Summary
The Joint Committee on Taxation identified improved taxpayer compliance with the real-estate tax deduction as a way to reduce the federal tax gap--the difference between taxes owed and taxes voluntarily and timely paid. Regarding the deduction, GAO was asked to examine (1) factors that contribute to taxpayers including nondeductible charges, (2) the extent that taxpayers may be claiming such charges, (3) the extent that Internal Revenue Service (IRS) examinations focus on the inclusion of such charges, and (4) possible options for improving taxpayer compliance. GAO surveyed a generalizable sample of local governments, studied taxpayer compliance in two jurisdictions that met selection criteria, reviewed IRS documents, and interviewed government officials and others. Addressing the complexity of current tax law on real-estate tax deductions was outside the scope of this review.
Taxpayers who itemize federal income-tax deductions and whose local real-estate tax bills include nondeductible charges face challenges determining what real-estate taxes they can deduct on their federal income tax returns. Neither local-government tax bills nor mortgage-servicer documents identify what taxpayers can properly deduct. Without such information, determining deductibility can be complex and involve significant effort. While IRS guidance for taxpayers discusses what qualifies as deductible, it does not indicate that taxpayers may need to check both tax bills and other information sources to make the determination. In addition, tax software and paid preparers may not ensure that taxpayers only deduct qualified amounts. There are no reliable estimates for the extent of noncompliance caused by taxpayers claiming nondeductible charges, or the associated federal tax loss. However, GAO estimates that almost half of local governments nationwide included generally nondeductible charges on their bills. While the full extent of overstatement is unknown due to data limitations, GAO estimates that taxpayers in two counties collectively overstated their deductions by at least $23 (or $46 million using broader matching criteria). IRS examinations of real-estate tax deductions focus more on whether the taxpayer owned the property and paid the taxes than whether the taxpayer claimed only deductible amounts, primarily because nondeductible charges are generally small. IRS guidance does not require examiners to request proof of deductibility or direct them to look for nondeductible charges on tax bills. Various options could improve compliance with the real-estate tax deduction, such as providing taxpayers with better guidance and more information, and increasing IRS enforcement. However, the lack of information regarding the extent of noncompliance and the associated tax loss makes it difficult to evaluate these options. If IRS obtained information on real-estate tax bill charges, it could find areas with potentially significant noncompliance and use targeted methods to reduce noncompliance in those areas.
Recommendations
Our recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director:
Team:
Phone:
Michael Brostek
Government Accountability Office: Strategic Issues
(202) 512-9039
Recommendations for Executive Action
Recommendation: To enhance IRS's guidance to help individual taxpayers comply in claiming the correct real-estate tax deduction, the Commissioner of Internal Revenue should place a stronger disclaimer early in the guidance to alert taxpayers to the need to check whether all charges on their real-estate tax bill are deductible.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: In process
Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.
Recommendation: To enhance IRS's guidance to help individual taxpayers comply in claiming the correct real-estate tax deduction, the Commissioner of Internal Revenue should clarify that real-estate tax bills may be insufficient evidence of deductibility when bills include nondeductible charges that are not clearly stated.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: In process
Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.
Recommendation: To enhance IRS's guidance to help individual taxpayers comply in claiming the correct real-estate tax deduction, the Commissioner of Internal Revenue should provide information or a worksheet on steps to take to get information about whether bills include nondeductible charges and about what those charges are.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: In process
Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.
Recommendation: To help ensure that individual taxpayers are getting the best information and assistance possible from third parties on how to comply with the real-estate tax deduction, the Commissioner of Internal Revenue should reach out to local governments to explore options for clarifying charges on the local tax bills or adding disclaimers to these bills that some charges may not be deductible.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: In process
Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.
Recommendation: To help ensure that individual taxpayers are getting the best information and assistance possible from third parties on how to comply with the real-estate tax deduction, the Commissioner of Internal Revenue should reach out to mortgage servicers to discuss adding disclaimers to their annual statements that some charges may not be deductible.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: In process
Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.
Recommendation: To help ensure that individual taxpayers are getting the best information and assistance possible from third parties on how to comply with the real-estate tax deduction, the Commissioner of Internal Revenue should reach out to tax-preparation software firms and other tax preparers to ensure that they are alerting taxpayers that some local charges are not deductible and that they are aware of any enhancements to IRS's guidance.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: In process
Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.
Recommendation: To improve IRS's guidance to its examiners auditing the real-estate tax deduction, the Commissioner of Internal Revenue should revise the guidance to indicate that evidence of deductibility should not rely on mortgage escrow statements, Forms 1098, and cancelled checks (which can be evidence of payment), and may require more than reliance on a real-estate tax bill.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: In process
Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.
Recommendation: To improve IRS's guidance to its examiners auditing the real-estate tax deduction, the Commissioner of Internal Revenue should revise the guidance to require examiners to ask taxpayers to substantiate the deductibility of the amounts claimed whenever they are examining the real-estate tax deduction and they have reason to believe that taxpayers have claimed nondeductible charges that are large, unusual, or questionable.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: In process
Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.
Recommendation: To learn more about where tax noncompliance is most likely, the Commissioner of Internal Revenue should identify a cost-effective means of obtaining information about charges that appear on real-estate tax bills in order to identify local governments with potentially large nondeductible charges on their bills.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: In process
Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.
Recommendation: To learn more about where tax noncompliance is most likely, the Commissioner of Internal Revenue should, if such local governments are identified, obtain and use the information, including uses such as compliance research focused on nondeductible charges; outreach to such local governments to help them determine which charges are deductible charges and help affected taxpayers correctly compute the deduction; targeted outreach to the tax-preparation and mortgage-servicer industries, and targeted examinations of the real-estate tax deduction in the localities.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: In process
Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.
