In like manner, income reported to IRS on a K-1 by S-Corps and trusts can  be matched with income reported on tax returns by shareholders and  beneficiaries, respectively. Data Transcription Errors and Erroneous TINs Reduce the Accuracy of K-1 Data

Data transcription errors made by IRS on paper-filed K-1 data and invalid  TINs submitted by flow-through entities on both paper-filed and e-filed K-1s  lower the accuracy of K-1 data. Consequently, data from an estimated 18 million tax  year 2002 paper K-1s that were entered into databases used by IRS for  research and enforcement purposes have transcription error rates from 5  to 9.5 percent. IRS Does Not Notify Flow- Through Entities of Invalid TINs That It Was Unable to Correct

After IRS checks the validity of TINs provided on K-1s, it does not notify  either paper-filing or e-filing flow-through entities of the invalid TINs it  finds so the entities can take steps to correct the TINs, due to concerns  about the potential burden on the entities and resource constraints. However, as table 1 shows, in tax year 2002 the overall percentage of  invalid K-1 TINs IRS found with its TIN validation program was comparable  for e-filed (about 7 percent) and paper (6 percent). K-1 Data Accuracy and Availability Pose Problems in Research and Examination Efforts

In addition to using K-1 data in its document-matching program, IRS is  using K-1 data in its research programs to better understand flow-through  relationships. Data limitations have also  affected IRS’s efforts to identify potentially noncompliant taxpayers for  examination. Based on our sample of closed examination cases, in at least 40 percent of  the examinations, IRS corrected line items that are currently not  transcribed. IRS examination and research staff we interviewed indicated  that if IRS captured this information and made it available to them, it would  help them identify those returns with errors or omissions that IRS should  examine. The benefits for IRS are faster and more comprehensive  information as well as cost reductions. The main challenge for  taxpayers is the cost of converting from paper to e-filing. Conclusions

Although there are some costs to taxpayers to e-file and to IRS in  processing e-filed flow-through entity returns and related K-1s, in general e- filed K-1s offer substantial advantages for both IRS and taxpayers. We are  not making a recommendation for further action to expand e-filing of flow  through-entities’ returns, including K-1s, because IRS agreed to take steps  to do so pursuant to a TIGTA recommendation and is currently studying the  costs of increasing e-filing to IRS and taxpayers. Objectives, Scope, and Methodology

Our objectives were to (1) evaluate the accuracy of K-1 data used by the  Internal Revenue Service (IRS), specifically transcription errors and invalid  taxpayer identification numbers (TIN); (2) determine whether any  limitations in the availability or accuracy of K-1 data have affected IRS’s  ability to identify noncompliance; and (3) describe the benefits and  challenges of increasing electronic filing of K-1s.
Why GAO Did This Study

Over a trillion dollars in income was distributed in tax year 2002 by flow-through entities, such as partnerships, subchapter S corporations, and trusts, to their partners, shareholders, or beneficiaries, respectively. The Internal Revenue Service (IRS) estimates that from 6 to 15 percent of such income is unreported on individual tax returns. This income is reported to both IRS and to the recipients on a Schedule K-1 (K-1). IRS uses K-1 data in its document-matching program to identify noncompliance and for other purposes. GAO was asked to (1) assess the accuracy of K-1 data, specifically transcription errors and taxpayer identification numbers (TIN); (2) determine whether any limitations in the availability or accuracy of K-1 data have affected IRS's ability to identify noncompliance; and (3) identify the benefits and challenges of increasing e-filing of K-1s.

What GAO Found

The accuracy of paper-filed K-1 data is reduced by transcription errors; paper and e-filed K-1s have inaccurate TINs. IRS estimates that transcription errors for tax year 2002 ranged from 5 and 9.5 percent and is taking steps to address such errors. Although e-filed K-1s do not require transcription, for tax year 2002, the percentage of invalid TINs for e-filed K-1s and paper-filed K-1s were comparable (7 and 6 percent, respectively). Due to potential burden on flow-through entities and resource constraints, IRS does not notify the entities of invalid TINs on K-1s for correction. If IRS did so, this would likely give e-filing entities enough time to correct invalid TINs before IRS runs its document-matching program. Inaccurate or limited K-1 data have created problems for IRS researchers and examiners. IRS research staff indicated that inaccurate TINs adversely affected their analysis of flow-through entity networks. Further, because IRS captures limited data from flow-through entity returns, including the K-1, IRS staff lack data they consider helpful, such as "Other Income" to help identify tax shelters. In at least 40 percent of closed examination cases we sampled, IRS examiners found errors with return line items not entered into IRS's databases when returns are received. If these lines were available up front, researchers say they would be able to better identify returns with potential noncompliance. Increased e-filing of K-1s would provide benefits and challenges to both IRS and taxpayers. Benefits for IRS include faster, more complete information and millions in annual cost reductions. Benefits for taxpayers include fewer IRS contacts with them because IRS would have more accurate information in its systems. The primary challenge for IRS is its current inability to electronically process all flow-through entity returns and related forms, including the K-1. For taxpayers, the primary challenge is the cost of converting from paper to e-filing.