Tax Gap: IRS Could Do More to Promote Compliance by Third Parties with Miscellaneous Income Reporting Requirements
GAO-09-238
Published: Jan 28, 2009. Publicly Released: Feb 27, 2009.
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Highlights
Third party payers, often businesses, reported $6 trillion in miscellaneous income payments to IRS in tax year 2006 on Form 1099- MISC information returns. Payees are to report this income on their tax returns. Even a small share of payers failing to submit 1099-MISCs could result in billions of dollars of unreported payments. IRS data suggest that payees are more likely to report income on their tax returns if IRS receives payers' information returns. GAO was asked to examine 1099- MISC reporting including the extent to which payers fail to submit 1099-MISCs; impediments to payers to submitting1099-MISCs; and whether IRS could better use the 1099-MISCs it currently receives. GAO reviewed IRS documents and compliance data and interviewed officials from IRS, its advisory groups, and others who advise 1099-MISC payers.
The Internal Revenue Service (IRS) does not know to what extent payers fail to submit required 1099-MISCs, but various sources point to the possibility of a significant problem. For tax year 2005, 8 percent of the approximately 50 million small businesses with assets under $10 million submitted 1099-MISCs, but IRS does not know how many of the other 92 percent were required to report payments but did not. Many business payments, such as payments to corporations, are not subject to 1099-MISC reporting. If even a small share of the businesses that did not submit a 1099-MISC should have, millions of 1099- MISCs could be missing with significant amounts of unpaid taxes by payees. GAO's prior work in 2003 found significant 1099-MISC payer noncompliance by some federal agencies. IRS could mitigate costs for research on payer noncompliance by building on its existing research programs. Payers face a variety of impediments that may contribute to 1099-MISC noncompliance, including complex reporting requirements and an inconvenient submission process. For example, certain payments to unincorporated persons or businesses are subject to 1099-MISC reporting, but payments to corporations generally are not, requiring payers to determine the status of their payees. GAO in the past determined that the benefits in terms of increased tax revenue and improved taxpayer compliance justify eliminating this distinction. IRS agrees, and the Bush Administration's proposal to do so would have required legislative action. Other options to remind payers about their reporting obligations include adding a tax return checkbox asking if payers submitted required 1099-MISCs and adding a chart to help payers navigate the detailed instructions for the Form 1099-MISC. IRS matches what the payees report on their tax returns to what payers report on 1099-MISCs to detect payees underreporting income and taxes. But IRS does not pursue all mismatches its computers detect. If IRS were to increase payer compliance with 1099-MISC requirements, the number of mismatches would likely increase. However, IRS does not systematically collect information on the causes of mismatches or whether they could be prevented.
Recommendations
Matter for Congressional Consideration
| Matter | Status | Comments |
|---|---|---|
| To simplify the burden that the corporate exemption places on payers to distinguish payees' business status and also provide greater information reporting, Congress may wish to consider requiring payers to report payments to corporations on the form 1099 MISC, as we previously suggested and as proposed in the Bush Administration's budget. | No legislative action has been taken, as of March 2024, to require payers engaged in a trade or business to report on payments to corporations for services, thereby reducing these payers' burden to determine which payments require reporting, as GAO recommended in January 2009. Reporting of third-party information is a powerful compliance tool, and eliminating the reporting exemption for payments to corporations would be a cost-effective way to improve voluntary compliance, resulting in increased revenue. |
Recommendations for Executive Action
| Agency Affected | Recommendation | Status |
|---|---|---|
| Internal Revenue Service | To gauge the extent of 1099-MISC payer noncompliance and its contribution to the tax gap, the Commissioner of Internal Revenue should, as part of future research studies, develop an estimate of 1099-MISC payer noncompliance. |
IRS agreed to research the nature and extent of 1099-MISC reporting compliance as GAO recommended in 2009. According to IRS, developing such an estimate requires a multi-pronged approach and a large amount of coordinated effort. One prong is to determine the extent of filing compliance among employers. A second prong would determine the extent to which 1099-MISC payers properly report their payments. Starting with the Tax Year 2001 individual income tax reporting compliance study, the National Research Program (NRP) office has been collecting some data related to Form 1099-MISC compliance, from both the payer and payee perspectives. Additional data were generated by the NRP reporting compliance study for employment tax. As part of the NRP employment tax research, IRS examiners were to review taxpayers' Form 1099 filing compliance. Data collected from these studies should shed some light on whether employers are appropriately reporting required payments on Form 1099-MISC. In June 2021, IRS provided GAO with the final results of its study using estimates from the NRP Employment Tax Study for Tax Years 2008-2010. This analysis satisfied this recommendation to estimate the extent of 1099-MISC reporting compliance. IRS estimated that unreported payments averaged $141 billion annually for the employer population over the study period. This represents about 3 percent of total amounts employers should have reported on 1099-MISC. IRS plans to draw on the 1099-MISC reporting compliance results to inform its approach for using information returns to promote voluntary compliance and address noncompliance.
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| Internal Revenue Service | To gauge the extent of 1099-MISC payer noncompliance and its contribution to the tax gap, the Commissioner of Internal Revenue should, as part of future research studies, determine the nature and characteristics of those payers that do not comply with 1099-MISC reporting requirements so that this information can be factored into an IRS-wide strategy for increasing 1099-MISC payer compliance. |
IRS agreed to research the nature and extent of 1099-MISC reporting compliance as GAO recommended in 2009. IRS researchers collected data on 1099-MISC reporting as part of its National Research Program (NRP) study on employment taxes, a program that involved examinations of a sample of tax returns for tax years 2008 through 2010. As part of the NRP employment tax research, IRS examiners were to review taxpayers' Form 1099 filing compliance. In June 2021, IRS provided GAO with the final results of its study using estimates from the NRP Employment Tax Study for Tax Years 2008-2010. This analysis satisfied this recommendation to estimate the nature and characteristics of employers who do not comply with 1099-MISC reporting requirements. Whereas IRS estimated the payments unreported amounted to 3 percent of amounts required to be reported on 1099-MISC, IRS estimated that overall 59 percent of employers with a filing requirement were noncompliant. IRS estimated that employers associated with its Small Business/Self-Employed (SB/SE) unit accounted for 65 percent of payments unreported on 1099-MISC. IRS estimated 1.4 million SB/SE employers did not voluntarily file any 1099-MISC, and a similar number of SB/SE employers who filed 1099-MISC underreported payments or omitted some forms. IRS plans to draw on the 1099-MISC reporting compliance results to inform its approach for using information returns to promote voluntary compliance and address noncompliance.
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| Internal Revenue Service | To increase IRS's ability to detect 1099-MISC payer noncompliance, the Commissioner of Internal Revenue should test the option of developing a stop filer notice program to target business, state, and local entities that submitted 1099-MISC one year but did not do so the next. |
In response to our recommendation, IRS analyzed payers who filed 1099-MISCs in 2005 but stopped filing in 2006. In September 2010, IRS decided not to pursue developing a stop filer notice program. IRS expected the expanded 1099-MISC reporting requirements enacted under the Patient Protection and Affordable Care Act of 2010 (PPACA) would substantially improve 1099-MISC reporting compliance for corporate and sole proprietor payers. However, the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011, Pub. L. No. 112-9, repealed the PPACA requirements that expanded 1099-MISC reporting to payments made to corporations and to payments for property and other gross proceeds. In 2011, IRS added a check-the-box question on Schedule C filed by sole proprietors as well as on corporate and partnership tax returns, asking filers if they made any payments requiring that they file a Form 1099 and, if so, whether or not they filed or will file all required Forms 1099. This checkbox question reminds payers about their reporting responsibilities and will aid in curbing payers from skipping their 1099-MISC filings.
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| Internal Revenue Service | To help payers better understand their 1099-MISC reporting responsibilities, the Commissioner of Internal Revenue should add a general reminder to Publication 535 Business Expenses to highlight 1099-MISC reporting responsibilities. |
In the 2009 Publication 535, Business Expenses, IRS added a general reminder about 1099-MISC reporting responsibilities. Specifically, the reminder is to file Form 1099-MISC, Miscellaneous Income, for each person to whom you have paid during the year in the course of your trade or business at least $600 in rents, services (including parts and materials), prizes and awards, other income payments, medical and health care payments, and crop insurance proceeds. The reminder also directs businesses to see the Instructions for Form 1099-MISC for more information about their reporting requirements.
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| Internal Revenue Service | To help payers better understand their 1099-MISC reporting responsibilities, the Commissioner of Internal Revenue should assess whether adding a checkbox to business tax returns, inquiring whether all 1099-MISCs have been submitted, to serve as a reminder to payers would help increase 1099-MISC payer compliance. |
In 2011, IRS added a check-the-box question for Schedule C filed by sole proprietors as well as for corporate and partnership tax returns, asking filers if they made any payments requiring that they file a Form 1099 and, if so, whether or not they filed or will file all required Forms 1099.
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| Internal Revenue Service | To help payers better understand their 1099-MISC reporting responsibilities, the Commissioner of Internal Revenue should include a chart on the Form 1099-MISC as well as business income tax instructions for distinguishing reportable from non-reportable payments and for calculating whether reportable payments reached the 1099-MISC reporting threshold. |
IRS disagreed with this recommendation and stated that the Form 1099-MISC instructions already list which payments are reportable and explain the rules for specific payment types. The 1099-MISC instructions are reviewed by internal and external stakeholders each year. In addition, IRS said the Information Reporting Program Advisory Group annually reviews IRS information reporting products. The IRS said they have not received comments or suggestions from these stakeholders that presenting the information in a different format, such as a chart, would increase taxpayer compliance. As of July 2013, IRS plans no action on this recommendation.
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| Internal Revenue Service | To reduce the submission burden facing many payers each submitting small numbers of 1099-MISCs, the Commissioner of Internal Revenue should collect data on the numbers of computer-generated black and white 1099-MISCs submitted by payers and the labor spent reentering forms that cannot be scanned, and evaluate the cost-effectiveness of eliminating or relaxing the red ink requirement. |
In April 2009, IRS conducted a test to evaluate the cost effectiveness of the red drop out ink requirement and determine the labor to process a sample of 4,027 red-ink 1099-MISCs versus the same documents photocopied. IRS told us that, using the same scanning equipment and employees, the red-ink sample took 2 hours and 9 minutes to process versus 28 hours and 44 minutes to process and manually key the photocopy sample. Based on the test results, IRS decided to maintain the red ink requirement to minimize its labor costs. However, IRS remains well short of its 80 percent electronic filing threshold for the form 1099-MISC. About 36 percent of 1099-MISCs were filed on paper in 2012, and IRS expects to receive more than 35 million paper 1099-MISCs in 2014. To reduce the burden on small businesses, IRS advisory groups--including the Electronic Tax Administration Advisory Committee (ETAAC) and IRS Advisory Council (IRSAC)--have recommended that IRS create a fillable form 1099-MISC and allow electronic filing. In 2009, we reported that electronic submission would facilitate more accurate 1099-MISC entry and aid processing by IRS.
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| Internal Revenue Service | To help IRS improve its use of 1099-MISC information, the Commissioner of Internal Revenue should collect and analyze data on the types of unproductive AUR cases to help identify reoccurring errors for use in the AUR case selection process and for identifying ways to improve guidance and outreach to help payers and payees more accurately report 1099-MISC payments. |
In 2010, IRS studied a sample of 1099-MISC Automated Underreporter (AUR) cases and identified a significant "no change" rate for cases where taxpayers did not report 1099-MISC income on the correct line on the Form 1040 Schedule C. Taxpayers responding to IRS inquiries demonstrated that they reported the 1099-MISC income as part of their gross receipts on the Schedule C and did not owe any additional taxes. Such unproductive cases cost IRS time and money that could be spent pursuing noncompliant taxpayers. In October 2011, IRS modified its tax year 2010 case selection criteria to help reduce the number of unproductive 1099-MISC cases. IRS uses1099-MISC other income information in testing gross receipts reported on the Schedule C. Based on its AUR 1099-MISC case review, IRS also identified recurring errors in taxpayer misreporting of income types and netting expenses and took action to target education on those common 1099-MISC reporting errors. For the 2010 National Tax Forums conducted in six cities during June through September 2010, IRS presented an AUR program overview to educate tax preparers on proper reporting practices to avoid receiving an AUR notice.
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Data collectionData integrityElectronic formsFederal formsFederal taxesFinancial statementsIncome taxesNoncompliancePersonal income taxesProgram evaluationReporting requirementsTax administrationTax nonpaymentTax return auditsTax returnsTax violationsTaxpayersVoluntary complianceResearch programsTax gapUnderreporting