Taxpayers are much more likely to report their income accurately when the income is also reported to IRS by a third party. By matching information received from third-party payers with what payees report on their tax returns, IRS can detect income underreporting, including the failure to file a tax return. Currently, businesses must report to IRS payments for services they make to unincorporated persons or businesses, but payments to corporations generally do not have to be reported.
Taxpayers who rent out real estate are required to report to IRS expense payments for certain services, such as payments for property repairs, only if their rental activity is considered a trade or business. Expanding information reporting in these areas could increase payee reporting compliance. In 2010, the Joint Committee on Taxation estimated revenue increases for a 10-year period from third-party reporting of (1) rental real estate service payments to be $2.5 billion and (2) service payments to corporations to be $3.4 billion.
A broader opportunity to address the tax gap involves simplifying the Internal Revenue Code, as complexity can cause taxpayer confusion and provide opportunities to hide willful noncompliance. Fundamental tax reform could result in a smaller tax gap if the new system has fewer tax preferences or complex tax code provisions, reducing IRS's enforcement challenges and increasing public confidence in the fairness of the tax system. Short of fundamental reform, targeted implification opportunities exist. For example, changing tax laws to include more consistent definitions across tax provisions, such as which higher education expenses qualify for some of the savings and tax credit provisions in the tax code, could help taxpayers more easily understand and comply with their obligations. For IRS to improve its enforcement of tax laws it must continue to:
" perform compliance research on a regular basis and use the results to identify areas of noncompliance;
" seek ways to leverage paid preparers to improve tax compliance;
" implement new (1) requirements for sources of taxpayer information and (2) technologies to enhance the effectiveness and timeliness of service and enforcement corrective measures; and
" develop return on investment measures to better allocate resources and maximize income tax collection.
In that regard, IRS should implement GAO's open recommendations, such as those on developing measures of direct revenue return on investment. To assist IRS in reducing the tax gap, Congress should consider expanding IRS's math error authority to correct taxpayer calculation mistakes or omitted or inconsistent entries during tax return processing before issuing refunds. Congress should also consider requiring payers to report service payments to corporations and making rental real estate owners subject to the same payment reporting requirements regardless of whether they engaged in a trade or business under current law. In the event that IRS cannot implement its new requirements without additional statutory authority, Congress should consider whether tax compliance could be improved by regulating paid preparers. The ongoing debate about tax reform also provides opportunities to consider the effect of tax simplification on taxpayer compliance and the tax gap.