The Internal Revenue Service could be foregoing billions of dollars in potential taxes because tens of thousands of employers are underreporting the amount of their workers’ wages and withholding taxes, according to a new report.

The report, from the Treasury Inspector General for Tax Administration, examined the IRS’s Combined Annual Wage Reporting Program, which compares the employee wage and withholding information reported to the IRS on employment tax forms with the withholding documents filed by employers with the Social Security Administration.

The CAWR Program aims to make sure employers report the correct amount of employment taxes and federal income tax withholding on the employment tax returns they file. It includes a document-matching process that identifies cases with the highest potential tax assessment amounts. The program picks out discrepancies such as when the amount of wages and withholding reported by an employer on Forms W-2 and W-3 to the SSA doesn’t match the Form 1099-R or W-2G information sent to the IRS.

Treasury Inspector General J. Russell George addressing a House subcommittee
Treasury Inspector General J. Russell George addressing a House subcommittee Bloomberg News

TIGTA analyzed 137,272 discrepancy cases from tax year 2013 and found the IRS worked on only 23,184 of them, or just about 17 percent. The other 114,088 discrepancy cases (or about 83 percent of the total) had a potential underreported tax difference of more than $7 billion.

The IRS’s discrepancy case selection processes don’t guarantee the agency makes a priority of working on cases with the highest potential tax assessment, the report found. TIGTA analyzed the 114,088 discrepancy cases the IRS didn’t work on to identify 23,184 with the highest potential underreported tax amounts by case type. TIGTA found the 23,184 cases had total potential underreported tax of over $6.8 billion.

TIGTA also analyzed the 114,088 TY 2013 discrepancy cases that the IRS didn’t work on and found that if the IRS selected the 23,184 cases from categories with a higher average assessment potential, rather than by random selection, it would have picked cases with more than $128 million in potential assessments.

The IRS could increase its return on investment by including prior-year discrepancy cases when working on current-year cases for the same employer, the report suggested. TIGTA found that 3,137 of the employers with discrepancy cases identified in tax year 2013 also had discrepancy cases in TY 2012, with potential underreported tax totaling more than $448 million for 2012.

“The IRS’s method of allocating resources to discrepancy cases hinders its ability to reduce the billions of dollars that are owed but are not assessed or collected, known as the tax gap,” said TIGTA Inspector General J. Russell George in a statement. “As such, the IRS needs to revise its case selection process to include cases with the highest potential tax assessment and expand the process to include cases that are currently excluded.”

TIGTA made seven recommendations in the report, suggesting the IRS should evaluate its current agreement and workload processes with the Social Security Administration to see if it can make some changes. The IRS should also revise its case selection criteria to include cases that have the highest potential tax assessment, TIGTA suggested. The report also recommended the IRS coordinate with its information technology staff to review and prioritize the needed programming enhancements. The programming upgrade should include prior-year discrepancy cases when any current-year discrepancy cases are chosen for the same employer.

The IRS agreed with six of TIGTA’s seven recommendations, but didn’t agree to include prior-year discrepancy cases when current-year discrepancy cases are selected for the same employer. However, the IRS said it would consider employers that have a prior-year discrepancy case as part of the selection criteria for current-year cases.

The IRS pointed to the budget constraints it is facing. “The number of discrepancy cases the IRS can handle each year relies upon a number of factors,” wrote Mary Beth Murphy, commissioner of the IRS’s Small Business/Self-Employed Division, in response to the report. “IRS compliance efforts continue to be affected by a sharp reduction in budget resources (a reduction of nearly $1 billion since 2010) as well as fewer enforcement staff and increased tax administration responsibility. The CAWR program has faced a more pronounced decline in staffing than the IRS as a whole during this period.”

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