TIGTA reports large increase in alimony tax gap

Editor: Sally P. Schreiber, J.D.

Discrepancies between the amount of alimony deducted by payers and reported as income by its recipients increased by 38% in six years, to $3.2 billion for tax year 2016, the Treasury Inspector General for Tax Administration (TIGTA) reported on Aug. 13 (TIGTA Rep’t No. 2019-40-048, available at www.treasury.gov).

TIGTA performed the audit to follow up its 2014 report on the alimony tax gap (TIGTA Rep’t No. 2014-40-022, available at www.treasury.gov; see related coverage from The Tax Adviser), in which it found a $2.3 billion alimony tax gap for 2010. Despite the IRS’s accepting the earlier recommendations, the latest report said the IRS still lacked sufficient systemwide processes to identify and address them and “has yet to adequately address the substantial compliance gap” they represent.

Before the Code was amended by the law known as the Tax Cuts and Jobs Act, P.L. 115-97, for alimony payable under separation agreements or divorce decrees executed on or before Dec. 31, 2018, alimony was deductible by the payer and includible in income of the recipient. For tax year 2016, TIGTA analyzed 569,978 returns claiming alimony deductions totaling nearly $13 billion. The amount of alimony reported as income on 284,053 returns yielded the $3.2 billion discrepancy. Some returns that should have reported income reported none or less than the corresponding deduction or were not filed at all. Of the returns that did report alimony income, 175,820 reflected a difference between the income amount and the associated deduction, for a net total discrepancy of $1.6 billion. The unreported income resulted in an apparent understated tax liability totaling more than $248 million for the tax year.

Taxpayers claiming an alimony deduction are required to provide the tax identification number (TIN) of the recipient, and for 54,560 of the deduction returns, reflecting $1.5 billion in deductions, TIGTA found no return filed for the corresponding TIN (noting that some may not have been required to file a return).

For another 2,168 deduction returns, the recipient’s TIN was invalid. TIGTA found that the IRS lacks a consistent process for validating these TINs and earmarking returns with invalid TINs for additional review. Also, although Sec. 6723 imposes a $50 penalty for failing to provide a valid TIN, TIGTA found this penalty was rarely imposed and, when it was, it was assessed for $5 rather than the statutory amount due to faulty programming.

Despite the increase in discrepancies and the IRS’s earlier agreements in response to TIGTA’s findings, the Service has examined only a small and dwindling number of these returns, TIGTA stated. In fiscal 2010, the IRS selected 13,594 returns with alimony deductions for examination, falling to 7,492 in fiscal 2016, which were approximately 5.1% and 3.2%, respectively, of the returns with alimony income that TIGTA identified as having a discrepancy with a corresponding deduction.

In its response to these latest findings, IRS management pointed out that the number of taxpayers reporting alimony could decrease as a result of the TCJA’s repeal; TIGTA pointed out in return that although the number of taxpayers reporting alimony likely will not increase, the number continuing to report it under pre-2019 agreements and decrees will likely remain sizable for the foreseeable future.

TIGTA also noted that although it recommended in its earlier audit that the IRS increase its use of “soft” notices to taxpayers with alimony discrepancies, the Service has not done so; TIGTA disagreed with several reasons IRS managers put forth for why soft notices (which are issued to taxpayers for informational purposes to tell them they may have an error on their return) are not feasible.

In response to this audit, the IRS agreed to monitor and revise its filters for selecting returns for examination, to improve its monitoring of TINs and processing of returns with invalid TINs, and to properly assess penalties for failure to provide a valid TIN.