Tax Administration: Tax Compliance of Nonwage Earners (Letter Report,
08/28/96, GAO/GGD-96-165).

Pursuant to a congressional request, GAO reviewed tax administration
issues related to the growth of nonwage income, focusing on the: (1)
primary sources of such income; (2) impact of nonwage income tax
delinquencies on the Internal Revenue Service's (IRS) accounts
receivable; and (3) potential options for improving the timely payment
of taxes on nonwage income.

GAO found that: (1) from 1970 to 1992, individuals' nonwage income
increased from 16.7 percent to 23.4 percent; (2) pensions, interest,
self-employment, capital gains, dividends, and partnerships accounted
for 91.6 percent of all nonwage income reported for 1992; (3) individual
tax returns showing only nonwage income increased from about 10 percent
to over 15 percent in 1992; (4) the proportion of the taxpayer
population reporting nonwage income will continue to increase as the
population ages because pension income is the largest and fastest
growing source of nonwage income; (5) taxpayers whose income derives
mainly from nonwage sources are more likely to have problems paying
their income taxes; (6) these taxpayers accounted for 74 percent of the
$79.2 billion in delinquent taxes owed by individuals in fiscal year
1993; (7) taxpayers with self-employment, interest, and dividend income
accounted for about two-thirds of the nonwage income included in the IRS
inventory of tax debts; and (8) options for improving timely tax
payments on nonwage income include expanding withholding to more nonwage
income sources, increasing taxpayer awareness of tax payment
responsibilities for nonwage income, and modifying the estimated tax
payment system.

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

 REPORTNUM:  GGD-96-165
     TITLE:  Tax Administration: Tax Compliance of Nonwage Earners
      DATE:  08/28/96
   SUBJECT:  Personal income taxes
             Delinquent taxes
             Tax administration systems
             Tax nonpayment
             Social security taxes
             Pensions
             Tax returns
             Taxpayers
             Reporting requirements

             
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Cover
================================================================ COVER


Report to the Chairman, Subcommittee on Oversight, Committee on Ways
and Means, House of Representatives

August 1996

TAX ADMINISTRATION - TAX
COMPLIANCE OF NONWAGE EARNERS

GAO/GGD-96-165

Nonwage Earners

(268648)


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

  IRS - Internal Revenue Service
  SOI - Statistics of Income
  SSA - Social Security Administration

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


B-260159

August 28, 1996

The Honorable Nancy L.  Johnson
Chairman, Subcommittee on Oversight
Committee on Ways and Means
House of Representatives

Dear Chairman Johnson: 

This report responds in part to the Subcommittee's request that we
review the tax administration issues related to tax payments and tax
delinquencies of individuals whose primary income is derived from
nonwage sources such as pensions, self-employment, interest,
dividends, partnerships, and capital gains.  This report presents
information on the growth of nonwage income, the primary sources of
such income, and the impact of nonwage income tax delinquencies on
the Internal Revenue Service's (IRS) accounts receivable.  We also
provide information on several options that we and others identified
as having potential for improving the timely payment of taxes on
nonwage income.  We make no specific recommendations in this report. 

A major difference between nonwage income and wage income is how
taxes are paid.  Although taxes are withheld from wage income,
taxpayers with nonwage income are generally required to calculate
their projected taxable income and make periodic payments during the
tax year. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

Nonwage income has grown significantly since 1970 when it accounted
for just 16.7 percent of total income\1 for individuals.  For tax
year 1992, the most recent available information at the time we did
our work, nonwage income accounted for 23.4 percent, or $859 billion,
of the $3,665 billion of total income for individuals.  The six
largest sources of nonwage income--pensions, interest,
self-employment, capital gains, dividends, and partnerships/
Subchapter S corporations--accounted for about $787 billion, or 91.6
percent, of all nonwage income reported by taxpayers for tax year
1992.  Pension income, at about $186 billion, was by far the largest
and fastest growing source of nonwage income. 

IRS data show that taxpayers earning most of their income from
nonwage sources are more likely to have problems paying their taxes
than wage earners and, as a result, owe more delinquent taxes than do
wage earners.  IRS' inventory of tax debt\2 for individual taxpayers
at the end of fiscal year 1993 totaled $79.2 billion, of which about
$58.5 billion, or 74 percent, was owed by taxpayers with primarily
nonwage income. 

Available IRS information showed that self-employment income was the
largest portion of nonwage income included in IRS' inventory of tax
debts at the end of fiscal year 1993.  Although we were unable to
analyze the extent and causes of tax delinquencies by sources of
nonwage income, we identified possible options that appear to have
potential for improving the timely payment of taxes on nonwage
income, some of which we have suggested in the past and others that
have support from analysts within IRS or outside tax experts.  These
options include withholding income taxes on more sources of nonwage
income, making taxpayers better aware of their tax payment
responsibilities, and modifying the estimated tax payment system. 


--------------------
\1 For purposes of this report, total income means total gross income
for tax purposes.  It excludes income not subject to federal tax,
such as tax- exempt interest. 

\2 The inventory of tax debt includes all outstanding debts owed by
taxpayers that are in IRS' detailed accounting records, which is
composed of both compliance assessments and financial receivables. 
According to IRS, its management information system is not designed
to specifically identify and separately track those owing taxes
reportable as accounts receivable. 


   BACKGROUND
------------------------------------------------------------ Letter :2

The Internal Revenue Code requires individuals to pay their income
taxes either through withholding by third parties or making estimated
tax payments.  Both withholding and estimated tax payments are
designed to collect income taxes on a "pay-as-you-go" basis during
the tax year.  IRS collects over 70 percent of individuals' income
tax payments through withholding.  Taxpayers generally remit the
remaining payments directly to IRS as estimated tax payments or final
payments with returns. 

Wage withholding is mandatory and automatic for wage-earning
taxpayers.  Under wage withholding, employees pay taxes through
regular withholding from their paychecks.  Employers are responsible
for remitting withholdings to IRS at least monthly (every few days
for larger employers).  Large employers are required to remit
withholdings by electronic fund transfer.  Wage withholding is
designed to cover employee income, Social Security, and Medicare
taxes.  The employer determines how much tax to withhold on the basis
of employee's wages and employee-supplied data about filing status
and withholding allowances.  Employees can adjust withholdings to fit
their tax situations and can even claim exemption from income tax
withholding if they had no income tax liability for the prior year. 
Furthermore, pension recipients usually have income taxes withheld
from their distributions; however, they have the option of not having
taxes withheld.  Withholding generally is not available for nonwage
income apart from pensions. 

Taxpayers without withholdings who expect to owe taxes must make
estimated tax payments to pay their income tax liabilities. 
Furthermore, self- employed people, like independent contractors,
must make estimated tax payments to cover their expected
self-employment tax, which supports the Social Security and Medicare
trust funds.  The individual taxpayer is required to make four
estimated tax payments each year.  Payments generally are due on
April 15, June 15, September 15, and January 15.  Taxpayers are
required to calculate the amount due for each period, on the basis of
their estimate of the year's total tax liabilities.  Generally, the
taxpayer mails the estimated tax payment to an IRS lockbox address,
along with a payment voucher, Form 1040-ES. 

Taxpayers who make inadequate tax payments during the year are
subject to estimated tax penalties.  This penalty is equivalent to an
interest charge from the due date of the estimated payment to the due
date of the annual tax return or the payment date, whichever comes
first.  Generally, no estimated penalty will be due if the amount due
at filing is less than $500, or the amount paid is 90 percent of the
total current year tax liability or 100 percent of the taxpayer's
prior year tax liability.  However, exceptions apply to farmers,
fishermen, and high income taxpayers. 


   OBJECTIVES, SCOPE, AND
   METHODOLOGY
------------------------------------------------------------ Letter :3

The objectives of this assignment were to determine (1) the growth
and primary sources of nonwage income, (2) the impact of nonwage
income tax delinquencies on IRS' accounts receivable, and (3) options
for enhancing the timely payment of taxes on nonwage income. 

To determine the growth and primary sources of nonwage income, we
analyzed IRS' Statistics of Income (SOI) data for tax year 1992--the
most recent information available at the time we did our
analyses--and compared the results with similar data for tax years
1970 through 1990.  For the second objective--determining the impact
of nonwage income tax delinquencies on IRS' accounts receivable--we
were limited to using IRS' summary information on its inventory of
tax debts because the more detailed information was not readily
available.  This inventory is a 10-year accumulation of tax
delinquencies and includes valid and invalid receivables and
duplicate assessments.  In addition, this information did not provide
the same detailed breakout of income as the SOI data.  We noted some
potential problems with the summary information on the inventory of
tax debts, for example income source data were shown only for the
last year that the taxpayer was delinquent.  Many taxpayers are
several years delinquent in paying taxes, and those years are
included in the inventory of tax debts.  However, if their primary
source of income changed from year to year, the information in the
inventory may not reflect the previous years' primary income source. 
Despite these limitations, we believe the information provides a
basis to show the significance of the problem. 

For the last objective--determining options for enhancing the timely
payment of taxes on nonwage income--we reviewed the Internal Revenue
Code and IRS publications, and we interviewed IRS headquarters,
regional, and service center staff.  Furthermore, we reviewed IRS,
GAO, and private studies on nonwage earners' tax compliance and ways
to improve tax payment compliance.  We also interviewed a wide range
of officials from organizations representing taxpayers, tax
preparers, and payers of nonwage income.  These organizations
included the American Institute of Certified Public Accountants, H &
R Block, the Securities Industry Association, the U.S.  Chamber of
Commerce, the National Association for the Self-Employed, and the
Small Business Legislative Council. 

We requested comments on a draft of this report from the Commissioner
of Internal Revenue.  On July 2, 1996, we received written comments
from IRS' Office of Legislative Affairs, which were prepared by the
National Director for Compliance Research.  These comments are
discussed on page 16. 

As agreed with your office, we closed our study because data were not
readily available to continue our efforts beyond those described
above.  We did our work from September 1994 to July 1996 in
accordance with generally accepted government auditing standards. 


   NONWAGE INCOME HAS BEEN A
   GROWING PORTION OF TOTAL
   INDIVIDUAL INCOME
------------------------------------------------------------ Letter :4

Nonwage income has grown significantly since 1970 when it accounted
for 16.7 percent of total income.  As a portion of total income,
nonwage income rose continuously through the 1980s, peaking in 1989
at 25.3 percent of total income.  In 1990, nonwage income was 24.4
percent of total income.  By 1992, the most recent available
information at the time we did our work, nonwage income still
accounted for 23.4 percent, or $859 billion, of the $3,665 billion of
total income for individuals.  This is a 39 percent increase in the
proportion of nonwage income to total income from tax year 1970 when
nonwage income represented 16.7 percent, or $107 billion, of the $639
billion in taxable income for individuals.  Figure 1 shows the growth
in nonwage income as a percentage of taxable income in 5- year
intervals from tax year 1970 to 1990. 

   Figure 1:  Growth in Nonwage
   Income, 1970 to 1990

   (See figure in printed
   edition.)

Note:  The abbreviation "bn" represents billion. 

Source:  Percentages are GAO calculations based on data from IRS'
Statistics of Income Bulletin, Fall 1994, p.  140. 

When reporting nonwage income to IRS, taxpayers use 15 different
income categories listed on IRS Form 1040.  Of these 15 different
categories, we found that 6--pensions, interest, self-employment
(Schedule C), capital gains, partnerships/Subchapter S corporations,
and dividends--accounted for 91.6 percent of all nonwage income
reported by taxpayers for tax year 1992.  Figure 2 shows the amount
of nonwage income reported by each category for tax year 1992. 

   Figure 2:  1992 Individual
   Taxpayer Income by Source

   (See figure in printed
   edition.)

Note:  The abbreviation "bn" represents billion. 

\a "Other" includes remaining nonwage categories that comprised
nonwage income in 1992, such as unemployment compensation $31.39 bn.,
taxable IRA distributions $26.27 bn., taxable Social Security $23.14
bn., Schedule E- other $13.63 bn., state/local income tax refunds
$10.19 bn., alimony $4.61 bn., farm income/loss -$2.54 bn.,
supplemental gain/loss -$2.65 bn., and all other -$31.78 bn. 

Source:  GAO analysis of IRS Statistics of Income data for 1992. 

The growth of nonwage income is also reflected by the increase in the
number of individual tax returns filed with income from only nonwage
sources.  In this regard, the number of these returns increased from
about 10 percent, or 7.3 million, of the 74 million individual tax
returns filed in 1970 to over 15 percent, or 17.3 million, of the 114
million tax returns filed in 1992.  Figure 3 shows the growth in tax
returns filed showing only nonwage income in 5-year intervals from
tax year 1970 to 1990. 

   Figure 3:  Returns With Only
   Nonwage Income, 1970 to 1990

   (See figure in printed
   edition.)

Source:  GAO analysis of IRS Statistics of Income Bulletin, Fall
1994, p.  140. 

Economic and demographic trends suggest that the proportion of
taxpayers with nonwage income could continue to grow at a faster pace
than those with wage income.  For example, as the taxpaying
population grows older and people live longer, more and more people
will receive pensions and other types of nonwage income.  In tax year
1992, over 17 million tax returns included pension income, which was
a significant increase from 1970 when only 3.2 million returns
included pension income.  Other categories of nonwage income have
also shown substantial growth in the past 2 decades.  For example,
the number of tax returns that included self- employment income
increased 138 percent from 1970 to 1990.  Figure 4 shows the
percentage growth in tax returns filed by major income category from
1970 to 1990. 

   Figure 4:  Growth In Forms With
   Wages And Key Nonwage Income
   Source

   (See figure in printed
   edition.)

Source:  GAO analysis of IRS Statistics of Income Bulletin, Fall
1994, p.  140. 


   IMPACT ON IRS INVENTORY OF TAX
   DEBTS
------------------------------------------------------------ Letter :5

Because there is generally no withholding of income taxes on nonwage
income, taxpayers with such income are required to make periodic
payments during the tax year, based on an estimate of their income,
deductions, and annual tax liability.  When periodic payments are not
sufficient, some taxpayers may not file tax returns, or they may file
returns without full payment of their tax liability.  The result is a
large and growing compliance problem, particularly among taxpayers
with nonwage income.  IRS data show that taxpayers receiving most of
their income from nonwage sources owe more delinquent taxes than do
wage earners.  Specifically, IRS' inventory of tax debt for
individual taxpayers at the end of fiscal year 1993 totaled $79.2
billion, of which 74 percent, or about $58.5 billion, was owed by
taxpayers with primarily nonwage income.  Figure 5 provides a
breakdown of the $79.2 billion of individual tax debt by wage and
nonwage sources. 

   Figure 5:  Fiscal Year 1993 IRS
   Receivables Analyzed by
   Individual Taxpayer Income Type

   (See figure in printed
   edition.)

Source:  IRS Accounts Receivable Management Information System
report, September 1993. 

Statistical information developed by IRS on the inventory of
individual tax debt at the end of fiscal year 1993 showed that about
two-thirds, or about $39 billion, of the $59 billion owed by
taxpayers with nonwage income was attributable to taxpayers whose
primary sources of income were from self- employment, interest, or
dividends.  IRS data also showed that the average tax delinquency for
taxpayers with primarily nonwage income was about 4 times greater
than that of wage earners.  In that regard, nonwage earners owed an
average of about $15,800 while wage earners owed an average of about
$3,600.\3


--------------------
\3 Both figures include tax, interest, and penalties. 


   OPTIONS FOR ENHANCING THE
   TIMELY PAYMENT OF TAXES ON
   NONWAGE INCOME
------------------------------------------------------------ Letter :6

On the basis of our review of relevant IRS and GAO studies,
discussions with various tax officials, and related information, we
identified several options that appear to have potential for
enhancing the timely payment and collection of taxes on nonwage
income.  These options include expanding tax withholding to cover
more nonwage sources of income, making taxpayers with nonwage income
better aware of their tax responsibilities, and modifying the
estimated tax system. 


      EXPANDING WITHHOLDING
---------------------------------------------------------- Letter :6.1

IRS estimates that tax reporting compliance for wage earners with
withholding is about 99 percent, while tax compliance for individuals
with income not subject to withholding is significantly less.  In the
case of self-employed taxpayers, IRS estimates that compliance is
about 41 percent.  As we mentioned earlier, IRS' breakdown of its tax
debts inventory indicates that almost 74 percent of the inventory was
associated with nonwage income at the end of fiscal year 1993. 
However, because taxpayer- related information was not readily
available, we were unable to break down annual delinquencies by
specific sources of nonwage income. 

The Internal Revenue Code provides for three types of withholdings--
mandatory, backup, and voluntary.  Mandatory withholding has been
used to collect income taxes on wages since World War II but has
rarely been used for nonwage income in the United States.\4 However,
a 1986 IRS study found that mandatory withholding was used for
certain nonwage income in other countries.  For example, many
countries collect taxes on interest and dividends through
withholding, and some use mandatory withholding on retirement,
commissions, self-employment, and agricultural income.  Congress
authorized 10-percent mandatory withholding on interest and dividend
income in 1982 but repealed the requirement in 1983 before it became
effective.  Mandatory withholding on interest and dividends was
repealed because of perceptions that withholding would impose undue
burdens on some taxpayers and financial and administrative burdens on
financial institutions.  Also, it was believed that the 10-percent
withholding would not eliminate all noncompliance.  In repealing the
mandatory withholding, Congress provided a backup withholding system. 

Backup withholding applies to all types of nonwage income that are
subject to information reporting when payors find they have an
incorrect taxpayer identification number or they lack certification
that the payee is not subject to backup withholding.  Backup
withholding also applies in cases when taxpayers significantly
underreport their income from interest and dividends.  According to
an IRS study, IRS is looking at ways to maximize underreporter backup
withholding and possibly expand its use.  A 1994 IRS internal study
on high-income taxpayers reported that backup withholding on
self-employment income of noncompliant taxpayers could bring $7
billion in "new money" into the Treasury over a 5-year period. 
However, according to IRS' study, broadening the use of backup
withholding would require congressional authorization. 

Voluntary withholding is another available option that has primarily
been used for pension income.  Individuals receiving pension payments
have the option to have income taxes withheld from their pension
payments.  In addition, effective January 1, 1997,\5 federal payors\6
and state unemployment commissions will be required to offer payees
the option to have income taxes withheld from certain nonwage
payments including Social Security. 

A number of IRS studies over the last 10 years have noted the high
occurrence of noncompliance by taxpayers receiving nonwage income,
particularly self-employed taxpayers.  We reported in July 1992 that
noncompliance among self-employed individuals was serious enough to
warrant some form of withholding.\7 As part of a broader effort
looking at taxpayer compliance in general, we convened a panel of tax
experts in 1995.  The purpose was to obtain the views of these
experts regarding innovative and practical means of increasing
taxpayer compliance.  One of several options presented by the
panelists was extending the reach of tax system requirements, such as
income tax withholding, to promote increased taxpayer compliance. 
Most panelists favored withholding on business payments to
independent contractors as a means of reducing the relatively high
degree of noncompliance among these taxpayers.\8


--------------------
\4 An exception would be taxable casino gambling profits paid to
Native American tribal members, which became subject to mandatory
withholding after December 31, 1994.  Also, Congress authorized
mandatory withholding on interest and dividends in 1982 but repealed
the requirement in 1983 before it became effective.  Treasury
proposed mandatory withholding on business payments to independent
contractors in 1979, but this proposal was never adopted. 

\5 P.  L.  103-465, section 702.  According to a Social Security
Administration (SSA) official, voluntary withholding on Social
Security benefits cannot be implemented until Congress amends a
Social Security Act provision that bars assignment of benefits. 

\6 Federal payors include the SSA, the Railroad Retirement Board, and
the Department of Agriculture. 

\7 Tax Administration:  Approaches for Improving Independent
Contractor Compliance (GAO/GGD-92-108, July 23, 1992). 

\8 Reducing the Tax Gap:  Results of a GAO-Sponsored Symposium
(GAO/GGD- 95-157, June 2, 1995). 


      MAKING TAXPAYERS BETTER
      AWARE OF TAX
      RESPONSIBILITIES
---------------------------------------------------------- Letter :6.2

Individuals in the private sector and IRS officials whom we met with
mentioned that the more taxpayers are aware of their tax obligations,
the more likely they are to comply.  One area mentioned was the
transition period when taxpayers go from wage earning to retirement. 
According to an IRS study, this can be a time of taxpayer confusion
about tax liabilities, and SSA officials said they have not, in the
past, educated Social Security recipients on tax issues.  As
discussed earlier in this report, new legislation effective January
1, 1997, permits withholding from Social Security payments if the
recipient so requests.  An SSA official informed us that SSA will be
ready to implement voluntary withholding in 1997, provided the agency
gets a necessary amendment to the Social Security Act. 

A tax practitioner told us that tax reminders and payment options
provided when income is received could increase taxpayer awareness of
tax payment compliance.  For instance, periodic statements that
report interest and dividend income could include language reminding
taxpayers of potential estimated tax requirements.  Similar reminders
could be given to taxpayers selling assets where capital gains or
losses are involved.  A practitioner also said this type of
information would help remind and educate taxpayers of the potential
tax consequences and the potential need to make estimated tax
payments.  However, broker industry representatives told us that
including such information on their statements may not be a
cost-effective solution.  They said reporting compliance is already
very high. 

We have previously reported that increasing the awareness of certain
self- employed individuals--independent contractors--regarding their
tax responsibilities could improve compliance.\9 This is important
because of the significant tax liabilities that can arise because, in
addition to individual income taxes, these taxpayers are liable for
the payment of self-employment Social Security taxes on their income. 
These self-employment taxes are assessed at a rate of 15.3 percent of
taxable income.  For self-employed taxpayers with low taxable
incomes, these taxes may be greater than their income taxes.  One way
to increase the awareness of the tax responsibilities of independent
contractors is through written agreements.  In this regard, two bills
were introduced in Congress last year dealing with the classification
of workers as either independent contractors or employees.  Both
bills would require written agreements to formalize the arrangement
for independent contractors.\10 One aspect of these written
agreements would be to specify who is responsible for tax payments
and what types of tax obligations are required of the independent
contractor. 


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

\10 "Independent Contractor Tax Fairness Act of 1995" (H.R.  582) and
"Independent Contractor Tax Simplification Act of 1995" (H.R.  1972). 


      MODIFYING THE ESTIMATED TAX
      SYSTEM
---------------------------------------------------------- Letter :6.3

Estimated tax procedures for individual taxpayers generally have not
changed for many years.  IRS sends individual taxpayers, who were
required to make estimated payments the prior year, instructions and
estimated tax- payment coupons at the beginning of the tax year. 
Taxpayers must estimate their annual income, expenses, deductions,
and potential tax liabilities, and mail their tax payments to IRS
four times a year.  We identified four suggestions to improve the
estimated tax system:  (1) a more flexible payment schedule, (2)
modernized payment channels, (3) IRS follow-up for missing payments,
and (4) stiffer penalties for noncompliance. 

Representatives of private sector groups we spoke with generally
favor a more flexible payment schedule, which recognizes that
individuals with nonwage income may not easily accumulate the
quarterly payments due under the current system.  Taxpayers might
find smaller monthly payments easier to make and more convenient. 
This may be especially true of self-employed taxpayers whose
estimated payments must include their income tax and self- employment
tax. 

New technology is also available to simplify the estimated tax
payment systems and ease taxpayer burden.  Electronic funds transfer
and automatic withdrawals from checking or savings accounts, for
example, are now commonly used to pay bills.  Private sector
spokesmen and a tax practitioner suggested that such techniques would
help taxpayers meet their estimated tax payment obligations with less
burden. 

Another area involves IRS reminding taxpayers of their estimated tax
payment responsibilities.  IRS does not have a system in place to
monitor whether an individual's estimated tax payments are made until
the tax year has ended.  In addition, IRS does not send any type of
reminder notice to taxpayers when the periodic estimated tax payments
are due.  An internal IRS study on tax delinquencies has recommended
that reminder notices be sent each quarter to taxpayers who should be
making estimated tax payments but are not.  According to an IRS
official, IRS has not pursued such a recommendation because
implementing such a system would be too complex and could burden too
many taxpayers who are not liable for estimated taxes.  Some IRS
officials believed that developing and operating such a monitoring
system and sending reminder notices may not be cost effective, and,
as a result, no actions were taken on the recommendations. 

Finally, it should be noted that the tax code includes a penalty for
taxpayers who fail to meet their estimated tax payment deadlines on
time.  The penalty for a late payment is essentially an interest
charge levied on the amount that was not paid for the period that the
payment is overdue.  A recent IRS internal study pointed out that
this penalty provides little financial reason for taxpayer
compliance--noting that the effective annual penalty rate was 4.8
percent.  The study recommended increasing the penalty, especially
for taxpayers with a history of payment delinquencies. 


   CONCLUSIONS
------------------------------------------------------------ Letter :7

It appears that income from nonwage sources will continue to be a key
portion of total income for individuals.  As this type of income
grows, tax delinquencies will probably grow because these taxpayers
are more likely to be delinquent than wage earners.  Dealing with the
delinquency problem will not be an easy task for IRS.  The tools,
primarily the mandatory withholding of income taxes, that increase
the compliance of wage earners are not currently available for
nonwage income.  In addition to withholding of income taxes, we point
out several options, including increasing individuals' awareness of
their tax responsibilities, simplifying the estimated tax payment,
and monitoring of estimated tax payments that have been suggested as
ways that have potential to assist taxpayers in making timely
payments of income taxes. 


   IRS COMMENTS AND OUR EVALUATION
------------------------------------------------------------ Letter :8

We received written comments on a draft of this report from IRS'
Office of Legislative Affairs on July 2, 1996.  The written comments,
prepared by IRS' National Director for Compliance Research, suggested
some clarifying language and editorial changes, which have been made,
and also addressed two of the options presented in the report. 
Regarding the option to expand withholding, IRS believes the problem
lies mostly with self- employed individuals and that mandatory
withholding on nonemployee (independent contractor) compensation
should continue to be explored.  For interest and dividend income,
IRS believes that any expansion of backup withholding should be
narrowly focused on taxpayers with egregious compliance situations. 
Regarding modifications to the estimated tax system, IRS still
believes it may not be cost effective to issue notices to all
individuals who stop making estimated tax payments because many do so
for valid reasons. 


---------------------------------------------------------- Letter :8.1

As agreed with the Subcommittee, unless you publicly announce its
contents earlier, we plan no further distribution of this report
until 30 days after its issue date.  At that time, we will send
copies of this report to the Ranking Minority Member of your
Subcommittee, the Chairmen and Ranking Minority Members of the Senate
Committee on Finance, and the House Committee on Ways and Means,
other interested congressional committees, the Secretary of the
Treasury, the Commissioner of IRS, and other interested parties.  We
will make copies available to others upon request. 

The major contributors to this report are listed in the appendix.  If
you have any questions, please contact me on (202) 512-8633. 

Sincerely yours,

Lynda D.  Willis
Director, Tax Policy and
 Administration Issues


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


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

Joseph E.  Jozefczyk, Assistant Director, Tax Policy and
 Administration Issues
Charlie W.  Daniel, Assignment Manager


   CHICAGO FIELD OFFICE
-------------------------------------------------- Appendix Appendix:2

Thomas D.  Venezia, Core Group Manager
Richard R.  Calhoon, Evaluator-in-Charge
David E.  Jakab, Senior Evaluator
Alexander G.  Lawrence, Senior Evaluator
Roger B.  Bothun, Evaluator

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