TIGTA: IRS Should Better Identify Withholding Noncompliance

Backup Withholding Noncompliance and Underreported Employment Taxes Continue to Contribute Billions of Dollars to the Tax Gap

May 17, 2021

This report has cleared the Treasury Inspector General for Tax Administration disclosure review process and information determined to be restricted from public release has been redacted from this document.

HIGHLIGHTS

Final Audit Report issued on May 17, 2021

What TIGTA Found

Backup withholding noncompliance continues to result in payers avoiding payment of billions of dollars in withholding each year. For Tax Year 2018, TIGTA identified 182,075 payers that submitted 440,404 information returns for which the payee Taxpayer Identification Number was either missing or incorrect, yet the payers did not backup withhold $13.3 billion on $55.6 billion in reported income.

In addition, payers continue to report billions of dollars in payments associated with Taxpayer Identification Numbers of deceased individuals. Our review identified 52,500 payers that submitted 2.7 million information returns for which the payee was deceased at least three years prior to the issuance of the information return. These 2.7 million information returns had reportable payments totaling $3.7 billion. Generally, payers should not submit information returns using the Taxpayer Identification Number of a deceased taxpayer for identification of the payee. These deceased taxpayer Social Security Numbers are likely being used because payers have not been notified about the death of a payee, an estate Employer Identification Number has not been provided to the payer, * * * 2 * * *.

Finally, due to a programming error, the IRS did not select Combined Annual Wage Reporting discrepancy cases with the highest assessment potential. Our analysis of Tax Year 2017 IRS discrepancy cases determined that the IRS worked 21,372 cases and assessed $58.8 million. However, for the 21,372 cases worked, TIGTA identified that the IRS still did not select cases with the highest potential tax assessment. Had the programming been working as intended, the IRS could have selected and worked cases with a higher potential assessment, resulting in an additional $133.1 million in assessments.

What TIGTA Recommended

TIGTA recommended that the IRS develop processes and procedures to identify and address the reporting of income on information returns using a deceased payee Taxpayer Identification Number and conduct an analysis of additional worked discrepancy cases to evaluate the use of the repeater indicator as another characteristic to prioritize Combined Annual Wage Reporting discrepancy cases.

IRS management agreed to develop necessary processes and procedures to identify and address the reporting of income on information returns using a deceased payee Social Security Number. However, management did not agree with the recommendation to conduct an analysis on the use of the repeater indicator on discrepancy cases. Management does not believe there is any evidence that such a study is worth the diversion of its limited resources.

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May 17, 2021

MEMORANDUM FOR:
COMMISSIONER OF INTERNAL REVENUE

FROM:
Michael E. McKenney
Deputy Inspector General for Audit

SUBJECT:
Final Audit Report — Backup Withholding Noncompliance and Underreported Employment Taxes Continue
to Contribute Billions of Dollars to the Tax Gap (Audit # 201940028)

This report presents the results of our review to assess the Internal Revenue Service's progress in making improvements to its Federal tax withholding processes and procedures. This review was part of our Fiscal Year 2020 Annual Audit Plan and addresses the major management and performance challenge of Improving Tax Reporting and Payment Compliance.

Management's complete response to the draft report is included as Appendix IV.

Copies of this report are also being sent to the Internal Revenue Service managers affected by the report recommendations. If you have any questions, please contact me or Russell P. Martin, Assistant Inspector General for Audit (Returns Processing and Account Services).

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Table of Contents

Background

Results of Review

Appendices

Appendix I — Detailed Objective, Scope, and Methodology

Appendix II — Outcome Measures

Appendix III — Information Returns Requiring Backup Withholding

Appendix IV — Management's Response to the Draft Report

Appendix V — Abbreviations

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Background

The Internal Revenue Code (I.R.C.) Section (§) 3402 requires employers to withhold taxes from employees' pay so that the employers pay taxes to the Department of the Treasury on a ratable basis throughout the year. Employers use information returns, such as Form W-2, Wage and Tax Statement, and payers¹ use Form 1099-MISC, Miscellaneous Income, to report income and tax withholding. On an annual basis, employers are required to report to the Social Security Administration (SSA) wage and withholding information for each employee through a process called Annual Wage Reporting. Employers and payers are also required to report and submit to the Internal Revenue Service (IRS) Federal taxes withheld from employees using one of the following forms (collectively referred to hereafter as an employment tax return):

• Form CT-1, Employer's Annual Railroad Retirement Tax Return.

• Form 941, Employer's QUARTERLY Federal Tax Return.

• Form 943, Employer's Annual Federal Tax Return for Agricultural Employees.

• Form 944, Employer's ANNUAL Federal Tax Return.

• Form 945, Annual Return of Withheld Federal Income Tax.

The IRS in turn uses the data from information returns to ensure compliance with withholding rules. Figure 1 shows some of the compliance efforts and data available for reconciliation related to withholding.²

[Editor's Note: The reference mark for footnote ³ appears in the image above.]

Results of Review

Prior Treasury Inspector General for Tax Administration (TIGTA) reviews⁴ identified that a lack of adequate processes resulted in billions of dollars in underreported taxes by employers not being addressed and taxpayers avoiding payment of billions of dollars in backup withholding.⁵ In response to recommendations included in these reviews, the IRS has taken the following actions:

• Stood up two new groups in Calendar Year 2019 to address reporting and noncompliance issues relating to backup withholding and the IRS Combined Annual Wage Reporting (IRS-CAWR) program. The IRS assigned 13 tax examiners to the backup withholding group and 14 tax examiners to the IRS-CAWR group to work issues identified for Tax Year (TY) 2017.⁶

• Updated forms, instructions, etc., to include Form 1099-G, Certain Government Payments, in backup withholding requirements. Payers that submit a Form 1099-G with a missing or incorrect payee TIN that reports taxable grants or agricultural payments are required to backup withhold.

• Initiated various outreach efforts (e.g., Tax Forum presentations) to increase awareness of backup withholding requirements and the IRS's emphasis on enforcing these requirements.

• Coordinated with the SSA to revise the Memorandum of Understanding regarding the transfer of employment tax data between the agencies. The revisions made were an effort to streamline the transmission of data and adjust language on how each agency can use the data.

However, our analysis of TY 2018 information return filings identified continued significant backup withholding noncompliance, with 182,075 payers not backup withholding approximately $13.3 billion as required. We also continue to identify employment tax discrepancy cases that remain unworked. We identified 65,166 TY 2017 discrepancy cases not worked, with potential tax assessments totaling $220 million.⁷ Another 83,570 TY 2017 discrepancy cases were also not worked, with potential tax assessments of $2.3 billion involving employers that reported information returns to the SSA but did not file an employment tax return with the IRS (i.e., nonfilers).

The noncompliance detailed above, and the IRS's lack of adequate actions to address this noncompliance, contributes to the Tax Gap, which the IRS reports is the amount of true tax liability that is not paid voluntarily and timely. The IRS's most recent estimate of the Tax Gap was $441 billion (published in September 2019).⁸

In its April 2018 Strategic Plan,⁹ the IRS stated that one if its goals is to protect the integrity of the tax system by encouraging compliance through administering and enforcing the tax code. The IRS planned to accomplish this by creating strategies to prevent and address noncompliance in high-risk areas, developing early warning and notification systems to resolve issues faster, and sharing data and coordinating on cases within and across relevant business units. Further, the Small Business/Self-Employed (SB/SE) Division's 2019 Annual Report¹⁰ highlights goals that align with the IRS Strategic Plan. While the actions taken by the IRS fit within the goals of the strategic plans, these actions have not had a significant impact on backup withholding compliance or employer underreporting of employment taxes.

Backup Withholding Noncompliance Continues to Result in Payers Avoiding Payment of Billions of Dollars in Withholding Each Year

Since issuing our prior report in September 2016, management has made little improvement to address payers not backup withholding billions of dollars as required. * * * 2 * * *. The requirement for backup withholding is not only outlined in the I.R.C. § 3406 but is also addressed in IRS Publication 1281, Backup Withholding for Missing and Incorrect Names/TIN(s). As it relates specifically to the actions a payer should take if a payee “refuses or neglects to provide a TIN,” this publication instructs payers to “begin backup withholding immediately on any reportable payments,” thus reaffirming the requirements provided in the I.R.C. For TY 2018, we identified 182,075 payers that submitted 440,404 information returns for which the payee TIN was either missing¹¹ or incorrect,¹² yet the payers did not backup withhold $13.3 billion on $55.6 billion in reported income. Figure 2 shows the number of TY 2018 information returns with reportable payments that had a missing TIN or incorrect TIN/name combination.

[Editor's Note: The reference mark for footnote ¹³ appears in the image above.]

[Editor's Note: The reference mark for footnote ¹⁴ appears in the image above.]

[Editor's Note: The reference mark for footnote ¹⁵ appears in the image above.]

The I.R.C. requires payers to backup withhold at a rate of 24 percent on reportable payments for a payee that refuses or neglects to provide a correct TIN

Our analysis of TY 2018 information returns identified that the number of information returns with missing or incorrect TINs, as well as the amounts not backup withheld, decreased when compared to our analysis of TY 2013 information returns in our last review.¹⁶ However, payers continue to report billions of dollars in payments without the required backup withholding. Figure 3 provides the comparison of TY 2013 to TY 2018 for information returns with missing or incorrect TINs.¹⁷

[Editor's Note: The reference mark for footnote ¹⁸ appears in the image above.]

Unlike information returns with missing TINs that require payers to immediately backup withhold, payers submitting information returns with an incorrect TIN are not required to backup withhold on payments to the payee until 30 business days after the IRS notifies the payer of the incorrect payee TIN. If the IRS sends a second notice in a three–calendar-year period to the payer, backup withholding must begin 30 business days after the notice is sent and the payer does not receive a copy of the payee's Social Security card or IRS letter validating the TIN from the payee.

Furthermore, our analysis of TY 2018 payers with missing TINs identified five payers that each should have backup withheld $10 million or more. These payers submitted a total of 683 information returns, which accounts for $396 million in potential backup withholding we identified. Figure 4 identifies the payers with over $10 million in required backup withholding for TY 2018.

Figure 5 identifies additional payers with over 1,000 information returns with missing or incorrect TINs that have also not complied with the backup withholding requirements.

As the above figures show, these payers represent $728 million in backup withholding not withheld as required. * * * 2 * * *. For example, one of the goals reported in the SB/SE Division's 2019 Annual Report and the IRS's Strategic Plan is to advance data access, usability, and analytics to inform decision-making and improve operational outcomes. To accomplish this goal, the IRS will emphasize the use of data analytics, in conjunction with qualitative information, to select high-priority work. The SB/SE Division's 2019 Annual Report recently touted that its Examination program used data analytics and other tools to identify the most noncompliant work and emerging high-risk issues — an effort which we believe should be applied in furtherance of its backup withholding strategy and to ensure that it maximizes its limited resources by focusing enforcement efforts on highly noncompliant payers.

In response to the results of our analysis, management noted that there could be a number of factors for which backup withholding is not applicable. For example, some taxpayers may use the Form 4669, Statement of Payments Received, and Form 4670, Request for Relief of Payment of Certain Withholding Taxes, process, which relieves the payer of their backup withholding liabilities. Additionally, it is possible that income reported on an information return with a missing payee TIN may have in fact been reported to the IRS on a subsequent information return with the correct payee TIN and taxed accordingly. Furthermore, IRS management stated * * * 2 * * *. However, no analysis has been performed by the IRS that would determine to what extent this occurs.

Functional areas initiated some efforts in an attempt to address backup withholding noncompliance, but these efforts are fragmented and inconsistent

The I.R.C. provides the IRS with the authority to hold noncompliant payers liable for amounts not withheld from payees by assessing payers the amount of backup withholding they failed to withhold.¹⁹ In addition to the noncompliance on the part of payers, enforcing payer backup withholding requirements is essential to ensuring that the Government is able to collect taxes on all appropriate income, particularly income that is not usually subject to withholding.²⁰ * * * 2 * * *, tax revenue may be lost each year.

In our September 2016 report,²¹ we recommended that the Commissioner, SB/SE Division, establish a Service-wide information returns backup withholding enforcement strategy. This should include specific time frames and actions to identify and enforce payer noncompliance with backup withholding provisions. The IRS agreed with this recommendation and noted that it was already evaluating its backup withholding process, identifying improvement opportunities, and determining overall oversight responsibility.

Although the IRS agreed with our recommendation, our review identified that a Service-wide information returns backup withholding enforcement strategy has yet to be developed. However, we did identify that efforts are being taken by some functional areas to address this significant noncompliance, whereas other functional areas have no actions being taken. Specifically, the SB/SE Division developed a multiyear strategy in Calendar Year 2018 to address backup withholding compliance. For Calendar Year 2019, the IRS is working TY 2017 backup withholding cases for which the payer submitted information returns with missing payee TINs, * * * 2 * * *. To date, the IRS has mailed adjustment letters to 1,845 taxpayers. These letters notify the payer that they have filed information returns that are potentially subjected to backup withholding requirements * * * 2 * * *. Additionally, the taxpayer is instructed on where to send * * * 2 * * * to resolve the potential noncompliance with backup withholding requirements. Results from these notifications remain unknown as the IRS had to halt work on these cases due to the pandemic. In addition, the strategy identifies additional actions the SB/SE Division plans to take. For example, in early Calendar Year 2021, the SB/SE Division plans to address other identified areas of noncompliance (e.g., payers that submit information returns reporting backup withholding * * * 2 * * *. 

Finally, we were informed by the Tax-Exempt/Government Entities Division that processes were developed in Calendar Year 2017 to identify payers who previously received a backup withholding notice to then prioritize these cases * * * 2 * * *. The Tax-Exempt/ Government Entities Division then works the backup withholding issue on the tax account to ensure that the taxpayer is compliant with the backup withholding requirements. Alternatively, the Large Business and International Division identifies backup withholding noncompliance as part of its regular examinations and sends the employment tax issues to the SB/SE Division's Employment Tax group to address.

During our discussions with IRS management, they advised that implementation of the Taxpayer First Act²² is expected to result in a reorganization that will bring all of the IRS's examination functions under one umbrella, thus facilitating the development of a uniform compliance strategy to address backup withholding noncompliance. To that end, IRS management stated they would be developing a cross-functional working group to analyze current backup withholding policies and procedures and make recommendations to the Taxpayer First Act Office for its consideration. As such, we will not be making a formal recommendation.

Payers Continue to Report Billions of Dollars in Payments Associated With Taxpayer Identification Numbers of Deceased Individuals

Our review of TY 2018 information returns identified 52,500 payers that submitted 2.7 million information returns on 1.2 million payee TINs for which the individual was deceased at least three years prior to the issuance of the information returns. These 2.7 million information returns had reportable payments totaling $3.7 billion; however, only $9.5 million was withheld. Figure 6 identifies the payers with more than 50,000 information returns that used a deceased payee TIN.

Figure 6: Payers That Submitted More Than 50,000 Information Returns That Used a Deceased Payee TIN

	Total Information Returns With a Deceased TIN	Total Income Reported	Federal Tax Withheld
Payer A	154,892	$41,869,215	$54,030
Payer B	120,377	$9,573,926	$285,843
Payer C	110,076	$107,864,538	$208,594
Payer D	95,601	$71,340,169	$148,522
Payer E	91,269	$92,041,702	$45,078
Payer F	80,821	$77,548,835	$146,003
Payer G	74,453	$146,836,420	$42,797
Payer H	74,367	$133,880,477	$689,299
Payer I	66,558	$80,411,376	$65,854
Payer J	51,317	$28,927,433	$160,858
Source: TIGTA analysis of TY 2018 information returns subject to backup withholding.

* * * 2 * * *. As previously stated, the IRS and SB/SE Division both have goals to advance data access, usability, and analytics to inform decision-making and improve operational outcomes. As such, the IRS should incorporate * * * 2 * * * to maximize its limited resources by focusing its enforcement efforts on highly noncompliant payers.

The majority of deceased payee TINs had no associated tax return reporting the income

Our analysis of the 1.2 million deceased payee TINs identified that only 59,649 (5 percent) deceased payee TINs were used to file either a Form 1041, U.S. Income Tax Return for Estates and Trusts; Form 1040, U.S. Individual Income Tax Return; or Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. The 59,649 deceased payee TINs were used on 256,068 submitted information returns with $770 million in reportable payments.

We identified and reported this concern in our September 2016 report. Specifically, our review of TY 2013 information returns identified 2.3 million returns submitted by payers for 1.6 million individuals for whom the payee TIN was that of a deceased individual.²³ These 2.3 million information returns had reportable payments totaling $4 billion. We recommended that the IRS:

• Include specific actions to address information return reporting of income under a deceased individual TIN. The IRS agreed with this recommendation, citing that it would include specific actions to address information return reporting under a decedent TIN as it develops the information returns compliance strategy. However, as previously noted, * * * 2 * * *, and as such, * * * 2 * * *.

• Add an indicator on the TIN Matching Program²⁴ alerting a payer of a payee's use of a deceased taxpayer's Social Security Number (SSN). The IRS agreed with this recommendation, stating that it would first evaluate the use of a general indicator on the TIN Matching Program without violating disclosure rules. The IRS evaluated our previous recommendation but determined that alerting a payer of a payee's use of a deceased taxpayer's SSN is an improper disclosure and violates I.R.C. § 6103. However, the IRS also recognizes the potential significance of this issue and conducted research on TY 2015 information returns with a deceased TIN. The IRS determined that, as TIGTA concluded, * * * 2 * * *.

Management further stated that, in some cases, the payer appears to be issuing the income to the estate or trust but still using the decedent's TIN. We do agree with the IRS that use of these TINs on a Form 1099-INT or Form 1099-DIV may be associated with estates, trusts, or joint accounts held at financial institutions. The majority of the information returns we identified were either Form 1099-B, Form 1099-DIV, or Form 1099-INT. Further, it would seem less likely, and in fact suspicious, for a decedent's TIN to be used on a Form 1099-MISC or Form W-2G, which is used for reporting payments to individuals that are not employees and gambling winnings. Figure 7 shows that 169,411 Forms 1099-MISC and Forms W-2G were filed by payers using a deceased payee's TIN that had reportable payments totaling approximately $1.7 billion and $2.5 million in withholding. Figure 7 provides a summary of all the information returns filed using deceased payee TINs.

Figure 7: Types of TY 2018 Information Returns With Decedent TINs

	Total Information Returns With a Deceased TIN	Total Income Reported	Federal Tax Withheld
Form 1099-B	942,323	$936,828,376	$1,840,542
Form 1099-DIV	989,031	$738,108,816	$4,831,588
Form 1099-G	4,670	$467,723	$2,460
Form 1099-INT	573,294	$236,574,845	$404,292
Form 1099-MISC	168,144	$1,671,959,147	$2,127,660
Form 1099-OID	8,434	$2,536,245	$372
Form 1099-PATR	11,947	$106,219,759	$6,488
Form W-2G	1,267	$3,938,167	$323,887
Total	2,699,110	$3,696,633,078	$9,537,289
Source: TIGTA analysis of TY 2018 information returns subject to backup withholding.

Due to a Programming Error, Combined Annual Wage Reporting Discrepancy Cases With the Highest Assessment Potential Are Not Selected

Our analysis of 86,538 TY 2017 IRS-CAWR discrepancy cases the IRS selected as of March 31, 2019, determined that the IRS worked 21,372 (25 percent) cases, securing tax returns or assessing additional tax totaling $58.8 million.²⁵ The remaining 65,166 (75 percent) cases were not worked, with a potential underreported total tax difference of approximately $220 million.²⁶ However, we identified that the IRS still did not select cases with the highest potential tax assessment. Our review of TY 2017 IRS-CAWR discrepancy cases identified 240 discrepancy cases that the IRS did not work despite the potential tax assessment amounts being higher than cases the IRS worked. The total potential tax associated with these 240 cases is $12.1 million.

When we asked IRS management to explain why the IRS did not work the 240 discrepancy cases, management stated that there was a computer programming error that resulted in the incorrect case selection. The IRS incorrectly programmed the potential tax assessment field used to prioritize IRS-CAWR selections. After we brought this to management's attention, the IRS updated the programming to ensure that the TY 2018 discrepancy cases were selected based on the highest potential tax assessment. We reviewed the potential tax assessment field and confirmed that the IRS updated the calculation. Thus, we will not be making a recommendation. Using the IRS's corrected program to select the discrepancy cases with the highest potential tax assessment would have resulted in the IRS reviewing cases with an additional $133.1 million in potential tax assessments.

Due to a lack of sufficient resources, the majority of nonfiler cases with potential tax assessments of $2.3 billion are not addressed

Our review of 85,692 TY 2017 CAWR nonfiler cases²⁷ determined that the IRS worked 2,122 nonfiler cases (2 percent) and assessed a total of $50.6 million in tax. The remaining 85,692 cases had potential tax assessments totaling $2.3 billion. However, similar to the IRS-CAWR program, the CAWR nonfiler program does not have enough resources to work the majority of cases. The overall goal, as stated in the IRS's May 2018 SB/SE Division's Nonfiler Strategic Plan, is to prioritize work that maximizes dollars collected, which the CAWR nonfiler program appears to be following. CAWR nonfiler program employees also analyzed an additional 3,115 prior tax years related to the 2,122 TY 2017 cases and made $67.8 million in additional tax assessments. The tax assessments for these TY 2017 and related prior year nonfiler cases totaled just over $118 million ($50.6 million plus $67.8 million). IRS management stated that CAWR nonfiler cases are worked along with other inventory, and there are no specific guidelines for focusing efforts on CAWR nonfiler cases.

The indicator that identifies a prior year employment tax discrepancy is still not used during case selection in order to maximize limited resources

We previously recommended that the IRS upgrade its system to include prior year discrepancy cases when current year discrepancy cases are selected for the same employer. The IRS disagreed with the recommendation, but stated that it planned to evaluate its methods to identify cases with the highest potential for adjustment, including the consideration of a prior year discrepancy as a selection criterion. The IRS subsequently created a repeater indicator to identify employers with both a current year and prior year discrepancy case. Additionally, there are different indicators if the repeater is in the same potential tax assessment category from year to year or in a different potential tax assessment category.

Although an indicator was developed, management stated that they do not use the indicator as part of their case selection criteria because many of the repeater cases are repeaters for different reasons (for example, the IRS identifies an employer in one year with underreported withholding tax for its employees and identifies the same employer in another year because it did not send in all its income documents). The IRS does not consider this a true repeater case because the discrepancy was not the result of the same issue. The IRS reviewed fifteen cases with a repeater indicator, which resulted in closing eight cases with no change and seven with assessments. Management stated that these repeater cases look very similar to regular IRS-CAWR discrepancy cases and felt that their normal criteria would select the highest potential assessment cases regardless of the use of the indicator.

Our analysis of the 18,822 discrepancy cases that had the repeater indicator identified that the IRS worked 4,917 (26 percent) cases with a repeater indicator and assessed $14.2 million working the current year discrepancy case. Further analysis on the worked cases with a repeater indicator identified that the IRS only had 571 discrepancy cases (12 percent) that resulted in no assessment or no tax return secured by the IRS. Therefore, 4,346 discrepancy cases resulted in an assessment during the initial phase or in the IRS securing a tax return. Additionally, there were 13,905 discrepancy cases with a repeater indicator not worked with potential tax assessments of $49.8 million. The IRS could use the repeater indicator as a characteristic to prioritize and select cases within each discrepancy category. For example, the IRS would work the highest potential tax assessment cases (i.e., case type “A”) with a repeater indicator, then the IRS would move to the highest potential tax assessment case without a repeater indicator. Thus, the IRS would prioritize first by highest potential tax assessment and then, within each case type category, prioritize cases with the repeater indicator.

In response to our concern, IRS management analyzed their TY 2017 CAWR discrepancy cases to simulate how those cases would have been prioritized using the repeater indicator. Their analysis showed that the IRS potential tax assessments would be approximately $20 million less when prioritizing with the repeater indicator. It is important to note that the IRS's analysis was based on one tax year, and each tax year creates a different mixture of discrepancy cases. To better understand the value of adding the repeater indicator as a characteristic when prioritizing cases, the IRS should conduct an analysis, similar to the one it performed on TY 2017, of additional worked discrepancy cases (e.g., TYs 2018 and 2019) to make a determination on the usefulness of the repeater indicator.

Improvements Have Been Made That Provide Flexibility When Working Wage Discrepancy Cases

In our July 2017 report, we recommended that the IRS evaluate the current agreement and workload processes with the SSA, as required, and ensure that the IRS is expending resources to work the most productive SSA-CAWR cases.²⁸ Management agreed and stated that they would look for opportunities to reduce the number of SSA-CAWR cases that cannot be successfully resolved prior to referral to the IRS. Figure 8 provides a comparison of IRS resources dedicated to the SSA-CAWR program and IRS-CAWR program. Figure 8 also provides a comparison of the assessments per case for each program.

As part of its ongoing negotiations for a new Memorandum of Understanding, the IRS identified areas that would help improve case identification. However, when we asked IRS management if the SSA agreed to make these changes, management stated that the SSA could not currently commit to make the changes as it is in the process of a modernization effort. The SSA informed the IRS that it would consider these changes and any others the IRS identifies as they partner through the modernization effort.

As we previously reported, in April 1988, the National Committee to Preserve Social Security filed a lawsuit to force prompt resolution of the backlog of unreconciled cases (i.e., wage information was not being timely recorded to earnings records) that resulted from a legislative change in the wage recording system. In addition, the lawsuit sought the adoption of measures to ensure that the problem does not recur in the future. As part of a settlement agreement resulting from the lawsuit, the IRS is required to work all SSA-CAWR cases. However, IRS Counsel recently determined that the 1988 National Committee to Preserve Social Security lawsuit settlement that resulted in the requirement that the IRS work all SSA-CAWR cases expired in December 1996. As a result, the IRS plans to assign resources to the SSA-CAWR program based upon available resources and not based upon the SSA-CAWR inventory. This should provide opportunities for the IRS to refocus resources to other areas, including the IRS-CAWR program.

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Appendix I

Detailed Objective, Scope, and Methodology

The overall objective of this review was to assess the IRS's progress in making improvements to its Federal tax withholding processes and procedures. To accomplish our objective, we:

• Assessed the status of the IRS's CAWR and backup withholding programs and determined if the IRS implemented recommendations from the prior audit reports.

• Assessed the status of IRS resources available to work the IRS-CAWR and backup withholding programs. We also determined if the IRS is efficiently using available resources for each program.

• Assessed the status of the IRS's information returns reporting strategy and determined if the IRS has taken appropriate actions to implement the strategy.

Performance of This Review

This review was performed with information obtained from the SB/SE Division in Covington, Kentucky, during the period August 2019 through December 2020. We conducted this performance audit in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objective. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objective.

Major contributors to the report were Russell Martin, Assistant Inspector General for Audit (Returns Processing and Account Services); Diana Tengesdal, Director; Jonathan Lloyd, Audit Manager; Jerry Douglas, Lead Auditor; and Jerome Antoine, Auditor.

Validity and Reliability of Data From Computer-Based Systems

We relied on data extracts from the IRS of all CAWR discrepancy cases for TY 2017 and TY 2018 and from TIGTA's Data Center Warehouse¹ copy of the Information Returns Master File² for Forms 1099 and Forms W-2 for TY 2015, TY 2016, TY 2017, and TY 2018. We performed tests to assess the reliability of data extracts by: 1) reviewing the data for obvious errors in accuracy and completeness and 2) selecting a judgmental sample³ of cases from each extract to verify that the data elements extracted matched the taxpayer account information in the Integrated Data Retrieval System.⁴ We determined that the data extracts were valid and reliable for the purposes of this audit.

Internal Controls Methodology

Internal controls relate to management's plans, methods, and procedures used to meet their mission, goals, and objectives. Internal controls include the processes and procedures for planning, organizing, directing, and controlling program operations. They include the systems for measuring, reporting, and monitoring program performance. We determined that the following internal controls were relevant to our audit objective: 1) processes and procedures to ensure that employers are reporting and paying the correct amount of employment taxes, 2) processes and procedures to identify noncompliance and enforce backup withholding requirements, and 3) processes and procedures to identify information returns with decedent TINs. We evaluated these controls by reviewing policies and procedures, interviewing employees and management, and analyzing data from various sources.

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Appendix II

Outcome Measures

This appendix presents detailed information on the measurable impact that our recommended corrective actions will have on tax administration. These benefits will be incorporated into our Semiannual Report to Congress.

Type and Value of Outcome Measure:

• Revenue Protection — Potential; $604.6 million in backup withholding if the IRS held payers liable (as specified by the I.R.C.) when submitting information returns with missing payee TINs that are subject to backup withholding (see page 3).

Methodology Used to Measure the Reported Benefit:

We obtained data for TY 2018 information returns subject to backup withholding. We then identified information returns with missing payee TINs (by analyzing certain data fields) and removed information returns that were not subject to backup withholding, e.g., duplicate returns, certain amended returns, foreign payers, and foreign payees.

Our review of TY 2018 information returns identified 123,069 payers that submitted 266,617 TY 2018 information returns for which the payee TIN was missing. These information returns reported payments totaling $44 billion. As such, payers were required to immediately withhold almost $11 billion from these payees, yet only $6 million was withheld. I.R.C. § 3406 requires payers to backup withhold at a rate of 24 percent on reportable payments to a payee after notification that the payee TIN is missing.

After further analysis, we noted that the income amounts reported by payers significantly differed from one year to the next. Thus, similar to how we accounted for this in our prior review, we identified those payers who submitted information returns for the same payee with a missing TIN for two years in a row. Our analysis identified 12,829 payers that submitted 22,406 information returns with the same missing payee TIN, payee name, and payee zip code for two consecutive tax years (TYs 2017 and 2018). These 22,406 information returns reported payments totaling about $2.5 billion. As such, payers were required to immediately withhold $606,756,565, yet just $2,130,240 was withheld. This resulted in the payers needing to report $604,626,325 in backup withholding.

Type and Value of Outcome Measure:

• Revenue Protection — Potential; $2.8 billion in backup withholding if the IRS held payers liable (as specified by the I.R.C.) when submitting information returns with incorrect payee TINs that are subject to backup withholding (see page 3).

Methodology Used to Measure the Reported Benefit:

We obtained data for TYs 2015, 2016, 2017, and 2018 information returns potentially subjected to backup withholding. We then identified information returns with incorrect payee name/TIN combinations (by analyzing certain data fields) and removed information returns not subject to backup withholding, e.g., duplicate returns, certain amended returns, foreign payers, and foreign payees.

Our review of TY 2018 information returns identified 65,717 payers that submitted 173,787 information returns for which the payer used the same incorrect payee TIN for four consecutive years (TYs 2015 through 2018). These information returns reported payments totaling $11.6 billion in TY 2018. As such, payers were required to withhold nearly $2.8 billion from these payees, yet only $2.6 million was withheld. I.R.C. § 3406 requires payers to backup withhold at a rate of 24 percent on reportable payments to a payee after notification that the payee TIN is incorrect. This resulted in the payers needing to report $2,770,804,013 in backup withholding.

Unlike information returns with missing TINs that require payers to immediately backup withhold, payers are not required to backup withhold on payments to the payee until 30 business days after the IRS sends the payer correspondence notifying them of an incorrect payee TIN. If the IRS sends a second notice in a three-calendar-year period to the payer, backup withholding must begin 30 business days after the notice is sent and the payer does not receive a copy of the payee's Social Security card or IRS letter validating the TIN from the payee.

IRS management indicated there are a number of factors that contribute to whether backup withholding is applicable. For example, taxpayers may use the Form 4669 and Form 4670 process that relieves the payer from their backup withholding liabilities. Additionally, it is possible that income reported on an information return with a missing payee TIN may have in fact been reported to the IRS on a subsequent information return with the correct payee TIN and taxed accordingly. Furthermore, * * * 2 * * * .

Type and Value of Outcome Measure:

• Reliability of Information — Potential; 2.4 million information returns submitted with deceased individuals' TINs as the payee TINs (see Recommendation 1).

Methodology Used to Measure the Reported Benefit:

We obtained data for TY 2018 information returns subject to backup withholding. We then identified information returns with payee TINs of deceased individuals by analyzing the SSA file that includes dates of death. We identified forms issued to payees who had been deceased for at least three years (since December 31, 2015). We arbitrarily chose three years as we thought this was sufficient time to allow the IRS to update its systems for these decedent TINs.

Our review of TY 2018 information returns subject to backup withholding found that the IRS received 2,699,110 returns from 52,500 payers totaling $3.7 billion in reportable payments for 1.2 million deceased individuals who were deceased three years prior to the information return reportable payments; therefore, we assume the income likely does not belong to the taxpayer.

We also analyzed IRS tax records to determine if the 1.2 million decedent payee TINs were used to file TY 2018 tax returns to claim the income reported on the information returns. Our analysis identified that 59,649 decedent TINs were used to file either a Form 1041, Form 1040, or Form 706. The 59,649 deceased payee TINs submitted 256,068 information returns with $770 million in reportable payments. As a result, 1.1 million decedent TINs used on 2,443,042 (2,699,110 – 256,068) information returns were not used to file a Form 1041, Form 1040, or Form 706 to claim the reportable payments on the information returns. Generally, payers should not submit information returns using the SSN of a deceased taxpayer for identification of the payee. These taxpayers have been deceased for three or more years and thus are likely being used because payers have not been notified about the death of a payee, an estate EIN has not been provided to the payer, or payees are providing the * * * 2 * * *.

Type and Value of Outcome Measure:

• Increased Revenue — Potential; $133.1 million in additional tax assessments from IRS-CAWR discrepancy cases with the highest potential for assessment not worked by the IRS (see page 11).

Methodology Used to Measure the Reported Benefit:

Our review of TY 2017 IRS-CAWR discrepancy cases shows that the IRS is still not selecting discrepancy cases with the highest potential for assessment. The IRS selected and worked 21,372 TY 2017 IRS-CAWR discrepancy cases resulting in securing tax returns or assessing additional tax totaling $58.8 million. The IRS worked an additional 2,497 discrepancy cases after the initial selection of 86,538 discrepancy cases, which resulted in additional tax assessed or tax returns secured totaling $5.9 million. Our review of TY 2017 IRS-CAWR discrepancy cases identified 240 discrepancy cases for which the IRS-CAWR program did not work the case despite the potential tax assessment being greater than cases the IRS worked. The total potential tax associated with these 240 discrepancy cases is $12.1 million. The IRS confirmed that a programming error resulted in the IRS not selecting TY 2017 cases by the highest potential tax assessment as was intended. This resulted in the IRS not working potentially $133,071,799 in additional tax assessments. We calculated the outcome by taking the difference between what the IRS could have assessed ($197,722,352) and what the IRS actually assessed through securing tax returns or assessing additional tax ($58,778,182) and additional discrepancy cases worked after initial population ($5,872,371).

Appendix III

Information Returns Requiring Backup Withholding

Form 1099-B	Brokers and Barter Exchanges
Form 1099-DIV	Dividends and Distributions
Form 1099-G	Certain Government Payments
Form 1099-INT	Interest Income
Form 1099-K	Payment Card and Third Party Network Transactions
Form 1099-MISC	Miscellaneous Income
Form 1099-OID	Original Issue Discount
Form 1099-PATR	Taxable Distributions Received from Cooperatives
Form W-2G	Gambling Winnings1

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Appendix IV

Management's Response to the Draft Report

In addition to the items listed above, SB/SE is taking action to address employers who use one EIN for their tax return and a different EIN for associated information returns. These mismatches make it difficult to use data analysis to validate return data for compliance purposes. To improve detection of non-compliance by both our backup withholding and CAWR programs, we are implementing a requirement that taxpayers report and remit taxes using the same EIN they used on any associated information returns (e.g. Forms 1099-MISC) and Forms W-2, Wage and Tax Statement and Form and W-3, Transmittal of Wage and Tax Statements. We revised the TY 2020 forms and instructions as needed, and Form 945, Annual Return of Withheld Federal Income Tax; Form 941, Employer’s Quarterly Federal Tax Return; Form 943, Employer’s Annual Federal Tax Return for Agricultural Employees; and Form 944, Employer’s Annual Federal Tax Return all instruct taxpayers of this “same EIN” requirement. We have developed a communications plan to ensure that the “same EIN” policy is communicated to impacted taxpayers and are currently working with our research function to identify potential recipients of compliance notices and refine next steps.

In conclusion, you have conducted multiple audits and made several recommendations for these programs in recent years. We have taken actions to implement substantially all those recommendations. We have also independently identified and are pursuing improvements to both the backup withholding and employment tax discrepancy programs. You continue to disregard our limited resources and competing compliance priorities when evaluating our programs.

Attached is a detailed response outlining our corrective actions to address your recommendations and outcome measures. If you have any questions, please contact me or Scott Irick, Director, Examination Operations.

Attachment

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Attachment

RECOMMENDATION 1:

The Deputy Commissioner for Services and Enforcement should develop processes and procedures to identify and address the reporting of income on information returns using a decedent taxpayer identification number (TIN).

CORRECTIVE ACTION:

We will use data analytics to determine the size and scope of potential non-compliance of information returns using the Social Security number (SSN) of a deceased person and determine what processes and procedures, if any, can be developed to address the issue.

IMPLEMENTATION DATE:

10/15/2022

RESPONSIBLE OFFICIAL:

Director, SB/SE HQ Exam

CORRECTIVE ACTION MONITORING PLAN:

IRS will monitor this corrective action as part of our internal management system of controls.

RECOMMENDATION 2:

The Deputy Commissioner for Services and Enforcement should conduct an analysis (i.e., similar to the one performed for TY 2017) of additional worked discrepancy cases to determine if the repeater indicator should be used as another characteristic to prioritize IRS-CAWR discrepancy cases with the highest potential tax assessment within each case type.

CORRECTIVE ACTION:

TIGTA has not provided any data indicating “repeaters” are more productive cases. TIGTA has not demonstrated “repeaters” yield assessments that are larger or more frequently sustained or collected as compared to non-repeaters. TIGTA has completed two audits of this program and has data for cases as far back as 2012. As a result of the prior 2017 TIGTA audit, “repeater” cases are marked with an indicator. Thus, TIGTA could have analyzed its own data as part of this audit to determine whether “repeaters” are more productive work but has chosen not to do so. As we shared with TIGTA during this audit, we applied the recommended “repeater” criterion to our TY 2017 closed cases to determine if it would have yielded more productive work; it did not. In fact, under the best-case scenario, the use of that criterion would have reduced the TY 2017 potential tax assessments by approximately $20 million. As TIGTA has acknowledged in this audit and its prior audit, the CAWR program does not have enough resources to work the majority of cases, and we do not believe it is a good business decision to commit to perform an additional study when TIGTA has not presented any evidence that such a study is worth the diversion of our limited resources.

IMPLEMENTATION DATE:

NA

RESPONSIBLE OFFICIAL:

NA

CORRECTIVE ACTION MONITORING PLAN:

NA

OUTCOME MEASURE 1:

Revenue Potential: $604.6 million in backup withholding if the IRS held payers liable (as specified by the I.R.C.) when submitting information returns with missing payee TINs that are subject to backup withholding (see page 3).

IRS RESPONSE:

We disagree with this measure. Numerous factors contribute to whether some or all of a payment is truly reportable and subject to backup withholding by a payer. For example, * * * 2 * * *. Additionally, it cannot be assumed that income reported on an information return without a payee TIN has not been properly reported by the payee and taxed accordingly. A payer has available the Form 4669 and Form 4670 process, which may relieve the payer of the backup withholding tax liability. Lastly, the IRS has a finite amount of resources to address multiple areas of noncompliance with competing priorities, yet TIGTA's outcome measure does not consider the opportunity costs of diverting resources from one workstream to another.

OUTCOME MEASURE 2:

Revenue Protection — Potential; $2.8 billion in backup withholding if the IRS held payers liable (as specified by the I.R.C.) when submitting information returns with incorrect payee TINs that are subject to backup withholding (see page 3).

IRS RESPONSE:

We disagree with this outcome measure. Numerous factors contribute to whether some or all of a payment is truly reportable and subject to backup withholding by a payer. For example, * * * 2 * * *. Additionally, it cannot be assumed that income reported on an information return with an incorrect payee TIN has not been properly reported by the payee and taxed accordingly.

A payer has available the Form 4669 and Form 4670 process, which may relieve the payer of the backup withholding tax liability.

As noted in TIGTA's report, the IRS is already addressing backup withholding in field examinations as well as in our campus operations. Specifically, TIGTA acknowledges that the IRS is working “TY 2017 backup withholding cases where the * * * 2 * * *. To date, these efforts have resulted in adjustment letters to 1,845 taxpayers.” TE/GE has also been working these cases for two years. Both SB/SE and TE/GE are working field examinations addressing backup withholding. These programs have already started addressing 2018 cases.

TIGTA also assumes that the IRS has resources available to address 100% of these returns. The IRS has a finite amount of resources to address multiple areas of noncompliance with competing priorities. TIGTA's outcome measures do not consider the opportunity costs of diverting resources from one workstream to another.

OUTCOME MEASURE 3:

Reliability of Information — Potential; 2.4 million information returns submitted with deceased individuals' TINs as the payee TINs (Recommendation 1).

IRS RESPONSE:

We disagree with this outcome measure. The SSN of a deceased person is not an invalid TIN and can be reflected on information returns in accordance with information return filing guidelines. TIGTA wrongly states, “Generally, payers should not submit information returns using the TIN of a deceased taxpayer for identification of the payee.” If the payer hasn't been notified of a change in name or TIN, by either the payee or the IRS, the payer is in compliance as long as it is filing information returns on time and using a valid TIN.

TIGTA also did not thoroughly analyze if this income was reported elsewhere. The report observes that information returns report income associated with TINs of deceased taxpayers that are not associated with filed Forms 1040. However, TIGTA * * * 2 * * *. TIGTA also failed to check for this income being reported on any surviving spouse's Forms 1040.

OUTCOME MEASURE 4:

Increased Revenue — Potential; $133.1 million in additional tax assessments from IRS-CAWR discrepancy cases with the highest potential for assessment not worked by the IRS (see page 9).

IRS RESPONSE:

We disagree with this outcome measure. TIGTA incorrectly assumes 100% of the potential tax assessments would be realized in every case. The IRS informed TIGTA that this assumption is wrong. Numerous factors contribute to whether some or all of a potential discrepancy is fully assessable. TIGTA’s outcome measure does not take into consideration cases that are worked correctly yet result in no tax or a reduced tax assessment. Datasets provided by TIGTA [in support of this outcome measure?] contained 23,865 cases that showed current case status. However, these datasets did not include dollars associated with these categories of cases, so we are able to only make the following general observations: Of the 23,865 returns, 12% (2,732) of the closed work has been reconsidered after initial assessment and generally would indicate that the ultimate assessment was lower than the amount originally proposed. An additional subset of 15,449 (65%) cases requires rework and has the potential for a similar outcome (i.e., reduced assessment). Only 17% (4,250) of the returns identified by TIGTA resulted in a full agreement or a return being secured that could equal the full potential tax assessment.

TIGTA’s outcome measure also assumes that the IRS has unlimited resources and does not take into account our finite resources and the opportunity costs of diverting resources from one workstream to another.

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Appendix V
Abbreviations

CAWR	Combined Annual Wage Reporting
I.R.C.	Internal Revenue Code
IRS	Internal Revenue Service
SB/SE	Small Business/Self-Employed
SSA	Social Security Administration
SSN	Social Security Number
TIGTA	Treasury Inspector General for Tax Administration
TIN	Taxpayer Identification Number
TY	Tax Year