Charitable Donation Reporting Abuse Hard to Solve

A new report from the Government Accountability Office blames misreporting of charitable donation deductions as a major factor behind the tax gap, but said that requiring more information reporting might not improve compliance.

The report noted that in tax year 2001, an estimated 46 percent of taxpayers who deducted cash contributions misreported the donations, resulting in an estimated $13.8 billion in underreported net income. Since this amount is in income, and not tax dollars, however, the tax gap from the misreported cash contributions was much less than $13.8 billion. About 79 percent of misreporting taxpayers overstated a total of $16 billion in contributions while about 21 percent of misreporting taxpayers understated a total of $2.2 billion in contributions. A possible solution could be a requirement for more information reporting on charitable donations, but the GAO has its doubts whether that will be effective.

“One approach that generally tends to lead to high levels of taxpayer compliance is information reporting, through which third parties, such as employers or banks, file returns with [the] IRS and taxpayers that provide information on a variety of taxpayer transactions,” wrote Michael Brostek, director of tax issues at the GAO, in a letter to the leaders of the Senate Finance Committee, who had requested the report. “[The] IRS tries to match information from information returns filed by third parties against taxpayers’ income tax returns to see if taxpayers have filed returns and reported all their income. Currently, information reporting is not required for cash contributions to charities.”

The GAO acknowledged that requiring information reporting for charitable cash contributions might not be an effective way to improve compliance. Charities could incur substantial costs and burdens if they were required to file information returns with the IRS and taxpayers on the cash contributions they receive.

Exempting some cash contributions, such as those below a certain dollar amount or those made to small or religious charities, from information reporting could reduce the burden on some charities, the GAO noted. However, exempting some cash contributions from information reporting would reduce the effect that the reporting would have on improving compliance, in part because the IRS might not be able to match information returns against tax returns without complete information reporting.

In addition, the extent to which information reporting would improve voluntary compliance is unclear. Since a tax year 2001 study by the IRS’s National Research Program, more stringent requirements for the documentation taxpayers must keep to substantiate their cash contributions have gone into effect. It is not yet known whether the requirements have improved taxpayer-reporting compliance, although an ongoing NRP study of individual taxpayers could show this, the GAO noted.

The IRS attempts to ensure charitable cash contribution reporting compliance through enforcement and taxpayer service efforts, said the GAO. Cash contributions are one of the areas the IRS examines most frequently for individual taxpayers. For fiscal year 2008, the IRS examined about 175,000 taxpayers who potentially misreported cash contributions, out of about 1.4 million individual taxpayers it examined that fiscal year, and adjusted cash contribution amounts by $593 million in net terms. Through its taxpayer service programs, the IRS also provides publications and instructions to tax forms to help taxpayers comply with cash contribution reporting and recordkeeping requirements.

The GAO made no recommendations in its report, but the IRS agreed with its overall conclusion that requiring information reporting for charitable cash contributions may not be an effective way to improve compliance.