WASHINGTON - The Internal Revenue Service (IRS) appears to have missed opportunities to audit tax returns with large discrepancies between payments reported on Forms 1099-K and income reported on taxpayers' tax returns, according to a report that the Treasury Inspector General for Tax Administration (TIGTA) issued today.
Congress enacted legislation in July 2008 requiring payment settlement entities to report payments made to merchants in settlement of payment card transactions. In response, the IRS developed Form 1099-K, Payment Card and Third Party Network Transactions, for submission by payment settlement entities starting in Calendar Year 2012. The law requires payers to report annual gross payment transactions to the IRS and send a written statement containing the same information to the participating payees that received these payments.
The IRS uses Form 1099-K to assist in comparing payee gross receipts from payment card sales to gross receipts reported on the taxpayer's tax return. A reportable payment card transaction involves a bank or other entity with a contractual obligation to make a payment to a merchant, in settlement of reportable payment card transactions, including credit cards, debit cards, and stored-value cards. A third-party network transaction involves a third-party settlement organization, which has the contractual obligation to make payments to participating payees in a third-party payment network. An example of a third-party settlement organization is an online auction payment facilitator, such as PayPal, which operates as an intermediary between a buyer and seller by transferring funds between accounts in settlement of an auction or purchase.
This audit was initiated to determine whether the IRS is using merchant card third-party reporting (Form 1099-K) information in an effective manner for the assignment of productive audits. This information reporting was intended to assist the IRS in matching income from gross receipts to income reported on tax returns in an effort to reduce the Tax Gap, which is the amount of taxes that are not paid voluntarily and timely. The IRS's latest estimate of the Tax Gap was $458 billion, including a significant portion ($125 billion, or 27 percent) attributed to underreporting of business income earned by entities other than corporations.
TIGTA reviewed a subset of taxpayers with one Form 1099-K (some taxpayers have more than one) and found a total of 20,881 taxpayers with discrepancies of more than $10,000 between income reported on their tax returns and their Forms 1099-K amounts (and reporting less than 90 percent of the amount on the Form 1099-K). The tax accounts for these taxpayers had no indication of any audit activity.
"Without contacting taxpayers through a notice or initiating an audit, the IRS cannot determine the reasons for discrepancies between amounts reported on Form 1099-K and income reported on tax returns," said J. Russell George, the Treasury Inspector General for Tax Administration. "The IRS needs to take appropriate action at all times, and particularly when the discrepancy islarge," he added.
TIGTA recommended that the IRS 1) consider implementing compliance projects to test the use of Form 1099-K data to identify certain types of tax returns for audit and 2) identify and address the reasons tax returns with large discrepancies between income reported on tax returns and the amounts reported on Forms 1099-K were not selected for audit or other treatment. The IRS agreed with the recommendations and plans to take corrective action, but disagreed with TIGTA as to the magnitude of the issue.