Summaries of Tax-Related Products Issued

in Fiscal Year 1992 by Subject Matter

Related GAO Product(s)

before being granted access to tax data. Moreover, IRS opposes granting HUD access to federal tax data because of its continuing concern about the potential negative impacts of tax data being used for nontax administration of the nation's tax system. As of December 31, 1991, no administrative or congressional action had been taken.

GAO/HRD-86-32, 03/12/86; GAO/HRD-87-79FS, 05/26/87; GAO/HRD-87-62, 09/21/87; GAO/HRD-88-24, 03/16/88; and GAO/HRD-92-37, 12/23/91

Summaries of Tax-Related Products Issued
in Fiscal Year 1992 by Subject Matter

Independent
Contractor
Compliance

GAO/GGD-92-108, 7/23/92 and GAO/T-GGD-92-63, 7/23/92

At the request of Senators Max Baucus and David Pryor and
Representative Doug Barnard, Jr., GAO reviewed the tax effects of the
Internal Revenue Service's (IRS) Employment Tax Examination Program
(ETEP). This program focuses on small business compliance with the
common law rules for classifying workers as either "employees" or
"independent contractors" (self-employed individuals who provide
services).

GAO issued its report and testified at a hearing before the Subcommittee on Select Revenue Measures, House Committee on Ways and Means. In both the report and testimony, GAO said the common law rules for classifying workers remain as unclear and subject to conflicting interpretations as GAO described in its 1977 report entitled Tax Treatment of Employees And Self-Employed Persons by the Internal Revenue Service: Problems and Solutions. Since then, no final action has been taken to clarify the common law.

GAO also reported that independent contractor compliance continued to be
a concern. As early as 1979, GAO concluded that noncompliance among
self-employed workers, such as independent contractors, was serious
enough to warrant tax withholding on payments to them. Since the
mid-1970s, IRS studies have documented the lower level of compliance of
independent contractors compared to employees. IRS estimated that
self-employed individuals (including independent contractors) would
underpay $20.3 billion in 1992 taxes by not reporting income.

Because of the continual high tax noncompliance of independent contractors, IRS began the nationwide ETEP in 1988. IRS planned to reduce this noncompliance by requiring businesses to treat misclassified independent contractors as employees subject to withholding taxes. GAO reported that 6,900 ETEP audits through December 1991 proposed assessments of $468 million and reclassified 338,000 workers as employees. Since fiscal year 1989, IRS data show that 90 percent of ETEP audits found misclassified workers.

GAO found that while the classification rules still need to be clarified, IRS
could use approaches in addition to ETEP to help improve independent
contractor compliance. For example, IRS could require businesses to
(1) withhold taxes from payments to independent contractors and
(2) improve compliance in filing information returns on payments to

Summaries of Tax-Related Products Issued

in Fiscal Year 1992 by Subject Matter

Recommendation(s) to

Congress

Action(s) Taken And/or
Pending

independent contractors. GAO concluded that either approach should help collect more of the taxes owed through means other than retroactive tax assessments under ETEP. While GAO acknowledged that both approaches would increase the burden on independent contractors and businesses that use them, GAO believed that both approaches have merit.

GAO reported on the pros and cons of each approach. For example, GAO said withholding provides the cornerstone of employees' tax compliance, as well as a gradual and systematic method to pay taxes. GAO also reported that withholding has several administrative problems that need to be resolved-such as ensuring that the tax withheld approximates the tax

due.

GAO's second approach—improving information reporting-would shift emphasis to the clearer laws on information returns. IRS' data show that independent contractors reported 97 percent of the income that appears on information returns. Without these returns, contractors reported only 83 percent. GAO assessed eight options for strengthening information reporting, itemizing the various pros and cons of each. GAO identified the options largely through past and ongoing work.

Congress needs to clarify the rules for classifying workers along the lines that GAO recommended in its 1977 report by amending the law to exclude certain classes of workers from the common law definition of “employee." Congress also should consider legislation to improve independent contractor compliance through withholding and/or improved information reporting.

AS GAO Completed its report, H.R. 5011-the Employment Tax Improvement Act of 1992—was introduced to revise employment tax procedures and improve information reporting along with the compliance of independent contractors. This bill included many of GAO's eight options as well as others. No further action was taken as of December 31, 1992.

Related GAO Product(s)

GAO/GGD-89-107, 9/25/89; GAO/GGD-91-94, 8/28/91; and
GGD-77-88, 11/21/77

Summaries of Tax-Related Products Issued
in Fiscal Year 1992 by Subject Matter

Federal Agencies
Should Report Service
Payments Made to
Corporations

GAO/GGD-92-130, 09/22/92

As part of its ongoing work on corporate compliance, GAO explored
whether information reporting by federal agencies that pay corporations
for services would help to improve compliance. In a report to the Director,
Office of Management and Budget, GAO reported that IRS data have shown
that corporate tax compliance is a problem. For example, among small
corporations (those having less than $10 million in assets), (1) voluntary
compliance declined from 81 percent in 1980 to 61 percent in 1987; and
(2) income was underreported by $15 billion, including over $9 billion in
gross receipts earned from providing services and goods.

GAO said that IRS estimated that small corporations will not pay $7 billion in
federal income taxes and large corporations will not pay $24 billion in
1992. In addition, about 22 percent of 26,000 federal corporations,
90 percent of which were contractors, owed $773 million in federal taxes
as of July 1991.

In 1990, federal agencies awarded $68 billion for service contracts of more than $25,000. Of this amount, GAO estimated that $61 billion (90 percent) went to corporations. Because information reporting generally excludes payments to corporations, federal agencies did not have to inform IRS of this $61 billion.

Requiring federal agencies to report such payments could improve corporate tax compliance and provide IRS with an important tool for detecting unreported income or unfiled tax returns. Considering the past problems in reporting payments made to individuals, GAO said that agencies need controls to ensure that they report all required payments made to federal contractors, as well as the correct tax identification numbers.

Recommendation(s)

The Director of the Office of Management and Budget should require agencies to

⚫ issue information returns on payments to corporations providing services;

• validate taxpayer identification numbers for those contractors receiving federal contracts for services before making the first payment;

⚫ withhold 20 percent of contract payments, under the terms of the contract,
to contractors providing invalid identification numbers until these
numbers are validated; and