Washington (July 11, 2003) -- Internal Revenue Service steps to improve its K-1 matching program, including more stringent screening criteria before notices can be sent, may not be enough to reduce the burden on compliant taxpayers, according to a General Accounting Office report.

Because of the significant amount of unreported flow-through income from partnerships, S corporations, estates and trusts, the IRS began in 2001 to match the tax year 2000 Schedule K-1 information against the flow-through income reported on individuals' tax returns.

Although the original IRS focus was to be on interest and dividends, the IRS expanded the program's scope to cover additional categories of income when it learned it couldn't separate K-1 interest and dividends from other underreported interest and dividend income, such as that paid by banks.

In April 2002 it started notifying taxpayers of potential discrepancies between the income reported by the flow-through entities and the income they reported on their individual 1040s. However, more than two-thirds of the 69,000 notices were sent to taxpayers later found to be compliant, and the IRS stopped sending the notices in August 2002.

The GAO said that two parts of the program were not properly implemented. First, the IRS did not test the feasibility of focusing the program in interest and dividend income until after recommending such a focus and communicating the recommendation to taxpayers, tax preparers, and other stakeholders. Second, after changing the plan, the IRS did not clearly communicate with taxpayers, tax preparers, and other stakeholders about the changes.

Although the IRS has taken steps intended to improve the K-1 matching program for 2003, the GAO concluded "Neither IRS nor we know whether these changes will reduce the burden on compliant taxpayers while maintaining the effectiveness of the Schedule K-1 matching program as a compliance tool."

"It remains to be seen whether the IRS will revise Schedule K-1 to increase compliance," said Bob Trinz, an editor of RIA's Federal Taxes Weekly Alert, a Thomson business.

-- Roger Russell

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