Office of Audit
THE USE OF SCHEDULE K-1 DATA TO ADDRESS TAXPAYER NONCOMPLIANCE CAN BE IMPROVED
Final Report issued on September 27, 2019
Highlights of Reference Number:† 2019-30-078 to the Commissioner of Internal Revenue.
IMPACT ON TAXPAYERS
The IRS conducts a Tax Gap study periodically to determine the nature and extent of taxpayer noncompliance to assist in formulating tax administration strategies.† The last study, completed in April 2016, estimated the amount of tax liability not paid voluntarily and timely was $458 billion annually for Tax Years 2008 through 2010.† The nonfiling portion of the Tax Gap is estimated to be $32 billion annually, while the underreporting portion is $387 billion annually, and the underpayment portion is $39 billion annually.
The Tax Gap study also found that noncompliance varies with the amount of information reporting by third parties (e.g., employers, banks, partnerships).† Items subject to substantial information reporting and withholding (e.g., wages) have a misreporting rate of 1 percent for the individual income tax, while the misreporting rate for items subject to lesser degrees of information reporting are considerably higher.
WHY TIGTA DID THE AUDIT
This audit was initiated to determine whether the IRS uses Schedule K-1 data effectively to identify taxpayers not submitting tax returns or taxpayers underreporting tax while also minimizing unnecessary notices to taxpayers.† Schedules K-1 are used by flow‑through entities to report recipientsí allocated share of income, deductions, credits, and other amounts.† Unlike other information returns, Schedules K-1 are not submitted directly to the IRS, but are attachments to flow‑through returns submitted on paper or by electronic filing.† ******************2********************** Schedules K-1 will limit the IRSís ability to identify potential noncompliance, resulting in the loss of tax revenue and inequitable treatment of taxpayers as well as potentially creating unnecessary work and increasing taxpayer burden.
WHAT TIGTA FOUND
TIGTA found that improvements are needed with
the IRSís process design and collection of Schedule K-1 data to strengthen
efforts to address the noncompliance of nonfilers and underreporters. †Specifically,
TIGTA found that the IRS: †1) annually accepts flow-through returns with approximately
3 million *******************2****************** Schedules K‑1;
2) did not identify approximately 4,000 nonfilers who received $25,000 or more of Schedule K-1 income; and 3) could improve identification of underreporter noncompliance.
WHAT TIGTA RECOMMENDED
TIGTA made 11 recommendations to the Commissioner, Small Business/Self-Employed Division, and the Commissioner, Wage and Investment Division, to improve the IRSís processes for collecting and using Schedule K-1 data.
The IRS agreed with 10 of 11 recommendations. †Management stated that its disagreement with the recommendation to enhance the information return verification process to consider the date of death was due to its minimal benefit and significant programming changes. †TIGTA contends that implementation of this recommendation would improve the IRSís ability to check tax compliance by better identifying the actual recipients of Schedules K‑1.
2 = Law Enforcement Techniques/ Procedures and Guidelines for Law Enforcement Investigations or Prosecutions.
READ THE FULL REPORT
To view the report, including the scope, methodology, and full IRS response, go to:
Phone Number ††/† 202-622-6500
E-mail Address †/† TIGTACommunications@tigta.treas.gov
Website†††††† ††††††/† https://www.treasury.gov/tigta