Advances in Nonfiling Measures

1. Advances in Nonfiling Measures Presentation to the IRS-TPC Research Conference June 21, 2012 Mark Payne – RAS:OR: Taxpayer Analysis & Modeling Alan Plumley – RAS: Office of Research Brian Erard – B. Erard & Associates Note: The views expressed herein are those of the authors and are not necessarily the official positions of the U.S. Treasury Department or the Internal Revenue Service.

2. June 21, 2012 Nonfiling Measures Two main measures related to Nonfiling: Nonfiling Gap ($) Voluntary Filing Rate (% of returns) Nonfiling Gap definition: Tax not paid on time by those who don’t file on time or don’t file at all. Measure of the No-Return portion of Non-Filing Gap was presented at 2011 IRS research conference. Use IRS administrative data (especially information returns) Use information from the Current Population Survey (CPS) on living arrangements and family structures Construct synthetic tax returns for persons not found on a tax return and estimate their tax liability and balance due

3. June 21, 2012 Non-Filing Gap Estimation No-Return Population (TY2005 tax liability minus withholding): $12.9B Late Returns Reported $8.7B balance due Add income from information documents Recompute tax and balance due ($13.0B) Total Nonfiling Gap (No-Return + Late group) For TY2005: $12.9B + $13.0B = $25.9B Projectionto TY2006 (reflecting decline in number of nonfilers): $25 B

4. June 21, 2012 Voluntary Filing Rate History:Originated in the mid-1990s to examine factors that influence individual income tax filing compliance Definition: Data: Numerator: Tax return data for the population on Compliance Data Warehouse Denominator: Current Population Survey (CPS) from Census/Bureau of Labor Statistics

5. June 21, 2012 Key Methodological Issues Who is required to file? (thresholds based on gross income but definition of gross income not clear) Make numerator and denominator as comparable as possible given limitations of the data. Same population and same definition of required to file Cope with changes over time in definition. (e.g. Social Security income included in gross income 1984-1994 and since 2008 but excluded 1995-2007)

6. June 21, 2012 Adjustments to the Numerator Restrict to U.S. residents > age 14 (to correspond with Census) Include only timely filers who file within 1 year of close of tax year (omits some combat extensions) Apply definition of required to file from instructions using best approximation Use gross income concept for each income type when possible (e.g. for Schedule C use line 7 “Gross Income” before subtracting out expenses and do not reduce taxpayer total income by any loss on line 7)

7. June 21, 2012 Apply different factors to convert net business income to gross income When net income ≤ 0 When 0 < net income < $433 When net income > $433 (always required to file) Applied definition of required to file to CPS as best as possible Imputed additional pension, Social Security, and sole proprietor income to the CPS records to account for known understatements Adjusted denominator to reflect income types not in CPS (e.g. capital gains, state and local tax refunds) Adjustments to the Denominator

8. June 21, 2012 Social Security Income Reported on 1099 SSA-RRB vs. CPS, TY2010

9. June 21, 2012 Pension Income Reported on 1099-R vs. CPS, TY2010

10. June 21, 2012 Self-Employment Income: IRTF vs. CPS,TY 2010

11. June 21, 2012 Imputation of Income to CPS Pension and Social Security income Estimated receipt of these income types using a bivariate probit model and income amounts with a seemingly unrelated regression model based on information documents Independent variables: age, gender, region, citizenship and amounts for wages, interest, and unemployment compensation Applied estimates to CPS records Self-Employment Income Used an ordered probit model to estimate whether income received and in what amount category (negative, $0-$433, or over $433) and then separately modeled the magnitude in each category Independent variables: age, gender, filing status, region, number of dependents and amounts for wages, interest, and unemployment compensation Applied estimates to CPS records Still clearly a lower bound on this income

12. June 21, 2012 Impact of Imputations Estimated Number of Required Returns, CPS (millions)

13. June 21, 2012 Accounting for Income Not Reflected in CPS Used IRTF data for timely and late filers to estimate number of required returns with and without: Capital gains & losses (and other gains/losses) State & local tax refunds Royalties and miscellaneous other Schedule E income Computed the “delta” and added this to denominator (a lower bound on impact of this income). Checked this method for self-employment income, but imputation method worked better.

14. June 21, 2012 Estimated VFR Trend

15. June 21, 2012 Reasons for Fluctuations • 2006: The Credit for Federal Telephone Excise Tax Paid (TETR) appears to have prompted some to file who otherwise wouldn’t have filed on time. • 2007: The Economic Stimulus Payment appears to have given many an incentive to file on time who otherwise wouldn't have done so. • Decline since 2007: Due both to a return to normal incentives and a poor economy (those just over the filing threshold more likely to file late or not at all).

16. June 21, 2012 Benefits of VFR Analysis Improved understanding of the extent to which Census understates certain income types Developed a reasonable approach to imputing these incomes to the CPS each year Better understanding of the drivers of VFR fluctuations over time Improved 1040 instructions about the filing requirement