors were
potentially service providers, with the estimates varying across the
three groups that we analyzed. 

Using its most recent TCMP data, IRS estimated the 1992 tax gap for
all sole proprietors at $37.2 billion.  Of this amount, between $21
billion and $30.3 billion was associated with sole proprietors who
provided services.  Table 1 shows the estimated 1992 tax gap for
three groupings of service providers.\8 The table stratifies the
service providers into nine major sectors--seven service provider
sectors based on PBA codes used by IRS to categorize sole
proprietors, one sector for all nonservice sector businesses that
reported no COGS, and one sector for informal suppliers.\9



                                Table 1
                
                Estimated Tax Gap for Potential Service
                        Provider Groups for 1992

                         (Dollars in millions)


                                               Average or     Based on
Description of sector                No COGS   lower COGS    PBA codes
-------------------------------  -----------  -----------  -----------
Construction services                $ 1,209      $ 2,229      $ 3,804
Real estate, insurance, and              937        1,027        1,379
 financial services
Transportation and                       800          979        1,140
 communication services
Business services\a                    2,122        2,375        2,893
Personal services\b                       61          954        1,349
Medical services\c                       610          634          984
All other services\d                   1,045        2,106        3,144
All other businesses with no           1,057        1,057        1,057
 COGS\e
Informal suppliers                    13,191       13,784       14,526
======================================================================
Total\f                              $21,031      $25,146      $30,276
Percent of tax gap for all sole        56.5%        67.5%        81.3%
 proprietors
----------------------------------------------------------------------
Note:  Appendix V shows population estimates by sector and group. 

\a This sector includes services such as legal and accounting. 

\b This sector includes services such as beauty shops, child day
care, and counseling. 

\c This sector includes services such as doctors and dentists. 

\d This sector contains services not covered in the above sectors
such as agricultural, automotive, and hotels. 

\e This sector contains businesses in the manufacturing, mining, and
sales sectors, with no COGS. 

\f Totals may not add due to rounding. 

Source:  IRS tax gap model and TCMP database. 

As table 1 shows, the lowest estimate of the possible service
provider tax gap was $21 billion, or about 57 percent of the total
$37.2 billion sole proprietor tax gap estimate.  This estimate
covered only those sole proprietors with no COGS, regardless of their
PBA code.  We estimated that about 9.2 million sole proprietors fell
into this group.  In its instructions to small businesses, IRS
indicated that COGS are used to record the expenses of any goods that
are purchased for resale.  Thus, we assumed that any sole proprietor
that reported no COGS received all gross receipts from providing
services.  This would be the purest form of service provider. 
However, this definition excludes service providers who have COGS
because they sold some goods in the course of providing services (for
example, a mechanic who also sells automobile parts). 

IRS' intermediate estimate of the possible service provider tax gap
totaled $25.1 billion among an estimated 10.3 million sole
proprietors.  In addition to those sole proprietors with no COGS,
this estimate also included those who sold some goods in the course
of providing services.  We defined these sole proprietors as service
providers if their reported COGS as a percent of gross receipts was
at or below the average for all sole proprietors in the same sector. 
We used the average COGS amount as a measure to limit the group to
only those sole proprietors whose sales of goods were incidental to
providing services. 

The highest estimate of the possible service provider tax gap was
$30.3 billion among an estimated 11.5 million sole proprietors.  To
identify this group of service providers, we used the service-related
PBA codes that sole proprietors reported on their Schedule C plus
those included in the prior two groups.  This group does not include
sole proprietors with PBA codes in the manufacturing, mining, and
wholesale and retail sales sectors that reported any amount of COGS. 

Table 1 also shows that informal suppliers were responsible for the
largest portion of the tax gap for all three groupings.  Based on the
1988 TCMP data, an estimated 2.6 million service providers were
informal suppliers.  IRS officials said they have not determined why
informal suppliers accounted for such a large portion of the tax gap. 
They did say that the informal supplier tax gap estimate has a high
degree of uncertainty and that IRS has not allocated this estimate
among the industrial sectors to avoid adding even more uncertainty. 
Accordingly, in table 1 we did not allocate the informal supplier tax
gap to each sector.  However, table 2 allocates the informal supplier
estimate across these sectors, using the informal supplier compliance
rate for each sector as the basis for the allocations.  The resulting
allocation of the tax gap estimates should be viewed as rough
approximations that can provide insight as to the potential breakdown
by industry sector.  Appendix VI provides more details on these
allocations. 



                                Table 2
                
                    Estimated Allocation of Informal
                Supplier Tax Gap Among Business Sectors,
                                  1992

                         (Dollars in millions)


                                              Average and     Based on
Description of sector                No COGS   lower COGS    PBA codes
-------------------------------  -----------  -----------  -----------
Construction services                $ 5,900      $ 6,200      $ 6,500
Real estate, insurance, and                0            0            0
 financial services
Transportation and                     1,100        1,100        1,200
 communication services
Business services\a                    1,100        1,200        1,200
Personal services\b                    2,000        2,100        2,200
Medical services \c                      300          300          300
All other services\d                   1,200        1,300        1,300
All other businesses with no           1,600        1,600        1,700
 COGS\e
======================================================================
Total\f                              $13,200      $13,800      $14,500
----------------------------------------------------------------------
Note:  Numbers are rounded to the nearest $100 million. 

\a This sector includes services such as legal and accounting. 

\b This sector includes services such as beauty shops, child day
care, and counseling. 

\c This sector includes services such as doctors and dentists. 

\d This sector contains services not covered in the above sectors
such as agricultural, automotive, and hotels. 

\e This sector contains businesses in the manufacturing, mining, and
sales sectors, with no COGS. 

\f Totals may not add due to rounding. 

Source:  TCMP database, IRS tax gap model, and GAO analysis. 


--------------------
\8 Appendix III provides a similar table for the 1988 tax gap. 

\9 Appendix IV lists PBA codes for each business sector. 


   SERVICE PROVIDER TAX GAP
   RELATED TO MISCLASSIFIED
   WORKERS
------------------------------------------------------------ Letter :5

Using the broadest definition of service provider, we estimated that
between 0.2 million and 1.6 million of the 11.5 million service
providers may be misclassified employees.\10 The estimate of the 1992
income tax gap for these service providers ranged from $2 billion to
$3.5 billion.  The $2 billion estimate covered only those sole
proprietors who reported $20,000 or more in income from one business. 
The $3.5 billion estimate covered service providers who received all
of their income from just one business, regardless of the amount. 
Table 3 shows the estimated tax gap for these two groups in total and
as a percentage of the total service provider tax gap. 



                                Table 3
                
                     Estimated Tax Gap Amounts for
                   Potentially Misclassified Service
                           Providers in 1992

                         (Dollars in millions)


                                                            Percent of
                                                               service
                                                              provider
                                                               tax gap
                                 Potentially                      from
                                 misclassifi               potentially
Type of potentially               ed service  All service  misclassifi
misclassified service providers    providers    providers   ed workers
-------------------------------  -----------  -----------  -----------
Providers who reported $20,000        $2,037      $30,276          6.7
 or more in gross receipts from
 just one payer
Providers who reported any            $3,503      $30,276         11.6
 amount of gross receipts from
 just one payer
----------------------------------------------------------------------
Source:  The IRS tax gap model using TCMP and IRMF data. 

If all of these were actually misclassified and IRS were to correct
the classification to employee, after the fact, IRS would not
necessarily collect either the $2.0 billion or the $3.5 billion.\11
However, had these workers been classified correctly as employees, a
significant amount of the taxes owed would likely have been withheld
by the employer.  IRS studies have indicated that taxpayers subject
to withholding were substantially more compliant.  For example, the
1988 TCMP showed that employees reported 99.8 percent of their wages,
while sole proprietors reported only 75.2 percent of their business
income. 


--------------------
\10 We used the service provider tax gap estimate defined by the PBA
codes because it contained the most TCMP sample cases and, therefore,
was likely to provide the most precise estimates.  Appendix I shows
the number of TCMP cases for each group. 

\11 IRS data also show an estimated $2 billion employment tax gap for
1992 for misclassified workers.  This would likely be reduced if
workers were properly classified. 


---------------------------------------------------------- Letter :5.1

As agreed with the Committee, we will send copies of this report to
the Secretary of the Treasury, the Commissioner of Internal Revenue,
and other interested parties.  We also will make copies available to
others upon request.  This report was prepared under the supervision
of Natwar M.  Gandhi, Associate Director. 

Major contributors to this report are listed in appendix VII.  If you
have any questions, please contact me at (202) 512-5407.

Jennie S.  Stathis
Director, Tax Policy
 and Administration Issues


METHODOLOGY FOR IDENTIFYING
INDUSTRIES AS SERVICE PROVIDERS
=========================================================== Appendix I

Neither income tax return nor TCMP data are specific enough for
developing a tax gap estimate on independent contractors.  Our
discussions with IRS officials and representatives of various
business community interest groups revealed that independent
contractors are generally considered service providers, rather than
manufacturers or sellers of goods.  Even so, we could not use service
providers as an exact surrogate for independent contractors.  Neither
the IRS sole proprietor tax gap nor TCMP data specifically identify
sole proprietors whose incomes are primarily derived from providing
services as opposed to those who primarily receive income from
manufacturing or selling goods. 

We tried to use depreciation and the presence of an information
return for nonemployee compensation as ways to distinguish income
derived from providing services as opposed to other types of income. 
However, these options did not work.  We found no pattern in our
analysis of depreciation that clearly differentiated between income
earned by providing services and income derived from manufacturing
and selling goods.  Likewise, using information returns would have
excluded service income that is not required to be reported on
information returns (for example, income from providing services to
individuals not engaged in a trade or business) and income that was
not reported on information returns as required. 

Lacking a specific definition of service providers, we made
assumptions about sole proprietors, resulting in three service
provider definitions.  We then gave IRS information about sole
proprietors in the 1988 TCMP database that met these three
definitions.  IRS used its tax gap model to prepare an estimate for
each definition. 

Our first service provider definition consisted of all sole
proprietors from the TCMP database with no COGS.  IRS instructions
indicate that a business must complete the COGS section when the
production, purchase, or sale of merchandise produced income.  We
reasoned that if sole proprietors had no COGS, then all their gross
receipts must come from providing services.  Accordingly, this group
should represent the most stringent test for service providers. 

The second definition of service providers consisted of all sole
proprietors whose PBA code was not in the manufacturing, mining, and
sales categories and whose COGS, as a percent of gross receipts, was
at or below the industry average.  For these sole proprietors, we
reasoned that their gross receipts included some mix of payments for
services provided and for materials used in providing those services. 
For example, gross receipts for repairing plumbing fixtures in a
building included charges for the repair service and the new
fixtures.  The cost of the fixtures can be shown as a part of COGS. 
We considered the sole proprietors at or below the industry average
as primarily service providers.  We used the IRS Statistics of Income
data to develop industry averages for COGS as a percent of gross
receipts. 

The final group represents the broadest definition of service
providers.  On tax returns, IRS asks that sole proprietors categorize
their businesses by using PBA codes.  IRS has over 170 PBA codes that
can be used to determine whether sole proprietors' primary business
is service related.  Relying on IRS' defined PBA codes, our third
group includes all sole proprietors whose PBA codes fall into one of
these service-related sectors. 

In each of the three definitions of service providers, we included
sole proprietors in the manufacturing, mining, and sales categories
(i.e., nonservice sector) that paid no COGS.  In the nonservice
group, sole proprietors operating businesses such as food markets,
dry goods stores, restaurants, or metal shops should have substantial
COGS.  For example, Statistics of Income data show that in the
nonservice group COGS averaged almost 65 percent of gross
receipts.\12 We reasoned that sole proprietors with PBA codes in this
group and with no COGS were probably either providing services to the
industries or were misclassified employees.  Accordingly, we included
them in each of our definitions.  Table I.1 provides specific
information about the number of service providers in each group plus
the estimated population of those who were potentially misclassified
workers. 



                               Table I.1
                
                Data on the Observations and Population
                Estimates Used to Make Tax Gap Analysis
                                for 1988

                                   Number of
                                 observation                  Sampling
                                   s in TCMP    Estimated  error (plus
Service provider groups                 data   population    or minus)
-------------------------------  -----------  -----------  -----------
No COGS                                9,939    9,152,583      332,440
At or below average COGS              11,614   10,269,196      317,278
As defined by IRS' PBA code           14,423   11,473,195      347,065
Potentially misclassified                393      187,418       21,816
 workers with over $20,000 of
 income
Potentially misclassified              1,306    1,618,550      160,061
 workers with any amount of
 income
----------------------------------------------------------------------
Source:  The IRS 1988 TCMP. 

IRS calculated the tax gap estimates using its tax gap model, which
was developed to estimate federal income tax revenue lost from
underreporting income and overstating deductions.  For these
estimates, IRS used data from its TCMP for tax year 1988 returns
filed by individuals.  The model also uses methodology developed by
IRS to estimate unreported income that was not identified in the TCMP
audits.\13 We did not verify tax gap data provided by IRS because we
had no access to the IRS model.  IRS has not calculated a sampling
error for its tax gap estimates. 

As part of its tax gap calculation, IRS makes an estimate for
informal suppliers.  IRS defines informal suppliers as individuals
who provide products or services through informal arrangements, which
frequently involve cash transactions.  This special class of
individuals is believed to include persons who are at the core of the
so-called "underground economy." IRS calculates the tax gap for
informal suppliers differently than for other nonfarm sole
proprietors.  Rather than relying solely on TCMP data, IRS also uses
estimates of income received by informal suppliers.  These estimates
are made by an outside consultant.  In this report, we categorize the
informal supplier tax gap separately from that of other sole
proprietors. 


--------------------
\12 In contrast, COGS for all industries not in the manufacturing,
mining, or sales industries was less than 24 percent of gross
receipts. 

\13 For more details on the IRS tax gap estimates, see The Tax Gap: 
Definition, Studies, Assumptions, and Components,(GAO/GGD-88-66BR
Mar.  25, 1988, and GAO/T-GGD-88-22, Mar.  31, 1988). 


SUMMARY OF THE 20 COMMON-LAW
FACTORS THAT DISTINGUISH EMPLOYEES
FROM INDEPENDENT CONTRACTORS
========================================================== Appendix II

Workers are generally employees if they

  -- must comply with employer's instructions about the work;

  -- receive training from or at the direction of the employer;

  -- provide services that are integrated into the business;

  -- provide services that must be rendered personally;

  -- hire, supervise, and pay assistants for the employer;

  -- have a continuing working relationship with the employer;

  -- must follow set hours of work;

  -- work full-time for an employer;

  -- must do their work on the employer's premises;

  -- must do their work in a sequence set by the employer;

  -- must submit regular reports to the employer;

  -- receive payments of regular amounts at set intervals;

  -- receive payments for business and/or traveling expenses;

  -- rely on the employer to furnish tools and material;

  -- lack a major investment in resources for providing services;

  -- cannot make a profit or suffer a loss from the services;

  -- work for one employer at a time;

  -- do not offer their services to the general public;

  -- can be fired by the employer; or

  -- may quit work anytime without incurring liability. 

Source:  Exhibit 4640-1, Internal Revenue Manual 4600 (Employment Tax
Procedures). 


1988 TAX GAP FOR SERVICE PROVIDERS
========================================================= Appendix III



                              Table III.1
                
                Estimated Tax Gap for Service Providers
                                for 1988

                         (Dollars in millions)


                                                  Average     Based on
Description of sector                No COGS         COGS    PBA codes
-------------------------------  -----------  -----------  -----------
Construction services                   $698       $1,287       $2,196
Real estate, insurance, and              541          593          796
 financial services
Transportation and                       462          565          658
 communication services
Business services                      1,225        1,371        1,670
Personal services                         35          551          779
Medical services                         352          366          568
All other services                       603        1,216        1,815
All other businesses with no             610          610          610
 COGS
Informal suppliers                     9,385        9,807       10,335
======================================================================
Total                                $13,911      $16,366      $19,433
----------------------------------------------------------------------
Source:  The IRS tax gap model and TCMP database. 


TYPES OF SERVICE PROVIDERS BY
SECTOR
========================================================== Appendix IV



                               Table IV.1
                
                   Types of Service Providers In the
                          Construction Sector

PBA code  Description of service provider
--------  ------------------------------------------------------------
0018      Operative builders (building for own account)

0034      Residential building

0059      Nonresidential building

0075      Highway and street construction

0232      Plumbing, heating, and air conditioning

0257      Painting and paperhanging

0273      Electrical work

0299      Masonry, drywall, stone, and tile

0414      Carpeting and flooring

0430      Roofing, siding, and sheet metal

0455      Concrete work

0471      Water well drilling

0885      Other building trade contractors

3889      Other heavy construction
----------------------------------------------------------------------
Source:  1988 TCMP database. 



                               Table IV.2
                
                 Types of Service Providers in the Real
                    Estate, Insurance, and Financial
                            Services Sector

PBA code  Description of service provider
--------  ------------------------------------------------------------
5512      Real estate agents and managers

5538      Operators and lessors of buildings

5553      Operators and lessors of other real property

5710      Subdividers and developers

5736      Insurance agents and services

5751      Security and commodity brokers, dealers, and investment
          services

5777      Other real estate, insurance, and financial activities
----------------------------------------------------------------------
Source:  1988 TCMP database. 



                               Table IV.3
                
                   Types of Service Providers in the
                Transportation and Communication Sectors

PBA code  Description of service provider
--------  ------------------------------------------------------------
6114      Taxicabs

6312      Bus and limousine transportation

6338      Trucking (except trash collection)

6510      Trash collection

6536      Public warehousing

6551      Water transportation

6619      Air transportation

6635      Travel agents and tour operators

6650      Other transportation and related services

6676      Communications services

6692      Utilities, including dumps, snowplowing, and road clearing
----------------------------------------------------------------------
Source:  1988 TCMP database. 



                               Table IV.4
                
                   Types of Service Providers in the
                        Business Services Sector

PBA code  Description of service provider
--------  ------------------------------------------------------------
7617      Legal services (or lawyer)

7633      Income tax preparation

7658      Accounting and bookkeeping

7674      Engineering, surveying, and architectural

7690      Management, consulting, and public relations

7716      Advertising, except direct mail

7732      Employment agencies and personnel supply

7757      Computer and data processing, including repair and leasing

7773      Equipment rental and leasing

7914      Investigative and protective services

7880      Other business services
----------------------------------------------------------------------
Source:  1988 TCMP database. 



                               Table IV.5
                
                   Types of Service Providers in the
                        Personal Services Sector

PBA code  Description of service provider
--------  ------------------------------------------------------------
8110      Beauty shops or beauticians

8318      Barber shops or barbers

8334      Photographic portrait studios

8516      Shoe repair and shine services

8532      Funeral services and crematories

8714      Child day care

8730      Teaching or tutoring

8755      Counseling (except health practitioners)

8771      Ministers and chaplains

6882      Other personal services
----------------------------------------------------------------------
Source:  1988 TCMP database. 



                               Table IV.6
                
                   Types of Service Providers in the
                        Medical Services Sector

PBA code  Description of service provider
--------  ------------------------------------------------------------
9217      Offices and clinics of medical doctors

9233      Offices and clinics of dentists

9258      Osteopathic physicians and surgeons

9274      Chiropractors

9290      Optometrists

9415      Registered and practical nurses

9431      Other licensed health practitioners

9456      Dental laboratories

9472      Nursing and personal care facilities

9886      Other health services
----------------------------------------------------------------------
Source:  1988 TCMP database. 



                               Table IV.7
                
                Types of Service Providers in All Other
                       Service-Related Businesses

PBA code  Description of service provider
--------  ------------------------------------------------------------
1917      Soil preparation services

1933      Crop services

1958      Veterinary services, including pet

1974      Livestock breeding

1990      Other animal services

2113      Farm labor and management services

2212      Horticulture and landscaping services

2238      Forestry, except logging

2279      Fishing, hunting, and trapping

7096      Hotels, motels, and tourist homes

7211      Rooming and boarding houses

7237      Camps and camping parks

7419      Coin operated laundries and dry cleaning

7435      Other laundry, dry cleaning, and garment services

7450      Carpet and upholstery cleaning

7476      Janitorial and related services

8813      Automotive rental and leasing without driver

8839      Parking, except valet

8854      General automotive repair service

8870      Specialized automotive repair service

8896      Other automotive services (wash, towing, etc.)

9019      TV and audio equipment repair services

9035      Other electrical equipment repair service

9050      Reupholstery and furniture repair

2881      Other equipment repair services

8557      Physical fitness facilities

9613      Videotape rental stores

9639      Motion picture theaters

9654      Other motion picture and TV film and tape activity

9670      Bowling alleys

9696      Professional sports and racing

9811      Theatrical performers, musicians, agents, producers, and
          related services

9837      Other amusement and recreational services
----------------------------------------------------------------------
Source:  1988 TCMP database. 


POPULATION ESTIMATES BY SERVICE
PROVIDER DEFINITION AND SECTOR
=========================================================== Appendix V



                               Table V.1
                
                    Population Estimates for Service
                         Providers With No COGS


                                                              Sampling
                                              Estimated    error (plus
Description of sector                            number      or minus)
----------------------------------------  -------------  -------------
Construction services                           899,098        123,848
Real estate, insurance, and financial         1,105,244        101,930
 services
Transportation and communication                512,366         67,728
 services
Business services                             2,054,035        155,543
Personal services                             1,550,542        152,537
Medical services                                501,777         55,267
All other services                            1,286,405        147,154
All other businesses with no COGS             1,243,115        137,544
======================================================================
Total service providers with no COGS          9,152,583        332,440
Percent of all sole proprietors                   68.1%           3.6%
----------------------------------------------------------------------
Source:  The IRS tax gap model and TCMP database. 



                               Table V.2
                
                    Population Estimates for Service
                  Providers With Average or Lower COGS


                                                              Sampling
                                              Estimated    error (plus
Description of sector                            number      or minus)
----------------------------------------  -------------  -------------
Construction services                         1,343,180        135,945
Real estate, insurance, and financial         1,129,957        102,256
 services
Transportation and communication                546,740         68,340
 services
Business services                             2,231,821        163,622
Personal services                             1,698,522        157,157
Medical services                                521,696         55,627
All other services                            1,554,165        151,367
All other businesses with no COGS             1,243,115        137,544
======================================================================
Total service providers with average         10,269,196        317,278
 COGS
Percent of all sole proprietors                   76.4%           3.3%
----------------------------------------------------------------------
Source:  The IRS tax gap model and TCMP database. 



                               Table V.3
                
                    Population Estimates for Service
                   Providers Defined by the PBA Code


                                                              Sampling
                                              Estimated    error (plus
Description of sector                            number      or minus)
----------------------------------------  -------------  -------------
Construction services                         1,707,309        141,375
Real estate, insurance, and financial         1,178,942        103,819
 services
Transportation and communication                597,864         71,842
 services
Business services                             2,408,087        167,606
Personal services                             1,889,072        161,994
Medical services                                593,901         56,818
All other services                            1,854,906        157,816
All other businesses with no COGS             1,243,115        137,544
======================================================================
Total service providers as defined by        11,473,195        347,065
 the PBA code
Percent of all sole proprietors                   85.3%           3.0%
----------------------------------------------------------------------
Source:  The IRS tax gap model and TCMP database. 


ALLOCATION OF INFORMAL SUPPLIER
TAX GAP
========================================================== Appendix VI

The tax gap for informal suppliers accounted for a large part of the
overall service provider tax gap.  IRS does not routinely allocate
this estimate among the various business sectors because no generally
accepted methodology existed for making such an allocation.  Also,
allocating the informal supplier tax gap estimate among the various
sectors adds an additional degree of uncertainty to the estimate.  To
provide additional information, we developed tables VI.1 to VI.3 in
which we allocated the informal supplier tax gap among the business
sectors.  Based on discussions with IRS officials, we allocated the
informal supplier tax gap by the proportion of noncompliance found in
TCMP for the sector. 



                               Table VI.1
                
                Allocation of Informal Supplier Tax Gap
                by Proportion of Noncompliance (No COGS)

                         (Dollars in millions)


                                               All other         Total
                                  Informal       service       service
Description of sector            suppliers     providers     providers
----------------------------  ------------  ------------  ============
Construction services              $ 5,923       $ 1,209       $ 7,132
Real estate, insurance, and              0           937           937
 financial services
Transportation and                   1,068           800         1,868
 communication services
Business services                    1,121         2,122         3,243
Personal services                    2,005            61         2,066
Medical services                       317           610           927
All other services                   1,200         1,045         2,245
All other services with no           1,557         1,057         2,614
 COGS
======================================================================
Total                              $13,191       $ 7,841       $21,032
----------------------------------------------------------------------
Source:  TCMP database and the IRS tax gap model. 



                               Table VI.2
                
                Allocation of Informal Supplier Tax Gap
                by Proportion of Noncompliance (Average
                             or Lower COGS)

                         (Dollars in millions)


                                               All other         Total
                                  Informal       service       service
Description of sector            suppliers     providers     providers
----------------------------  ------------  ------------  ============
Construction services              $ 6,189       $ 2,229       $ 8,418
Real estate, insurance, and              0         1,027         1,027
 financial services
Transportation and                   1,117           979         2,096
 communication services
Business services                    1,172         2,375         3,547
Personal services                    2,095           954         3,049
Medical services                       331           634           965
All other services                   1,254         2,106         3,360
All other services with no           1,627         1,057         2,684
 COGS
======================================================================
Total                              $13,784       $11,361       $25,145
----------------------------------------------------------------------
Source:  TCMP database and the IRS tax gap model. 



                               Table VI.3
                
                Allocation of Informal Supplier Tax Gap
                  by Proportion of Noncompliance (PBA
                                 Code)

                         (Dollars in millions)


                                               All other         Total
                                  Informal       service       service
Description of sector            suppliers     providers     providers
----------------------------  ------------  ------------  ============
Construction services              $ 6,522       $ 3,804       $10,326
Real estate, insurance, and              0         1,379         1,379
 financial services
Transportation and                   1,177         1,140         2,317
 communication services
Business services                    1,235         2,893         4,128
Personal services                    2,208         1,349         3,557
Medical services                       349           984         1,333
All other services                   1,322         3,144         4,466
All other services with no           1,714         1,057         2,771
 COGS
======================================================================
Total                              $14,526       $15,750       $30,276
----------------------------------------------------------------------
Source:  TCMP database and the IRS tax gap model. 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================= Appendix VII

GENERAL GOVERNMENT DIVISION,
WASHINGTON D.C. 

Tom Short, Assistant Director, Tax Policy and Administration Issues
Ralph Block, Assistant Director, Tax Policy and Administration Issues

SAN FRANCISCO REGIONAL OFFICE

Lou Roberts, Evaluator-in-Charge
Sam Scrutchins, Technical Consultant

*** End of document. ***