The Internal Revenue Service has been updating its assessment of the extent to which underreported employment taxes are contributing to the tax gap, but it may not be using the right methodology to revise its numbers.

A new report from the Treasury Inspector General for Tax Administration recommends improvements to the sampling data that the IRS is using for its tax gap study.

The IRS Office of Research, Analysis and Statistics, or RAS, initiated the Employment Tax Study in February 2010 to better estimate the tax gap for underreported employment taxes and determine compliance rates for business taxpayers. The current estimate of the tax gap was released in 2005 based on data from tax year 2001 and earlier. In 2005, underreported employment taxes were estimated to account for $54 billion of the tax gap.

TIGTA performed its audit of this work because employment taxes are a major source of revenue for the federal government, and it has been more than 25 years since the IRS conducted a comprehensive review of employer tax compliance. TIGTA’s overall objective was to determine whether the sampling methodology developed by the IRS’s RAS office will provide a valid representation of employment tax compliance rates for business taxpayers.
TIGTA found that the IRS’s sample of employers included in the study may not enable IRS

management to fully estimate compliance levels for business taxpayers. In particular, the IRS plans to sample only 50 large international business taxpayers in each year of the three-year study, which may be too small of a sample to provide meaningful compliance estimates. Further, IRS management specifically excluded some larger employers due to the time necessary to complete these complex audits. As a result, the study will not provide any information about the compliance levels of these employers, which could impair the IRS’s ability to measure compliance and effectively plan future tax studies for this segment of employers.

TIGTA recommended that the IRS develop an action plan for any future study that outlines a strategy to achieve the goal of updating the employment tax gap estimates; determine the percentage of the total population that the excluded entities represent; and evaluate whether future employment tax studies should include the large employers excluded in this study.

In response to the report, IRS officials agreed with TIGTA’s recommendations. IRS management agreed to develop goals and project plans during the design phase of their future studies, document the findings related to the excluded entities as companion data to the study results, and re-evaluate whether future employment tax studies should include the large employers.