Tax Administration: Billions in Self-Employment Taxes Are Owed (Chapter
Report, 02/19/99, GAO/GGD-99-18).
Pursuant to a congressional request, GAO provided information on: (1)
the number and characteristics of self-employed taxpayers who receive
social security credit for self-employment earnings when they are
delinquent in paying the self-employment taxes on those earnings; (2)
why self-employed taxpayers who have not paid their self-employment
taxes are allowed to receive social security credit; and (3) any
potential actions that could enhance the collection of self-employment
taxes.
GAO noted that: (1) analysis of Internal Revenue Service's (IRS)
accounts receivable data showed that more than 1.9 million self-employed
taxpayers were delinquent in paying $6.9 billion in self-employment
taxes on 3.6 million returns; (2) these taxpayers can be generally
characterized by their low income and multiple delinquencies; (3) over
70 percent of their returns reported net self-employment income of less
than +$20,000, and over half of the taxpayers owed delinquent taxes for
more than one tax year; (4) more than 144,000 taxpayers with delinquent
self-employment taxes of $487 million were receiving about $105 million
in monthly social security benefits; (5) the income on which the
self-employment taxes had not been paid resulted in at least an
estimated $2.5 million in monthly benefits that would not have been paid
if those earnings had not been included in the benefit computation; (6)
self-employed taxpayers can get social security benefits based on
earnings for which they did not pay taxes because the Social Security
Act requires the Social Security Administration (SSA) to grant earnings
credits, which are used to determine benefit eligibility and amounts,
and pay benefits without regard to whether the social security taxes
have been paid; (7) not all self-employed taxpayers can receive credit
for their earnings; (8) under the Social Security Act, when taxpayers do
not file their tax returns within 3 years, 3 months, and 15 days after
the end of the year in which the income was earned, they are not to
receive social security credit; (9) of the 3.6 million returns with
delinquent self-employment tax, SSA did not post earnings to its records
for 473,755 returns; (10) for an estimated 81.9 percent of the returns
with unposted earnings, taxpayers filed the returns after the statutory
time limit; (11) IRS has recently been given the option to continuously
levy taxpayers' social security benefits and other federal payments to
recover delinquent taxes and is in the process of developing a program
to do so; (12) this levy program would affect taxpayers that are already
delinquent in paying their taxes and should reduce their tax debt; (13)
another way to collect taxes before taxpayers become delinquent would be
to encourage more self-employed individuals to make their required
estimated tax payments; and (14) GAO estimated that most self-employed
delinquent taxpayers did not make required estimated tax payments, and
many were assessed an estimated tax penalty.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: GGD-99-18
TITLE: Tax Administration: Billions in Self-Employment Taxes Are
Owed
DATE: 02/19/99
SUBJECT: Voluntary compliance
Tax nonpayment
Tax administration
Delinquent taxes
Taxpayers
Self-employed
Social security taxes
Statistical data
Social security benefits
Government collections
IDENTIFIER: IRS Nonfilers Program
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gg99018 TAX ADMINISTRATION
Billions in SelfEmployment Taxes Are Owed
United States General Accounting Office
GAO Report to the Chairman, Subcommittee on Oversight, Committee
on Ways and
Means, House of Representatives
February 1999
GAO/GGD-99-18
February 1999 GAO/GGD-99-18
United States General Accounting Office Washington, D. C. 20548
GAO
General Government Division
B-276940 February 19, 1999 The Honorable Amo Houghton Chairman,
Subcommittee on Oversight Committee on Ways and Means House of
Representatives
Dear Mr. Chairman: This report responds to the Subcommittee's
request that we (1) determine the number and characteristics of
self- employed taxpayers who receive social security credit for
selfemployment earnings when they are delinquent in paying the
self- employment taxes on those earnings; (2) determine why self-
employed taxpayers who have not paid their selfemployment taxes
are allowed to receive social security credit; and (3) identify
any potential actions that could enhance the collection of self-
employment taxes. It makes recommendations to the Internal Revenue
Service and the Social Security Administration to enhance the
administration and collection of self- employment taxes.
As agreed with your office, unless you publicly announce its
contents earlier, we plan no further distribution of this report
until 30 days from the date of this letter. At that time we will
send copies of this report to the former Chair and the Ranking
Minority Member of your Committee, the Chairman and Ranking
Minority Member of the Senate Finance Committee, other interested
Committees and Members, the Secretary of the Treasury, the
Commissioner of Internal Revenue, and the Commissioner of Social
Security. Copies will also be available to others on request.
Major contributors to this report are listed in appendix V. If you
have any questions, please call me on (202) 512- 9110.
Sincerely yours, James R. White Director, Tax Policy and
Administration Issues
Executive Summary
Page 2 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Internal Revenue Service (IRS) data show that the compliance rate
for paying Social Security and Medicare taxes is over two times
higher for wage- earners and their employers than for self-
employed workers. Furthermore, regardless of whether they pay
their self- employment taxes, most self- employed individuals can
receive Social Security credit for their earnings.
Because of the high self- employment tax noncompliance rate, the
Subcommittee on Oversight, House Committee on Ways and Means,
asked GAO to (1) determine the number and characteristics of self-
employed taxpayers who receive Social Security credit for self-
employment earnings when they are delinquent in paying the self-
employment taxes on those earnings, (2) determine why self-
employed taxpayers who have not paid their self- employment taxes
are allowed to receive Social Security credit, and (3) identify
any potential actions that could enhance the collection of self-
employment taxes.
The Social Security program is based on the concept that when
individuals work, they pay taxes into the program based on their
earnings, and when they retire, become disabled, or die, they or
their spouse and qualified dependents may receive monthly benefits
that are based on those earnings. The program was designed to be
self- financing from taxes levied on employees' wages and the net
earnings of self- employed individuals, plus interest earned on
the investment of trust fund balances in government securities.
According to IRS, a key reason for the compliance rate difference
between wage- earners and the self- employed is in how the Social
Security and Medicare taxes are computed and paid. Employers are
required to withhold these taxes from employees' wages, remit
withholdings to IRS at least quarterly, and report each employee's
earnings to the Social Security Administration (SSA) annually. In
1998, wage- earners and their employers each were required to pay
7.65 percent (a total of 15.3 percent) of an employee's gross
salary, up to $68,400. Self- employed taxpayers, however, were
required to pay the entire 15.3 percent on net earnings from
selfemployment if their net earnings were more than $400 for the
year, and they were generally required to remit self- employment
taxes directly to IRS each quarter. From information reported on
annual tax returns, IRS submits self- employed taxpayers' earnings
data to SSA, which posts them to its taxpayers' accounts up to the
earnings limit. This earnings information is used by SSA to
determine if an individual is eligible for Social Security
benefits and the amount of such benefits. Purpose
Background
Executive Summary Page 3 GAO/GGD-99-18 Billions in SE Taxes Are
Owed
GAO's analysis of self- employment tax delinquencies is based on
IRS records of taxpayers who, as of September 27, 1997, owed
selfemployment taxes for one or more tax years. GAO identified
self- employed taxpayers with delinquent self- employment tax by
assuming that partial payments made by taxpayers were first
applied against self- employment taxes and any remaining payments
were then applied to income and other taxes shown on their
returns. Thus, if the partial payments were sufficient to cover
the self- employment tax liability, these taxpayers were not
included in GAO's estimates. While the self- employment tax
delinquencies included both Social Security and Medicare taxes,
GAO did not examine the number of self- employed delinquent
taxpayers who were receiving Medicare benefits. Also, GAO was not
able to deduct the Medicare taxes from the total self- employment
taxes because the IRS accounts receivable data GAO used did not
separately list Social Security and Medicare taxes.
For all sample results, GAO calculated sampling errors and
presents them as 95- percent confidence intervals around each
sample estimate.
Analysis of IRS' accounts receivable data as of September 27,
1997, showed that more than 1.9 million self- employed taxpayers
were delinquent in paying $6.9 billion in self- employment taxes
on 3.6 million returns. These taxpayers can be generally
characterized by their low income and multiple delinquencies. Over
70 percent of their returns reported net self- employment income
of less than $20,000, and over half of the taxpayers owed
delinquent taxes for more than one tax year. Also, more than
144,000 taxpayers with delinquent self- employment taxes of $487
million were receiving about $105 million in monthly Social
Security benefits. The income on which the self- employment taxes
had not been paid resulted in at least an estimated $2.5 million
(the 95- percent confidence interval ranged from $2.5 million to
$9.9 million) in monthly benefits that would not have been paid if
those earnings had not been included in the benefit computation.
Self- employed taxpayers can get Social Security benefits based on
earnings for which they did not pay taxes because the Social
Security Act requires SSA to grant earnings credits, which are
used to determine benefit eligibility and amounts, and pay
benefits without regard to whether the Social Security taxes have
been paid. However, not all self- employed taxpayers can receive
credit for their earnings. Under the Social Security Act, when
taxpayers do not file their tax returns within 3 years, 3 months,
and 15 days after the end of the year in which the income was
earned, they are not to receive Social Security credit. Of the 3.6
million returns with delinquent self- employment tax, SSA did not
post earnings to its records Results in Brief
Executive Summary Page 4 GAO/GGD-99-18 Billions in SE Taxes Are
Owed
for 473,755 returns. For an estimated 81.9 percent (plus or minus
6.5 percent) of the returns with unposted earnings, taxpayers
filed the returns after the statutory time limit. Many of the
taxpayers may not have been aware of the statutory time limit
because neither SSA's nor IRS' widely available publications
discuss it.
There are several potential ways to enhance the collection of
taxes from self- employed individuals. IRS has recently been given
the option to continuously levy taxpayers' Social Security
benefits and other federal payments to recover delinquent taxes
and is in the process of developing a program to do so. This levy
program would affect taxpayers that are already delinquent in
paying their taxes and should reduce their tax debt. With regard
to collecting taxes before taxpayers become delinquent, proposals
have been made by the Department of the Treasury and others to
require withholding on business payments to certain self- employed
individuals, such as independent contractors, which could help
reduce self- employment tax delinquencies. However, Congress has
not acted on these proposals because of the administrative burden
they would place on those businesses that would have to withhold
taxes.
Another way to collect taxes before taxpayers become delinquent
would be to encourage more self- employed individuals to make
their required estimated tax payments. GAO estimated that most
self- employed delinquent taxpayers did not make required
estimated tax payments, and many were assessed an estimated tax
penalty. Taxpayers could be encouraged to make estimated tax
payments if IRS had a program to remind previously noncompliant
taxpayers to make such payments.
After applying all payments taxpayers made to their self-
employment tax liability, GAO found, as of September 27, 1997,
more than 1.9 million taxpayers involving 3.6 million returns
still owed more than $20.5 billion in total tax. Included in that
amount were $6.9 billion in delinquent selfemployment taxes, or an
average of $1,917 per return. The tax years involved in these
delinquencies ranged from 1963 to 1996. However, about three-
fourths of the 3.6 million returns were from tax years 1990 to
1996. The average self- employment income per return was over
$16,000, and over 70 percent of the returns showed self-
employment income of less than $20,000. For 51 percent of the 3.6
million tax returns involving about $3.3 billion in delinquent
self- employment tax, the taxpayers filed the Principal Findings
Number and Characteristics of Delinquent SelfEmployed Taxpayers
Executive Summary Page 5 GAO/GGD-99-18 Billions in SE Taxes Are
Owed
required returns and self- assessed their taxes. For the remaining
49 percent, tax assessments were made as a result of one of IRS'
compliance programs. Also, even though IRS was in the process of
taking some sort of collection action on the majority of the
delinquencies, IRS said there was no guarantee that it would
collect those taxes.
GAO's analysis of IRS and SSA records showed that as of April 21,
1998, 144,473 of the 1.9 million taxpayers delinquent in paying
their selfemployment tax were receiving monthly Social Security
retirement or disability benefits. These taxpayers owed $487
million in self- employment tax and were receiving $105 million a
month in benefits, or an average of $727 per taxpayer per month.
At GAO's request, SSA recalculated the Social Security benefits
for a representative sample of these taxpayers by excluding from
the benefit computation those earnings on which the selfemployment
taxes had not been paid. On the basis of SSA's recalculations, GAO
estimates that the benefit amount would be reduced by at least
$2.5 million (the 95- percent confidence interval ranged from $2.5
million to $9. 9 million) monthly, or $30 million annually (the
95- percent confidence interval ranged from $30 million to $118.8
million). The average monthly benefit payment would be reduced by
about $43 per taxpayer.
The Social Security Act requires SSA to grant credits for coverage
and pay benefits without regard to whether the taxes have been
paid. There were congressional proposals in the past to make
credits for self- employment earnings conditional upon the payment
of the tax because of the perception that the current policy
undermines the compulsory contribution principle of the Social
Security program and that it is unfair to others who pay their
taxes. However, Congress took no action on those proposals.
Making self- employment earnings credits conditional on the
payment of the tax would reduce the total amount of Social
Security benefit payments. For the 144,473 self- employed
delinquent taxpayers collecting Social Security benefits as of
April 21, 1998, the benefit payments would be reduced by at least
$30 million per year, or about 2 percent of the $1.3 billion in
annual benefit payments paid to them.
Under current law IRS cannot administratively allocate taxpayers'
tax payments among self- employment tax and other income taxes
reported on returns. Thus, if Congress made the posting of
earnings conditional on the payment of taxes, it would have to
specify how IRS should allocate taxpayer payments among self-
employment taxes and other income taxes. Whatever allocation
formula was mandated would require IRS to develop a The Social
Security Act
Requires That Coverage Be Based on Self- Employment Earnings, Not
Taxes Paid, But There Is an Exception
Executive Summary Page 6 GAO/GGD-99-18 Billions in SE Taxes Are
Owed
system to track payments by type of tax and send SSA information
on the self- employment tax payments made. SSA would also have to
establish procedures for tracking and posting the information
received from IRS. It was beyond the scope of GAO's review to
evaluate the effects of making Social Security credit for earnings
conditional on the payment of selfemployment taxes on the Social
Security program or the tax system.
Not all taxpayers can get Social Security credit for their
earnings. Under the Social Security Act, to get Social Security
credit, self- employed taxpayers must file their income tax
returns within 3 years, 3 months, and 15 days after the end of the
calendar year in which the income was earned. About $9.6 billion
of the $60 billion in self- employment income reported on 473,755
returns, did not get posted to SSA's records for the delinquent
taxpayers in GAO's population. In an estimated 81.9 percent (plus
or minus 6.5 percent) of those returns, the earnings were not
posted because the taxpayer filed after the statutory time limit.
In an estimated 11.3 percent (plus or minus 4.9 percent) of these
returns, the taxpayers were making payments to clear their tax
debt. Many of these taxpayers may not have known that they would
not receive credit for their self- employment earnings because
SSA's and IRS' widely available publications for the selfemployed
made no mention of the time limit. GAO also found that when IRS
contacts taxpayers under its Non- Filer Program, it does not
inform taxpayers about the time limit for filing returns in order
to get Social Security credit.
The Taxpayer Relief Act of 1997 gave IRS the option of using a new
type of levy that would continuously levy up to 15 percent of
federal payments (including Social Security benefits) made to
delinquent taxpayers until the tax debt is paid in full. With this
authority, IRS plans to give the Department of the Treasury's
Financial Management Service, which is to be responsible for
levying payments, information on the delinquent accounts to be
levied. IRS and the Financial Management Service expect the levy
program to be operational by July 2000. IRS does not plan to levy
against all the delinquent taxpayers. For example, IRS does not
plan to levy Social Security benefits for those taxpayers whose
accounts are classified as currently- not- collectible because of
hardship or those who have installment agreements in effect.
Applying IRS' levy criteria, GAO found that IRS would levy about
41,000 of the 144,473 taxpayers who, as of April 21, 1998, were
receiving Social Security benefits and who were delinquent in
paying about $108 million in self- employment tax.
In general, self- employed taxpayers are less likely to file their
returns and report their earnings than wage- earners, who are
subject to withholding. Potential Actions to Reduce
Self- Employment Tax Delinquencies
Executive Summary Page 7 GAO/GGD-99-18 Billions in SE Taxes Are
Owed
Thus, it seems likely that withholding on business payments to
certain selfemployed individuals, such as independent contractors,
could reduce the amount and number of self- employment tax
delinquencies. As far back as 1979, Treasury proposed mandatory
withholding on business payments to independent contractors, but
Congress did not act on the proposal because of the costs and
burdens on the businesses that would have to withhold. In 1992,
GAO proposed withholding on payments made by businesses to
independent contractors, and in 1995, a panel of former senior
Treasury and IRS officials presented several options for
increasing the compliance of self- employed taxpayers, including
withholding on business payments to independent contractors. GAO
categorized 1.1 million delinquent selfemployed taxpayers by
business activity and found that 40 percent could be subject to
such withholding as independent contractors under the various
proposals. Any provision to withhold on payments made by
businesses to the self- employed would increase the burden on both
the self- employed and the businesses making the payments.
Taxpayers not subject to withholding are generally required to
make quarterly estimated tax payments. However, GAO found that
most delinquent self- employed taxpayers did not make these
required payments. GAO estimated that the taxpayers for 2.5
million (plus or minus 200,000 returns) of the 3.6 million returns
with delinquent self- employment taxes should have made estimated
payments, but in an estimated 2. 3 million returns (plus or minus
200, 000 returns), the taxpayers failed to make these required
payments.
In 1991, IRS initiated a reminder notice program to get more
taxpayers to make required estimated payments. IRS sent reminder
notices to all taxpayers who were compliant in making estimated
payments during the previous year but had not made any in the
current year. However, IRS stopped sending the notices because
taxpayer response to them was negative. The taxpayers considered
the notices intrusive because they believed IRS was making
assumptions based on the previous year that might not apply to the
current year. IRS had no data to show whether the reminder notices
increased the estimated tax payment compliance of individuals who
received notices. Taxpayers would have less cause for concern if
the notices were sent only to taxpayers who were not compliant in
making estimated tax payments during the previous year that is, to
those who (1) in the current year had not made an estimated tax
payment and (2) in the previous year owed self- employment taxes
and were assessed an estimated tax penalty. GAO estimated that
about 1.2 million of the 2.5 million returns (plus or minus
200,000 returns) where estimated payments were required met these
criteria.
Executive Summary Page 8 GAO/GGD-99-18 Billions in SE Taxes Are
Owed
To enhance the administration and collection of self- employment
taxes, GAO is making two recommendations to the Commissioner of
Internal Revenue and one recommendation to the Commissioner of
Social Security. GAO recommends that
the Commissioner of Internal Revenue revise IRS' self- employment
publications, including those given under its Non- Filer Program,
to ensure that self- employed taxpayers know about the need to
file tax returns with self- employment earnings within the
statutory time frame;
the Commissioner of Internal Revenue undertake a pilot project to
test the feasibility of sending notices to noncompliant self-
employed taxpayers; and
the Commissioner of Social Security revise SSA's publications
dealing with self- employed individuals to inform them about the
need to file tax returns with self- employment earnings within the
statutory time frame.
In written comments on a draft of this report, both the
Commissioner of Internal Revenue and the Commissioner of Social
Security agreed to implement the recommendations. Their written
comments, discussed in chapters 3 and 4, set forth the agencies'
specific strategies for implementing the recommendations. In
addition, both IRS and SSA included technical comments that GAO
incorporated throughout the report as appropriate. Recommendations
Agency Comments
Page 9 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Page 10 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Contents 2 Executive Summary 14 Background 14 Objectives, Scope,
and Methodology 17 Chapter 1
Introduction 21 Number and Characteristics of Self- Employed
Delinquent
Taxpayers 21
Some Self- Employed Delinquent Taxpayers Are Receiving Security
Benefits
25 Conclusions 26 Chapter 2
Self- Employed Delinquent Taxpayers Owe Billions in SelfSocial
Employment Taxes
27 The Social Security Act Requires Credits for Social
Security Coverage to Be Based on SE Earnings, Not SE Taxes Paid
27 Self- Employment Earnings Do Not Get Posted When
Returns Are Filed After a Certain Date 28
Conclusions 30 Recommendation to the Commissioner of Internal
Revenue 31
Recommendation to the Commissioner of Social Security 31 Agency
Comments 31 Chapter 3
Taxpayers Receive Social Security Credit When Taxes Are Not Paid,
With One Exception
33 Levying Social Security Benefit Payments 33 Withholding on
Payments Made by Businesses to Self Taxpayers
34 Reminding Delinquent Self- Employed Taxpayers to Make
Estimated Tax Payments 36
Conclusions 36 Recommendation to the Commissioner of Internal
Revenue 37
Agency Comments 37 Chapter 4
Potential Ways to Reduce SelfEmployed Employment Tax Delinquencies
Appendix I: Sampling and Data Analysis Methodology 40 Appendixes
Appendix II: Additional Characteristics of Delinquent Self-
Employed Taxpayers
42
Contents Page 11 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Appendix III: Comments From the Internal Revenue Service
45 Appendix IV: Comments From the Social Security
Administration 47
Appendix V: Major Contributors to This Report 50 Table 2.1:
Returns With Delinquent SE Tax by Taxpayer
and Amount of SE Tax Owed 22
Table 2.2: Returns With Delinquent SE Tax and the Amount of SE Tax
Owed by Tax Year
22 Table 2.3: Returns and Amount of Delinquent SE Tax by
Self- Employment Income 23
Table 2.4: Collection Status of Returns and the Amount of
Delinquent SE Tax
24 Table 2.5: Returns and Delinquent SE Tax by Years in
Accounts Receivable Inventory 24
Table 2.6: Monthly SSA Benefits Retained by Taxpayers After
Benefit Amount Recalculation
25 Table II. 1: Reasons IRS Categorized SE Returns With
Balance Due as Currently- not- Collectible 42
Table II. 2: Collection Status of Returns for Which Delinquent
Taxpayers Were Receiving Social Security Benefits
43 Table II. 3: Delinquent SE Taxes Assessed Through IRS
Compliance Programs 43
Table II. 4: Age of Delinquent Taxpayers Currently Collecting
Social Security Benefits and Delinquent SE Tax
44 Table II. 5: Age of Delinquent Taxpayers Not Yet
Receiving Social Security Benefits and Delinquent SE Tax
44 Tables
Contents Page 12 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Abbreviations
FMS Financial Management Service IRS Internal Revenue Service SE
Self- employment SSA Social Security Administration
Page 13 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Chapter 1 Introduction
Page 14 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Self- employed workers have to pay Social Security and Medicare
taxes, which are called self- employment (SE) taxes, when their
net earnings from self- employment exceed $400 in a tax year. The
collection of these SE taxes has long been a problem. The Internal
Revenue Service (IRS) estimated that the noncompliance rate for
the amount of these SE taxes that were owed but not paid
voluntarily and timely has been over 50 percent since 1984. Since
1951, self- employed taxpayers have been covered by Social
Security, and they can receive Social Security credit for their
earnings regardless of whether their SE taxes are paid.
This report responds to a request from the Chairman, Subcommittee
on Oversight, House Committee on Ways and Means, that we (1)
determine the number and characteristics of self- employed
taxpayers who receive Social Security credit for self- employment
earnings when they are delinquent in paying the SE taxes on those
earnings, (2) determine why self- employed taxpayers who have not
paid their SE taxes are allowed to receive Social Security credit,
and (3) identify any potential actions that could enhance the
collection of SE taxes.
Several types of employment taxes have been established to pay for
Social Security and medical benefits to entitled workers. Social
Security taxes are imposed on earnings to provide benefits and
protect against the loss of earnings when individuals retire, die,
or become disabled. Social Security is the largest income
maintenance program in the United States and is financed by flat-
rate taxes levied on wages and self- employment income. In 1998,
the Social Security tax rate for employees and their employers was
6.2 percent each on gross wages up to $68,400 and 12.4 percent on
earnings net of expenses for self- employed individuals up to
$68,400. 1 In addition, hospital insurance (Medicare) was
established to help pay for hospital, home health, skilled
nursing, and hospice care for the aged and disabled. In 1998, the
Medicare tax rate for employees and employers was 1.45 percent
each and 2.9 percent for self- employed workers. There is no
earnings limit for the Medicare tax.
All Social Security and Medicare taxes are first deposited in the
general fund of the Treasury. For Social Security, the revenues
are allocated to the Social Security trust funds (one for old- age
and survivors insurance and the other for disability insurance)
and for Medicare, the revenues are allocated to the Medicare trust
fund for hospital insurance. The exact amount of the Social
Security and health insurance contributions are not
1 Self- employed individuals are not required to pay SE taxes
unless earnings net of expenses are $400 or more for the year.
Background
Chapter 1 Introduction
Page 15 GAO/GGD-99-18 Billions in SE Taxes Are Owed
known at the time taxes are deposited because they are not
specifically identified in collection reports. Thus, the
allocation to each of the trust funds is estimated. Periodic
adjustments to the trust funds are subsequently made based on
earnings reports filed with the Social Security Administration
(SSA) by employers for each of their employees and tax returns
filed with IRS by the self- employed. IRS subsequently provides
reports of each self- employed taxpayer's earnings net of expenses
to SSA. SSA records these reported earnings in each worker's
account. It then certifies the amount of Social Security earnings
in its records to the Treasury, which uses the certified amounts
in conjunction with the appropriate tax rates to adjust the trust
fund records. All program benefits are paid from the trust funds.
To the extent that tax revenues are greater than program operating
expenses and benefit payments, the excess revenues are invested in
interest- bearing federal securities. This process gives no
consideration to whether Treasury has collected all Social
Security taxes. 2
The Social Security program is based on the concept that when
individuals work, they pay Social Security taxes into the system,
and when they retire, become disabled, or die, they or their
spouse and qualified dependents receive monthly benefits based on
the insured worker's average lifetime earnings. According to IRS
data, the compliance rate for paying Social Security and Medicare
taxes is considerably higher for wage- earners and their employers
than for self- employed workers. IRS estimated that in 1994, the
gross Social Security and Medicare tax gap, 3 which is the annual
amount of Social Security and Medicare taxes that were owed but
not paid voluntarily and timely, was between $17. 1 billion and
$18.1 billion for wage- earners and their employers, which
represents a compliance rate between 95.8 percent and 96 percent.
The SE taxes that were owed but not paid voluntarily and timely by
self- employed individuals was between $27.9 billion and $31.6
billion, which represents a compliance rate of between 41.3
percent and 44.4 percent.
IRS data also indicate that its enforcement programs (i. e.,
Examination and Collection) were able to reduce the gross tax gap
associated with Social Security and Medicare taxes for wage-
earners and their employers by about 40 percent. IRS did not have
data on how much the gross tax gap
2 In a report, Social Security: Reconciliation Improved SSA
Earnings Records But Efforts Were Incomplete (GAO/HRD-92-81, Sept.
1, 1992), we said Congress should consider revising section 201(
a) of the Social Security Act to provide that the trust funds
receive revenue based on the amount of Social Security taxes
collected each year.
3 The gross tax gap consists of taxes that were not reported on
returns and taxes that were reported but not paid. Tax Compliance
Is Lower
for Self- Employed Individuals Than WageEarners
Chapter 1 Introduction
Page 16 GAO/GGD-99-18 Billions in SE Taxes Are Owed
for self- employed taxpayers was reduced through its enforcement
programs.
A key difference between wage- earners and self- employed
individuals is in how the Social Security and Medicare taxes are
computed and paid. Wageearners and their employers each are
required to pay half of the Social Security and Medicare taxes. 4
The Internal Revenue Code requires employers to withhold the
employees' share of these taxes from their wages. Wage withholding
is mandatory for employees, and taxes are imposed starting with
the first dollar of earnings. Employers are responsible for
remitting withholdings and their share of the taxes to IRS at
least quarterly and for reporting each employee's earnings to SSA
annually.
Self- employed taxpayers are required to pay all of their SE
taxes. Selfemployed individuals get two deductions that reduce
their tax liability to treat them in much the same way as
employers and employees for Social Security and income tax
purposes. First, in determining SE tax liability, self- employment
earnings net of expenses are reduced by the product of the
taxpayer's net earnings from self- employment and one- half of the
SE tax rates. This is similar to the way employees are treated
under the tax laws in that the employer's share of Social Security
and Medicare taxes is not considered income to the employee.
Second, self- employed individuals can deduct half of their SE tax
as a trade or business deduction from their gross income in
determining adjusted gross income for income tax purposes. This is
similar to the way employers are treated under the tax laws in
that the employer's share of Social Security and Medicare taxes
can be deducted from gross income.
Unlike wage- earners, self- employed taxpayers do not have a third
party (employer) to withhold and pay taxes to the Treasury.
Instead, these taxpayers are to make their own quarterly estimated
payments each year to cover their expected tax liability.
Taxpayers who make insufficient tax payments to cover the expected
tax liability are subject to estimated tax penalties. Generally,
no estimated penalty is to be assessed if the amount of tax due at
filing is less than $1,000 or the amount of withholding and
credits is 90 percent of the total current year tax liability or
100 percent of the taxpayer's prior year tax liability.
4 Most economists agree that the burden of Social Security and
Medicare taxes is borne by wage- earners in the form of lower
wages. For example, both the Congressional Budget Office and the
Joint Committee on Taxation attribute these taxes to wage- earners
when making estimates of the distributional effects of taxes. How
Social Security and
Medicare Taxes Are Computed, Paid, and Reported
Chapter 1 Introduction
Page 17 GAO/GGD-99-18 Billions in SE Taxes Are Owed
In addition to the differences in the computation and payment of
taxes, there is also a difference in how the earnings are reported
between wageearners and self- employed individuals. For wage-
earners, employers are to report employee earnings annually to SSA
on Form W- 2 (Wage and Tax Statement). However, self- employed
individuals are to report their earnings to IRS on Schedule SE
(Self- Employment Tax), which is required to be filed with their
annual Form 1040 (U. S. Individual Income Tax Return). IRS is to
subsequently submit Schedule SE earnings data to SSA.
When SSA receives earnings data, it is to post them to the
taxpayers' accounts on its Master Earnings File up to the earnings
limit. This earnings information is used by SSA to determine the
number of Social Security coverage credits and amount of benefits
for individuals seeking Social Security benefits. For example, to
be eligible for retirement benefits, a person needs 40 credits,
which is equivalent to 10 years of work. In 1998, both wage-
earners and self- employed taxpayers earned one coverage credit
for each $700 in earnings. A maximum of four credits can be earned
per year. The amount of earnings required to earn a coverage
credit is statutorily set to increase each year as average wage
levels rise.
Generally, the amount of a Social Security benefit is based on
each person's average lifetime earnings. When an eligible taxpayer
requests Social Security retirement or disability benefits, SSA
computes the benefit amount by (1) determining the number of years
of earnings to use as a base, (2) adjusting those earnings for
inflation, (3) determining the average adjusted monthly earnings,
and (4) multiplying the average adjusted earnings by percentages
in a formula specified by law.
Because of the high SE tax noncompliance rate, the Chairman of the
Subcommittee on Oversight, House Committee on Ways and Means,
asked us to review various issues relating to SE tax
delinquencies. Our specific objectives were to (1) determine the
number and characteristics of selfemployed taxpayers who receive
Social Security credit for selfemployment earnings when they are
delinquent in paying the SE taxes on those earnings, (2) determine
why self- employed taxpayers who have not paid their SE taxes are
allowed to receive Social Security credit, and (3) identify any
potential actions that could enhance the collection of SE taxes.
(See app. I, which describes how we selected, analyzed, and
projected our sample.) How SSA Credits Earnings
and Determines Benefit Amounts
Objectives, Scope, and Methodology
Chapter 1 Introduction
Page 18 GAO/GGD-99-18 Billions in SE Taxes Are Owed
To determine the number and characteristics of taxpayers who
receive Social Security credit for their self- employment earnings
when delinquent in paying the SE taxes on those earnings, we first
contacted IRS National Office staff in the Information Systems
Development, Research, Collection, and Examination Divisions.
Next, we obtained an extract from IRS' Individual Master File, as
of September 27, 1997, for all returns with delinquent SE tax
included in the total tax liability. 5 At the same time, we
obtained access to IRS' Accounts Receivable File, which contained
detailed information on returns with delinquent taxes. We matched
the two files to create a new database containing both master file
and accounts receivable data. This match produced a population of
6,020,291 tax returns with SE tax included in total tax liability.
IRS does not allocate taxpayer payments to any particular type of
tax; therefore, we met with various IRS officials to discuss how
we could determine the amount of SE taxes that were still owed. We
agreed to the most conservative methodological approach, which was
to assume that partial payments were applied to the SE tax portion
of the delinquency until paid in full and then to income and other
taxes owed. Working with IRS officials, we developed a two- step
formula that we used to determine if taxpayers were delinquent in
paying their SE tax. For the first step in the formula, we
subtracted the total tax owed for each delinquent return, as of
September 27, 1997, from the original total tax liability. The
difference represented the total amount of tax paid by the
taxpayer as of September 27, 1997. In the second step, we
subtracted the total amount of taxes paid by the taxpayer from the
SE tax amount included on the return. If the amount of SE tax
exceeded the total amount of taxes paid by $1 or more, we
considered the taxpayer delinquent in paying SE taxes on that
return.
To confirm whether these taxpayers were receiving credit at SSA
for their earnings, we matched delinquent taxpayers against SSA's
earnings records. In addition, we matched the universe of
delinquent taxpayers against SSA's Master Benefit Record to
determine how many of these delinquent taxpayers were currently
receiving Social Security retirement or disability benefits under
their own entitlement. 6 While the SE tax delinquencies included
both Social Security and Medicare taxes, we did not examine the
number of self- employed delinquent taxpayers who were receiving
5 The data extracted included the (1) taxpayer identification
number, (2) master file tax code, (3) delinquent tax year, (4)
adjusted gross income, (5) taxable income, (6) total tax liability
per taxpayer, (7) SE tax amount, and (8) SE income.
6 Individuals may be eligible for Social Security benefits under
their own entitlement or that of a parent or spouse. What Are the
Number and
Characteristics of SE Taxpayers?
Chapter 1 Introduction
Page 19 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Medicare benefits. Also, we were not able to deduct the Medicare
taxes from the total SE taxes because the IRS accounts receivable
data we used did not separately list Medicare and Social Security
taxes.
To determine what effect, if any, the earnings on which the SE
taxes had not been paid had on the SSA's monthly benefit amount,
we asked staff at SSA's Kansas City Program Service Center to
recompute benefits for a random sample of 125 current benefit
recipients, excluding such earnings. This sample was weighted to
project to the population of self- employed delinquent taxpayers
collecting Social Security benefits.
To determine if taxpayers were making estimated payments when
required to cover their tax liability, we selected a stratified
random sample of 352 returns with delinquent SE tax as of
September 27, 1997. This sample was weighted to project to the
total population of returns with delinquent SE tax. For each of
the returns, we reviewed IRS transcripts of the taxpayers'
accounts to determine if (1) the taxpayer should have made
estimated tax payments, (2) such payments were made, and (3) IRS
assessed an estimated tax penalty against the taxpayer when such
payments were not made.
To determine why taxpayers receive credit for their earnings when
the SE taxes on such earnings have not been paid, we interviewed
officials in IRS' National Office as well as various staff at SSA
headquarters. We also researched the Social Security Act to
determine if it required SSA to post self- employment earnings
regardless of whether IRS had collected the related SE tax. In
addition, we obtained and analyzed IRS' and SSA's policies and
procedures relative to the posting of self- employment earnings to
determine (1) the type of self- employment data IRS sends to SSA
and how frequently IRS sends the data to SSA and (2) how SSA posts
self- employment earnings to its Master Earnings File.
While analyzing SSA posted earnings on which the SE taxes had not
been paid, we identified a universe of taxpayers who had earnings
per IRS records that were not posted by SSA. To determine why
these earnings were not posted, we analyzed a sample of 143
returns randomly selected from the total population of returns
with unposted earnings. This sample was weighted to project to the
total population of 473,755 returns.
All sample results are subject to sampling error because we
reviewed only a sample of the population. For all sample results,
we calculated sampling errors and present them as 95- percent
confidence intervals around each sample estimate. Why Do Self-
Employed
Individuals Receive Credit for Earnings on Which SE Taxes Are
Unpaid?
Chapter 1 Introduction
Page 20 GAO/GGD-99-18 Billions in SE Taxes Are Owed
To identify any potential actions that could enhance the
collection of SE taxes, we interviewed SSA headquarters officials
in various offices, including the Offices of Legislation and
Congressional Affairs, Program Benefits Policy, and Financial
Policy and Operations. In addition, we interviewed IRS National
Office officials in the Submissions Processing, Collection, and
Examination Divisions. We also visited IRS' St. Louis and Chicago
District Offices and discussed options for change with Collection
and Examination officials. We also reviewed prior reports by IRS
and us relative to self- employed individuals.
We reviewed legislative changes in the Taxpayer Relief Act of 1997
that gave IRS the option of using a new type of levy to
continuously levy up to 15 percent of federal benefit payments,
including Social Security benefits, made to delinquent taxpayers.
In addition, we met with IRS and Financial Management Service
officials to document the status of efforts to implement the
continuous levy program and the milestones for such
implementation.
We obtained written comments on a draft of this report from the
Commissioner of Internal Revenue and the Commissioner of Social
Security. We have summarized the relevant portions of their
comments at the end of chapters 3 and 4 and reprinted the written
comments in appendixes III and IV. In addition, we incorporated
technical comments provided by both IRS and SSA throughout the
report, as appropriate.
We did our work from April 1997 to September 1998 in accordance
with generally accepted government auditing standards. What
Potential Actions
Could Enhance SE Tax Collection?
Chapter 2 Self- Employed Delinquent Taxpayers Owe Billions in
Self- Employment Taxes
Page 21 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Our analysis of IRS' accounts receivable data, as of September 27,
1997, showed that more than 1.9 million taxpayers owed $6.9
billion in SE taxes on about 3.6 million returns. The taxpayers
were delinquent in paying their SE taxes for tax years 1963 to
1996, and over half owed taxes on two or more returns. For almost
half of the 3. 6 million returns, tax assessments were made as a
result of one of IRS' compliance programs. Although the other
taxpayers filed their returns and self- assessed their tax
liability, they did not pay the liability in full. IRS was in the
process of taking some sort of collection action on the majority
of the delinquencies; however, according to IRS, there is no
guarantee that IRS will be able to collect those taxes.
SSA posts reported self- employment earnings without considering
whether the SE taxes on those earnings have been paid. When an
individual applies for benefits, those earnings are used in
determining eligibility for benefits and in computing monthly
Social Security benefits. Thus, even though they had not paid
about $487 million in SE taxes for the years 1963 through 1996,
more than 144,000 taxpayers were receiving at least an estimated
$2.5 million in monthly Social Security benefits that were based
on earnings for which the SE taxes were delinquent. 1
Below, we describe some of the characteristics of the 1. 9 million
selfemployed delinquent taxpayers. Appendix II describes
additional characteristics.
IRS' accounts receivable data as of September 27, 1997, showed
that over 6 million tax returns filed by 3.4 million taxpayers
included SE tax in the total tax liability. These returns reported
total tax liabilities of $28 billion, including about $14 billion
in SE taxes. We applied the payments taxpayers had made to the SE
tax portion of their total tax liability first and found that more
than 1.9 million taxpayers, involving nearly 3.6 million returns,
still owed more than $20.5 billion in total tax, including over
$6.9 billion in SE taxes, or an average SE tax delinquency of
$1,917.
Many of the 1.9 million taxpayers delinquent in paying their SE
tax were delinquent for more than one tax year. Our analysis of
IRS' accounts receivable data as of September 27, 1997, showed
that about 59 percent of the taxpayers were delinquent on two or
more returns, accounting for over 86 percent of the $6.9 billion
delinquent SE taxes. Forty- five percent of the delinquent SE tax
was owed by 15 percent of taxpayers who had five or more returns
with delinquent taxes. (See table 2.1.)
1 The 95- percent confidence interval ranged from $2. 5 million to
$9. 9 million. Number and
Characteristics of SelfEmployed Delinquent Taxpayers
Profile of SE Tax Delinquencies
Chapter 2 Self- Employed Delinquent Taxpayers Owe Billions in
Self- Employment Taxes
Page 22 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Returns per taxpayer Delinquent
taxpayers Percent of total Delinquent
SE tax Percent of total
1 786,181 40.8 $943,563,492 13.7 2 422,798 22.0 970,706,066 14.0 3
256,964 13.4 975,864,003 14.1 4 163,777 8.5 910,840,190 13.2 5
109,684 5.7 821,945,830 11.9 6- 10 175,191 9.1 2,067, 039, 263
29.9 More than 10 10,703 0.6 222,975,171 3.2 Total 1,925,298 100.0
$6,912,934,015 100.0
Note: Percentages may not add to 100 because of rounding. Source:
GAO analysis of IRS' accounts receivable data.
IRS data showed that the tax years involved in these delinquencies
ranged from 1963 to 1996. 2 About three- fourths of both the 3.6
million returns and $6.9 billion in delinquent SE taxes were for
tax years 1990- 96. Tax year 1996 accounted for the highest
percentage of returns, with about 480,000 or 13.5 percent, and
11.8 percent of the $6.9 billion in delinquent SE taxes. (See
table 2.2.)
Tax year a Number of returns Percent
of total Delinquent SE tax Percent
of total
1996 480,357 13.5 $818,715, 284 11.8 1995 403,973 11.3 762,721,779
11.0 1994 381,160 10.7 771,164,165 11.2 1993 379,496 10.6
778,524,728 11.3 1992 357,834 10.0 762,761,167 11.0 1991 333,548
9.4 717,788,098 10.4 1990 322,218 9.0 678,678,014 9.8 1980- 89
906,051 25.4 1,618, 274, 425 23.4 1963- 79 3,958 0.1 4,756, 546 b
Total 3,568,595 100.0 $6,913,454,590 100.0
Note: Percentages may not add to 100 because of rounding. a We
obtained our data as of September 27, 1997, and it included 32
returns for tax year 1997 and
$70,384 in delinquent SE tax, which we included in our analysis,
but not in this table. b Less than one- tenth of one percent.
Source: GAO analysis of IRS' accounts receivable data.
IRS' accounts receivable data as of September 27, 1997, showed
that the delinquent taxpayers reported about $60 billion in self-
employment income on the 3.6 million returns, for an average of
over $16, 600 per return. About
2 Typically, by statute, IRS has 3 years from the date of the
return to assess taxes and 10 years from the date of assessment to
collect the taxes. However, IRS and the taxpayer could agree to
extend the statutory limit at any time before its expiration. The
IRS Restructuring and Reform Act of 1998 restricts the situations
where the statute may be extended by agreement and requires IRS to
notify the taxpayer of his or her right to refuse to extend the
statute.
Table 2.1: Returns With Delinquent SE Tax by Taxpayer and Amount
of SE Tax Owed
Table 2.2: Returns With Delinquent SE Tax and the Amount of SE Tax
Owed by Tax Year
Chapter 2 Self- Employed Delinquent Taxpayers Owe Billions in
Self- Employment Taxes
Page 23 GAO/GGD-99-18 Billions in SE Taxes Are Owed
70 percent of the returns showed self- employment income of less
than $20,000, and they accounted for about 40 percent of the
delinquent SE tax. Fifteen percent of the returns with over $30,
000 in self- employment income accounted for over 40 percent of
the delinquent SE tax. (See table 2.3.)
Self- employment income range Number of
returns Percent of total Delinquent
SE tax Percent of total
Less than$ 10,000 1, 501,424 42.1 $1,100,835,389 15.9 Between
$10,000 and $19,999 1,041,328 29.2 1,642, 986, 945 23.8 Between
$20,000 and $29,999 490,598 13.8 1,368, 492, 069 19.8 Between
$30,000 and $39,999 237,115 6.6 948,033,032 13.7 Between $40,000
and $49,999 149,444 4.2 768,871,356 11.1 $50,000 or more 148,718
4.2 1,084, 235, 799 15.7
Total 3,568,627 100.0 $6,913,454,590 100.0
Note: Percentages may not add to 100 because of rounding. Source:
GAO analysis of IRS' accounts receivable data.
Our analysis of IRS' accounts receivable data showed that
taxpayers responsible for over 51 percent of the 3.6 million
returns involving about $3.3 billion in delinquent SE taxes filed
the required return and selfassessed their SE tax. However, these
taxpayers did not pay their tax liability in full. For the
remaining 49 percent of returns, involving over $3.6 billion in
delinquent SE tax, assessments were made as a result of one of
IRS' compliance programs, such as its Examination, Non- Filer,
Substitutefor- Return, or Underreporter Programs.
Our analysis showed that about $0.9 billion in SE tax was assessed
under IRS' Examination Program. Also, about $2. 7 billion in SE
tax was assessed through IRS' document matching program, which
covers the Non- Filer, Substitute- for- Return, and Underreporter
Programs. The document matching program matches tax return
information against data on information returns, such as Form
1099- MISC (Miscellaneous Income), to identify people who either
fail to file returns or underreport their income. The Substitute-
for- Return Program is similar to the Non- Filer Program except
that IRS prepares the return for the taxpayer, using available
information.
As of September 27, 1997, IRS' records showed that returns with
delinquent SE taxes were in various collection stages. IRS was
pursuing collection in 60 percent of the returns involving about
63 percent of the delinquent SE taxes through installment
agreements with the taxpayer, telephone calls to taxpayers through
its Automated Collection System, delinquency notices to taxpayers,
and revenue officer contacts with taxpayers. The remaining 40
percent were in an inactive status because
Table 2.3: Returns and Amount of Delinquent SE Tax by Self-
Employment Income
How Delinquent Taxes Were Assessed
Collection Status of SelfEmployed Delinquent Taxpayers
Chapter 2 Self- Employed Delinquent Taxpayers Owe Billions in
Self- Employment Taxes
Page 24 GAO/GGD-99-18 Billions in SE Taxes Are Owed
they had been classified as currently- not- collectible, the
delinquency amounts were below the dollar tolerance for pursuing
collection, or they were in the queue awaiting assignment to
revenue officers in the field for enforced collection action.
Table 2.4 shows the collection status of the 3.6 million returns
and the amount of delinquent SE tax associated with such returns.
Collection status Number of returns Percent
of total Delinquent SE tax Percent
of total
Active Installment agreement 738,951 20.7 $1,280,707,155 18.5
Automated Collection System 683,366 19.1 1, 186,892, 127 17.2
Delinquency notice 406,216 11.4 844,411,019 12.2 Field collection
- revenue officers 309,090 8.7 1,061, 750, 197 15.4 Inactive
Currently- not- collectible a 1,003,105 28.1 2,071, 673, 761 30.0
Below tolerance 208,775 5.9 65,188,458 0. 9 In queue awaiting
assignment 219,021 6. 1 402,539,810 5. 8 Other b 103 292,063
Total 3,568,627 100.0 $6,913,454,590 100.0
a Appendix II, table II. 1 provides information on the reasons why
IRS classified the returns as currentlynot- collectible. b Other
includes returns on which IRS was taking no collection action
because (1) returns had not
been posted, (2) taxpayers had been granted extensions for filing,
or (3) IRS' Examination or Criminal Investigation units were
reviewing the case.
Source: GAO analysis of IRS' accounts receivable data.
IRS' records as of September 27, 1997, showed that the agency was
pursuing collection in the majority of returns with delinquent SE
tax; however, according to IRS officials, there is no guarantee
IRS will actually collect the taxes. For example, IRS' financial
statement data for fiscal year 1997 indicated that about 65
percent of all types of delinquent taxes may be uncollectible.
According to IRS officials, the longer a delinquency is in the
accounts receivable inventory, the less likely it is that IRS will
collect those taxes. Table 2. 5 shows the number of years returns
with delinquent SE taxes have been in the accounts receivable
inventory.
Years in inventory Number of returns Percent
of total Delinquent SE tax Percent
of total
Less than 1 935,242 26.2 $1,851,512,531 26.8 Between 1 and up to 2
565,853 15.9 1,174, 591, 505 17.0 Between 2 and up to 5 1, 243,026
34.8 2,520, 074, 103 36.5 Between 5 and up to 10 781,455 21.9
1,299, 981, 157 18.8 More than 10 43,051 1.2 67,295,294 1.0
Total 3,568,627 100.0 $6,913,454,590 100.0
Note: Percentages may not add to 100 because of rounding. Source:
GAO analysis of IRS' accounts receivable data.
Table 2.4: Collection Status of Returns and the Amount of
Delinquent SE Tax
Table 2.5: Returns and Delinquent SE Tax by Years in Accounts
Receivable Inventory
Chapter 2 Self- Employed Delinquent Taxpayers Owe Billions in
Self- Employment Taxes
Page 25 GAO/GGD-99-18 Billions in SE Taxes Are Owed
As of April 21, 1998, a match of taxpayers with delinquent SE tax
with Social Security benefit records showed that 144,473 of the
1.9 million selfemployed delinquent taxpayers who owed $487
million in SE taxes were receiving $105 million in monthly Social
Security benefits, or an average monthly benefit of $727 per
taxpayer.
Of the 144,473 delinquent taxpayers receiving Social Security
benefits, nearly two- thirds were receiving retirement benefits
while the remaining one- third were receiving disability benefits.
The taxpayers were delinquent in paying their SE tax on 291,114
returns. Also, almost 60 percent of the returns were in an
inactive collection status (e. g., currently- not- collectible or
below tolerance). Appendix II, tables II. 2, II. 3, and II. 4
describe additional characteristics of the 144,473 taxpayers
currently collecting Social Security benefits.
At our request, SSA recomputed the monthly benefit amounts for a
sample of delinquent taxpayers currently receiving benefits. The
recomputed benefit amounts show the effect of excluding earnings
on which the SE taxes had not been paid from the benefit
computation. On the basis of SSA's recalculation, we estimate that
the monthly benefit payments to the delinquent self- employed
taxpayers would be reduced by at least $2.5 million, or $30
million annually. 3 As shown in table 2.6, the benefits for an
estimated 34 percent of the taxpayers would not be affected by the
recalculation because either SSA had posted no self- employment
earnings for the delinquent years or the earnings excluded were
low and not used in the original benefit computation. 4 The table
also shows that about 3 percent of the taxpayers would have lost
all of their benefits. 5
Percent of benefits remaining after recalculation Number of
taxpayers Percent of total
0 4, 096 2.8 50- 89 11,699 8. 1 90- 99 80,043 55.4 100 48,635 33.7
Total 144,473 100.0
Source: GAO analysis of IRS and SSA data.
3 The 95- percent confidence interval ranged from $2. 5 million to
$9. 9 million monthly, or from $30 million to $118.8 million
annually. 4 The 95- percent confidence interval ranged from 22. 9
percent to 44. 5 percent
5 The 95- percent confidence interval ranged from 0.1 percent to
5.5 percent. Some Self- Employed
Delinquent Taxpayers Are Receiving Social Security Benefits
Table 2.6: Monthly SSA Benefits Retained by Taxpayers After
Benefit Amount Recalculation
Chapter 2 Self- Employed Delinquent Taxpayers Owe Billions in
Self- Employment Taxes
Page 26 GAO/GGD-99-18 Billions in SE Taxes Are Owed
The effect on Social Security benefits of excluding earnings for
which SE taxes were not paid would be dependent upon the
significance of the earnings excluded relative to a beneficiary's
total lifetime earnings, as shown in the following examples.
An individual who owed SE taxes on more than $160,000 in
selfemployment earnings for 5 years, was receiving $1,121 per
month in disability benefits. According to SSA, when these
earnings were excluded from the benefit calculation, the
recomputed benefit amount was zero because without the excluded
earnings, the individual lacked sufficient earnings credits to be
eligible for the disability benefits.
An individual who owed SE taxes on earnings of more than $290,000
over a 12- year period was receiving $990 per month in retirement
benefits. If those earnings had been excluded, the benefit amount
would have been reduced to $688 per month a reduction of about
$302.
In most instances, however, the effect of excluding such earnings
was much less significant, as shown in the following examples.
For an individual receiving $824 in retirement benefits, the
recomputation had no effect on the benefit amount after excluding
over $1,300 in earnings for one tax year. Because the earnings
during the delinquent tax year were low, SSA had not used them in
computing the original benefit amount.
An individual's $349 monthly benefit would have been reduced by
$19, to $330, after SSA excluded over $26,000 in earnings for 2
tax years.
The number of taxpayers delinquent in paying their SE tax and
collecting Social Security benefits could increase in the future.
We found that as of September 27, 1997, 72,000 taxpayers who still
owed SE taxes were over age 62, the minimum age to be eligible for
SSA retirement benefits, and could begin drawing benefits at any
time. However, we cannot say with any certainty how many taxpayers
delinquent in paying their SE tax will receive Social Security
benefits in the future.
Substantial numbers of self- employed individuals do not pay all
of their SE taxes. These taxpayers can be generally characterized
by their low income and multiple delinquencies. Owing SE taxes
does not prevent individuals from receiving Social Security
benefits, and some do receive them. Conclusions
Chapter 3 Taxpayers Receive Social Security Credit When Taxes Are
Not Paid, With One Exception
Page 27 GAO/GGD-99-18 Billions in SE Taxes Are Owed
The Social Security Act requires SSA to credit individuals'
earnings for Social Security coverage without regard to whether
their SE taxes have been paid. As a consequence, individuals can
receive Social Security benefits based on earnings for which they
have not paid SE taxes. An exception prevents certain individuals
(including the self- employed) from receiving credit for their
earnings when tax filing was not timely, even if the taxes
eventually are paid. Congress could make Social Security credit
conditional on payment of SE taxes and has considered proposals to
do so in the past. Making credit conditional would raise a number
of issues, such as how to allocate payments between SE and other
income taxes.
As noted in chapter 2, a significant number of self- employed
individuals are collecting Social Security benefits, a portion of
which are based on earnings for which the SE taxes have not been
paid. The Social Security Act requires SSA to grant credits for
coverage and pay benefits without regard to whether the taxes have
been paid. This issue has been addressed by the Supreme Court. In
a 1960 decision, the Court stated that the amount of Social
Security benefits do not in any true sense depend on contributions
to the program through the payment of taxes, but rather on the
earnings record of the beneficiary. 1
Past congressional proposals have sought to make credits for
selfemployment earnings conditional upon the payment of the tax
because of the perception that to give credit for earnings where
taxes have not been paid undermines the compulsory contribution
principle of the Social Security program and that it is unfair to
others who pay their taxes. 2 However, no action was taken on
those proposals. While wage- earners can also receive credit for
Social Security coverage when their Social Security and Medicare
taxes are not paid, these proposals were not directed at them
because they do not have the same responsibilities for assessing
and paying the taxes as the self- employed. For wage- earners,
employers are responsible for assessing and withholding taxes and
remitting those withheld taxes to IRS. Thus, while wage- earners
can be considered innocent third parties when their employers fail
to pay withheld taxes, the self- employed cannot because they are
responsible for assessing their taxes and paying those taxes to
IRS.
1 Flemming v. Nestor, 363 U. S. 603 (1960). 2 During the 95th
Congress, the Chairman of the Ways and Means Oversight
Subcommittee introduced H. R. 12565, the Self- Employment Tax
Payment Act of 1978, which contained such a change. In 1979, the
Subcommittee Chairman reintroduced the bill, which was renumbered
as H. R. 5465. The Social Security Act
Requires Credits for Social Security Coverage to Be Based on SE
Earnings, Not SE Taxes Paid
Chapter 3 Taxpayers Receive Social Security Credit When Taxes Are
Not Paid, With One Exception
Page 28 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Excluding the earnings on which the SE taxes had not been paid
from benefit calculations would reduce the total amount of Social
Security benefit payments made. For example, we found that for the
144,473 delinquent self- employed taxpayers receiving benefits as
of April 21, 1998, the benefit amount would be reduced by an
estimated $74.4 million (plus or minus $44.4 million) annually,
which is about 6 percent of their $1.3 billion in annual benefit
payments.
If Congress made the posting of earnings conditional on payment of
SE taxes, it would have to resolve some issues related to tax
payments. For example, Congress would have to specify how to
allocate taxpayer payments between SE taxes and other income taxes
because IRS cannot, under current law, administratively make these
allocations. Furthermore, since only a minimum amount of earnings
are required to get Social Security credit, the Social Security
Act would have to include a provision as to when SSA could give
taxpayers credit for their earnings. To illustrate, taxpayers
could get credit when they paid taxes on the minimum earnings
amount or when they paid their full SE tax liability.
In addition, making Social Security credit conditional on the
payment of SE taxes could require IRS to develop a system to track
payments and send SSA the information when SE taxes were paid. SSA
may also have to develop procedures to post the earnings data more
frequently than it does now, depending upon whether IRS would send
the earnings data to SSA after each SE tax payment or when the
liability was completely paid. Currently, IRS forwards self-
employment earnings data to SSA after it processes the Schedule
SE, and SSA then posts the earnings to the person's earnings
record. Generally, the posting occurs once a year for each
taxpayer when SSA receives the Schedule SE data. It was beyond the
scope of our review to evaluate the effects of making Social
Security credit for earnings conditional on the payment of SE
taxes on the Social Security program or the tax system.
The Social Security Act provides that the posting of self-
employment earnings is conditional upon taxpayers filing their
income tax returns within 3 years, 3 months, and 15 days after the
end of the tax year in which the income was earned. However, the
law applies the time limitation differently to self- employed
individuals than to wage- earners. It requires SSA to strictly
enforce the time limitation when posting the reported earnings of
self- employed individuals, but allows the posting of the earnings
of wage- earners after expiration of the time limitation if the
wageearners submit proof of earnings, such as pay records and tax
returns. Self- Employment
Earnings Do Not Get Posted When Returns Are Filed After a Certain
Date
Chapter 3 Taxpayers Receive Social Security Credit When Taxes Are
Not Paid, With One Exception
Page 29 GAO/GGD-99-18 Billions in SE Taxes Are Owed
In comparing the self- employment earnings reported to IRS with
the earnings posted by SSA for the 3.6 million returns with
delinquent SE tax, we found 473,755 returns where the self-
employment earnings did not get posted to Social Security records.
The earnings not posted by SSA amounted to $9.6 billion, or 16
percent of the over $60 billion in SE income reported to IRS by
273, 476 taxpayers. In the majority of these returns, the earnings
were not posted because taxpayers had not filed their income tax
returns within the statutory time limit. On the basis of our
analysis of a representative sample of self- employed delinquent
taxpayers whose earnings were not posted to SSA records, we
estimate that 81. 9 percent of the returns were filed after the
statutory time limit had expired. 3 IRS had pursued these returns
under its Non- Filer Program but had not secured the returns in
time for the taxpayers to get Social Security credit for their
earnings. Although the remaining returns were filed within the
statutory time limit, SSA officials told us there could be a
number of reasons why the earnings were not posted, including the
taxpayers' use of invalid Social Security numbers and names on
their tax returns.
The following two examples illustrate how late- filed returns
affect the posting of earnings for self- employed individuals.
One taxpayer reported over $14,000 in self- employment earnings
on his 1992 individual tax return. To receive Social Security
credit, the return had to be filed by April 15, 1996. However, IRS
did not receive the return until December 19, 1996, which was 8
months after the 3- year, 3- month, and 15day time limit.
Therefore, SSA did not post the earnings.
Another taxpayer did not file a tax year 1991 return, so IRS,
using data from information returns, filed a substitute return for
the taxpayer. On April 21, 1996, IRS assessed over $8,000 in SE
tax on earnings of more than $53,000. SSA did not post the
earnings because the assessment was made after the April 15, 1995,
time limit for filing a timely return.
Even if the taxpayers in these instances were to eventually pay
the SE tax owed, they would not receive credit for their self-
employment earnings. We estimate that in about 11.3 percent of the
returns where taxpayers filed returns after the statutory time
limitation expired, they were making payments to clear their tax
debt even though their self- employment earnings would not be
posted by SSA. 4
3 The 95- percent confidence interval ranged from 75. 4 percent to
88. 4 percent. 4 The 95- percent confidence interval ranged from
6.4 percent to 16. 2 percent.
Chapter 3 Taxpayers Receive Social Security Credit When Taxes Are
Not Paid, With One Exception
Page 30 GAO/GGD-99-18 Billions in SE Taxes Are Owed
SSA officials told us that self- employed taxpayers who file their
returns too late for their earnings to be posted may not realize
they will not receive credit toward Social Security benefits. They
said they receive many inquiries from taxpayers applying for
benefits who question why they did not receive credit for their
self- employment earnings. In 1995, SSA began sending Personal
Earnings and Benefit Estimate Statements automatically to workers
who had reached age 60. Starting in fiscal year 2000, SSA plans to
send the statements annually to almost every worker in the country
age 25 and older an estimated 123 million people each year. These
six- page statements provide workers with a list of their yearly
earnings on record at SSA, information about their eligibility for
benefits, and estimates of those benefits. The statement also
provides workers with a toll- free number for any questions they
may have concerning the statement.
Our review of widely available SSA and IRS publications that
address self- employment issues showed no mention of the time
limit. 5 We also found that when IRS contacts taxpayers under its
Non- Filer Program, it does not inform them about the time limit
for filing returns in order to get Social Security credit. Letting
taxpayers know about the statutory time limit could increase the
number of taxpayers who would file within that time limit.
The Social Security Act requires SSA to post all of the reported
earnings of a self- employed person, regardless of whether the SE
taxes on those earnings have been paid, as long as the return is
filed within the statutory time limit. While this may be unfair to
taxpayers who pay their taxes, changing it to make getting Social
Security credit conditional on paying taxes would require
congressional action. This change would require a detailed
analysis of all costs and benefits as well as an evaluation of the
effect such a change would have on other aspects of the Social
Security program and the tax system. Such analysis was beyond the
scope of our review.
When individuals apply for benefits, their earnings are used to
determine eligibility and compute their monthly benefit amount.
However, as of September 27, 1997, SSA had not posted about $9.6
billion in selfemployment earnings from 473,755 returns. We
estimate that SSA did not post the self- employment earnings in
81.9 percent (plus or minus 6.5 percent) of those returns because
they were not filed within the statutory time limitation. Many of
these taxpayers may be unaware that they will not
5 These publications include SSA Publication 05- 10022: If You're
Self- Employed and IRS Publication 533: Self- Employment Taxes.
Conclusions
Chapter 3 Taxpayers Receive Social Security Credit When Taxes Are
Not Paid, With One Exception
Page 31 GAO/GGD-99-18 Billions in SE Taxes Are Owed
receive Social Security credit for these earnings. Neither IRS nor
SSA publications relating to self- employment make note of this
time limitation.
To better inform taxpayers of the importance of filing tax returns
within the statutory time limit, we recommend that the
Commissioner of Internal Revenue revise IRS' self- employment
publications, including those given under its Non- Filer Program,
to ensure that self- employed taxpayers know about the need to
file tax returns with self- employment earnings within 3 years, 3
months, and 15 days after the end of the calendar year in which
the self- employment income was earned in order to get Social
Security credit for those earnings.
To better inform potential Social Security recipients of the
importance of filing tax returns within the statutory time limit,
we recommend that the Commissioner of Social Security revise SSA's
publications for selfemployed individuals to inform them about the
need to file tax returns with self- employment earnings within 3
years, 3 months, and 15 days after the end of the calendar year in
which their self- employment income was earned in order to get
Social Security credit for those earnings.
In written comments on our draft report, the Commissioner of
Internal Revenue and the Commissioner of Social Security agreed
with the recommendations to better inform self- employed taxpayers
of the statutory time limit for filing returns with SE income in
order to receive Social Security credit.
The Commissioner of Internal Revenue said that IRS has included
information on the statutory time limit for filing returns in the
1998 revision of Publication 533, Self- Employment Tax. Also, IRS
plans to revise the 1999 versions of Publication 583, Starting a
Business and Keeping Records, and Publication 334, Tax Guide for
Small Business, to provide such information. In addition, the
Commissioner agreed to modify IRS' non- filer notices to make it
clear to taxpayers that they will not receive Social Security
credit for their earnings if they do not file their returns within
the time limit.
The Commissioner of Social Security agreed to include information
on the statutory time limit in all publications for the self-
employed as those publications are revised. The Commissioner
stated that SSA Publication 05- 10022: If You're Self- Employed,
was recently revised, but will be updated in the Fall of 1999 to
include information on the statutory time limit. The Commissioner
also stated that SSA plans to use a public information package
that is distributed monthly to all field offices to better
Recommendation to
the Commissioner of Internal Revenue
Recommendation to the Commissioner of Social Security
Agency Comments
Chapter 3 Taxpayers Receive Social Security Credit When Taxes Are
Not Paid, With One Exception
Page 32 GAO/GGD-99-18 Billions in SE Taxes Are Owed
inform taxpayers of the statutory time limit for filing. This
package includes, among other information, a newspaper column that
the field offices provide to local newspapers as part of an
ongoing column on Social Security matters. According to the
Commissioner, the February 1999 column will focus on self-
employment issues and will include information on the statutory
time limit.
Chapter 4 Potential Ways to Reduce Self- Employment Tax
Delinquencies
Page 33 GAO/GGD-99-18 Billions in SE Taxes Are Owed
There are several potential ways to enhance the collection of
delinquent taxes from self- employed individuals. 1 IRS has
recently been given the option to continuously levy taxpayers'
Social Security benefits and other federal payments to recover
delinquent taxes and is in the process of developing a program to
do so. This levy program affects taxpayers that are already
delinquent in paying their taxes and should reduce their tax debt.
With regard to collecting taxes before taxpayers become
delinquent, proposals have been made by Treasury and others to
require withholding on certain types of payments made to the self-
employed, which could help reduce SE tax delinquencies. However,
Congress has not acted on these proposals because of the
administrative burden they would place on those businesses that
would have to withhold taxes. Also, since most selfemployed
delinquent taxpayers did not make required estimated tax payments,
a program, such as one that reminds taxpayers to make the payments
could enhance self- employment tax collections.
The Taxpayer Relief Act of 1997 gave IRS the option of using a new
type of levy to continuously levy up to 15 percent of federal
payments (including Social Security benefits) made to delinquent
taxpayers until their entire tax debt is paid in full. Although
IRS had the authority to levy Social Security benefits prior to
the 1997 act, it did not have authority to levy such benefits
continuously. Federal payments are made by the Department of the
Treasury's Financial Management Service (FMS), and it is to be
responsible for developing and administering the program,
including levying the payments and forwarding levy payments to
IRS. Under the program, IRS plans to give FMS information on the
delinquent accounts to be levied. For Social Security payments,
FMS is to match these accounts against its file of Social Security
benefit recipients and levy benefit payments. Because of the
sensitivity of levying delinquent taxpayers' Social Security
benefit payments, IRS wants to ensure that the program will
function as authorized and will not result in inappropriate
levies. Therefore, IRS plans to issue two notices before levying
Social Security payments to give taxpayers time to resolve their
delinquencies. The first notice is to be sent when the match is
made, and a second 30 days later.
Initially, IRS officials believed the levy program could be
implemented by January 1999. However, both IRS and FMS officials
told us that they had jointly agreed to delay implementation of
the program until July 2000. The delay is to afford both IRS and
FMS time to negotiate a mutually
1 It was beyond the scope of this review to examine all potential
options that could enhance the collection of SE taxes. For
example, we did not examine what impact increased IRS enforcement
action might have on compliance. Levying Social Security
Benefit Payments
Chapter 4 Potential Ways to Reduce Self- Employment Tax
Delinquencies
Page 34 GAO/GGD-99-18 Billions in SE Taxes Are Owed
acceptable set of implementation requirements as well as time for
FMS to make necessary modifications to its offset program. Also,
the delay will allow both IRS and FMS more time to develop
regulations for the levy program.
IRS plans to levy the federal payments (including Social Security
benefits) for the total tax liability including interest and
penalties. The 144,473 delinquent self- employed taxpayers who
were receiving Social Security benefits as of April 21, 1998, owed
about $2.1 billion in total taxes, of which $487 million was SE
tax and $1.6 billion was income tax. In addition, the taxpayers
owed $4.6 billion in assessed and accrued interest and penalties.
However, IRS does not plan to levy against all delinquent
taxpayers. For example, IRS does not plan to levy Social Security
benefits for those taxpayers whose accounts are classified as
currently- notcollectible because of hardship or those who have
installment agreements. 2 Applying IRS' levy criteria, we found
that IRS would levy about 41,000 of the 144,473 taxpayers
delinquent in paying about $108 million in SE tax.
While the continuous levy program should result in recovering some
delinquent SE taxes, it would be preferable to get taxpayers to
pay their SE taxes at the time they earn their income instead of
when they begin collecting Social Security benefits. IRS officials
in Collection and Examination told us that withholding taxes from
payments by businesses to certain self- employed individuals could
reduce the number of SE tax delinquencies. In general, self-
employed taxpayers are less likely to report their earnings or pay
their tax liability than are wage- earners, who are subject to
withholding. IRS data show that the compliance rate for reporting
income for taxpayers subject to withholding is 99 percent versus
80 percent for self- employed taxpayers.
Withholding on payments by businesses to self- employed
individuals is not a new idea. As far back as 1979, the Department
of the Treasury proposed withholding by businesses on payments
made in the course of a trade or business for services provided by
independent contractors, who include subcontractors, accountants,
lawyers, and engineers. It proposed withholding at a flat rate of
10 percent, but would have exempted workers who normally worked
for five or more businesses in a calendar year or expected to owe
less tax than the withheld amount. However, this proposal was not
enacted by Congress because of the administrative
2 Section 3462( b) of the IRS Restructuring and Reform Act of 1998
prohibits IRS from levying while an installment agreement is
pending or in effect or while an offer- in- compromise is pending.
Withholding on
Payments Made by Businesses to SelfEmployed Taxpayers
Chapter 4 Potential Ways to Reduce Self- Employment Tax
Delinquencies
Page 35 GAO/GGD-99-18 Billions in SE Taxes Are Owed
burden that would have been placed on those businesses that would
have to do the withholding.
In July 1992, we reported that the noncompliance among independent
contractors was serious enough to warrant some form of withholding
and proposed that Congress consider legislation to improve
compliance through withholding, but Congress took no action. 3 In
addition, in 1995, a panel of tax experts, including former senior
officials in IRS and Treasury, presented several options for
increasing the compliance of self- employed taxpayers. One such
option supported by most panelists was withholding on business
payments to independent contractors. Furthermore, various IRS
studies have recognized that withholding could be an up- front
tool to reduce the number of SE tax delinquencies. Of the 1. 9
million delinquent SE taxpayers, we were able to categorize 1.1
million by type of business using IRS data. Of the 1.1 million, 40
percent were engaged in personal, professional, or business
services and would have been subject to the mandatory withholding
under the various proposals.
Mandatory withholding by employers of taxes from employees has
been the cornerstone of the U. S. tax compliance system for years,
and it has worked very well with over 99 percent of wages
voluntarily reported. Implementing mandatory withholding on
business payments to independent contractors could have a similar
effect on the tax compliance of these individuals. However, there
are administrative concerns that would need to be resolved, such
as determining the rate of withholding so that the tax withheld
approximates the tax due for the year.
In addition to administrative considerations, withholding on
business payments to independent contractors would increase the
burden on both the independent contractors and the businesses that
use them. It could adversely affect the cash flow of some
independent contractors who could have business expenses that
reduce their annual net income and taxes owed below the withheld
amount. In addition to the burden on taxpayers, businesses would
have costs and burdens associated with withholding and depositing
the taxes into the Treasury as well as reporting the income and
taxes to IRS. Businesses would also have the burden of identifying
those independent contractors who would be exempted from
withholding.
3 Tax Administration: Approaches for Improving Independent
Contractor Compliance (GAO- GGD- 92108, July 23, 1992).
Chapter 4 Potential Ways to Reduce Self- Employment Tax
Delinquencies
Page 36 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Taxpayers not subject to withholding are generally required to
make quarterly estimated tax payments. IRS' Statistics of Income
data for tax year 1994 showed that about 4.4 million of the 12.2
million taxpayers who reported SE taxes on their returns made
estimated tax payments. About 5 million taxpayers were assessed an
estimated tax penalty because they failed to make required
quarterly payments.
As of September 27, 1997, we estimate that of the 3.6 million
returns with delinquent SE tax, the taxpayers responsible for 2.5
million returns (69 percent) were required to make estimated tax
payments. 4 However, in an estimated 2.3 million (92 percent) of
those returns, taxpayers failed to make the required estimated
payments. 5
In 1991, IRS sent reminder notices to all taxpayers who were
compliant in making estimated tax payments in the prior year but
had not made any in the current year. According to an IRS
official, the taxpayer response to these notices was negative, and
taxpayers considered them to be intrusive because they believed
that IRS was making assumptions based on the previous year that
might not apply to the current year. As a result of the negative
taxpayer reaction, IRS stopped sending the notices. IRS had no
data to show whether the reminder notices increased the estimated
tax payment compliance of individuals who received notices.
However, taxpayers would have less cause for concern if the
notices were sent only to taxpayers who were not compliant in
making estimated tax payments during the previous year-- that is,
to those who (1) in the current year had not made an estimated tax
payment and (2) in the previous year had filed a Schedule SE and
were assessed an estimated tax penalty. We estimate that about 1.2
million of the 2.5 million returns (48 percent) where the taxpayer
was required to make estimated payments met these criteria. 6
Sending such a reminder notice would not be costly and could
encourage noncompliant taxpayers to make required estimated
payments.
IRS now has the option to continuously levy taxpayers' Social
Security payments to collect delinquent taxes. How much delinquent
SE taxes IRS would be able to secure through the continuous levy
program is unknown; however, less than 30 percent of delinquent
self- employed taxpayers that
4 The 95- percent confidence interval ranged from 2.3 million to
2. 7 million returns. 5 The 95- percent confidence interval ranged
from 2.1 million to 2. 5 million returns. 6 The 95- percent
confidence interval ranged from 1.0 million to 1. 4 million
returns. Reminding Delinquent
Self- Employed Taxpayers to Make Estimated Tax Payments
Conclusions
Chapter 4 Potential Ways to Reduce Self- Employment Tax
Delinquencies
Page 37 GAO/GGD-99-18 Billions in SE Taxes Are Owed
we identified as receiving Social Security benefits would meet
IRS' criteria for levying.
Intervening with taxpayers before they become delinquent may
reduce the amount and limit the number of SE tax delinquencies.
One potential way to do this would be to implement withholding on
payments made by businesses to independent contractors. This would
help ensure that some portion of the tax liability is collected at
the time the income is earned. However, withholding would impose
costs and burdens on those businesses that would have to withhold
the taxes and could affect the cash flow of independent
contractors. Congress has not enacted prior proposals to implement
withholding on independent contractors.
Since self- employed taxpayers are not subject to withholding,
many are required to make estimated payments to cover their tax
liability. However, we found that 2.3 million taxpayers did not
make required estimated tax payments. In the past, IRS tried
sending notices to all self- employed taxpayers who had made
estimated payments in the prior year but not the current year,
reminding them that they may be liable for estimated payments in
the current year. According to an IRS official, taxpayers
considered these notices intrusive because they believed that IRS
was making assumptions based on the previous year that might not
apply to the current year. IRS could send a reminder notice only
to those taxpayers who were noncompliant in making estimated tax
payments in the previous year. We estimate about 1.2 million of
the 2.5 million returns where the taxpayer was required to make
estimated payments met these criteria.
To reduce SE tax delinquencies, we recommend that the Commissioner
of Internal Revenue undertake a pilot project to test the
feasibility of sending notices to noncompliant self- employed
taxpayers who in the current year had not made estimated payments
and in the previous year had filed a Schedule SE and were assessed
an estimated tax penalty.
Although this report discusses the issue of extending mandatory
withholding to cover payments by businesses to certain self-
employed individuals, such as independent contractors, such action
would require legislation, which would require Congress to make a
value judgment as to the need for such a change. A full- scale
evaluation of the costs and burdens of withholding was beyond the
scope of our review. Therefore, we do not make a recommendation on
this issue.
In written comments on our draft report, the Commissioner of
Internal Revenue agreed with the recommendation to pursue a pilot
project to test Recommendation to
the Commissioner of Internal Revenue
Agency Comments
Chapter 4 Potential Ways to Reduce Self- Employment Tax
Delinquencies
Page 38 GAO/GGD-99-18 Billions in SE Taxes Are Owed
the feasibility of sending reminder notices to noncompliant self-
employed taxpayers. The Commissioner stated that IRS plans to
incorporate the recommendation into its national non- filer
strategy. Under this strategy, IRS plans to improve compliance and
service to taxpayers by emphasizing delinquency prevention. The
Commissioner also stated that IRS had selected an executive to
head up the non- filer strategy, and expected the strategy to be
in place by the end of fiscal year 1999.
Page 39 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Appendix I Sampling and Data Analysis Methodology
Page 40 GAO/GGD-99-18 Billions in SE Taxes Are Owed
This appendix describes how we selected, analyzed, and projected
the sample data for three random samples to the universe of
returns of taxpayers delinquent in paying their SE taxes. The
samples pertain to (1) computing Social Security benefit amounts,
(2) determining whether the taxpayers were required to make
estimated payments, and (3) determining why SSA did not post self-
employment earnings in some cases.
Our computer analysis of IRS and SSA records showed that of the
1.9 million taxpayers delinquent in paying their SE tax as of
September 27, 1997, 144,473 were collecting $105 million in
monthly Social Security retirement or disability benefits as of
April 21, 1998. To determine what effect, if any, the earnings on
which the SE taxes had not been paid had on SSA's monthly benefit
amount, we selected a stratified random sample of 125 taxpayers
from the population of delinquent taxpayers receiving Social
Security benefits. The population was divided into 14 strata based
on the amount of delinquent SE tax and the Social Security monthly
benefit amount. Once the sample was selected, we asked staff at
SSA's Kansas City Program Service Center to recompute benefits for
those taxpayers, excluding from the computation earnings on which
the SE taxes had not been paid. In the analysis, the sample
selections were weighted to represent the total population of
144,473 taxpayers receiving monthly Social Security retirement or
disability benefits.
In the process of confirming that self- employment earnings were
being posted at SSA, we identified about $9.6 billion from 473,755
returns that SSA did not post to the taxpayers' accounts. The
Social Security Act provides that for self- employed individuals,
SSA will post earnings to their account so long as the return is
filed timely. The act defines timely as being within 3 years, 3
months, and 15 days after the end of the calendar year in which
the income was earned. For returns filed after that date, no self-
employment earnings are to be posted.
Discussions with SSA officials led us to believe that late- filed
returns was the primary reason earnings were not posted by SSA. To
determine if our belief was valid, we selected a stratified random
sample of 143 returns from the population of 473,755 returns for
which no earnings were posted. The population was divided into 10
strata based on the amount of SE tax owed as of September 27,
1997. Our review of IRS transcripts of account for the 352 returns
selected for the estimated payment sample identified 40 returns
for which SSA had posted no earnings. However, that sample was too
small to produce reliable estimates. As a result, we selected a
supplemental sample of 103 returns with unposted earnings. The 40
returns previously identified were excluded from the supplemental
sample. Recomputation of SSA
Benefits Nonposting of SelfEmployment Earnings by SSA
Appendix I Sampling and Data Analysis Methodology
Page 41 GAO/GGD-99-18 Billions in SE Taxes Are Owed
For the 143 returns, we reviewed IRS transcripts of account to
determine if the returns were filed timely and if the taxpayers
were making payments to satisfy their liability. 1 In our
analysis, the sample selections have been weighted to represent
the total population of 473, 755 returns with selfemployment
earnings per IRS records that were not posted to the taxpayer's
account by SSA.
Self- employed taxpayers are not covered by mandatory withholding.
As a result, they are to make estimated tax payments when, after
subtracting withholding and credits from the tax liability, they
expect to owe more than $500. 2 There are some exceptions to this
requirement. For example, if the taxpayer's withholding and
credits are equal to 100 percent of their prior year's tax or 90
percent of the current year's tax, no estimated payment is
required. Because not all self- employed taxpayers are required to
make estimated payments, we selected a stratified random sample of
352 returns from the total population of 3.6 million returns for
which taxpayers were delinquent in paying their SE tax. The
population was divided into 10 strata based on the amount of SE
tax owed as of September 27, 1997, and the source of the
taxpayers' income. For each of the returns, we reviewed IRS
transcripts to determine if (1) the taxpayer should have made
estimated tax payments, (2) such payments were made, and (3) IRS
assessed an estimated tax penalty against the taxpayer when such
payments were not made. In the analysis, the sample selections
have been weighted to represent the total population of 144, 473
receiving monthly Social Security retirement or disability
benefits.
Because our results come from samples, the estimates used in the
report are subject to sampling errors. Sampling errors measure the
extent to which estimates from samples of these sizes and
structure can be expected to differ from the total population
values. From the sample estimates, together with estimates of
their sampling errors, interval estimates can be constructed with
prescribed confidence that they each include actual population
values. Each of our sample estimates is surrounded by a 95percent
confidence interval indicating that we are 95- percent confident
that the results for the total population will be within each
confidence interval.
1 Because of difficulties in obtaining a transcript for one of the
143 returns, we reviewed transcripts for only 142 returns. 2 For
tax year 1998, the $500 requirement has been raised to $1, 000.
Estimated Payments
Sampling Errors for Key Estimates Used in the Report
Appendix II Additional Characteristics of Delinquent SelfEmployed
Taxpayers
Page 42 GAO/GGD-99-18 Billions in SE Taxes Are Owed
This appendix provides additional characteristics of the taxpayers
delinquent in paying their SE tax. These characteristics include
IRS' reasons for classifying returns as currently- not-
collectible, collection status of delinquent taxpayers collecting
Social Security benefits, IRS enforcement actions required to
obtain a return and assess the taxes owed for those taxpayers
currently collecting Social Security benefits, and the ages of
both those currently collecting Social Security benefits and those
not yet collecting benefits.
As noted in chapter 2, table 2.4, IRS had classified 28 percent of
the 3.6 million returns with delinquent SE tax and 30 percent of
the delinquent SE tax as currently- not- collectible. Table II. 1
shows, as of September 27, 1997, the most common reasons IRS used
in categorizing a balance due as uncollectible.
Reason Number of returns Percent
of total Delinquent SE tax Percent
of total
Undue hardship on taxpayer 746,845 74.5 $1,597,301,095 77.1 Unable
to contact taxpayer 127,376 12.7 199,878,431 9. 7 Unable to locate
taxpayer 86,924 8. 7 197,054,660 9. 5 Deceased taxpayer 40,718 4.
1 75,511,492 3. 6 Other a 1,242 0.1 1, 928,083 0.1
Total 1,003,105 100.0 $2,071,673,761 100.0
Note: Percentages may not add to 100 because of rounding. a Other
includes returns with a balance due below the tolerance for
collection action.
Source: GAO analysis of IRS' accounts receivable data.
Analysis of IRS and SSA data showed that, as of September 27,
1997, about 58 percent of the returns for the 144,473 taxpayers
collecting Social Security benefits were in an inactive collection
status because they had been classified as currently- not-
collectible, were below the tolerance for collection action, or
were in the queue awaiting assignment to revenue officers in the
field. These returns accounted for 56 percent of the $487 million
in delinquent SE tax. (See table II. 2.)
Table II. 1: Reasons IRS Categorized SE Returns With Balance Due
as Currentlynot- Collectible
Appendix II Additional Characteristics of Delinquent Self-
Employed Taxpayers
Page 43 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Collection status Number of returns Percent
of total Delinquent SE tax Percent
of total
Active Installment agreement 45,442 15.6 $62,172,414 12.8
Automated Collection System 36,719 12.6 56,063,820 11.5
Delinquency notice 21,597 7. 4 37,732427 7. 7 Field collection by
revenue officers 19,559 6. 7 60,408,421 12.4 Inactive Currently-
not- collectible 132,046 45.4 239,899,340 49.2 Below tolerance
20,426 7. 0 5,517,467 1.1 In queue awaiting assignment 15,319 5. 3
25,424,191 5. 2 Other 6 8, 731
Total 291,114 100.0 $487,226,811 100.0
Note: Percentages may not add to 100 because of rounding. Source:
GAO analysis of IRS' accounts receivable data.
Taxpayers voluntarily filed returns self- assessing the taxes owed
in about 51 percent of the returns for taxpayers who were
receiving Social Security benefits. These returns accounted for 45
percent of the delinquent SE tax.
For the remaining 49 percent of the returns, IRS enforcement
action was required to obtain the return or assess the taxes owed.
As of September 27, 1997, these returns accounted for 55 percent
of the $487 million in delinquent SE tax. As shown in table II. 3,
IRS used various compliance programs to assess the taxes due.
IRS compliance program Number of returns Percent
of total Delinquent SE tax Percent
of total
Non- Filer 57,373 40.5 $102,303,549 38.0 Substitute- for- Return
26,094 18.4 65,961,971 24.5 Audit by Examination 35,617 25.1
80,412,961 29.9 Underreporter 15,496 10.9 12,716,049 4. 7 Other a
7,136 5.0 7, 946,358 2.9
Total 141,716 100.0 $269,340,888 100.0
Note: Percentages may not add to 100 because of rounding. a Other
includes adjustments, math errors, and penalties.
Source: GAO analysis of IRS' accounts receivable data.
About 69 percent of the 144,473 delinquent taxpayers receiving
Social Security benefits were age 63 and over and accounted for
about 76 percent of the delinquent SE tax.
Table II. 2: Collection Status of Returns for Which Delinquent
Taxpayers Were Receiving Social Security Benefits
Table II. 3: Delinquent SE Taxes Assessed Through IRS Compliance
Programs
Appendix II Additional Characteristics of Delinquent Self-
Employed Taxpayers
Page 44 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Age Number of taxpayers Percent
of total Delinquent SE tax Percent
of total
30 and under 575 0.4 $614,212 0.1 31- 40 5,829 4.0 10,650,448 2.2
41- 50 12,559 8.7 30,631,544 6.3 51- 55 8,967 6.2 25,549,207 5.2
56- 62 15,533 10.8 47,264,519 9.7 63- 65 24,746 17.1 88,609,353
18.2 66- 70 41,481 28.7 163,081,601 33.5 Over 70 33,145 23.0
117,809,196 24.2 No date of birth available 1,698 1.1 2,982, 291
0.6
Total 144,473 100.0 $487,192, 371 100.0
Source: GAO analysis of IRS and SSA data.
Finally, our analysis of IRS and SSA data showed that, as of
September 27, 1997, over 72,000 taxpayers delinquent in paying
their SE tax were over age 62, the minimum age to be eligible for
Social Security retirement benefits, but were not yet receiving
those benefits. In addition, there were about 190,000 taxpayers
between the age of 56 and 62 that could become eligible for Social
Security benefits within the next several years.
Age Number of taxpayers Percent
of total Delinquent SE tax Percent
of total
30 and under 148,313 8.3 $211,816, 368 3.3 31- 40 494,819 27.8 1,
462,396, 521 22.8 41- 50 550,376 30.9 2, 313,429, 461 36.0 51- 55
211,827 11.9 1, 025,227, 749 16.0 56- 62 189,928 10.7 915,022,838
14.2 63- 65 31,304 1.8 164,336,108 2. 6 66- 70 21,173 1.2
100,336,474 1. 6 Over 70 19,642 1.1 56,038,381 0. 9 No date of
birth available 113,443 6.4 177,137,744 2. 8
Total 1,780,825 100.0 $6,425,741,644 100.0
Note: Percentages may not add to 100 because of rounding. Source:
GAO analysis of IRS' accounts receivable data.
Table II. 4: Age of Delinquent Taxpayers Currently Collecting
Social Security Benefits and Delinquent SE Tax
Table II. 5: Age of Delinquent Taxpayers Not Yet Receiving Social
Security Benefits and Delinquent SE Tax
Appendix III Comments From the Internal Revenue Service
Page 45 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Appendix III Comments From the Internal Revenue Service
Page 46 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Appendix IV Comments From the Social Security Administration
Page 47 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Appendix IV Comments From the Social Security Administration
Page 48 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Appendix IV Comments From the Social Security Administration
Page 49 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Appendix V Major Contributors to This Report
Page 50 GAO/GGD-99-18 Billions in SE Taxes Are Owed
James M. Fields, Senior Social Science Analyst James J. Ungvarsky,
Computer Specialist Elizabeth W. Scullin, Communications Analyst
William J. Staab, Senior Evaluator Vanessa R. Taylor, Evaluator
Shirley A. Jones, Senior Attorney Ralph Block, Assistant Director
Terry Tillotson, Evaluator- in- Charge Yong Meador, Evaluator
Thomas N. Bloom, Computer Specialist General Government
Division, Washington, D. C.
Health and Human Services Division, Washington, D. C.
Office of General Counsel, Washington, D. C.
San Francisco Office Kansas City Office
Page 51 GAO/GGD-99-18 Billions in SE Taxes Are Owed
Page 52 GAO/GGD-99-18 Billions in SE Taxes Are Owed
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