Increased Outreach Efforts Could Enhance Taxpayer Awareness of the Benefits of the Qualified Joint Venture Filing Option
March 17, 2010
Reference Number: 2010-40-034
This report has cleared the Treasury Inspector General for Tax Administration disclosure review process and information determined to be restricted from public release has been redacted from this document.
Redaction Legend:
1 = Tax Return/Return Information
Phone Number |
202-622-6500
Email Address | inquiries@tigta.treas.gov
Web Site |
http://www.tigta.gov
March 17, 2010
MEMORANDUM
FOR
COMMISSIONER, SMALL BUSINESS/SELF-EMPLOYED DIVISION
COMMISSIONER, WAGE AND INVESTMENT DIVISION
FROM: Michael R. Phillips /s/ Michael R. Phillips
Deputy Inspector General for Audit
SUBJECT: Final Audit Report – Increased Outreach Efforts Could Enhance Taxpayer Awareness of the Benefits of the Qualified Joint Venture Filing Option (Audit # 200940023)
This report represents the results of our review to determine whether taxpayers that appear to meet the requirements to elect Qualified Joint Venture (QJV)[1] treatment on their tax return were adequately informed of this information and the potential benefits it provides. The audit addresses the major management challenges of Taxpayer Rights and Entitlements and Reduction of Taxpayer Burden and is part of our Fiscal Year 2009 Annual Audit Plan.
Impact on the Taxpayer
For Tax Year 2007, approximately 40,000 U.S. Return of
Partnership Income (Form 1065) and an additional 350,000 U.S. Individual Income
Tax Returns (Form 1040) containing Profit or Loss From Business (Schedule C) were
filed by taxpayers who could have potentially benefited by electing to use the
new QJV option. We identified many
potentially qualified individuals who were not aware of this option. The new option allows taxpayers to bypass the
filing of the Form 1065 and the associated Supplemental Income and Loss
(Schedule E) on Form 1040 and file only a Form 1040 with two supporting
Schedules C and two Self-Employment Tax (Schedule SE). Married individuals currently filing a single
Schedule C might benefit from the new option by allocating the Schedule C
income and having both individuals receive Social Security credit, resulting in
potential future Social Security benefits.
Synopsis
Prior to Tax Year 2007, joint husband-and-wife businesses with material participation by both spouses were considered partnerships and were required to file Form 1065 annually, as well as their regular Form 1040. Legislation was enacted to make the QJV option effective with the start of Tax Year 2007 to simplify the filing requirements for husband-and-wife businesses by allowing them to be treated as sole proprietorships rather than partnerships for tax purposes. The option also helps to ensure each spouse gets proper Social Security credit for his or her self-employment earnings.
Many taxpayers were not aware of the QJV filing option. Our review found two reasons contributing to the lack of awareness of this new option. First, the Internal Revenue Service (IRS) did not clearly present the new tax law provision and its associated benefits in some of its publications or provide sufficient outreach to emphasize the new tax law change to the paid preparer community. Second, the tax preparation software packages used by taxpayers and paid preparers did not adequately prompt or notify users of the new provision.
Recommendations
Increased outreach efforts could further taxpayer awareness and increase the number of qualified taxpayers electing treatment as a QJV. We recommended the Director, Tax Forms and Publications, Wage and Investment Division, and the Director, Examination, Small Business/ Self-Employed Division, ensure publications and instructions for QJV election are clear and accurate. The tax products and IRS public web site, IRS.gov, should include explanations on partnership status and potential spousal benefits when electing the QJV filing option. The Director, Electronic Tax Administration and Refundable Credits, Wage and Investment Division, should work more closely with the tax preparation software vendor community to ensure software packages adequately alert users of tax preparation software about the QJV election. Also, the Director, Communications, Liaison, and Disclosure, Small Business/Self-Employed Division, and the Director, Communications and Liaison, Wage and Investment Division, should design an outreach marketing plan for husband-and-wife businesses and tax practitioners to ensure the market segment and practitioner industry are aware of the QJV election and its benefits. The plan should explain the potential Social Security benefits and reduction of taxpayer burden.
Response
IRS management agreed with all of our recommendations. They committed to improve their efforts to provide clear and understandable information regarding QJVs, including various options available to taxpayers. They will update their publications and forms, update the content on IRS.gov to ensure it is accurate and understandable, and enhance their marketing efforts to software industry professionals. In addition, they will undertake an effort to ensure the spousal elections, and their impact on Social Security benefits, are clearly communicated to the taxpayers. Management’s complete response to the draft report is included as Appendix VI.
Copies of this report are also being sent to the IRS managers affected by the report recommendations. Please contact me at (202) 622-6510 if you have questions or Michael E. McKenney, Assistant Inspector General for Audit (Returns Processing and Account Services), at (202) 622-6513.
Many Taxpayers Are Not Aware of the Qualified Joint Venture
Filing Option
Appendices
Appendix I – Detailed Objective,
Scope, and Methodology
Appendix II – Major Contributors to
This Report
Appendix III – Report Distribution
List
Appendix IV – Outcome Measures
Appendix V – Questions to Taxpayers
Appendix VI – Management’s Response to
the Draft Report
Abbreviations
|
IRS |
Internal
Revenue Service |
|
QJV |
Qualified
Joint Venture |
|
TIGTA |
Treasury
Inspector General for Tax Administration |
The law
provides taxpayers an additional option when reporting their income from a
Qualified Joint Venture.
During May 2007, legislation was enacted[2] to simplify the filing requirements for husband-and-wife businesses and also to help ensure both spouses get proper Social Security credits for their earnings while self-employed. A provision in the legislation known as the Qualified Joint Venture (QJV) provision was effective for Tax Year 2007 returns. The provision allows married taxpayers who wholly own a business to be treated as sole proprietors rather than partners for tax purposes.
Previously, married taxpayers who materially participated in the business were considered partners, even if there was no official partnership agreement. As such, the taxpayers were required to file a U.S. Return of Partnership Income (Form 1065) annually, as well as their regular U.S. Individual Income Tax Return (Form 1040). The new law provides taxpayers an additional option when reporting their income from a QJV, allowing the taxpayers to decide how to file.
Because the partnership filing requirement was costly and time consuming, many taxpayers avoided the filing requirement by reporting the self-employed income as earned by only one of the spouses on the Form 1040, indicating the business was a sole proprietorship, a filing option allowed by the Internal Revenue Service (IRS). However, this resulted in the other spouse receiving no Social Security credit for his or her portion of the self-employment income.
Recognizing that this situation was burdensome for taxpayers, the IRS National Taxpayer Advocate recommended in her Fiscal Year 2002 and 2004 annual reports that the law be changed. According to the National Taxpayer Advocate, the issue arose as a ‘common-sense change’ and not because of some reported problems or specific taxpayer complaints. The Fiscal Year 2002 report stated there were approximately 2.1 million joint returns filed in Tax Year 1999 with a Profit or Loss From Business (Schedule C) for which the spouse did not have any wages. From this, the National Taxpayer Advocate inferred that these returns could be affected by the issue.
The practical effect of the law is that taxpayers are now allowed to split their business income on two Schedules C[3] and also split the net self-employment earnings on two Self-Employment Tax (Schedule SE) forms. This will ensure that both taxpayers get proper Social Security credits. In addition, taxpayers are no longer required to file a Form 1065, which greatly reduces taxpayer burden when preparing and filing the returns.
The QJV election is one of three
filing options available to husband-and-w
Figure 1: Tax Year 2007 Filing Options for Husband-and-Wife Businesses
|
Filing Option |
Filing Type |
Forms / Schedules |
Advantages |
Disadvantages |
|
Sole
Proprietorship |
Married
Filing Jointly |
- 1 Form
1040 - 1 Schedule
C - 1 Schedule
SE |
- Taxpayer files only one
type of tax return with two schedules:
Form 1040, Schedule C, and Schedule SE. |
- Only one spouse receives Social Security
credit. |
|
Qualified
Joint Venture |
Married
Filing Jointly |
- 1 Form
1040 - 2
Schedules C - 2
Schedules SE |
- Taxpayer does not have
to file - Both spouses receive
Social Security credits |
- Increased taxpayer
burden to file additional Schedules C and SE. |
|
Partnership |
Married
Filing Jointly |
- 1 Form 1065 - 2 Schedules
K-1 - 1 Form
1040 - 1 Schedule
E - 2
Schedules SE |
- Both spouses receive
Social Security credits |
- This option requires
the highest number of forms and schedules. |
Source: Treasury Inspector
General for Tax Administration (TIGTA) analysis of IRS publications and
instructions.
This review was performed at the IRS Fresno Submission
Processing Site and included discussions with officials in the IRS National
Headquarters in
Many Taxpayers Are Not Aware of the Qualified Joint Venture Filing Option
To identify taxpayers who may be eligible for the QJV option and determine if they were aware of the option, we sent survey questionnaires to a random sample of 400 married taxpayers reporting income from a partnership (Form 1065) and to 800 married taxpayers reporting income from a sole proprietorship (Schedule C) in Tax Year 2007.[4] Survey results indicated many joint taxpayers were not aware of the QJV filing option.
We received 95 replies from
taxpayers filing Forms 1065. Fifty-two of
the taxpayers who replied qualified for the QJV option. Only 8 of the 52 were aware of but chose not
to elect the option.[5]
The remaining 44 (85 percent) were
unaware of the option, and 37 (71 percent) of the 52 would consider using it in
the future. Figure 2 shows the Form 1065
filers who were eligible for the QJV option.
Figure 2: Form 1065 Filers Who Were Eligible for the QJV
Option
Figure 2 was removed due to its size. To see Figure 1, please go to the Adobe PDF
version of the report on the TIGTA Public Web Page.
We received 166 replies from
taxpayers filing Schedules C. Fifteen of
these taxpayers qualified for the QJV option. Only 3 of the 15 were aware of but chose not
to elect the option. The remaining 12 (80
percent) were unaware of the option, and ****1*****of the 15 would
consider using it in the future. Figure
3 shows the Schedule C filers who were eligible for the QJV option.
Figure 3: Schedule C Filers Who Were Eligible for the
QJV Option
Figure
3 was removed due to its size. To see
Figure 3, please go to the Adobe PDF version of the report on the TIGTA Public
Web Page.
To determine reasons why many filers were not aware of the QJV option, we reviewed the instructions provided by the IRS in publications, forms, and tax preparation web sites. We also tested consumer tax preparation software to see if the software provided the preparer with QJV prompts whenever there was an indication of qualifying for the QJV option.
Some publications and instructions could be
more complete or clear
Federal guidelines[6] require information to be presented in a clear, accurate, and complete manner, including information disseminated via the Internet. We observed that the IRS did not always ensure that QJV information in forms and instructions was clear and complete.
The IRS updated forms and form instructions, as well as the IRS public web site, IRS.gov, with QJV information. QJV information was presented in the “What’s New” sections and in the text of instructions providing information that accurately described who is eligible and how to elect the option. Instructions related to one form, Schedule E, and two publications, Taxable and Nontaxable Income (Publication 525) and Residential Rental Property (Publication 527), presented QJV information in a clear, direct, and readable manner.
However, the QJV filing option information was not as clear in
the Farmer’s Tax Guide (Publication 225),
Tax Guide for Small Business
(Publication 334), and Partnerships
(Publication 541), and was not presented clearly in Schedules C, E, and F. We found the benefits of the filing option were
explained only in Publication 541. All these documents had the partnerships and QJV information presented
in the same paragraphs, with the QJV filing option discussed only towards the
end. For example, the QJV filing option is
discussed after the partnership filing requirement in the instructions for
Publication 541 (Rev. April 2008) presented below:
Husband-wife partnership.
If spouses carry on a business together and share in the profits and
losses, they may be partners whether or not they have a formal partnership
agreement. If so, they should report income or less from the business on Form
1065. They should not report the income on a separate Schedule C (form 1040) in
the name of one spouse as a sole proprietor. However, the husband and wife can
elect not to treat the joint venture as a partnership if they meet each of the following
requirements.
The first three sentences instruct taxpayers to file a partnership return. While the QJV option is presented in the example above, those first three sentences may cause taxpayers to read no further than the partnership filing requirement information, thus the taxpayer is left unaware of the new filing option. In addition, the IRS does not use a QJV information caption in this publication. Clarity could be improved by presenting QJV instructions separately under a QJV caption, as the IRS did in Tax Year 2007 Schedule SE instructions presented below:
Qualified Joint Ventures
If you and your spouse materially
participate (see Material participation
in the 2007 Instructions for Schedule C) as the only members of a jointly owned
and operated business, and you file a joint return for the tax year, you can make
a joint election to be taxed as a qualified joint venture instead of a partnership.
To make this election, you must divide all items of income, gain, loss, deduction,
and credit between you and your spouse in accordance with your respective interests
in the venture. Each of you must file a separate Schedule C, C-EZ, or F. On each
line of your separate Schedule C, C-EZ, or F, you must enter your share of the
applicable income, deduction, or loss. You .also must file a separate Schedule
SE to pay SE tax on your share of the joint venture income.
The information provided to the
public does not adequately emphasize the benefits such as the Social Security
benefit to the spouse or not having to file a partnership return when using the
QJV filing option. Publication 541 (Rev.
April 2008) provides only minimal information on Social Security benefits as
shown below:
If the husband and wife do not
make the election to treat their joint venture as sole proprietorships, each
spouse should carry his or her share of the partnership income or loss from Schedule
K-1 (Form l065) to their joint or separate Form(s) 1040. Each spouse should
include his or her respective share of self-employment income on a separate Schedule
SE (Form 1040), Self-Employment Tax. This generally does not increase the total
tax on the return, but it does give each spouse credit for social security earnings
on which retirement benefits are based.
With the exception of Publication 541 and IRS.gov, none of the related instructions we reviewed in publications, forms, and schedules contained details of the Social Security benefits related to the QJV option. While IRS.gov presents information on the Social Security benefit, it states that certain married co-owners could avoid filing partnership returns, but the web site does not elaborate on this as a benefit derived from choosing the QJV filing option.
In addition, there may be some confusion that using the QJV filing option will terminate the partnership entity. Both Form 1065 instructions and IRS.gov state, “The partnership terminates at the end of the tax year immediately preceding the year the election takes effect.” The IRS has stated that only the partnership filing requirement is terminated and not the partnership itself. Taxpayers can use the partnership Employer Identification Number[7] again if they no longer qualify for the QJV filing option. If taxpayers believe their partnership entity will be terminated, they may not want to use the QJV filing option.
Per the IRS web site, the Tax Forms and Publications office mission statement is to originate and improve tax forms, instructions, and publications that 1) are technically accurate, timely, understandable, and as easy to use as possible and 2) enable taxpayers to fulfill their tax filing and payment obligations. This office provides the tax forms, form instructions, and publications to the Submission Processing office for them to determine the record layout changes to communicate to the tax preparation software industry via the Electronic Return File Specifications for Individual Income Tax Returns (Publication 1346).
The QJV filing option was not emphasized in tax preparation
software
Many tax preparation software packages are designed to work in two ways. For taxpayers with limited knowledge of tax laws, there is a guided interview process to help determine what areas apply to the taxpayer depending on how they answer certain questions. Taxpayers with more advanced knowledge can choose to go directly to the sections that they want to complete to prepare their return in a minimal amount of time.
Replies from our random sample of taxpayer surveys showed
that 97 percent of Form 1065 filers and 90 percent of Schedule C filers used a paid
preparer or tax preparation software package to prepare their tax returns. Figure 4 gives detailed information on the
replies we received from our taxpayer surveys.
Figure 4: Paid Preparers and Tax Preparation
Software Packages
Figure 4 was removed due to its size. To see Figure 4, please go to the Adobe PDF
version of the report on the TIGTA Public Web Page.
To test if consumer tax preparation software prompted for the QJV election, we prepared seven Tax Year 2007 returns reporting income from a partnership or a sole proprietorship. Each return included the same basic criteria of a joint return that would result in Schedules E and SE for Form 1065 filers and in Schedules C and SE for the Schedule C filers. We reviewed the legal requirements for the QJV election as set forth in the law,[8] IRS forms, and Publication 541 to ensure the sample test data qualified for the QJV election. In the scenario we used, the taxpayer is eligible for the election.
In the two major software packages we tested, there were no specific prompts about the QJV to alert the user to the potential benefits of electing the QJV option. The user needed to be aware of the QJV and/or have tax knowledge of how to answer questions in order to generate the forms and schedules required to elect the QJV option. One tax preparation software package did provide side margin Frequently Asked Questions for the user to obtain more information, but no specific prompts were provided to alert the user of potentially qualifying for QJV treatment.
In addition to the software we tested, we obtained tax preparation software screen prints for two other software packages. Both screen prints applied to preparation of Tax Year 2007 returns and should have generated whenever a joint Schedule C business was selected. The screen prints displayed a caution for the preparer to file a partnership return or elect the option to file two separate Schedules C. One screen print included an additional caution that their client may receive IRS inquiries if a joint Schedule C is filed. This caution may discourage preparers from the QJV election.
We also spoke with member practitioners from the American Institute of Certified Public Accountants and the National Association of Enrolled Agents to determine if the professional tax preparation software these practitioners used included adequate information to alert the user about the QJV election. The practitioners stated their professional tax preparation software[9] did not prompt them for the QJV election; however, some of these practitioners stated that their software[10] provided drop down menus or checkboxes needed to prepare the QJV schedules or provided a screen for joint Schedule C filers. Practitioners also stated the IRS did not emphasize the QJV filing option when issuing guidance.
The IRS Electronic Tax Administration office has a National
Account Management program with a mission to “ease taxpayer burden and increase compliance by
establishing and maintaining relationships with National Accounts, industry and
IRS; and developing and exploring new electronic business opportunities and
effectively managing associated issues.” Many top tax preparation software providers participate
in the National Account Management program and have their own assigned IRS
account manager. The Electronic Tax Administration
office also provides assistance as a mediator between the industry and the IRS.
The Small Business/Self-Employed Division has a Communications office with
a role that “designs, develops and implements communication strategies and
plans, and delivers communications for internal and external stakeholders.” This role is accomplished by working with
business owners to enhance understanding and taxpayer compliance, identifying
objectives and appropriate communication and delivery channels that leverage
relationships with stakeholders, supporting marketing efforts to practitioners
and small business communities, and ensuring a communications link exists
across the Small Business/Self-Employed Division business units and other IRS functions
and operating divisions.
Consumer and professional tax preparation software packages did not adequately prompt the user to the QJV election, thus many taxpayers and preparers may be unaware of the QJV option. This presents a taxpayer burden to potentially 40,000 Form 1040 filers having to also file Form 1065 for their husband-and-wife business and could adversely affect taxpayer rights and entitlements for 350,000 Schedule C spousal taxpayers who do not split the income between both spouses in order to earn Social Security credit for each portion of their self-employment income. Based on the survey replies received from taxpayers and tax professionals, increased outreach efforts could further taxpayer awareness and increase the number of qualified taxpayers electing the QJV option.
Recommendations
Recommendation 1: The Director,
Tax Forms and Publications, Wage and Investment Division, should ensure all tax products (forms, instructions, publications)
that include a discussion on QJVs produced by Tax Forms and Publications are
clear and accurate. The tax products
should include explanations that are consistent on partnership status and
potential spousal benefits when electing the QJV filing option.
Management’s Response: IRS management agreed with this recommendation. Tax Forms and Publications office management will
review all tax products containing information on QJVs to ensure the
information is clear and accurate. They
will also ensure the tax products include a consistent discussion on husband-and-wife
businesses and provide information to show each
spouse how to obtain credit for his or her respective Social Security earnings
on which retirement benefits will be based.
Recommendation 2: The Director,
Examination, Small Business/Self-Employed Division, should ensure all related
IRS publications and instructions on the IRS.gov web site that include a discussion on QJVs are clear and accurate. The IRS.gov information should include
explanations that are consistent on partnership status and potential spousal
benefits when electing the QJV filing option.
Management’s Response: IRS management agreed with this recommendation. They will review all related IRS publications
and instructions located on the IRS.gov web site that discuss QJVs to ensure the
information is clear and accurate. They
will include explanations that are consistent on partnership status and refer
to the potential spousal benefits that pertain to the QJV filing option.
Recommendation 3: The Director, Electronic Tax Administration and Refundable
Credits, Wage and Investment Division, should work more closely with tax preparation software vendors to
help ensure tax preparation software packages are adequately prompting
taxpayers and paid preparers to the QJV election when it becomes apparent they
may qualify for the election.
Management’s
Response:
IRS management agreed with this recommendation. The Director, Electronic Tax Administration
and Refundable Credits, Wage and Investment Division will work with the Small Business/Self-Employed
Division to increase outreach to the software industry through their regularly
scheduled meetings and conferences with the industry throughout the year. The Examination function has agreed to
provide a subject matter expert to address the industry and to fully explain the
QJV option.
Recommendation
4: The Director,
Communications, Liaison, and Disclosure, Small Business/Self-Employed Division;
the Director, Examination, Small Business/Self-Employed Division; and the
Director, Communications and Liaison, Wage and Investment Division, should
design an outreach marketing plan for husband-and-wife businesses and tax
practitioners to ensure the market segment and practitioner industry are aware
of the QJV election. The plan should
explain the potential Social Security benefits and reduction of taxpayer
burden.
Management’s
Response:
IRS management agreed with this recommendation. The Director, Communications, Liaison, and
Disclosure, Small Business/Self-Employed Division; the Director, Examination, Small
Business/Self-Employed Division; and the Director, Communications and Liaison,
Wage and Investment Division agree to design an outreach marketing plan focused
on the availability of the QJV election to certain taxpayers. This includes providing information to the
husband-and-wife businesses market segment and the tax professional community
to make them aware of potential spousal Social Security benefits and reduction
of taxpayer burden when electing the QJV filing option.
Appendix I
Detailed Objective, Scope, and Methodology
Our overall objective was to determine whether taxpayers who appear to meet the requirements to elect QJV treatment on their tax return were adequately informed of this information and the potential benefits it provides. To accomplish our objective, we:
I. Determined whether the IRS provided adequate information related to the QJV provision in forms and publications and by other methods.
A. Evaluated the primary forms and publications related to the filing of a U.S. Return Partnership Income (Form 1065) or a Profit or Loss From Business (Schedule C) to determine if they adequately conveyed information about QJV treatment and the potential benefits to making the election.
B. Evaluated other methods the IRS used to disseminate QJV information (e.g., the IRS public web site, IRS.gov) to determine if they were adequate.
II. Determined whether commercial software adequately informed professional tax preparers of the QJV election requirements and the benefits of the election.
A. Contacted committee members of the American Institute of Certified Public Accountants and National Association of Enrolled Agents to determine if professional tax preparation software adequately prompted the user to the QJV election.
B. Identified two major consumer tax preparation software packages and prepared seven sample returns using each software package to determine if these two consumer tax preparation software packages adequately prompted the user to the QJV election.
C. Contacted a professional tax preparation software company to determine how QJV information is presented and conveyed in their software.
III. Determined other possible reasons why taxpayers did not claim QJV treatment.
A. Sent a survey questionnaire to 1,200 taxpayers and contacted the American Institute of Certified Public Accountants and National Association of Enrolled Agents professional accounting organizations to determine their reasons for not using the QJV filing option.
We selected a statistically valid random sample to project the population of filers who potentially qualified for the QJV election. Using a 95 percent confidence level, an expected error rate of 50 percent, and precision factor of ± 5 percent, we selected Tax Year 2007 samples of 400 taxpayers from the Form 1065 filing population of 104,300 and 800 taxpayers from the Schedule C filing population of 4.8 million.
All computer-processed data were extracted
from the TIGTA Data Center Warehouse Returns Transaction Files (Individual Master
File).[11] We validated the data by examining a random
sample of 25 from each sample population. All criteria used to extract the data were
confirmed in the data validation samples. This validation test demonstrated that the
data were sufficiently reliable and could be used to meet the objectives of
this audit.
B. Evaluated the questionnaire responses and other information to determine the primary reasons why taxpayers did not make the election and why tax preparers would not use the QJV filing option.
Internal controls methodology
Internal controls relate to management’s
plans, methods, and procedures used to meet their mission, goals, and
objectives. Internal controls include
the processes and procedures for planning, organizing, directing, and controlling
program operations. They include the
systems for measuring, reporting, and monitoring program performance. We determined the following internal controls
were relevant to our audit objective: the Small Business/Self-Employed Division and the Wage and Investment
Division policies, procedures, and practices for communicating new tax law changes.
We evaluated these controls by reviewing
instructions provided on related forms, publications, and web sites and by
interviewing management and other employees associated with promoting awareness
of new tax laws. We assessed the
accuracy of information communicated via the IRS’ forms, publications, and web
site. In addition, we also reviewed
survey responses from affected taxpayers and tax practitioners.
Appendix II
Major Contributors to This Report
Michael
E. McKenney, Assistant Inspector General for Audit (Returns Processing and
Account Services)
Kyle
R. Andersen, Director
Richard
J. Calderon, Audit Manager
Jennie
G. Choo, Lead Auditor
Glory
Jampetero, Senior Auditor
John
B. Mansfield, Senior Auditor
Steven
D. Stephens, Senior Auditor
Appendix III
Commissioner C
Office of the Commissioner – Attn: Chief of Staff C
Deputy Commissioner for Services and Enforcement SE
Deputy Commissioner, Small Business/Self-Employed Division SE:S
Deputy Commissioner, Wage and Investment Division SE:W
Director, Communications, Liaison, and Disclosure, Small Business/Self-Employed Division SE:S:CLD
Director, Communications and Liaison, Wage and Investment Division SE:W:C
Director, Customer Account Services, Wage and Investment Division SE:W:CAS
Director, Customer Assistance, Relationships, and Education, Wage and Investment Division SE:W:CAR
Director, Electronic Tax Administration and Refundable Credits, Wage and Investment Division SE:W:ETARC
Director, Examination, Small Business/Self-Employed Division SE:S:E
Director, Media and Publications, Wage and Investment Division SE:W:CAR:MP
Director, Submission Processing, Wage and Investment Division SE:W:CAS:SP
Director, Tax Forms and Publications SE:W:CAR:MP:T
Chief Counsel CC
National Taxpayer Advocate TA
Director, Office of Legislative Affairs CL:LA
Director, Office of Program Evaluation and Risk Analysis RAS:O
Office of Internal Control OS:CFO:CPIC:IC
Audit Liaisons:
Commissioner, Small Business/Self-Employed Division SE:S
Chief, Program Evaluation and
Improvement, Wage and Investment Division
SE:W:S:PRA:
Appendix IV
This appendix presents detailed information on the measurable impact that our recommended corrective actions will have on tax administration. These benefits will be incorporated into our Semiannual Report to Congress.
Type and Value of Outcome Measure:
· Taxpayer Burden – Potential; 40,000 U.S. Return of Partnership Income (Form 1065) joint taxpayers were burdened with additional time and cost in preparing forms to file their tax returns as partnerships (see page 3).
Methodology Used to Measure the Reported Benefit:
To determine the number of joint Form 1065 taxpayers who were burdened with filing additional forms, we first had to determine the number of joint Form 1065 taxpayers that potentially qualified for the QJV option.
All data were queried and extracted from the TIGTA Data Center Warehouse Returns Transaction Files (Individual Master File).[12] We queried for all Tax Year 2007 joint returns processed in Processing Year 2008 with a single Supplemental Income and Loss (Schedule E), two Self-Employment Tax (Schedule SE), and no Profit or Loss From Business (Schedule C) or Profit or Loss From Farming (Schedule F).[13] Our criteria identified 104,300 filers in the Form 1065 population that could potentially qualify for the QJV provision.
Our sample size was determined based on a 95 percent confidence level, an expected error rate of 50 percent, and a precision factor of ± 5 percent. A statistically valid random sample was taken because we wanted to project the number of joint taxpayers that were potentially eligible to elect the QJV option. A sample size of 383 was identified from our Form 1065 population. We increased our sample size to 400 to allow for cases that would need to be excluded from our sample. We sent a survey questionnaire to 400 joint taxpayers and received a 24 percent response rate. Based on the number of replies received, we adjusted our original precision factor of ± 5 percent to a precision factor of ± 10 percent.
We received 95 Form 1065 taxpayer replies and identified that 52 (55 percent) of the taxpayers who replied potentially qualified for the QJV option. Of those qualified, 67 percent were not aware of the QJV option and another 2 percent believed they did not qualify but would consider the QJV election. We multiplied the 104,300 Form 1065 population by 55 percent to project the number of joint taxpayers potentially eligible to elect the QJV option, and then multiplied this total by the 69 percent[14] potential taxpayer benefit to further project 39,582 joint taxpayers who potentially prepared additional forms to file their returns as partnerships.
Type and Value of Outcome Measure:
· Taxpayer Rights and Entitlements – Potential; 350,000 Schedule C spousal taxpayers did not receive Social Security credits for their portion of self-employment income (see page 3).
Methodology Used to Measure the Reported Benefit:
To determine the number of joint Schedule C spousal taxpayers who potentially did not receive Social Security credits for their self-employment income, we first had to determine the number of joint Schedule C taxpayers that potentially qualified for the QJV option.
All data were queried and extracted from the TIGTA Data Center Warehouse Returns Transaction Files (Individual Master File). We queried for all Tax Year 2007 joint returns processed in Processing Year 2008 with a single Schedule C and positive income, one or more Schedules SE, and no Schedule F.[15] Our criteria identified 4.8 million Schedule C filers who may be eligible to qualify for the QJV option. We did not further refine our criteria because we did not want to exclude potentially qualified Schedule C filers from the population.
Our sample size was determined based on a 95 percent confidence level, an expected error rate of 50 percent, and precision factor of ± 5 percent. A statistically valid random sample was taken because we wanted to project the number of joint taxpayers that were potentially eligible to elect the QJV option. A sample size of 384 was identified from our Schedule C population. We doubled our sample size to 800 because we anticipated a majority of replies received would show that the taxpayers were not qualified for the QJV option. We sent a survey questionnaire to 800 joint taxpayers and received a 21 percent response rate. Based on the number of replies received, we adjusted our original precision factor of ± 5 percent to a precision factor of ± 8 percent.
We received 166 Schedule C taxpayer replies and identified that 15 (9 percent) of the taxpayers who replied potentially qualified for the QJV option. Of those qualified, ***1*** were not aware of the QJV option and another ********1*********. We multiplied the 4.8 million Schedule C population by 9 percent to project the number of joint taxpayers potentially eligible to elect the QJV option, and then multiplied this total by the 80 percent[16] potential taxpayer benefit to further project 349,875 spousal taxpayers who did not receive Social Security credits for their portion of the self-employment income.
Appendix V
Additional information.
Please include any additional information from the questions above, as
well as anything else you feel is pertinent to our inquiry. An additional page can be attached if needed.
Definitions
Material Participation (taken from
IRS Schedule C Instructions):
Participation
generally includes any work you did in connection with an activity if you owned
an interest in the activity at the time you did the work. The capacity in which you did the work does
not matter. However, work is not treated
as participation if it is work an owner would not customarily do in the same
type of activity and one of your main reasons for doing the work was to avoid
the disallowance of losses or credits from activity under the passive activity
rules. Work you did as an investor in an
activity is not treated as participation unless you were directly involved in
the day-to-day management or operations of the activity.
You
materially participated in the operation of this trade or business if you met ANY of the following seven
tests:
Qualified Joint Venture (taken from
IRS Form 1065 instructions):
If you and
your spouse materially participate as the only members of a jointly owned and
operated business, and you file a joint return for the tax year, you can make
an election to be treated as a qualified joint venture instead of a
partnership. By making this election you
will not be required to file Form 1065 for any year the election is in effect
and will instead report the income and deductions directly on your joint
return.
To make
this election, you must divide all items of income, gain, loss, deduction, and
credit between you and your spouse in accordance with your respective interests
in the venture. Each of you must file a
separate Schedule C, C-EZ, or F. On each
line of your separate Schedule C, C-EZ, or F, you must enter your share of the
applicable income, deduction, or loss.
Each of you also must file a separate Schedule SE to pay self-employment
tax.
Once made,
the election cannot be revoked without IRS consent. If you and your spouse filed a Form 1065 for
the year prior to the election, you do not need to amend that return or file a
final Form 1065 for the year the election takes effect. However, the partnership terminates at the
end of the tax year immediately preceding the year the election takes effect.
Profit and Loss From Business (Schedule C) Filers:
Additional information.
Please include any additional information from the questions above, as
well as anything else you feel is pertinent to our inquiry. An additional page can be attached if needed.
Definitions
Material Participation (taken from
IRS Schedule C Instructions):
Participation
generally includes any work you did in connection with an activity if you owned
an interest in the activity at the time you did the work. The capacity in which you did the work does
not matter. However, work is not treated
as participation if it is work an owner would not customarily do in the same
type of activity and one of your main reasons for doing the work was to avoid
the disallowance of losses or credits from activity under the passive activity
rules. Work you did as an investor in an
activity is not treated as participation unless you were directly involved in
the day-to-day management or operations of the activity.
You
materially participated in the operation of this trade or business if you met ANY of the following seven
tests:
Qualified Joint Venture (taken from
IRS Schedule SE instructions):
If you and
your spouse materially participate as the only members of a jointly owned and
operated business, and you file a joint return for the tax year, you can make a
joint election to be taxed as a qualified joint venture instead of a
partnership. To make this election, you
must divide all items of income, gain, loss, deduction, and credit between you
and your spouse in accordance with your respective interests in the
venture. Each of you must file a
separate Schedule C, C-EZ, or F. On each
line of your separate Schedule C, C-EZ, or F, you must enter your share of the
applicable income, deduction, or loss.
You also must file a separate Schedule SE to pay Self-Employment tax on
your share of the joint venture income.
Appendix VI
Management’s
Response to the Draft Report
DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
Deputy Commissioner
February 24, 2010
MEMORANDUM FOR MICHAEL R. PHILLIPS
DEPUTY INSPECTOR GENERAL FOR AUDIT
FROM: Steven T. Miller /s/ Steven T. Miller
Deputy Commissioner
SUBJECT: Draft Audit Report –Increased Outreach
Efforts Could Enhance Taxpayer Awareness of the Benefits
of the Qualified Joint
Ventures (Audit No.
200940023)
Thank you for the opportunity to review your draft report titled, “Increased Outreach Efforts Could Enhance Taxpayer Awareness of the Benefits of the Qualified Joint Ventures.”
We are committed to improving our current efforts to provide clear and understandable information regarding Qualified Joint Ventures including various options available to taxpayers. We will update our publications and forms, update the content on IRS.gov to ensure it is accurate and understandable, and enhance our marketing efforts to software industry professionals. In addition, we will undertake an effort to ensure the spousal elections, and their impact on social security benefits, are clearly communicated to the appropriate taxpayers.
If you have any questions, please contact me, or a member of your staff may contact Christopher Wagner, Commissioner, Small Business/Self Employed Division, at (202) 622-0600.
Attachment
Attachment
RECOMMENDATION 1:
The Director, Tax
Forms and Publications, Wage and Investment Division, should ensure all tax
products (forms, instructions, publications) that include a discussion on QJVs
produced by Tax Forms and Publications are clear and accurate. The tax products
should include explanations that are consistent on partnership status and
potential spousal benefits when electing the QJV filing option.
CORRECTIVE ACTION:
We agree with this
recommendation. Tax Forms and Publications will review all tax products
containing information on Qualified Joint Ventures (QJV) to ensure they are
clear and accurate. We will also ensure the tax products include a consistent
discussion on husband-wife partnerships, and ensure they provide information to
show each spouse how to obtain credit for their respective social security
earnings on which their retirement benefits will be based.
IMPLEMENTATION DATE:
March 15, 2011
RESPONSIBLE
OFFICIAL:
Director, Media and
Publications, Wage & Investment Division
(W&I)
CORRECTIVE ACTION
MONITORING PLAN:
We will monitor
this corrective action as part of our internal management control system.
RECOMMENDATION 2:
The Director,
Examination, Small Business/Self Employed Division, should ensure all related
IRS publications and instructions on the IRS.gov web site that include a
discussion on QJVs are clear and accurate. The IRS.gov information should
include explanations that are consistent on partnership status and potential
spousal benefits when electing the QJV filing option.
CORRECTIVE ACTION:
We agree with this
recommendation. We will review all related IRS publications and instructions
located on the IRS.gov web site that discuss Qualified Joint Ventures to ensure
they are clear and accurate. We will include explanations that are consistent
on partnership status and refer to the potential spousal benefits that pertain
to the QJV filing option.
IMPLEMENTATION DATE:
March 15, 2011
RESPONSIBLE
OFFICIAL:
Director,
Examination Policy, Small Business/Self-Employed Division (SB/SE)
CORRECTIVE ACTION
MONITORING PLAN:
The Director,
Examination Policy, SB/SE will advise the Director, Examination, SB/SE of any
delays in implementing this corrective action.
RECOMMENDATION 3:
The Director,
Electronic Tax Administration and Refundable Credits, Wage and Investment
Division, should work more closely with tax preparation software vendors to
help ensure tax preparation software packages are adequately prompting
taxpayers and paid preparers to the QJV election when it becomes apparent they
may qualify for the election.
CORRECTIVE ACTION:
We agree with this
recommendation. The Director, Electronic Tax Administration and Refundable
Credits, Wage and Investment Division will work with SB/SE to increase outreach
to the software industry through our regularly scheduled meetings and
conferences with the industry throughout the year. SB/SE Examination has agreed
to provide a subject matter expert to address the industry and to fully explain
the Qualified Joint Venture (QJV) option.
IMPLEMENTATION DATE:
March 15, 2011
RESPONSIBLE
OFFICIAL:
Director, Electronic
Tax Administration and Refundable Credits, Wage and Investment Division
(W&I)
CORRECTIVE ACTION
MONITORING PLAN:
We will monitor
this corrective action as part of our internal management control system.
RECOMMENDATION 4:
The Director,
Communications, Liaison, and Disclosure, Small Business/Self Employed Division,
the Director, Examination, Small Business/Self Employed Division, and the
Director, Communications and Liaison, Wage and Investment Division, should
design an outreach marketing plan for husband-and-wife businesses and tax
practitioners to ensure the market segment and practitioner industry are aware
of the QJV election. The plan should explain the potential Social Security
benefits and reduction of taxpayer burden.
CORRECTIVE
ACTION:
We
agree with this recommendation. The Director, Communications, Liaison and Disclosure,
Small Business/Self Employed Division, the Director, Examination, Small
Business/Self Employed Division, and the Director, Communications and Liaison,
Wage and Investment Division agree to design an outreach marketing plan focused
on the availability of the Qualified Joint Venture (QJV) election to certain
taxpayers. This includes providing information to the market segment of husband-and-wife
businesses and the tax professional community to make them aware of potential
spousal Social Security benefits and reduction of taxpayer burden when electing
the QJV filing option.
IMPLEMENTATION
DATE:
March
15, 2011
RESPONSIBLE
OFFICIAL:
Director, Examination
Policy, SB/SE
CORRECTIVE
ACTION MONITORING PLAN:
The Director, Examination Policy, SB/SE will advise the Director, Examination, SB/SE of any delays in implementing this corrective action.
[1] The provision allows married taxpayers who wholly own a business to be treated as sole proprietors rather than partners for tax purposes.
[2]
[3] The provision also applies to farm income reported on Profit or Loss From Farming (Schedule F). However, for simplicity we limited the scope of our audit to Schedule C filers.
[4] We identified partnership tax returns with a single Schedule E, two Schedules SE, and no Schedule C or F. We also identified individual tax returns with a single Schedule C, one or more Schedules SE, and no Schedule F. We identified 104,300 Form 1065 filers and 4.8 million Schedule C filers potentially eligible for the QJV option.
[5] Taxpayers who were aware of the QJV option but did not use it either believed they would not qualify, preferred filing the old way they had in the past, or were advised by their tax preparer not to use the QJV option.
[6] Office of Management and Budget, Guidelines for Ensuring and Maximizing the Quality, Objectivity, Utility,
and Integrity of Information Disseminated by Federal Agencies, (
[7] A unique nine-digit number used to identify a taxpayer’s business account.
[8]
[9] Lacerte, ProSeries, and Ultra Tax.
[10] Lacerte, ProSystemFX, and Tax Works.
[11] The IRS database that maintains transactions or records of individual tax accounts.
[12] The IRS database that maintains transactions or records of individual tax accounts.
[13] We omitted Schedules C and F because we could not determine where the Schedule SE income came from and we would be unable to reconcile the Form 1065 income back to the Schedule SE without performing significant analysis.
[14] We combined the ****1**** who were not aware with the ******1******* and identified them as missing the potential QJV benefit of reduction in taxpayer burden.
[15] Schedule F would only be included (but not reviewed) in our population if the taxpayer also had a single Schedule C.
[16] We combined the 67 percent who were not aware with the 13 percent who would consider the QJV option and identified them as missing the potential QJV benefit of assigning Social Security credits to the spouse.