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Form 1098 — A New Way to Uncover Non-filers and Under-reporters?

A new TIGTA report concludes that a large number of taxpayers paying mortgage interest either don't file tax returns or report income that's not enough to cover mortgage obligations and living expenses.

October 5, 2009
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TIGTA Report Recommends Using Form 1098 to Uncover Non-filers and Under-reporters

A new report by the Treasury Inspector General for Tax Administration (TIGTA) recommends that IRS should use mortgage interest data reported to it on Form 1098 (Mortgage Interest Statement) to uncover non-filers and taxpayers who have underreported their income. Extrapolating from a statistical sample, the report concludes that a large number of taxpayers paying mortgage interest either don't file tax returns or report income that's not enough to cover mortgage obligations and living expenses.

Observation. Computer matching is commonly used by IRS to uncover income reported on a tax return that's less than the amount shown as received on information returns or uncover claimed deductions that are higher than the amounts shown as paid on information returns. Form 1098 based matching would be an innovative approach that would use data on expenses shown as paid on an information report to uncover income that hasn't been declared.

Surprising Findings. TIGTA evaluated statistically valid samples of individuals with combined Forms 1098 totaling $20,000 or more of mortgage interest that were filed with IRS for Tax Year (TY) 2005 and selected two samples. For the first, it found 219,593 individuals without a corresponding tax return. From these potential non-filers, TIGTA randomly selected 100 for review and identified 21 individuals who appeared to have a filing requirement for TY 2005, but had yet to be contacted by IRS. To determine the amount of taxes these 21 potential non-filers may owe, TIGTA used IRS's Examination function's cash transaction analysis process and estimated that they may owe as much as $177,715 in delinquent taxes and $107,209 in penalties and interest. Projected to the sample's population of 219,593 potential non-filers, TIGTA's results indicated that 46,115 potential non-filers may collectively owe $625 million in delinquent taxes, penalties and interest for TY 2005. The projection is based on a 95 percent confidence level, TIGTA claims.

In the second sample, TIGTA identified 245,535 individuals who reported less adjusted gross income on the returns they filed for TY 2005 than the amount of mortgage interest reflected on their income tax return forms. After randomly selecting 100 of the 245,535 individual returns for review, TIGTA identified 37 individuals who may have underreported their income because their mortgage interest and basic living expenses appear to exceed their income. TIGTA estimated that these 37 individuals may owe $265,018 in additional taxes and $61,233 in penalties and interest. When projected to the sample's population of 245,535 filers, the results indicated that 90,848 taxpayers may owe $801 million in additional taxes, penalties, and interest for TY 2005. This projection, too, is based on a 95-percent confidence level.

TIGTA cautioned that it didn't know if the potential non-filers identified in its review were, in fact, required to file tax returns, or if the potential under-reporters owe additional taxes, penalties, and interest (only an IRS exam could determine what's owed).

IRS response. The IRS has used Form 1098 in its compliance efforts and is using these documents in its Return Delinquency Program. In response to the TIGTA report, the IRS says it will expand an existing Area-wide Compliance Initiative Project on the mortgage interest deduction to a Nationwide Compliance Initiative Project. Additionally, the IRS Small Business/Self-Employed Division will form a task team to study the existing processes for identifying non-filers to ensure that mortgage interest is appropriately considered in selecting non-filer cases for examination.

— Published in the October 2009 issue of the Gear Up Gold Rush newsletter available from the Tax & Accounting business of Thomson Reuters. Copyright October 2009. To learn more about Gear Up, visit trainingcpe.thomson.com/GearUp.