Most Small Businesses are Individuals, but Most Small Business Income is Earned by Partnerships and Corporations

As shown in figure 1, using data from researchers at Treasury’s Office of  Tax Analysis (OTA), most small businesses (approximately 69 percent or  16 million) are individual taxpayers who report business income on their  Form 1040, using Schedule C (sole proprietor), Schedule E-Part I  (landlords), or Schedule F (farmers). The remaining 31 percent of small  businesses (or roughly 7.3 million) are partnerships, S corporations, or C  corporations. About 99 Percent of Businesses Report Total Income and Deductions of Less Than $10 Million

Small businesses (as defined as reporting total income and deductions of  less than $10 million) make up 99 percent of the taxpayers identified as   For  being engaged in substantial and substantive business activity.each type of filer, small businesses account for at least 95 percent of  businesses. Employers make up about 20 percent of all small businesses. Tax Compliance Burdens Vary Depending on a Small Business’s Size, Number of Employees, Entity Type, Industry, and Other Characteristics

Small businesses undertake a number of tax compliance-related activities  that create burden. These activities can be grouped into general  categories: employer-related tax activities, and third-party information reporting and industry-specific tax activities. The tax compliance burden associated with these activities varies by  characteristics of the small business. Estimated Recordkeeping and Filing Burdens Vary with Characteristics of Businesses and Complexity of Returns

Estimates of business compliance burdens that IRS’s models have  produced over the years indicate that burdens increase with the size of  businesses, whether measured in terms of assets, receipts, or  employment; however burden per dollar of assets or receipts or per  employee decline with size due to economies of scale. IRS measured money and time burden as a portion of total business  receipts, total assets, and burden per employee. Across all three  measures, IRS results are consistent with the assumption that small  businesses face significant fixed compliance costs combined with  decreasing marginal costs as the business grows (see appendix III, tables  9 through 11).businesses, estimated total monetized business compliance costs by  business entity type varied depending on the type of entity and the  entity’s gross receipts. IRS’s Decision- Making Framework Includes Consideration of Small Business Compliance Burden

		IRS’s Strategic Goals and Internal Revenue Manual Describe the Agency-wide Approach to Taxpayer Burden Reduction

One of IRS’s goals in its strategic plan is to deliver high quality and timely  service to reduce taxpayer burden and encourage voluntary  compliance. IRS Has Worked with Internal and External Stakeholders to Identify and Reduce Small Business Tax Compliance Burden

IRS officials provided examples of efforts made to engage with internal  and external stakeholders to reduce small business tax compliance  burden. One notable example of a  burden reduction initiative at IRS was developing a simplified method for  determining the Office in the Home tax deduction. Payment card reporting also provides IRS with an information source it  can use to compare against the income reported by small business  taxpayers on their tax returns. IRS’s Evaluation Plan Enabled It to Rapidly Test, Learn from, and Adapt Pilot Activities, but Does Not Include Key Elements for Assessing Overall Pilot Performance

To assess IRS’s plan for evaluating the payment card pilot we used our  previously developed guidance to identify key elements for designing  quality evaluations. While IRS has defined high-level pilot goals, such as improving voluntary  compliance and reducing the tax gap, it did not establish performance  measures for these goals and has not decided on a time frame for  developing them. According to IRS officials, one of the  evaluation goals was to learn why some compliant taxpayers were  identified as potential underreporters of income. IRS did not have evaluative questions and criteria to assess whether the  overall pilot or the pilot activities achieved the intended goals or produced  the intended results. Recommendations

To improve the evaluation of the payment card pilot, the Commissioner of  Internal Revenue should take the following actions:
Clearly define the stages of the payment card pilot and establish  measurable goals for determining when the pilot advances from one  stage to the next. Develop an evaluation plan for the overall pilot and building on pilot  activities to inform decisions about whether, how, and when to  integrate pilot activities into overall enforcement efforts. This plan  should include evaluation questions, evidence-based evaluative criteria, an analysis plan, a complete description of data to be collected, a data reliability assessment, and documentation of evaluation limitations. Appendix I: Objectives, Scope, and Methodology

The objectives of this report are to: (1) describe the characteristics of the  small business population; (2) describe how characteristics of a small  business affect compliance burden; (3) describe how the Internal  Revenue Service (IRS) integrates small business compliance burden  considerations in decision making; and (4) assess IRS’s plan for  evaluating its payment card pilot. Open recommendations  goals on ensuring compliance in a cost-effective way  while minimizing taxpayer burden. Supporting documentation from IRS is  pending.
Why GAO Did This Study

A challenge IRS faces is balancing efforts to minimize taxpayer burden with efforts to ensure compliance with the tax code. Small businesses are a vital source of economic growth in the United States. Reducing their costs for complying with the tax code may free up resources to expand, hire new employees, and contribute to the growth of the U.S. economy. GAO was asked to examine small business tax compliance burden and IRS's payment card pilot that addresses taxpayer non-compliance. This report: (1) describes characteristics of the small business population (2) describes how characteristics of a small business affect compliance burden; (3) describes how IRS integrates small business compliance burden considerations in decision-making; and (4) assesses IRS's plan for evaluating its payment card pilot. To answer these objectives, GAO analyzed Treasury and IRS data, research, and other documentation and interviewed agency officials. GAO used its guidance on program design evaluation to assess IRS's payment card pilot evaluation plan.

What GAO Found

According to estimates produced by government tax researchers using 2010 taxpayer data, small businesses (defined in the research as individuals or entities with substantive business activity but with less than $10 million in total income and deductions) make up 99 percent of all businesses. Approximately 69 percent of small businesses (about 16 million) are individual taxpayers who report business income and the remaining 31 percent (or roughly 7.3 million) are partnerships or corporations. Small businesses with at least one employee make up about 20 percent of the small business population, but produce about 71 percent of total small business income.
Small businesses undertake a number of tax compliance-related activities that create burden. These activities can be grouped into general categories such as income tax activities, employer-related tax activities, and third-party information reporting activities. The tax compliance burden associated with these activities varies depending on the businesses' asset size, filing entity type (e.g., sole proprietor, partnership), number of employees, and industry type. According to IRS research, compliance burden increases with the size of businesses, whether measured in terms of assets, receipts, or employment. IRS also measured money and time burden as a portion of total business receipts, total assets, and burden per employee. Across all three measures, IRS results were consistent with the assumption that small businesses face significant fixed compliance costs combined with decreasing marginal costs as the business grows.
IRS's decision-making framework for administering the tax system includes consideration of small business compliance burden. For example, IRS's strategic plan identifies reducing taxpayer burden as a strategic goal. IRS provided examples of how it works with internal and external stakeholders to reduce taxpayer burden on small businesses. For example, IRS collaborated with Treasury and external stakeholders to develop a simplified method for some small businesses to calculate a home office deduction, which was introduced in January 2013. Previously, businesses had to complete a complex property depreciation calculation.
To improve tax compliance among small businesses, in 2012, IRS began piloting a program that compares payment data from payment settlement entities (such as credit card companies) with income reported by small businesses. IRS is testing ways to use payment data to detect underreporting of taxable income while minimizing small business taxpayer burden. While IRS's plans for evaluating the pilot include many key evaluation elements that GAO identified, other elements are missing. For example, IRS has defined high level pilot goals such as improving voluntary compliance and reducing the tax gap, but has not established measures for determining progress against these goals. Additionally, the plan did not adequately document evaluative questions, data collection needs, or the evaluative criteria necessary to assess whether pilot activities produced the intended results. Without these and other elements, IRS cannot ensure it is making evidence-based decisions about expanding and integrating pilot activities into broader small business compliance improvement efforts.

What GAO Recommends

To improve the evaluation of the payment card pilot, GAO recommends that IRS clearly define the stages of the pilot and establish measurable goals for determining when the pilot progresses from one stage to the next and develop an evaluation plan for the overall pilot that includes evaluation questions, complete descriptions of needed data, and evaluation criteria. IRS agreed to take the recommended actions.