The IRS uses the information it collects to detect, prevent, and reduce noncompliance and fraud. The US Government accountability Office (GAO) produced a Tax Administration Report on December 2020 (Better Coordination Could Improve IRS’s Use of Third-Party Information Reporting to Help Reduce the Tax Gap). IRS research (via GAO) discloses that when third-party reporting exits, Taxpayers are less likely to misreport their income. That said, when third-party reporting does not exist (or minimal at best), Taxpayers are likely to misreport income.
Via Information Reporting, the IRS is looking for “Mismatches”
Information Returns are forms filed by third parties (such as employers and financial institutions) that provide information about taxable transactions and are submitted to the IRS, the Social Security Administration, and the Taxpayers. There are fifty types of Information Returns that provide information to the IRS on individual taxpayers. The IRS identifies mismatches between information returns and tax returns for potential additional review, including enforcement actions.
Purpose of IRS Compliance Programs
IRS Compliance Programs use Information Returns to help identify and detect fraud and noncompliance among Taxpayers that file tax returns and those that do not. Information Returns provide taxable Taxpayer data to the IRS so that the IRS can:
- identify cases of potential noncompliance and fraud
- select cases from within this pool to be addressed by a compliance program
- determine accurate tax liability
IRS Automated Compliance Programs
The IRS has four automated compliance programs. Two of the Programs are for Filers and the other two Programs are for Non-Filers. These programs rely on the data provided by Information Returns for the IRS to conduct its “Matching” process. Here are the Programs:
- Return Review Program: Matches information returns submitted by third parties against income tax returns submitted by a Taxpayer. This program is the IRS’s primary pre-refund fraud and improper payment detection system that uses multiple analytic techniques and filters to detect a variety of suspicious returns, before refunds are issued. The systemic verification feature of the Return Review Program compares wage and nonemployee compensation information returns to a Taxpayer’s tax returns to detect potentially suspicious cases.
- Automated Underreporter Program: Matches information returns submitted by third parties against income tax returns submitted by a Taxpayer. This program compares information reported by a Taxpayer against information returns but identifies cases after the filing season ends to determine if a Taxpayer s may have underreported income or claimed unwarranted deductions. Inconsistencies between the information returns IRS has for a taxpayer and what that taxpayer claims on his or her tax return can indicate that the taxpayer has reported something incorrectly. Since this program operates after the filing season, it has a wider variety of information returns available for these checks.
- Automated Substitute for a Return in Collections (Non-Filer Program): This program uses information returns to identify Non-Filer Taxpayers and calculates the tax due for these individuals. The program focuses primarily on income to determine if a Taxpayer had a significant income tax liability. The Collection Nonfiler program automatically creates a Substitute for a Return.
- Substitute for a Return in Examination (Non-Filer Program): This program also uses information returns to identify Non-Filer Taxpayers and calculates the tax due for these individuals. The program also focuses primarily on income to determine if a Taxpayer had a significant income tax liability. This program will also automatically create a Substitute for a Return. However, the Examination Non-Filer program uses a less automatic process to develop tax returns for Non-Filers with more complex tax situations.
Taxpayers Ought to Keep in Mind that Congressional approval of the Additional Funding to the IRS proposed by the Biden Administration will increase IRS Enforcement
On April 28, 2021, The US Department of the Treasury issued a Press Release entitled “Investing in the IRS and Improving Tax Compliance”. According to the article, funding the IRS will allow the Agency to escalate enforcement activities and assist with reducing the Tax Gap; currently estimated to reach approximately $7 Trillion over the next ten years.
The US Treasury Press release states that providing the IRS with the resources and information it needs to address the reporting shortfall will generate an additional $700 billion in tax revenue over the next ten years (net of the investments made).
Out of compliance Taxpayers will “Feel increased IRS Enforcement”
It is evident that the proposed IRS reform and increased funding would increase enforcement and address tax evasion amongst corporations and high-income taxpayers. It would result in more audits across a wide spectrum of taxpayers. Out-of-compliance taxpayers ought to seek the help and representation from experienced tax representatives that have a proven track record and experience with dealing with the IRS.
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