A Comprehensive Estimate of the Business Nonfiling Tax Gap May Be Infeasible, but IRS Operational Data Could Provide Partial Information

According to IRS, the primary challenge for IRS in developing a business  tax gap estimate is a lack of data. A  partial estimate could be based on IRS’s inventory of over 40 million  potential nonfiler cases. IRS does not know what share of its inventory  represents instances of actual nonfiling. The BMF CCNIP  represents a significant modernization of IRS’s business nonfiler  compliance program. However, IRS does not have all the information it  needs to know how well the new initiative is working. IRS Has Performance Information for Its Individual Nonfiler Program but Not for Its Business Nonfiler Program

In addition to measures specific to the BMF CCNIP, IRS has also  developed four Servicewide performance and outcome measures for IRS’s  nonfiler activities overall. However, it is not clear whether the meeting will include setting a deadline  for developing such measures. IRS Is Monitoring the Use of Selection Codes but Does Not Yet Have a Formal Plan to Evaluate Them

Selection codes are a key feature of the BMF CCNIP because they distill  the business information that IRS has on a case into a prioritized code. Selection codes are readily available on the computer  screens that IRS collections staff use to research cases and record case  closings. IRS has faced several challenges in its business nonfiler program. IRS  generally identifies more potential nonfilers than it can thoroughly  investigate, and many of those it does investigate turn out not to owe the  return IRS expects based on its records. This initiative should help IRS  choose cases to work, but without an estimate of the business nonfiler tax  gap, IRS does not have a data-driven basis for allocating resources to its  business nonfiler efforts. IRS could also explore adding non-IRS data to  the BMF CCNIP. Identifying Additional Actions to Help Achieve the Goal of Fewer  Unproductive Cases    Add closing codes that would better indicate all known causes for “not  liable to file” determinations and use this information to analyze  causes of unproductive cases and use them as appropriate to identify  any actions IRS could take either administratively or through  education and outreach that could reduce the number of business  nonfiler cases where the filing requirement in IRS’s records is not  applicable. Agency Comments and Our Evaluation

We provided a draft of this report to the Commissioner of Internal  Revenue. IRS agreed that identifying and  pursuing active business nonfilers is key to enforcement efforts and  acknowledged that our recommendations could assist these efforts. IRS  agreed with four of our eight recommendations and indicated as discussed  below some steps it would take to address the other four. Our recommendation was  that IRS draw a sample of potential business nonfilers and thoroughly  investigate those cases to estimate the number of actual business nonfilers  in IRS’s business nonfiler inventory. With respect to our recommendation that IRS should study the feasibility  and cost-effectiveness of using private sector business activity data and  federal contract data, IRS agreed to evaluate the effectiveness of data  mining using the Central Contractor Registration database but did not  agree to study the feasibility of using private sector data. IRS stated that a federal contractor with an unfiled employment tax return  is a high priority in the case selection process. Key contributors to this report are listed in appendix V.

Appendix I: Scope and Methodology

The objectives of this report were to assess (1) the data challenges of  estimating the business nonfiler tax gap, (2) how recent program changes  in the Internal Revenue Service’s (IRS) processes and procedures have  affected its capacity to identify and pursue business nonfilers, and            (3) what opportunities exist for IRS to improve its use of third-party  information returns or other sources to identify and pursue business  nonfilers. We analyzed Business Master File Case Creation Nonfiler  Identification Process (BMF CCNIP) inventory data to determine the  number of potential business nonfilers IRS identifies and analyzed IRS’s  fiscal year 2009 Collection Activity Reports to determine the number of  business nonfiler cases IRS closed as not liable to file returns. To test whether  information return income could be useful in making case closure  decisions under BMF CCNIP, we matched IRS’s calendar year 2007  Aggregated Information Return (AIR) file, which is used in BMF CCNIP  and contained summaries of information returns that were received by  IRS, to IRS’s Nonfiler Measurement file that contained data on all tax year  2007 cases that were closed as not liable to file partnership (Form 1065)  and corporation (Form 1120) returns.
Why GAO Did This Study

The Internal Revenue Service (IRS) does not know how many businesses failed to file required returns, nor does it have an estimate of the associated lost tax revenue--the business nonfiling tax gap. Many cases it does investigate are unproductive because the business does not owe the return IRS expects. GAO was asked to assess (1) the data challenges of estimating the business nonfiler tax gap, (2) how recent program changes have affected IRS's capacity to identify and pursue business nonfilers, and (3) additional opportunities for IRS to use third-party data. GAO reviewed IRS's tax gap estimates, nonfiler program processes and procedures, and matched closed nonfiler cases with various other data.

What GAO Found

IRS cannot develop a comprehensive estimate of the business nonfiling rate and associated tax gap because it lacks data about the population of all businesses. However, IRS could develop a partial estimate using its business nonfiler inventory. IRS identifies several million potential business nonfilers each year, more than it can thoroughly investigate. IRS could take a random sample of its inventory, thoroughly investigate those cases, and use the results to estimate the proportion of actual nonfilers in its inventory of potential nonfilers. Until recently IRS has not had a way to prioritize cases in its large inventory. IRS modernized its business nonfiler program in 2009 by incorporating income and other data in its records indicating business activity. Active businesses generally have an obligation to file a return. IRS's Business Master File Case Creation Nonfiler Identification Process (BMF CCNIP) now assigns each case a code based on this data. IRS uses the code to select cases to work with the goal of securing tax returns from nonfilers and collecting additional revenue. This is a significant modernization, but IRS lacks a formal plan to evaluate how well the codes are working. IRS has performance information on its individual nonfiler program but less on its business nonfiler program. Key management reports needed to provide program data are under development but no deadline has been set. IRS could also use more information on why many nonfiler cases are unproductive. This could potentially lead IRS to identify actions that could reduce IRS resources used on these cases and associated taxpayer burden. GAO identified several opportunities including the following to enhance IRS's identification and pursuit of business nonfilers. (1) The new BMF CCNIP selection codes provide a quick way to verify taxpayer statements that a business has ceased operations and does not need to file a return. Collections staff have been instructed to use the codes when making case closure decisions. They were previously instructed to use other income data but GAO's analysis indicated this may not have been done in all cases. (2) Non-IRS data on businesses including federal contractors could be used to verify taxpayer statements about whether a tax return should have been filed. GAO's analysis of cases in two states that were closed as not liable to file a return found 7,688 businesses where non-IRS data showed business activity as measured by sales totaling $4.1 billion. GAO also found cases closed as not liable to file a return involving 13,852 businesses on the federal contractor registry. GAO's analyses illustrated the potential value of non-IRS data but GAO did not assess which non-IRS data would be most useful nor examine the capacity of IRS's systems to use such data on a large scale.

What GAO Recommends

GAO recommends that the Commissioner of Internal Revenue develop a partial business nonfiler rate estimate; set a deadline for developing performance data; develop a plan for evaluating the selection codes; reinforce the need to use income data and selection codes in verifying taxpayer statements; and study the feasibility and cost-effectiveness of using non-IRS data to verify taxpayer statements. In written comments on a draft of this report IRS agreed that identifying and pursuing active business nonfilers is key to enforcement efforts and acknowledged that our recommendations could assist these efforts. IRS agreed with four of GAO's recommendations and indicated some steps it would take to address the other four.