How the IRS uses information statements for compliance
The IRS is leveraging data and developing initiatives to automatically match information.
July 1, 2013
The IRS estimates that employers, businesses, financial institutions, and other payers will file almost 2.3 billion information statements for 2012 to report income and financial transactions. Individuals and businesses use this information to help prepare accurate tax returns. The IRS uses this information to address the estimated $450 billion annual loss in taxes due to taxpayer underreporting, nonfiling, and underpayment.
Importance of information statements to compliance efforts
Every year, an IRS Oversight Board survey studies factors that influence taxpayer voluntary compliance. Third-party information statements consistently rank as the second-most compelling factor that holds taxpayers accountable for accurately filing and paying their taxes. This ranks even higher than fear of an IRS audit, and is second only to personal integrity.
As the IRS faces reduced budgets and personnel, its use of information statements is a cost-effective, high-touch strategy for holding taxpayers accountable. In information-matching programs, IRS systems detect inconsistencies between third-party information statements and taxpayer data, and the taxpayer receives a notice. In 2012, information-matching programs were the only major compliance initiative area to increase enforcement revenue compared with the previous year.
The IRS will continue to develop initiatives in this area. For example, in 2012, the IRS expanded its underreporter matching programs to businesses. The IRS is setting the stage to use technology and information statements to address the most egregious underreporters: small businesses.
How the IRS already uses information statements
There are a variety of existing IRS information-matching programs for individuals and businesses. Here’s how several of the programs work:
Individual Automated Underreporter (AUR) program
This matching program is better known by its primary notice: CP2000, Notice of Proposed Adjustment for Underpayment/Overpayment. IRS systems automatically send this notice when items reported on Form 1040, U.S. Individual Income Tax Return, don’t match information reported to the IRS by employers and other payers. The first round of these notices arrives just after Thanksgiving, and the second round arrives toward the end of the next year’s filing season.
The CP2000 notice has been a mainstay of IRS information reporting for decades. In 2012, the IRS issued more than 4.5 million CP2000 notices, with an average of $1,572 in additional taxes owed.
Business Underreporter (BMF-AUR) program
Many taxpayers and practitioners think that the IRS matches income reported under business employer identification numbers to business returns. However, until September 2012, the IRS conducted business matching only in audits. The IRS is in the preliminary stages of a program that matches business income against filed Forms 1120, U.S. Corporation Income Tax Return, producing a new automated notice: CP2030, Initial Notice Issued to Request Verification for Unreported Income, Deductions, Payments and/or Credits on BMF Income Tax Returns Matched to Payer Information Documents.
Form 1099-K merchant card transaction matching program
In 2012, the IRS started receiving Forms 1099-K, Payment Card and Third Party Network Transactions, reporting merchant card transactions—and the IRS quickly began using this information to match against business returns. However, because businesses do not specifically report merchant card transactions as separate line items on business tax returns, the IRS can only infer potential underreporting. For example, if a business has a disproportionate amount of cash to credit/debit card sales, based on its line of business, the IRS may look closer. These kinds of mismatches have led the IRS to develop compliance initiatives, including “soft” notices requesting explanation and mail audits requesting documentation.
The IRS is in the learning stages of developing the Form 1099-K matching initiative. Many initial notices indicate that the IRS is focusing on underreporting cases in which merchant card payments appear to make up the majority or even exceed the total business receipts reported on the return. In these cases, the IRS perceives that the business is underreporting cash sales due to the disproportionate share of merchant card payments. Accrual-basis taxpayers and e-commerce businesses whose receipts do not neatly match merchant card transactions are likely early targets in this program.
Automated Substitute for Return program
According to the 2006 Tax Gap Study, the U.S. Treasury loses $28 billion annually due to taxpayers who don’t file their returns. When a taxpayer does not file and the IRS has information statements indicating a filing requirement, the IRS uses the data to file a return on behalf of the taxpayer if there is a projected balance owed. In 2012, the IRS used information statements to file 803,000 returns for taxpayers, totaling $6.7 billion in additional taxes owed.
The IRS also uses information statements to investigate nonfilers. These inquiries are called taxpayer delinquency investigations (TDIs), in which the IRS Collection function pursues potential nonfilers who don’t respond to delinquent return notices. At the end of 2012, 3.9 million TDIs were in progress.
How the IRS will expand its use of information statements
Congress expanded the IRS’s reach to access more information to enforce compliance and implement new legislation. Here are two examples:
Underreporting of foreign income
According to a 2009 TIGTA study, losses to the U.S. Treasury due to international underreporting could be as high as $123 billion a year. To combat that loss, the IRS is implementing the Foreign Account Tax Compliance Act, P.L. 111-147, (FATCA) to receive information on foreign accounts. In 2014, the IRS will have the ability to match taxpayers’ returns against the information it receives on U.S. taxpayers with accounts at foreign financial institutions. The IRS will likely scrutinize taxpayers who have not filed the required Form 8938, Statement of Specified Foreign Financial Assets.
Affordable Care Act compliance
As the Patient Protection and Affordable Care Act, P.L. 111-148, (PPACA) is implemented in the next several years, the IRS will start using information statements for individual and employer compliance with PPACA mandates. In 2012, employers reported the value of employer-provided health insurance on Forms W-2, Wage and Tax Statement, to inform taxpayers of the value of their health insurance coverage. As proposed in Notice 2012-32, in 2015 the IRS will also receive information from health insurance companies on employee coverage, including the name and identifying information of the employer. The IRS can use the information to identify and penalize individuals and employers for noncompliance with PPACA mandates.
The future: Compliance achieved through Big Data
A recent U.S. Government Accountability Office study showed that the IRS spends $267 million on underreporter matching programs, compared with the $4.2 billion it spends on audits. The return on investment for automated information-matching programs is almost six times larger than from audits.
With fewer IRS agents and reduced budgets, the IRS will increasingly rely on technology-driven matching programs to bring in more tax dollars.