An individual applying for a new  business license or a renewal of his/her business license to operate a farm  labor contracting, garment manufacturing, or car washing and polishing  business must first prove full compliance with federal employment taxes  by filing all required federal employment tax returns and resolving all  outstanding federal employment taxes through full payment or appeal. According to the IRS  Ogden database on business applicants, 7,194 businesses applied for a  business license in the three industries one or more times from calendar  years 2006 through 2008 and requested that IRS provide California with  information on their compliance with federal employment taxes. California businesses filed 441 employment tax returns to come into  compliance to qualify for California business licenses and IRS collected  nearly $7.4 million in employment taxes, according to IRS Ogden  spreadsheets. We estimated that IRS incurred about $331,348 to operate the data-sharing  arrangement in calendar years 2006 and 2007. Using our estimate, the ROI for this data-sharing arrangement is 22:1. IRS  has not tracked the cost data needed to do a study comparing the ROI of  the IRS Ogden/DLSE enforcement activity with those of other current  enforcement activities to determine how the IRS Ogden/DLSE data-sharing  arrangement ROI compares with those of IRS’s other enforcement  activities. However, IRS has developed ROI estimates for five new direct  revenue-producing enforcement initiatives it proposed in its fiscal year  2009 budget submission. Tax Compliance among Businesses Showed Improvement after They Applied for State Business Licenses

We identified the 2,017 businesses that applied for business licenses in  calendar year 2006 only, and found that 315 of these businesses had  unpaid assessments at the time of applying and that tax compliance  improved for these 315 businesses. All but 1 of the 350 businesses that had unpaid assessments when they  applied for business licenses in calendar year 2006 were small businesses. Many Opportunities Exist to Require Federal Tax Compliance to Qualify for State Business Licenses, but Challenges Exist

We contacted revenue officials in every state and the District of Columbia  to ask whether their states have business licensing requirements and, if so,  whether they require demonstration of state tax compliance before  business licenses are granted. Some states and some business types may represent more of an immediate  opportunity for establishing arrangements that require federal tax  compliance to qualify for state business licenses. States that currently  require compliance with state taxes for selected business license  applicants may be more amenable to requiring federal tax compliance than  states that do not even require state tax compliance since they already  recognize tax compliance as important for the businesses. Appendix I: Scope and Methodology

Our objectives were to analyze (1) the extent to which requiring a  demonstration of federal tax compliance to qualify for a state business  license has the potential to improve federal tax compliance and (2) what  opportunities exist for increasing arrangements that require federal tax  compliance to qualify for state business licensing. To provide background on data-sharing arrangements that require  compliance with tax obligations to qualify for state business licensing, we  reviewed relevant Internal Revenue Service (IRS) and California  Department of Industrial Relations, Division of Labor Standards  Enforcement (DLSE) documents and interviewed IRS and California  officials. For our analysis, we  matched records of the California businesses that we selected from the  Access database because they applied in calendar year 2006 only with  IRS’s Unpaid Assessments file as of the weeks of September 18, 2006, and  August 18, 2008; identified the number of businesses with unpaid  assessments and the amounts of their tax debt as of the week of  September 18, 2006; and identified the applicants for business licenses in  2006 only that had resolved their unpaid assessments as of August 18,  2008, and the amounts of their tax debt they resolved. To determine what opportunities exist for increasing data sharing for  arrangements that require federal tax compliance to qualify for state  business licensing, we (1) analyzed and summarized which states and the  District of Columbia have data-sharing arrangements that require state tax  compliance to qualify for state business licensing, which states do not  have such arrangements, and which states do not require businesses to  obtain business licenses on the state level; (2) contacted revenue officials  in 50 states and the District of Columbia via e-mail with structured  questions about the extent to which their states engage in data-sharing  arrangements that require demonstration of tax compliance before  business licenses are granted; and (3) sent a follow-up e-mail to 21 state  revenue officials who confirmed that their states require applicants to be  compliant with state taxes to qualify for business licenses, by requesting  information on the amount of taxes collected, the costs associated with  operating the data-sharing arrangements, and benefits of these data- sharing relationships to the states.
Why GAO Did This Study

The California Department of Industrial Relations, Division of Labor Standards Enforcement (DLSE), requires applicants for California business licenses in three industries--farm labor contracting, garment manufacturing, and car washing and polishing--to be in compliance with federal employment tax obligations to qualify. Based on questions about whether the Internal Revenue Service (IRS) is fully using data from state and local governments to reduce the tax gap, GAO was asked to analyze (1) the extent to which requiring a demonstration of federal tax compliance to qualify for a state business license has the potential to improve federal tax compliance and (2) what opportunities exist for increasing arrangements that require federal tax compliance to qualify for state business licensing. To address these objectives, GAO analyzed IRS administrative and tax data. GAO identified California as a case study. GAO interviewed IRS and state officials and contacted revenue officials in the 50 states and the District of Columbia.

What GAO Found

The California requirement that three types of businesses be in compliance with federal employment taxes to obtain a state business license shows promise as a valuable tool for improving federal tax compliance. According to data from IRS, of 7,194 businesses that applied for a California business license one or more times from calendar years 2006 through 2008 about 24 percent had to file employment tax returns or pay overdue taxes to come into compliance with federal employment taxes. California businesses filed 441 employment tax returns and IRS collected nearly $7.4 million in current dollars in employment taxes in calendar year 2006 and in 8 months of calendar year 2007. GAO estimated that IRS incurred about $331,348 to operate the data-sharing arrangement for this period. Using this cost estimate, the ROI for this arrangement is 22:1. IRS has not tracked the cost data needed to compare the ROI of the IRS-DLSE enforcement activity with other current enforcement activities. However, IRS's highest estimated ROI among five new direct revenue-producing enforcement initiatives proposed in its fiscal year 2009 budget was 11.4:1. Tax compliance among businesses after they applied for state business licenses showed continued improvement. GAO identified 2,017 businesses that applied for business licenses in calendar year 2006 only and found that 315 of these businesses had unpaid assessments as of September 18, 2006. By August 18, 2008, 165 of these businesses had resolved or lowered their unpaid assessment debt by $1,925,162. All but 1 of the 350 businesses that had unpaid assessments when they applied for business licenses in calendar year 2006 were small businesses. GAO's analysis, although showing a promising ROI, did not take into account certain factors, such as whether other tax collection activities were in process for the businesses that applied for licenses. Many opportunities exist to require federal tax compliance to qualify for state business licenses. GAO contacted revenue officials in every state and the District of Columbia to ask whether their states require tax compliance for business licenses. For the 48 respondents, 20 revenue officials said that their states require compliance with state taxes to obtain a state business license, and that these requirements exist for one or more industries. Twenty said that their states do not have such a requirement; 8 said that their states have no business license requirement at the state level. According to IRS, arrangements exist with 13 states that require compliance with one or more federal taxes to qualify for a state business license. Varying licensing requirements from state to state and lack of uniformity among states in categorizing a license as a "business license" make pinpointing the exact number of opportunities difficult. States that currently require compliance with state taxes for selected business license applicants may represent more of an immediate opportunity for establishing arrangements that require federal tax compliance to qualify for a state business license since they already see tax compliance as important for the businesses. Some challenges, such as a lack of current legal authority in some states to link businesses to tax compliance, would need to be addressed if requiring federal tax compliance for state business licenses is to be expanded.