tax year 2006 individual income tax underreporting gap drew johns – irs office of research new...
TRANSCRIPT
Tax Year 2006 Individual Income Tax
Underreporting GapDrew Johns – IRS Office of Research
New Research on Tax Administration: An IRS-TPC Conference
June 21, 2012
The content of this presentation and views expressed here ultimately reflect the opinions of the presenter and do not necessarily represent the position of the Internal Revenue Service.
RAS:R – June 21, 20123
Tax Gap Map for TY 2006 ($B)
Nonfiling$28
IndividualIncome Tax
$25CorporationIncome Tax
#Employment
Tax#
ExciseTax#
EstateTax
$3
Tax Paid Voluntarily & Timely: $2,210Total Tax
Liability
$2,660Enforced & Other
Late Payments of Tax
$65
Net Tax Gap: $385(Tax Never Collected)
(Net Compliance Rate = 85.5%)
Gross Tax Gap: $450
(Voluntary Compliance Rate = 83.1%)
Actual Amounts
Updated Estimates
No Estimates Available
Categories of Estimates
#
Underpayment$46
IndividualIncome Tax
$36CorporationIncome Tax
$4
EmploymentTax$4
EstateTax$2
ExciseTax$0.1
FICATax on Wages
$14
UnemploymentTax$1
IndividualIncome Tax
$235
Non-BusinessIncome$30.6
BusinessIncome$65.3
CorporationIncome Tax
$67
EstateTax$2
ExciseTax#
BusinessIncome
$122
Large Corporations
(assets > $10m)$48
Self-EmploymentTax$57
Non-BusinessIncome
$68
Small Corporations
(assets < $10m)$19
Credits
$28
Adjustments,Deductions,Exemptions
$17
Underreporting$376
EmploymentTax$72
Source: http://www.irs.gov/pub/irs-soi/06rastg12map.pdf
RAS:R – June 21, 20124
Key Estimation Issues
Ideal audit sample has two qualities: Representative of the entire population Comprehensive- detects all misreporting
National Research Program (NRP) audits Randomly selected, therefore representative Not comprehensive in detecting all income
1976 TCMP: for every $1.00 of IRP income detected without use of IRP documents, $2.28 went undetected
Supplemented w/estimates of undetected income
RAS:R – June 21, 20125
NRP Form 1040 Studies
TY01: Random sample ~45,000 returns TY06: Random sample ~13,000 returns
First of smaller, more timely annual studies Independent samples that can be combined
Classification: Type of exam
No contact: accepted as filed or w/ minor adjustment Correspondence exam (a few simple issues) Face-to-face exam: RA or TCO (about 90% of returns)
Issues/Line Items
RAS:R – June 21, 20126
Accounting for Undetected Income Detection Controlled Estimation (DCE)
Original methodology by Jonathan Feinstein (1990, 1991)
Extended by Brian Erard & Feinstein (2005, 2006, 2007 & forthcoming)
DCE Rationale Examiners have detection strengths and weaknesses Statistical procedure controls for who conducted the
exam Scales up observed audit result as if line item was
examined by the “best” examiner
RAS:R – June 21, 20127
Basic DCE Methodology
Audit Adjustment (actually observed)
N: True Noncompliance equation D: Detection equation
Observed audit adjustment depends on both true noncompliance and examiner detection capability
DNA *
RAS:R – June 21, 20128
Estimated at the Line Item Level Routinely classified line items
Items not typically covered by IRP documents Schedules C, D, E, and F, Form 4797 income, Form 1040
“other income” line Non-routinely classified line items
Items typically covered by IRP documents Wages & salaries, interest, dividends, state and local tax
refunds, pensions and IRA’s, gross Social Security income, and unemployment income
Misreporting of adjustments, exemptions, deductions, and credits assumed fully detected
RAS:R – June 21, 20129
DCE as Estimated
Estimated only for face-to-face audits Need sufficient number (~15) of returns on which a
given examiner audited a given line item Joint estimation with common detection equation
Routinely classified items (except C/F) estimated jointly Non-routinely classified items estimated jointly
Return level estimates: The probability of undetected income for a given line item The amount of undetected income conditional on the
presence of undetected income
RAS:R – June 21, 201210
Imputing DCE to TY06 NRP
TY06 sample too small to estimate DCE Not a sufficient number of returns audited by the
same examiner Solution:
Estimate using larger TY01 NRP sample Impute undetected income to the TY06 NRP data
Stage 1: TY01 DCE simulations Stage 2: TY06 DCE imputations
RAS:R – June 21, 201211
Stage 1: TY01 DCE Simulations Allocate undetected income to reflect a
realistic distribution across returns Want to allocate undetected income to a small
number of returns using the estimated probability Instead of allocating small amount to many returns
For each income item and each return Draw a random number between 0 and 1 If random number < estimated probability then allocate
undetected income
Repeat 10 times (10 simulations)
RAS:R – June 21, 201212
Stage 2: Deciles For each income item, calculate reported
income deciles for TY01 & TY06 If income item reported, calculate income item
deciles Else, calculate reported AGI deciles
For each TY01 simulation, calculate by decile: Mean undetected income of returns with
undetected income Mean probability of the presence of undetected
income
RAS:R – June 21, 201213
Stage 2: Imputations
For each line item on face-to-face audits Draw a random number between 0 and 1 If random number < estimated probability for the
decile then allocate the mean undetected income Adjust the mean undetected income by the ratio of
the TY06 to TY01 mean detected incomes Repeat for each of the 10 TY01 simulations to
create 10 TY06 data sets with imputed income
RAS:R – June 21, 201214
Supplemental Information Tip Income
Very hard to detect Excluded from DCE estimation
S corporation and Partnership Income Underreporting by both shareholder and entity Examiners rarely audit the entity Undetected income further adjusted based on the
results of the TY2003/2004 NRP S corporation reporting compliance study
RAS:R – June 21, 201215
Tax Calculator
Income and deductions: Step 1: Add unreported income (detected + undetected) for
first line item (wages and salaries) Step 2: Calculate tentative tax and subtract reported
tentative tax to estimate line item tax gap Step 4: Drop unreported income Repeat Steps 1 to 4 for remaining line items
Credits: Step 1: Add all unreported income and deductions Step 2: Calculate credits and subtract reported credits
Repeat for all 10 simulations and average
RAS:R – June 21, 201216
Income “Visibility” Chart
Source: http://www.irs.gov/pub/irs-soi/06rastg12overvw.pdf
RAS:R – June 21, 201217
Summary
Methodological improvements Return level estimates of undetected income Line-item level DCE estimation Tax calculator replaced average marginal tax
curves TY06 NRP data used for the first time
Future research DCE estimation using multiple years of the new
annual NRP samples