TREASURY INSPECTOR GENERAL FOR TAX ADMINISTRATION

Office of Audit

Improvements Are Needed to Ensure That Puerto Rico Residents With Unreported and Underreported Self-Employment Tax Are Properly Identified and Examined

Final Report Issued on August 14, 2017

Highlights

Highlights of Reference Number:  2017-30-045 to the Internal Revenue Service Commissioner for the Large Business and International Division.

IMPACT ON TAXPAYERS

Internal Revenue Code Section 933 excludes from taxation the income of full-time residents of the Commonwealth of Puerto Rico when the income is derived within Puerto Rico.  However, U.S. citizens and residents of Puerto Rico generally must still pay self-employment tax on net self-employment earnings of $400 or more.  This law applies whether or not the earnings are excludable from gross income and whether or not a U.S. income tax return must otherwise be filed.

WHY TIGTA DID THE AUDIT

This audit was initiated as a follow-up to an IRS research report issued in June 2009 to determine if the IRS is improving tax compliance of self-employed residents of Puerto Rico.  The 2009 research report identified a 33.8 percent nonfiler rate for Tax Year 2007.  The nonfiler rate was the percentage of qualified self-employment income earners who did not file an IRS return, divided by the number expected to file based on self-employment income reported to the Commonwealth of Puerto Rico taxation authority (La Hacienda).  The objective of this review was to determine how effectively the Large Business and International Division identifies and addresses noncompliance of residents of Puerto Rico who have self‑employment income but fail to report or underreport their self-employment income to the U.S. Government.

WHAT TIGTA FOUND

Some improvements are needed to ensure that Puerto Rico residents with unreported and underreported self-employment tax are properly identified and examined.  Specifically, 1) the Large Business and International Division is not effectively identifying Puerto Rico residents with unreported or underreported self-employment income and 2) some Puerto Rico residents with no requirement to report self-employment income were incorrectly selected for examination.  TIGTA’s review identified potential unreported self-employment tax of approximately $30 million for Tax Years 2012 and 2013.  Additionally, TIGTA found potential underreported self-employment tax of approximately $60.3 million for Tax Years 2012 and 2013.  

WHAT TIGTA RECOMMENDED

TIGTA recommended that the IRS 1) evaluate the data analysis process and methodology used to analyze the La Hacienda data and document the process to be used in the future; 2) work with La Hacienda for more timely  receipt of the annual data file; 3) analyze and examine underreported Puerto Rico self‑employment tax in addition to addressing nonfilers; 4) evaluate the examinations identified for Tax Year 2012 and correct any identified erroneous assessments; and 5) develop and implement written procedures to validate the data provided by La Hacienda.

In their response, IRS management agreed with TIGTA’s recommendations and stated that corrective actions have been implemented to address the identified weaknesses.

READ THE FULL REPORT

To view the report, including the scope, methodology, and full IRS response, go to:

https://www.treasury.gov/tigta/auditreports/2017reports/201730045fr.pdf.