Treasury Inspector General for Tax Administration
November 1, 2010
TIGTA - 2010-70
Contact: Karen Kraushaar
WASHINGTON – While the Internal Revenue Service (IRS) is generally effective in checking for unreported income during field audits of sole proprietors, it could take further steps to determine if additional sources of income need to be reported, according to a report publicly released today by the Treasury Inspector General for Tax Administration (TIGTA).
While IRS field examiners generally check for unreported income, TIGTA found that the IRS could improve the accuracy of its preliminary cash transaction analyses by taking greater advantage of performance feedback mechanisms and ensuring that appropriate personal-living-expense data are being used. The preliminary cash transaction analysis involves little or no taxpayer burden; but uses tax return and personal expense data to determine whether the sole proprietor’s income and expenses are roughly equal.
“Tests for unreported income during IRS audits of sole proprietors are critical to the process of verifying that the correct amount of tax is reported,” said J. Russell George, the Treasury Inspector General for Tax Administration. “Our results indicate that sole proprietors may have avoided tax and interest assessments of over $8 million in Fiscal Year 2008.”
The IRS’s National Research Program estimated that unreported business income by sole proprietors accounted for $68 billion (20 percent) of the $345 billion Tax Gap. This is due in large part to resource constraints and the need to balance audit coverage across other segments of the tax return filing population, such as corporations and partnerships.
TIGTA recommended that the IRS issue guidance to group managers to provide specific written feedback to examiners on the adequacy of their tests for unreported income, and that the IRS reinforce the requirement and importance of using appropriate personal-living-expense data in preliminary cash transaction analyses. The IRS agreed with these recommendations and plans to take appropriate corrective actions.
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