a

GAO

United States Government Accountability Office

Report to the Committee on Finance, 

U.S. Senate

September 2004 TAX 

ADMINISTRATION

IRS Should Take Steps 

to Improve the 

Accuracy of Schedule 

K-1 Data 

GAO-04-1040
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

www.gao.gov/cgi-bin/getrpt?GAO-04-1040.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Michael 

Brostek at (202) 512-9110 or 

brostekm@gao.gov. 

Highlights of GAO-04-1040, a report to the 

Committee on Finance, U.S. Senate. 

September 2004

TAX ADMINISTRATION

IRS Should Take Steps to Improve the 

Accuracy of Schedule K-1 Data 

The accuracy of paper-filed K-1 data is reduced by transcription errors; paper 

and e-filed K-1s have inaccurate TINs. IRS estimates that transcription errors for 

tax year 2002 ranged from 5 and 9.5 percent and is taking steps to address such 

errors. Although e-filed K-1s do not require transcription, for tax year 2002, the 

percentage of invalid TINs for e-filed K-1s and paper-filed K-1s were comparable 

(7 and 6 percent, respectively). Due to potential burden on flow-through entities 

and resource constraints, IRS does not notify the entities of invalid TINs on K-1s 

for correction. If IRS did so, this would likely give e-filing entities enough time 

to correct invalid TINs before IRS runs its document-matching program. 

Inaccurate or limited K-1 data have created problems for IRS researchers and 

examiners. IRS research staff indicated that inaccurate TINs adversely affected 

their analysis of flow-through entity networks. Further, because IRS captures 

limited data from flow-through entity returns, including the K-1, IRS staff lack 

data they consider helpful, such as “Other Income” to help identify tax shelters. 

In at least 40 percent of closed examination cases we sampled, IRS examiners 

found errors with return line items not entered into IRS’s databases when 

returns are received. If these lines were available up front, researchers say they 

would be able to better identify returns with potential noncompliance. 

Increased e-filing of K-1s would provide benefits and challenges to both IRS and 

taxpayers. Benefits for IRS include faster, more complete information and 

millions in annual cost reductions. Benefits for taxpayers include fewer IRS 

contacts with them because IRS would have more accurate information in its 

systems. The primary challenge for IRS is its current inability to electronically 

process all flow-through entity returns and related forms, including the K-1. For 

taxpayers, the primary challenge is the cost of converting from paper to e-filing.

Paper K-1s: Lengthy Processing Yields Incomplete Data 

Over a trillion dollars in income 

was distributed in tax year 2002 by 

flow-through entities, such as 

partnerships, subchapter S 

corporations, and trusts, to their 

partners, shareholders, or 

beneficiaries, respectively. The 

Internal Revenue Service (IRS) 

estimates that from 6 to 15 percent 

of such income is unreported on 

individual tax returns. This income 

is reported to both IRS and to the 

recipients on a Schedule K-1 (K-1). 

IRS uses K-1 data in its documentmatching program to identify 

noncompliance and for other 

purposes. GAO was asked to 

(1) assess the accuracy of K-1 data, 

specifically transcription errors 

and taxpayer identification 

numbers (TIN); (2) determine 

whether any limitations in the 

availability or accuracy of K-1 data 

have affected IRS’s ability to 

identify noncompliance; and 

(3) identify the benefits and 

challenges of increasing e-filing of 

K-1s. 

What GAO Recommends

To improve the availability and 

usefulness of K-1 data to IRS for 

detecting noncompliance, GAO 

recommends that IRS conduct a 

pilot study to determine the 

benefits and costs of obtaining 

corrected TINs from flow-through 

entities as soon as they are found 

to be invalid. 

IRS agreed with our 

recommendation. 
Page i GAO-04-1040 Schedule K-1 Matching Program

Contents

Letter 1

Results in Brief 3

Background 5

Data Transcription Errors and Erroneous TINs Reduce the Accuracy 

of K-1 Data 9

K-1 Data Accuracy and Availability Pose Problems in Research and 

Examination Efforts 15

Increasing E-Filing of K-1s Would Provide Benefits and Challenges 

for IRS and Taxpayers 20

Conclusions 24

Recommendation for Executive Action 25

Agency Comments and Our Evaluation 25

Appendixes

Appendix I: Objectives, Scope, and Methodology 27

Appendix II: Comments from the Internal Revenue Service 32

Table Table 1: Percentage of Invalid Schedule K-1 TINs That Were Not 

Corrected and Corrected by IRS for Tax Year 2002 by Type 

of Entity Return 13

Figures Figure 1: IRS’s Program to Match Flow-Through Income Reported 

by Partnerships with Income Reported on a Partner’s 

Federal Income Tax Return 6

Figure 2: Processing Flowchart for Paper and E-Filed Schedule 

K-1 8

Figure 3: How Inaccurate TINs May Prevent IRS from Tracking 

Flow of Income through a Chain of Financial 

Transactions 17

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Page 1 GAO-04-1040 Schedule K-1 Matching Program

United States Government Accountability Office

Washington, D.C. 20548

A

September 30, 2004 Letr

The Honorable Charles Grassley

Chairman

The Honorable Max Baucus

Ranking Minority Member

Committee on Finance

United States Senate

Over a trillion dollars in income was distributed in tax year 2002 by entities 

such as partnerships, subchapter S corporations (S-Corp), and trusts that 

distribute net income—as well as losses—to partners, shareholders, and 

beneficiaries.1

 Such entities, called flow-through entities, are required to 

report distributed income annually to the Internal Revenue Service (IRS) 

on a Schedule K-1, thus providing IRS with a way to determine whether 

individuals are reporting the income on tax returns.2

 IRS estimates that 

from 6 to 15 percent of such income is unreported on individual tax 

returns. In addition, IRS is concerned about flow-through entities claiming 

improper expenses or otherwise being used to evade tax liabilities. Thus, 

IRS is concerned both with potential noncompliance by individuals who 

fail to properly report income from flow-through entities and by flowthrough entities themselves, which ultimately leads to improper income 

reporting by individuals as well.

Schedule K-1s are one of several forms and schedules included in the 

annual return filed by a flow-through entity. Partnerships with more than 

100 partners are currently required by law to file their annual returns, 

including all Schedule K-1s,3

 electronically. Those with 100 partners or 

less, as well as S-Corps and trusts, are not required to do so. 

The annual returns of flow-through entities are used to report the income, 

deductions, gains, losses, and so forth of the respective entities. These 

returns, including the K-1s, enable IRS to identify compliance issues that 

1

 An S-Corp is a domestic corporation with no more than 75 shareholders, all of which are 

individuals, estates, exempt organizations, or certain trusts. A trust is an arrangement by 

which trustees take title to property for the purpose of protecting or conserving it for 

beneficiaries.

2

 Although for simplicity we refer only to individuals’ returns, corporations, partnerships, 

and trusts may also be recipients of flow-through entities’ income or losses.

3

 For the remainder of this report, we will refer to Schedule K-1s simply as K-1s.
Page 2 GAO-04-1040 Schedule K-1 Matching Program

may require an examination of the flow-through entities’ books and 

records. Further, during 2001, IRS began matching K-1 information with 

information included on individual tax returns to identify potential 

underreporting of income by individuals. To use K-1 information not filed 

electronically in its document-matching program,4

 IRS must first transcribe 

the data for use in its computer systems. As reported in 2003, this is a costly 

and error-prone process that can result in taxpayer burden.5 

Because of concerns about IRS’s ability to effectively use K-1 data to detect 

noncompliance, you asked us to assess IRS’s current use of this 

information. Specifically, our objectives were to (1) evaluate the accuracy 

of K-1 data used by IRS, specifically transcription errors and invalid TINs; 

(2) determine whether any limitations in the availability or accuracy of K-1 

data have affected IRS’s ability to identify noncompliance; and (3) describe 

the benefits and challenges of increasing electronic filing (e-filing) of K-1s.6

To meet our first objective, we discussed and obtained estimates from IRS 

staff concerning the type of IRS transcription errors for paper-filed K-1s. 

We also assessed IRS’s procedures related to the processing and 

transcription of K-1 information. In addition, we obtained and analyzed the 

IRS K-1 database for tax year 20027

 to identify, among other things, the size 

and type of entities that file K-1s, the frequency of inaccurate taxpayer 

identification numbers (TIN)8

 included on these schedules, and the amount 

of income associated with inaccurate TINs. On the basis of our data 

reliability review of IRS’s K-1 database, we determined that the data were 

4

 The document-matching program matches information concerning selected tax issues 

reported on tax returns by individual taxpayers and reported on information returns by third 

parties, such as employers, banks, flow-through entities, and other payers of income. 

Transcription involves manually keypunching the information for use in IRS’s computer 

systems.

5

 GAO, Tax Administration: Changes to IRS’s Schedule K-1 Document Matching Program 

Burdened Compliant Taxpayers, GAO-03-667 (Washington, D.C.: May 30, 2003).

6

 Because the K-1 is part of the flow-through entity return, increased e-filing of the K-1 would 

require increased e-filing of the flow-through entity return.

7

 At the time of our review, this was the most recent year that complete K-1 data were 

available from IRS. 

8

 The TIN is a unique nine-digit number, usually a Social Security number (SSN) for an 

individual, an employer identification number (EIN) assigned by IRS for a partnership or 

corporation, and either an SSN or an EIN for a sole proprietor.
Page 3 GAO-04-1040 Schedule K-1 Matching Program

sufficiently reliable to enable us to identify the extent to which K-1s have 

invalid TINs. 

To address our second objective, we determined what portion of flowthrough entities’ returns, including K-1s, is transcribed by IRS. We also 

discussed with IRS staff and research consultants from MITRE 

Corporation9

 how IRS currently uses K-1 information and whether and how 

data availability and accuracy affect their ability to use these data. We also 

reviewed a projectable sample10 of partnership and S-Corp closed 

examination files to determine the compliance issues IRS identified, the 

related line items that were adjusted, and whether having additional K-1 

line items available would help to identify potential noncompliance. We 

subsequently discussed our findings with IRS classification11 and 

examination staff. 

To meet our third objective, we discussed with both IRS officials and 

officials from seven organizations that represent the taxpayer community 

the costs, benefits, and challenges of requiring increased e-filing of K-1s. 

We selected the organizations based on prior GAO knowledge and referrals 

from some of the organizations that we contacted. We also contacted the 

software companies that offer e-filing for flow-through entities to obtain 

their current fees for preparing and e-filing flow-through entity returns, 

including K-1s.

Our work was done from May 2003 through August 2004 in accordance 

with generally accepted government auditing standards. (App. I describes 

our overall objectives, scope, and methodology.)

Results in Brief The accuracy of K-1 data is reduced by IRS transcription errors on paperfiled K-1s and by flow-through entities submitting invalid TINs on both 

9

 We talked with MITRE because IRS has a contract with MITRE to conduct flow-through 

entity data analysis.

10 The population from which the sample is drawn is agreed 2002 closed case examinations 

of partnerships and S-Corps listed in IRS’s Audit Information Management System with tax 

years ending in 2000 or 2001. Agreed cases are cases where the IRS has made adjustments 

to a taxpayer’s tax return, and the taxpayer has actively or passively accepted the 

adjustment.

11 Classification staff, called classifiers, review returns and related documentation and select 

returns to be examined.
Page 4 GAO-04-1040 Schedule K-1 Matching Program

paper and e-filed K-1s. IRS estimates that the overall transcription error 

rate for the almost 18 million tax year 2002 paper-filed K-1s ranged from 5 

to 9.5 percent based on its quality reviews. E-filed returns are not 

transcribed and thus do not have these errors. IRS is taking steps to reduce 

the transcription error rate, such as implementing a bar-coding process that 

bypasses the transcription process and taxpayer education and outreach 

efforts. In tax year 2002, IRS processed almost 1.5 million K-1s with invalid 

TINs. The combined income on these K-1s totaled $57.3 billion. IRS was 

able to correct the TINs on about half of the K-1s with income totaling 

$20.6 billion. The remaining 50 percent that had income of $36.6 billion 

could not be corrected and thus could not be used in the documentmatching program. Regarding TIN accuracy, the percentage of invalid TINs 

for tax year 2002 e-filed K-1s was 7 percent, which was comparable to the 6 

percent invalid TIN rate on paper-filed K-1s. IRS is not notifying flowthrough entities of invalid TINs so they can take corrective actions due to 

concern over taxpayer burden on flow-through entities and resource 

constraints. If this were done, it would more likely give e-filing entities 

enough time to correct many invalid TINs before IRS runs its documentmatching program because IRS could send error notices to e-filers more 

quickly than to paper filers.

Inaccurate or limited K-1 data have created some problems in IRS’s 

research and examination efforts. IRS research staff studying flow-through 

entity relationships indicated that missing or inaccurate TINs have affected 

their ability to build more effective computer models to analyze flowthrough networks that may be used for tax evasion. In addition, because of 

the limited number of line items captured from the flow-through entity 

return, including the K-1, research and examination staff lack certain data 

fields, such as “Other Income/(Loss),” that would be helpful to identify 

compliance issues and better target resources. Based on our sample of 

closed examination cases, in at least 40 percent of the examinations, IRS 

auditors corrected line items on entities’ returns that are not currently 

being transcribed.12 If these line items were available before IRS classifiers 

select returns for examination, IRS researchers could use the data to 

support more effective computer modeling and thereby focus examination 

classifiers’ attention on returns that are more likely to involve 

noncompliance.

12 Estimates from our sample are subject to sampling error. We are 95 percent confident that 

corrected line items not transcribed occur in at least 40 percent of the 2002 closed case 

examinations based on our sample evidence. 
Page 5 GAO-04-1040 Schedule K-1 Matching Program

Increasing e-filing of K-1s from the current rate of about 24 percent would 

provide benefits and challenges for IRS and taxpayers. For IRS, the benefits 

include faster and more comprehensive information as well as cost 

reductions due to the lack of transcription costs for e-filed returns. For 

example, in fiscal year 2002, IRS spent over $13 million for processing and 

transcribing paper-filed K-1s, much of which would be eliminated. For 

taxpayers, the benefits of e-filing include the receipt of an IRS acceptance 

acknowledgment; the quicker receipt of rejection notices that would allow 

the taxpayers to correct problem returns faster; and more accurate 

information in IRS databases due to the lack of transcription errors, thus 

reducing the potential for erroneous and burdensome taxpayer notices. 

IRS’s primary challenge in mandating increased e-filing of K-1s is its current 

inability to electronically process all the other forms that may accompany 

the flow-through entity return. IRS is scheduled to have this capability by 

2007. The primary challenge for taxpayers is the cost of converting from 

paper filing to e-filing. However, based on a limited review of flow-through 

entity returns, most K-1s are currently computer generated, which is a 

prerequisite for e-filing. Also, all of the software companies that offer efiling that disclosed their fees (about half of those we contacted) do so for 

less than a dollar per K-1 or at no additional cost. Both IRS and Congress 

are considering various administrative and legislative proposals to increase 

mandatory e-filing of information and tax returns, including those filed by 

flow-through entities.

We are making a recommendation that IRS implement a pilot study to 

determine the benefits and costs of requiring flow-through entities to 

correct invalid TINs on K-1s as soon as it has been determined that the 

TINs cannot be “perfected” via IRS’s TIN validation program. The 

Commissioner of Internal Revenue agreed with our recommendation and 

said that IRS plans to study a number of options to ensure that TINs 

included on Schedule K-1s are accurate. 

Background Partnerships, S-Corps, and trusts are commonly referred to as flow-through 

entities, as they do not generally pay taxes on income. Instead, they 

distribute net income—as well as losses—to partners, shareholders, and 

beneficiaries, respectively, who are subsequently required to report the net 

income or loss on their individual tax returns and to pay any applicable 

taxes. Distributed income is reported to IRS on a K-1, which is included in 

the annual return filed by the flow-through entity. Copies of the Schedule K1 are provided to partners, shareholders, and beneficiaries for use when 

filing their respective annual returns. Partners receive a Form 1065 
Page 6 GAO-04-1040 Schedule K-1 Matching Program

Schedule K-1, “Partner’s Share of Income, Credits, Deductions, etc.”; 

shareholders receive a Form 1120S Schedule K-1, “Shareholder’s Share of 

Income, Credits, Deductions, etc.”; and beneficiaries receive a Form 1041 

Schedule K-1, “Beneficiary’s Share of Income, Deductions, Credits, etc.”

As shown in figure 1, as part of its overall underreporter program, IRS has a 

specific K-1 document-matching program in which selected K-1 

information reported by flow-through entities is compared to information 

reported by individuals on their tax returns in order to determine whether 

distributed income has been reported as required. 

Figure 1: IRS’s Program to Match Flow-Through Income Reported by Partnerships 

with Income Reported on a Partner’s Federal Income Tax Return

In like manner, income reported to IRS on a K-1 by S-Corps and trusts can 

be matched with income reported on tax returns by shareholders and 

Partnership 

submits Form 1065

and all K-1s 

to IRS

IRS matches K-1

submitted by

partnership with

K-1 information

recorded on

corresponding

individual return

Each partner includes 

K-1 information on individual 

tax return and submits 

return to IRS

Partnership

sends copy of K-1

to partners

Business 

partnership

K-1 matching 

program

K-1 K-1

K-1 K-1

1040

IRS

1040

1040

Source: GAO analysis.

K-1 K-1 1065
Page 7 GAO-04-1040 Schedule K-1 Matching Program

beneficiaries, respectively.13 The purpose of this program is to increase 

voluntary reporting of flow-through income by taxpayers and to target K-1 

related underreporter notices to noncompliant taxpayers. IRS identified 

about $4.1 billion in underreported income for tax years 2000 and 2001 via 

the K-1 matching program and assessed about $110 million in additional 

taxes.14

In addition to use in the matching program, IRS can also use K-1 

information to aid in selecting flow-through entity returns for examination. 

For example, IRS can use K-1 information to aid in identifying flow-through 

entities involved in potential tax evasion schemes and to develop computer 

models that may enable IRS to more effectively select returns for 

examination with the greatest likelihood for a tax change.15

In order for IRS to use K-1 information in its matching program, the 

information must either be e-filed by a flow-through entity or, if filed via 

paper, transcribed by IRS staff for use in its computer systems. Currently, 

only partnerships with over 100 partners are required by law to e-file their 

annual returns, including any related K-1s. As a result, for tax year 2002, 

less than one-quarter of 1 percent of partnerships was required to e-file.

Figure 2 illustrates that an e-filed K-1 goes through two basic steps before 

the information is input into the Information Returns Master File (IRMF). 

At Step A, the K-1 undergoes up-front checks prior to final acceptance by 

IRS, whereby the K-1 data must pass specific checks or the entire flowthrough entity return is to be rejected until corrected by the entity. The upfront checks include verifying the tax year and proper formatting of names, 

addresses, and TINs. For example, the partner’s TIN on a K-1 filed by a 

partnership must be within a specific range established by IRS; if not, the 

entire partnership return is to be rejected. The only other step for an e-filed 

K-1 prior to its going through IRS’s document-matching program is the TIN 

validation process, in which the TIN and name on the K-1 are electronically 

13 For this report we focused upon the K-1 and did not assess the accuracy of the dollar 

amounts reported by the flow-through entity.

14 As of May 2004, the final results for tax year 2000 were complete, while the final results for 

tax year 2001 were still to be determined.

15 An IRS examination of a taxpayer’s books and records that results in no tax change is 

generally inefficient for IRS because it has spent resources to audit an accurate return. No 

tax change audits also burden taxpayers, who are forced to go through the audit process 

even though they are compliant.
Page 8 GAO-04-1040 Schedule K-1 Matching Program

matched with information in IRS’s files to determine whether the TIN is 

valid. Generally, this validation occurs several months after IRS accepts 

the e-filed return.

Figure 2: Processing Flowchart for Paper and E-Filed Schedule K-1

Note: Does not reflect the processing changes to paper K-1s that IRS began testing in April 2004 with 

the introduction of bar coding and scanning.

In contrast, a paper-filed K-1 goes through several manual steps, including 

some of the up-front checks conducted electronically for e-filed K-1s, 

before TIN validation takes place and the information can be input into the 

IRMF. These steps, particularly transcription, can take up to 6 months to 

complete, with transcription beginning in May. For example, at Step 4, IRS 

staff are to edit the flow-through entity return and contact the taxpayer if a 

required K-1 is missing. At Step 8, IRS staff are to transcribe selected K-1 

line items. During the transcription process, the computer conducts checks 

on select aspects of the keypunched data, such as correlating zip code and 

state information, and creates an error record for correction. Subsequently, 

other IRS staff are to compare a sample of the transcribed K-1 data to the 

original paper-filed K-1 to determine whether the data were accurately 

transcribed. The TIN on a paper-filed K-1, as on an e-filed K-1, is not 

Source: GAO analysis of IRS data.

Validated 

K-1 data to 

Information 

Returns 

Master File

TIN

validation

Step A–Acceptance

• Entity return and K-1 

 entered together

Entity 

return

and K-1 Entity returns 

are separated

from K-1s

and sent to 

transcription

Flow-through entity submits 

electronic tax forms to IRS Flow-through entity submits paper tax forms to IRS

Step 4–Code and edit

• edit entity return

• contact taxpayer for 

 missing K-1s

Step 6–K-1 

batching

• group K-1s

Step 5–Entity numbering

• number entity return

• forward entity return to 

 transcription

Step 7–K-1 numbering

• number K-1s

Step 8–Transcription

• transcribe select lines 

 from K-1

• transcribe select lines 

 from entity return

Step 1–Extracting

• sort by entity type Step 2–Second sort

• sort by tax year

Step 3–Entity batching

• batch in groups by type 

 of return, such as 

 partnerships, S-Corps, 

 and trusts

Average processing 

time is 2 days

TIN validation 

process is conducted 

4 times a year Starting in May processing time is up to 6 months

K-1 K-1 1065
Page 9 GAO-04-1040 Schedule K-1 Matching Program

computer validated until it reaches the stage where electronic TIN 

validation occurs, generally several weeks or months after the return was 

filed. 

IRS’s program to electronically validate TINs matches the TIN and name on 

the K-1 to taxpayer identity information in its files. If there is no match, IRS 

will attempt to “perfect” or correct an incorrect TIN/name combination via 

a TIN validation process, which entails matching the TIN and name 

control—the first four characters of an individual’s last name or the first 

four characters of a business name—with (1) a file which contains all 

Social Security numbers (SSN) ever issued and all name controls ever 

associated with them and (2) a file that contains all employer identification 

numbers (EIN) ever issued and all name controls associated with them. 

This TIN validation process occurs four times per year, beginning about a 

month and a half after the end of the filing season. 

Data Transcription 

Errors and Erroneous 

TINs Reduce the 

Accuracy of K-1 Data 

Data transcription errors made by IRS on paper-filed K-1 data and invalid 

TINs submitted by flow-through entities on both paper-filed and e-filed K-1s 

lower the accuracy of K-1 data. IRS transcription errors, which occur only 

for paper-filed K-1s, ranged from 5 to 9.5 percent for tax year 2002, and IRS 

is taking steps to reduce these errors. The percentage of invalid TINs for efiled K-1s is comparable to that for paper-filed K-1s. However, due to 

potential taxpayer burden and resource constraints, IRS is not notifying 

flow-through entities of invalid TINs so they can take corrective actions, a 

step which would likely give e-filing entities enough time to correct many 

invalid TINs before IRS runs its document-matching program. Paper-filing 

entities may not have sufficient time to correct invalid TINs before 

document matching occurs. 

Data from Paper-Filed K-1s 

Contain Transcription 

Errors, but IRS Is Taking 

Steps to Reduce These 

Errors

According to IRS K-1 quality reviews conducted at two IRS locations, the 

overall K-1 transcription error rate for tax year 2002 ranged from 5 to 9.5 

percent—errors that by definition are not made in e-filed returns. The most 

frequent errors dealt with names and addresses. IRS also found 

transcription errors in dollar amounts and TINs. Errors detected during 

quality reviews are corrected before the K-1s are posted to the IRMF, which 

IRS uses to detect potential underreporters and nonfilers. However, less 

than 2 percent of all K-1s are selected for the K-1 quality review. 

Transcription errors on all other K-1s are included when the data are 

posted to the IRMF. Consequently, data from an estimated 18 million tax 
Page 10 GAO-04-1040 Schedule K-1 Matching Program

year 2002 paper K-1s that were entered into databases used by IRS for 

research and enforcement purposes have transcription error rates from 5 

to 9.5 percent.16 For example:

• IRS’s K-1 database for tax year 2002 included 16 paper-filed K-1s each of 

which showed interest income of over $1 billion. These interest income 

amounts appeared to be transcription errors. One partnership filing 

paper K-1s had 73 partners. For 72 of the partners, the K-1 interest 

recorded in the IRMF was under $200,000. The remaining partner’s 

interest as recorded in the IRMF was $85.3 billion.17

• According to an IRS data quality review of tax year 2001 K-1 documentmatching cases, about 5 percent of the cases that were either screened 

out before taxpayers were contacted or resulted in no change to 

taxpayers’ tax liabilities after an erroneous underreporter notice was 

sent to the taxpayer were due to transcription errors. The transcription 

errors included misplaced decimal points and positive money amounts 

that were transcribed as negative numbers and vice versa. 

According to IRS officials, it would be too costly to do more data 

transcription quality review of paper-filed K-1s, such as reentry of K-1 data. 

Instead, IRS is taking other measures to improve K-1 data accuracy. For 

example:

• For tax year 2003, IRS began scanning all K-1s using optical character 

recognition (OCR) equipment. Also, for tax year 2003, IRS is accepting 

K-1s with bar codes that contain all the K-1 data. If the bar code is 

present, the system will pick up the information from the bar code, 

otherwise the system will image the K-1 and read the line entries using 

OCR. Portions of the K-1 or bar code that cannot be read by OCR are 

manually transcribed. Although IRS originally projected 30 percent of K1s would be bar coded in tax year 2003, as of July 2004 only 8 percent of 

K-1s submitted were bar coded. For the 92 percent of K-1s without bar 

16 Some transcription errors are corrected during processing after the point of transcription. 

IRS did not have data on what percentage of transcription errors are later corrected.

17 Because each partner’s distributive share of income is determined by the partnership 

agreement (and this will be respected for tax purposes unless the allocations agreed to lack 

“substantial economic effect”), income may not always be distributed evenly. However, this 

example was selected because $85.3 billion appears to be an excessive dollar amount for 

interest income. 
Page 11 GAO-04-1040 Schedule K-1 Matching Program

codes that OCR read, almost 20 percent required no transcription, 60 

percent required less than half of normal transcription, and 20 percent 

were entirely transcribed. Although bar coding and OCR bypass most of 

the manual data transcription, which reduces some data transcription 

cost and errors, IRS officials still prefer e-filing because bar coding is a 

paper process with accompanying processing costs.

• To improve the accuracy of transcription, IRS has implemented new 

software and improved transcription training. At two IRS locations, IRS 

is using a new transcription software intended to increase transcription 

productivity and accuracy, compared to the current transcription 

software. In addition, transcription training for the K-1 program has 

evolved. Each year, feedback is funneled to the IRS transcription 

trainers to improve the K-1 transcription process.

• IRS is redesigning the K-1s for both partnerships and S-Corp returns so 

that IRS can scan them into the computer instead of having to transcribe 

the data manually. Although the redesigned partnership and S-Corp K-1s 

are expected to be ready by tax year 2004, the redesigned trust K-1 will 

not roll out until tax year 2005 because trust law makes the trust K-1 

different from the other two K-1s. 

• IRS is conducting educational outreach to increase accurate K-1 filing 

and provide updates to changes in K-1 design. In April 2004, IRS issued a 

news release to provide tips for businesses, individuals, and tax 

professionals on accurate K-1 filing. For example, flow-through entities 

are instructed to ensure the correct TINs are used on K-1s. In addition, 

the six IRS Tax Forums in 2004 include a session on reporting flowthrough items, which addresses the redesign of K-1 forms and K-1 

reporting reminders. IRS has also included updates on the K-1 matching 

program and K-1 redesign in external speeches to stakeholder groups. 

Finally, in late 2004, IRS plans to implement a multifaceted 

communication plan to publicize the release of the redesigned K-1s.

IRS’s K-1 Data Contain 

Incorrect Taxpayer 

Identification Information 

For IRS to use K-1 data in its document-matching program, the TINs and 

names on K-1s need to be accurate so they can be linked to individuals’ tax 

returns and other tax documents. In tax year 2002, about 94 percent of 24 

million K-1s that IRS processed contained valid TINs. The remaining 6 

percent, or approximately 1.5 million K-1s, had invalid TINs because either 

IRS made transcription errors or the flow-through entities submitted 

invalid data. The 1.5 million K-1s with invalid TINs had combined income 
Page 12 GAO-04-1040 Schedule K-1 Matching Program

gains of $57.3 billion and combined income losses of $84.1 billion. IRS was 

able to correct the invalid TINS on about 750,000 of the K-1s, with income 

gains totaling $20.6 billion and incomes losses totaling $6.8 billion, so that 

they could be used in IRS’s document-matching program or for other 

compliance and research purposes. However, the remaining 740,000 K-1s 

with invalid TINs, with income gains of $36.6 billion and incomes losses of 

$77.2 billion, could not be perfected and thus were unmatchable. IRS did 

not have data on the number of K-1s that had either corrected or 

unmatchable TINs in the IRMF that resulted from transcription errors. 

IRS Does Not Notify FlowThrough Entities of Invalid 

TINs That It Was Unable to 

Correct

After IRS checks the validity of TINs provided on K-1s, it does not notify 

either paper-filing or e-filing flow-through entities of the invalid TINs it 

finds so the entities can take steps to correct the TINs, due to concerns 

about the potential burden on the entities and resource constraints. 

Because e-filed returns do not go through time-consuming paper 

processing steps, including transcription, if IRS were to notify the 

originating entities of invalid TINs, they should have time to correct invalid 

K-1s before IRS performs its document matching in the fall following a tax 

filing year. For paper-filed K-1s, many entities likely could not respond 

before the document matching occurs.

Because e-filed K-1s are not subject to transcription errors, none of the 

keypunching errors associated with paper returns are in e-filed data. 

However, as table 1 shows, in tax year 2002 the overall percentage of 

invalid K-1 TINs IRS found with its TIN validation program was comparable 

for e-filed (about 7 percent) and paper (6 percent). 
Page 13 GAO-04-1040 Schedule K-1 Matching Program

Table 1: Percentage of Invalid Schedule K-1 TINs That Were Not Corrected and Corrected by IRS for Tax Year 2002 by Type of 

Entity Return

Source: GAO analysis of IRS information. 

Note: Numbers may not add up to 100 percent because of rounding.

a

Not applicable because e-file was not available for S-Corp returns until tax year 2003.

Factors that may be contributing to e-filed K-1s having TIN errors 

comparable to those of paper K-1s include (1) large partnerships, which are 

mandated to file K-1s electronically, submitting such large volumes of K-1s 

that many may unknowingly submit one or more K-1s with invalid TINs18

and (2) IRS not applying one of its up-front checks for e-filed partnership K1s. 

According to our analysis of IRS’s K-1 database, partnerships that submit a 

higher volume of K-1s are more likely to submit a K-1 with an invalid TIN 

compared to partnerships that submit only a few K-1s. In tax year 2002, efiled partnerships’ K-1s had the highest rate of invalid TINs (8.7 percent). 

That same year, 97 percent of the partnerships with more than 100 partners, 

which are required to e-file, submitted at least one K-1 with an invalid TIN. 

In contrast, 18 percent of partnerships with 100 or fewer partners 

submitted at least one K-1 with an invalid TIN.

To encourage electronic filing of partnership returns, IRS is not applying its 

up-front check that would reject an e-filed partnership’s return if it has even 

one TIN on a K-1 that falls outside the range of numbers associated with 

SSNs and EINs. If IRS applied this validation criterion in tax year 2002, 12 

percent of the e-filed partnership K-1s with unmatchable TINs would have 

Type of entity 

return

E-filed K-1s Paper K-1s

Percentage of 

TINs found 

invalid by IRS’s 

validation 

program

Percentage of 

invalid TINs IRS 

was unable to 

correct

Percentage of 

invalid TINs IRS 

corrected

Percentage of 

TINs found 

invalid by IRS’s 

validation 

program

Percentage of 

invalid TINs IRS 

was unable to 

correct

Percentage of 

invalid TINs IRS 

corrected

Partnership 8.7 62.1 36.8 6.5 50.8 49.2

Trust 3.7 24.3 75.7 7.1 56.3 43.7

S-Corp n/aa n/aa n/aa 5.0 36.0 64.0

Total all K-1s 7.0 6.1

18 Each partner has a unique TIN.
Page 14 GAO-04-1040 Schedule K-1 Matching Program

been rejected and the originating entities would have been asked to take 

steps to correct the TINs. However, some partnerships have hundreds or 

thousands of partners, making it more challenging for them to ensure that 

all partners’ TINs are correct. IRS officials have determined that accepting 

an e-filed return when the vast majority of the K-1 TINs fall within the range 

of numbers associated with SSNs and EINs, rather than rejecting the entire 

entity return due to one or a few TINs that fall outside that range, promotes 

e-filing. 

In addition, IRS does not notify either e-filing or paper-filing flow-through 

entities if submitted TINs are found to be invalid during the TIN validation 

checks it performs subsequent to accepting entities’ returns. In tax year 

2002, more than half of the K-1s submitted by 2 percent of the flow-through 

entities contained invalid TINs. The total number of unmatchable K-1s 

submitted by these entities represented about 29 percent of the total 

number of K-1s with unmatchable TINs. IRS officials said that requiring 

flow-through entities to correct invalid TINs could be a burden because the 

entities rely on information supplied by individual taxpayers and the 

correct TINs may not be readily available, particularly for those entities 

submitting a large number of K-1s. In contrast, IRS does notify filers of 

missing or invalid TINs submitted on other types of information returns, 

which then may require the filers to contact third parties for corrected 

information. For example, for tax years 2000 and 2001 combined, IRS 

proposed just over $204 million in penalties against nonfederal payers for 

information returns with invalid TINs. IRS officials acknowledged that 

flow-through entities may have made mistakes themselves that resulted in 

invalid TINs or may have the correct information on hand. They also stated 

that sending such notices would entail some additional cost to IRS and that 

they currently face resource constraints. However, IRS officials do not 

have estimates of either the potential benefits, such as increased revenue 

obtained from document matching utilizing accurate TINs, or the cost to 

IRS of obtaining valid TINs from flow-through entities. 

If IRS were to notify flow-through entities of invalid TINs and ask that they 

take steps to correct the TINs, it likely would be able to receive many 

corrected TINs, particularly from e-filers, in time for its annual documentmatching program. IRS does its document matching generally from 

November of the calendar year through January of the following year. The 

time when document matching occurs changes somewhat from year to 

year. IRS corrects TINs, including K-1 TINs, four times a year: at the end of 

June, early September, mid-November, and late November. Based on the 

IRS’s 2001 Statistics of Income samples, at least 97 percent of partnerships 
Page 15 GAO-04-1040 Schedule K-1 Matching Program

and S-Corps filed calendar year returns.19 Consequently, all of these returns 

were due to be filed prior to IRS’s first TIN validation check in June.20 Since 

IRS accepts e-filed returns within 2 days of their submission, all e-filed 

returns for which filers have not requested extensions should be available 

for IRS’s June TIN validation program. In this case, IRS would be able to 

notify the flow-through entities of the invalid TINs and the entities would 

have several months to correct the TINs and get them back to IRS before 

IRS posts the corrected K-1s to the IRMF in time for use in the documentmatching program. Even if a flow-through entity did not submit the 

corrected TIN in time, the entity would be aware of the error and could 

correct the TIN for the following year. 

For paper-filing flow-through entities, fewer entities likely would be able to 

correct invalid TINs in time for inclusion in the document-matching 

program. Transcription of paper-filed entity returns, including K-1s, begins 

in May. Because transcription can take up to 6 months, a significant 

portion of paper-filed entity returns and associated K-1 TINs likely would 

not be available for the June TIN validation. For those not available until 

the early September TIN validation, the entities would have much less time 

to correct TINs and get back to IRS in time for IRS to include the corrected 

TINs in the document-matching program. Because IRS’s new return 

scanning and bar-coding efforts should make paper-filed return data 

available more quickly, IRS may be able to include more of them in the June 

TIN validation and thus provide entities sufficient time to provide 

corrected TINs if it sends notices of invalid TINs to flow-through entities.

K-1 Data Accuracy and 

Availability Pose 

Problems in Research 

and Examination 

Efforts

In addition to using K-1 data in its document-matching program, IRS is 

using K-1 data in its research programs to better understand flow-through 

relationships. When data such as TINs are unavailable or inaccurate, 

researchers are unable to establish a complete understanding of the 

network of related entities and taxpayers. Data limitations have also 

affected IRS’s efforts to identify potentially noncompliant taxpayers for 

examination. IRS researchers and examination staff indicated that more 

19 These figures are based on sample data and subject to sampling error. We are 95 percent 

confident that the percentages exceed the value shown for the tax year 2001 partnerships 

and S-Corps.

20 In general, for calendar year filers, S-Corp returns are due to be filed by March 15 and 

partnership returns are due by April 15.
Page 16 GAO-04-1040 Schedule K-1 Matching Program

complete and accurate data would enhance their efforts to detect 

noncompliance.

Inaccurate TINs Affect 

Research Efforts to Link 

Related Entities

IRS researchers are using K-1 data to visualize how taxpayers are related to 

different entities and to evaluate whether compliance issues may exist with 

flow-through entities. However, inaccurate TINs have sometimes 

prevented researchers from establishing all relevant links in a network of 

related entities. As a result, IRS is less able to track the flow of income and 

losses among entities and could be missing opportunities to address areas 

of noncompliance.

Figure 3 illustrates how inaccurate TINs may prevent IRS from tracking the 

flow of income through a chain of financial transactions. In this example, 

an S-Corp distributes losses to an individual shareholder, possibly to allow 

the shareholder to offset other gains, and distributes income to another 

shareholder, a trust. Since trusts are flow-through entities and may be 

nontaxable, the individual shareholder may be using the trust to reallocate 

income (perhaps to someone in a lower tax bracket) that would otherwise 

need to be reported and taxed on that individual’s return. 
Page 17 GAO-04-1040 Schedule K-1 Matching Program

Figure 3: How Inaccurate TINs May Prevent IRS from Tracking Flow of Income through a Chain of Financial Transactions

In our example, the S-Corp transfers income to Trust A, which in turn 

transfers the income to Trust B. In both transactions, the S-Corp and Trust 

A submit K-1s with accurate TINs to IRS, so IRS can track the flow of 

income between the entities. Trust B then transfers the income again to 

Trust C and submits a K-1 with an inaccurate TIN to IRS. Because of the 

inaccurate TIN on the K-1, IRS would likely be unable to identify that Trust 

C is related to the other entities or track the flow of income to its final 

destination and ultimately determine whether any income was 

underreported.

Limited Transcription Lines 

Do Not Fully Meet the 

Needs of Examination and 

Research Programs

IRS transcribes limited line items from K-1s that accompany partnership 

and S-Corp returns. According to IRS staff, at least some of the 

nontranscribed lines would provide useful information. Similarly, IRS does 

not transcribe many of the lines from the flow-through entity’s return to 

Source: GAO analysis of IRS data.

S-Corp

Individual

shareholder

K-1 K-1

K-1

K-1 sent to 

the shareholder 

showing losses

K-1 sent to 

Trust A showing 

gains

Trust A provides K-1

with accurate TIN to IRS

Trust A provides K-1 with

accurate TIN to Trust B

Trust B provides K-1 with

accurate TIN to Trust C

Trust A

Trust B

Trust C

K-1

$

Trust B provides K-1

with inaccurate TIN to IRS

Trust C provides K-1 K-1

with accurate TIN to IRS

IRS

IRS cannot link Trust C to the other entities because the inaccurate Trust C TIN 

that Trust B provides to IRS does not match the accurate TIN Trust C provides to 

IRS. The link is broken from Trust B to Trust C, therefore IRS cannot trace the 

gain (+$) to its final destination.

-$ +$

K-1

+$

+$

+$

K-1

+$
Page 18 GAO-04-1040 Schedule K-1 Matching Program

which the K-1s are attached. Since e-filing of the full entity’s return is part 

and parcel of achieving e-filing of K-1s, e-filing of K-1s would have the 

additional effect of making the complete entity’s tax return information 

available to IRS examiners and researchers. Complete entity data also 

would provide useful information for research and examination purposes. 

For K-1s, IRS identified the line items to be transcribed based on the needs 

of its document-matching program and not on other potential uses. 

Regarding K-1s, IRS transcribes about 14 percent of partnership K-1 line 

items and about 17 percent of S-Corp K-1 line items. Research and 

examination staff indicated that the nontranscribed information would 

provide useful information. For example:

• The “Other Income/(Loss)” line is not captured from the K-1 because it 

is not useful for document matching, but it can be helpful to researchers 

in identifying abusive shelters, for example, where the gain is allocated 

to a tax haven country and the loss is allocated to a domestic investor. 

• Transcribing the shareholder’s ownership percentage from the K-1 

would more easily allow classifiers to determine if the taxpayer has a 

controlling interest in the S-Corp and if income/losses are distributed 

evenly.

Regarding the flow-through entity’s return, IRS currently transcribes about 

23 percent and 20 percent of the line items for partnership and S-Corp 

returns, including the K-1, respectively. As discussed below, additional 

data from the full entity return would potentially benefit examination and 

research programs. For example:

• The IRS Examination Guide for Abusive Tax Shelters and 

Transactions lists partnership (Form 1065) and S-Corp (Form 1120S) 

tax return lines that when examined with other information, may 

indicate tax shelter transactions. For partnership returns, about 80 

percent of the line items listed in the guide as useful to detect tax 

shelters are not captured in IRS’s database. For S-Corp returns, about 

87 percent of line items listed are not captured. When selecting returns 

to be examined, IRS classifiers who focus on tax shelter issues lack 

information that may identify taxpayers most likely to be using tax 

shelters.

• IRS researchers developed a computer model to better identify S-Corp 

returns for examination by helping classifiers separate accurate returns 
Page 19 GAO-04-1040 Schedule K-1 Matching Program

from those needing further investigation. The model uses data from 

IRS’s database of business returns, including Form 1120S and 

accompanying schedules. From the approximately 23,000 returns that 

the model analyzed, IRS identified about 58 percent of the returns as 

having low potential for noncompliance and therefore eliminated them 

from the universe that might be examined. The remaining 42 percent of 

returns could not be classified because the model did not have enough 

data to evaluate them. As a result, IRS has continued to rely on 

examination staff who focus on S-Corp compliance issues to manually 

review the returns that the model has not been able to classify. To help 

address the lack of 1120S data, IRS will be capturing 10 additional line 

items from the 1120S for tax year 2003. One IRS researcher estimated 

that the 10 additional 1120S line items would enable the computer 

model to identify 15 S-Corp compliance issues compared to its current 

capability of identifying 2 compliance issues.

From our file review of closed S-Corp and partnership tax return 

examination cases and discussions with IRS examination and research 

staff, we also found that additional line items from the K-1 and other parts 

of the entity’s return may assist IRS in selecting tax returns to examine. 

Based on our sample of closed examination cases,21 in at least 40 percent of 

the examinations, IRS corrected line items that are currently not 

transcribed. IRS examination and research staff we interviewed indicated 

that if IRS captured this information and made it available to them, it would 

help them identify those returns with errors or omissions that IRS should 

examine. Most of the nontranscribed line items that were corrected were 

from Schedule A (Cost of Goods Sold) and Schedule K22 (Partners’ Shares 

of Income, Credits, Deductions, etc., or Shareholders’ Shares of Income, 

Credit, Deductions, etc.) for both partnerships and S-Corps. IRS identified 

two of these line items, both from Schedule K and K-1, as important for 

improving the effectiveness of computer modeling and mentioned other 

nontranscribed lines, such as “Short Term Capital Loss,” from the entity 

return that would be useful.

21 See app. I for information regarding the sample population.

22 Schedule K is a summary schedule of all partners’ or shareholders’ shares of the 

partnership’s or S-Corp’s income, credits, deductions, and so forth. Schedule K-1 shows 

each partner’s or shareholder’s separate share. In our file review, we noted adjustments on 

Schedule K, unless the adjustment was specific to Schedule K-1.
Page 20 GAO-04-1040 Schedule K-1 Matching Program

Increasing E-Filing of 

K-1s Would Provide 

Benefits and 

Challenges for IRS and 

Taxpayers 

Increasing e-filing of K-1s provides benefits and challenges for IRS and 

taxpayers. The benefits for IRS are faster and more comprehensive 

information as well as cost reductions. The benefits to taxpayers are the 

receipt of acknowledgment notices, faster rejection notices that allow 

taxpayers to resolve problems faster, and more accurate information. 

Currently IRS’s main challenge is the lack of complete e-filing capacity, but 

IRS is scheduled to have this capacity by 2007. The main challenge for 

taxpayers is the cost of converting from paper to e-filing. However, limited 

data indicate that most K-1s are computer generated, which is a 

prerequisite for e-filing. Also, all of the software companies that offer efiling that disclosed their fees (about half of those we contacted) do so for 

less than a dollar per K-1 or for no additional charge. Congress has 

mandated that IRS increase e-filing to at least 80 percent of all tax and 

information returns by 2007. Currently, both IRS and Congress are 

considering increasing mandatory e-filing of flow-through entity returns. 

Increasing E-Filing of K-1s 

Would Provide Better 

Information and Cost 

Reductions for IRS

Currently, IRS electronically receives about a quarter of the K-1s filed, 

although only partnerships with more than 100 partners are mandated to efile. Increasing e-filing of K-1s would benefit IRS because of the following: 

E-filing K-1s provides IRS with faster and more complete information for 

use in compliance and research programs. A recent Treasury Inspector 

General for Tax Administration (TIGTA) report stated that the savings in 

processing time resulting from e-filing would significantly affect IRS’s 

attempt to reduce its lengthy corporate examination process. In addition, 

the TIGTA report stated that comprehensive electronic information would 

minimize the number of no change audits by enabling IRS to better target 

resources to issues that have the greatest compliance risk.23

• E-filing K-1s would save IRS millions of dollars a year because it would 

eliminate the processing and transcription costs of paper K-1s. 

According to IRS, the cost to process e-filed K-1s is minimal once the 

systems are in place, while processing and transcribing paper K-1s cost 

IRS $14.6 million in fiscal year 2001 and $13.1 million in fiscal year 2002. 

If IRS was able to re-allocate these cost savings, IRS could, for example, 

23 Treasury Inspector General for Tax Administration, New Regulations Are Needed to Take 

Full Advantage of the Opportunities Offered by Filing Large Corporate Income Tax 

Returns Electronically, 2003-30-123 (Washington, D.C.: May 30, 2003).
Page 21 GAO-04-1040 Schedule K-1 Matching Program

pay the salaries of 284 additional field collection revenue officers. While, 

as noted earlier, some of the processing and transcribing costs will be 

reduced because of bar coding and scanning, IRS regards bar coding as 

a lesser alternative to e-filing. In addition, bar coding results in 

incomplete information because only the transcribed lines are scanned 

into the computer systems, and the K-1s are the only part of the entity 

return that is bar coded. Also, there is limited availability of software 

that has bar-coding capacity; only four software companies provide barcoding capability compared to 19 software companies that provide efiling.

The primary benefits for taxpayers of increasing e-filing are as follows: 

• Taxpayers that e-file will receive electronic acceptance or rejection 

notices within 2 days of submitting tax returns. The tax form is 

electronically transmitted to the software company and then the 

software company transmits the tax return to IRS. IRS sends the 

software company an electronic acceptance or rejection notice within 2 

days, and the software company then sends the notice to the taxpayers. 

Taxpayers that file paper returns do not receive acceptance notices and 

thus do not have proof that the returns were filed on time in case the tax 

returns are lost. E-filing taxpayers also receive rapid rejection notices 

and are thus informed of problems much faster than paper-filing 

taxpayers, who may wait for 6 months for IRS to process tax returns.

• The information on an e-filed tax return should be more accurate 

because of the lack of IRS transcription errors. More accurate 

information would reduce the potential for burdensome taxpayer 

notices resulting from transcription errors. To respond to IRS notices, 

taxpayers and preparers are required to collect, organize, and submit 

information to IRS to explain any discrepancies cited in the notices, 

which requires an investment of both the taxpayers’ time and money. In 

recent reports, TIGTA noted that e-filing would eliminate transcription 

errors that result in erroneous and burdensome taxpayer notices.24

24 Treasury Inspector General for Tax Administration, The Internal Revenue Service Could 

Reduce the Number of Unnecessary Notices Sent to Taxpayers Regarding Unreported 

Income From Schedule K-1, 2003-30-071 (Washington, D.C.: Mar. 14, 2003), and New 

Regulations Are Needed to Take Full Advantage of the Opportunities Offered by Filing 

Large Corporate Income Tax Returns Electronically.
Page 22 GAO-04-1040 Schedule K-1 Matching Program

Increasing Electronic Filing 

of K-1s Requires Complete 

IRS E-Filing Capacity and 

Taxpayers’ Conversion from 

Paper Filing to E-Filing 

The primary challenge for IRS of mandating increased e-filing is to 

implement computer systems that can electronically process the complete 

set of tax documents that flow-through entities may file with K-1s. 

Although IRS currently has the capacity to electronically process K-1s that 

accompany flow-through entity returns, IRS is unable to electronically 

process all the forms that accompany those of trusts and partnerships. This 

impedes e-filing of the flow-through returns with accompanying K-1s 

because taxpayers that submit partnership and trust returns (that include 

three-fourths of K-1s) have to submit both paper and electronic 

documents—a disincentive for e-filing. For example, signature forms have 

to be sent in on paper. In contrast, IRS currently has complete e-filing 

capacity for the entire S-Corp return, so no forms have to be filed on paper. 

IRS is scheduled to have complete e-filing capacity for partnerships and 

trusts, but has pushed the completion date for this effort from 2006 to 2007 

due to limited resources.

The main challenge to expanded use of e-filing for taxpayers is the cost of 

converting from paper filing to e-filing. In separate reviews of flow-through 

entity returns by IRS and GAO, the majority of the tax returns were found 

to be computer generated, prepared by a paid preparer, or both, which 

might make the conversion to e-filing easier. Based on our sample of Audit 

Information Management System agreed closed case examinations of 

partnerships and S-Corps with tax years ending in 2000 or 2001, paid 

preparers prepared at least 84 percent of the returns, and at least 90 

percent of the returns were computer generated.25 Of the nonprojectable 

sample of 200 partnership and trust returns that IRS reviewed, a paid 

preparer prepared 169 returns, and 173 were computer generated.26

Since the above-mentioned reviews of flow-through entity returns indicate 

that a paid preparer prepares the majority of returns that accompany K-1s 

by computer, the cost to convert to e-filing may be marginal or nonexistent. 

If a paid preparer is using software that has e-filing capacity, then taxpayers 

can simply choose to use this option, which can entail a marginal cost 

increase. According to our survey of the software companies that offer efiling of partnership, trust, and S-Corp returns, all of the software 

25 These figures are subject to sampling error. We are 95 percent confident that the 

percentages exceed the values shown.

26 IRS reviewed a nonprojectable sample of tax year 2000 partnership and trust returns from 

the Austin Service Center.
Page 23 GAO-04-1040 Schedule K-1 Matching Program

companies that disclosed their fees (about half of those we contacted) 

either charge from $0.30 to $0.90 per e-filed K-1 or include the option to efile in the price of the software. In order to e-file, flow-through entities 

have to buy the software and e-file the entire flow-through entity return, at 

costs that vary from $3.50 per return to over $15,000 for comprehensive 

support for partnership returns, corporate income tax returns, and 

affiliated forms. For partnerships, if the paid preparer does not use 

software with e-filing capacity and the data are formatted according to 

IRS’s specifications, paid preparers can send the partnership return 

electronically to a software company that will then electronically transmit 

the partnership return. One software company stated that it would 

generally charge $0.40 per K-1. 

IRS and Congress Are 

Considering Increasing EFiling

According to IRS officials, IRS is considering mandating increased e-filing 

of information and tax returns, including those of flow-through entities. In 

recent reports, TIGTA has recommended that IRS should work with the 

Department of the Treasury to mandate increased e-filing of flow-through 

entity returns, either through current regulatory provisions or through 

legislative action.27 As a result, IRS is currently studying the possibility of 

increasing mandated e-filing of flow-through entities’ returns with 

accompanying K-1s under Internal Revenue Code (I.R.C.) Section 6011 as 

part of an agencywide initiative to increase e-filing to meet a 

congressionally mandated goal of having at least 80 percent of all tax and 

information returns filed electronically by 2007.28 IRS’s study includes the 

cost for taxpayers to convert from paper filing to e-filing, the cost for IRS to 

initiate and administer increased mandated e-filing, the perspective of the 

paid tax preparer and business communities, and how to implement 

increased mandated e-filing. In addition, according to IRS officials, IRS is 

also considering mandating e-filing for those returns for which IRS has 

complete e-filing capacity.

27 Treasury Inspector General for Tax Administration, The Internal Revenue Service Could 

Reduce the Number of Unnecessary Notices Sent to Taxpayers Regarding Unreported 

Income From Schedule K-1 and New Regulations Are Needed to Take Full Advantage of the 

Opportunities Offered by Filing Large Corporate Income Tax Returns Electronically.

28 The TIGTA report noted that although there are restrictions under current law prohibiting 

IRS from requiring individuals, estates, or trusts to file electronically, there are no 

restrictions against IRS requiring through regulations that corporate and other types of 

returns be filed electronically.
Page 24 GAO-04-1040 Schedule K-1 Matching Program

In addition, Congress is currently considering the Tax Administration Good 

Government Act of 2004,29 which would permit IRS to mandate increasing 

e-filing of flow-through entity returns and accompanying forms, such as K1s, in two new ways. First, the law would remove the present restrictions in 

I.R.C. Section 6011 that prevent IRS from mandating individuals, estates, 

and trusts to e-file. Since the law would remove the restriction on 

mandating e-filing of individuals, IRS would then be able to mandate efiling by paid preparers that prepare individual tax returns. Second, the law 

would lower the threshold at which IRS could mandate e-filing of 

information and tax returns for any taxpayer to 5 returns. Currently, the 

threshold is 250 returns. Thus, IRS could mandate e-filing by paid preparers 

who file 5 or more flow-through entity returns or individual tax returns.

Conclusions Although there are some costs to taxpayers to e-file and to IRS in 

processing e-filed flow-through entity returns and related K-1s, in general efiled K-1s offer substantial advantages for both IRS and taxpayers. We are 

not making a recommendation for further action to expand e-filing of flow 

through-entities’ returns, including K-1s, because IRS agreed to take steps 

to do so pursuant to a TIGTA recommendation and is currently studying the 

costs of increasing e-filing to IRS and taxpayers. One step, upgrading its 

overall capability to accommodate an increase in e-filed flow-through 

entity returns, including K-1s, is under way. However, we are concerned 

that IRS’s estimated date for having this capacity has been pushed back to 

2007 due to limited resources. The sooner this can be accomplished, the 

sooner IRS can reap the potential benefits of an increase in e-filed Schedule 

K-1s while moving closer to achieving the congressionally mandated goal of 

having 80 percent of all federal tax returns and information returns filed 

electronically by 2007. 

Regardless of whether e-filing is expanded, IRS is missing an opportunity to 

improve the accuracy of TINs associated with K-1s and thereby is 

undermining the benefits that can be realized from its document-matching 

program, efficient targeting of examination resources, and new research to 

identify noncompliance. Although IRS officials expressed concern about 

the possible burden on flow-through entities of dealing with TIN error 

notices and about IRS’s ability to deal with the costs of sending such 

notices given its resource constraints, IRS does not have information on 

29 H.R.1528.
Page 25 GAO-04-1040 Schedule K-1 Matching Program

the likely benefits and costs of sending TIN error notices to flow-through 

entities. Given the high concentration of TIN errors among a small portion 

of flow-through entities, even if costs are high compared to the benefits of 

sending notices to some flow-through entities, the situation may be much 

different for error-prone flow-through entities.

Recommendation for 

Executive Action

To improve the availability and usefulness of Schedule K-1 data to IRS for 

detecting noncompliance, we recommend that IRS conduct a pilot study to 

determine the benefits and costs of requiring flow-through entities to 

correct invalid TINs on K-1s as soon as it has been determined that the 

TINs cannot be “perfected” via IRS’s TIN validation program. 

Agency Comments and 

Our Evaluation

We received written comments on a draft of this report from the 

Commissioner of Internal Revenue, which are reprinted in appendix II. The 

Commissioner agreed with our assessment of Schedule K-1 TIN accuracy 

and that a pilot project would be useful in identifying ways to improve TIN 

accuracy. He said that IRS plans to study a number of options to ensure 

that TINs included on Schedule K-1s are accurate, including our 

recommendation that IRS conduct a pilot study to determine the benefits 

and costs of obtaining corrected TINs from flow-through entities. The 

Commissioner said that IRS’s Flow-Through Compliance Committee 

recently initiated a project to study invalid TINs on Schedule K-1s to 

determine their potential compliance impact. In addition, he also 

mentioned other initiatives, such as form redesign, outreach efforts, and 

scanning Schedule K-1s, to improve the overall effectiveness of flowthrough compliance efforts.

As agreed with your offices, unless you publicly announce its contents 

earlier, we plan no further distribution of this report until 30 days after its 

date. At that time, we will send copies to the Chairman and Ranking 

Minority Member, House Committee on Ways and Means, and the Chairman 

and Ranking Minority Member, Subcommittee on Oversight, House 

Committee on Ways and Means. We will also send copies to the Secretary 

of the Treasury, the Commissioner of Internal Revenue, and other 

interested parties. The report will also be available at no charge on GAO’s 

Web site at http://www.gao.gov.
Page 26 GAO-04-1040 Schedule K-1 Matching Program

If you have any questions concerning this report, please contact me at (202) 

512-9110 or brostekm@gao.gov or Jonda Van Pelt at (415) 904-2186 or 

vanpeltj@gao.gov. Key contributors to this report were Ralph Block, Maya 

Chakko, Keira Dembowski, Elizabeth Fan, Robert McKay, and Samuel 

Scrutchins.

Michael Brostek

Director, Tax Issues
Page 27 GAO-04-1040 Schedule K-1 Matching Program

Appendix I

Objectives, Scope, and Methodology ApApenednxidexiIs

Our objectives were to (1) evaluate the accuracy of K-1 data used by the 

Internal Revenue Service (IRS), specifically transcription errors and invalid 

taxpayer identification numbers (TIN); (2) determine whether any 

limitations in the availability or accuracy of K-1 data have affected IRS’s 

ability to identify noncompliance; and (3) describe the benefits and 

challenges of increasing electronic filing of K-1s.

To evaluate the accuracy of K-1 data used by IRS, we requested, obtained, 

and analyzed data from IRS’s K-1 database for tax year 2002.1

 We examined 

two versions of the database, both of which had been modified from the 

original K-1 database by IRS research analysts. One, called the K-1 

“cleaned database,” has original K-1s removed when possible where 

duplicate or amended K-1s for the same taxpayer were subsequently 

submitted by the parent flow-through entity. The second, called the 

“money-cleaned database,” also has all amounts that were obvious 

transcription errors removed. Generally, these were amounts in excess of 

$900 million and that exceeded the total amount reported on the parent 

flow-through entity’s Schedule K for the particular line item. We used the 

“cleaned database” to identify one such transcription error.

We analyzed the “money-cleaned” database to identify the number of K-1s 

that were filed with inaccurate TINs by type of flow-through entity 

(partnership, subchapter S corporation (S-Corp), or trust) and by type of 

submission (e-filed versus paper filed). We subsequently analyzed this 

subset of K-1s to determine the number and total income of K-1s with 

invalid TINs that IRS (1) was able to perfect via its TIN Perfection Program 

and (2) could not perfect and thus remained invalid and, in effect, unusable 

for compliance or research purposes. Because specific data were 

unavailable from the K-1 database concerning transcription errors, we 

conferred with IRS analysts to identify the type of transcription errors 

found during K-1 product reviews they conducted from July through 

November 2003.

To identify whether any limitations in the availability or accuracy of K-1 

data have affected IRS’s ability to identify noncompliance, we obtained 

from IRS the line items the agency transcribes from the K-1 and related 

flow-through entity returns. When we calculated the percentage of line 

items transcribed from the entity return, we included the K-1 as part of the 

1

 At the time of our review, tax year 2002 was the most recent year for which complete K-1 

data was available from IRS. 
Appendix I

Objectives, Scope, and Methodology

Page 28 GAO-04-1040 Schedule K-1 Matching Program

return. To count line items, we included all labeled lines and sub lines, but 

excluded certain fields, including calendar or tax year, name and address, 

supplemental information/attachments, signature and date, preparer’s 

signature and date, preparer’s self-employment, and preparer’s firm name 

and address.

We also interviewed IRS examination and research staff, as well as outside 

research consultants from the MITRE Corporation, with whom IRS 

contracted to analyze flow-through entities. Specifically, we discussed how 

IRS currently uses K-1 data to select flow-through entity returns for 

examination, how IRS research staff and research consultants are using K-1 

data to develop analytical tools to aid IRS in better targeting returns for 

examination, and how data limitations affect their ability to effectively use 

K-1 information. 

To determine the compliance issues IRS identified and the related line 

items that were adjusted, we reviewed a stratified probability sample of 

partnership and S-Corp tax returns. We selected these returns from the 

population of 253 partnership and 1,121 S-Corp agreed closed examination 

cases listed in the IRS Audit Information Management System 2002 Closed 

Case database with tax years ending in 2000 or 2001. We reviewed a sample 

of 107 returns of which 91 returns, consisting of 52 of the partnership and 

39 of the S-Corp returns, could be analyzed. The remaining 16 returns 

could not be analyzed, generally because the examination workpapers 

were not available or the case adjustments were based on unusual 

circumstances, such as amended return submissions from taxpayers. We 

used this sample of 91 returns to estimate several characteristics2

 of this 

population of all 1,374 agreed partnership and S-Corp cases. 

Because these estimates are based on a probability sample, our sample is 

only one of a large number of samples that we might have drawn. Since 

each sample could have provided different estimates, we express our 

confidence in the precision of our particular sample’s results as a one-sided 

95 percent confidence interval. For example, paid preparers prepared an 

estimated 93 percent of the returns, and a one-sided 95 percent confidence 

interval for this estimate has a lower bound of 84 percent. Since the actual 

population value would be contained in this interval for 95 percent of the 

2

 These estimates are the percentage of returns with adjusted line items not currently 

transcribed, percentage of paid preparer prepared returns, and percentage of computergenerated returns.
Appendix I

Objectives, Scope, and Methodology

Page 29 GAO-04-1040 Schedule K-1 Matching Program

samples we could have drawn, we are 95 percent confident that the 

proportion of paid preparer returns in the study population exceeds 84 

percent. Similarly, for the adjusted lines found in the file review, we are 95 

percent confident that adjustments made to nontranscribed line items 

occur in at least 40 percent of the examinations.

We subsequently discussed our file review findings with IRS research and 

examination staff to obtain their views regarding whether having additional 

K-1 data available, such as line items not currently transcribed, would 

increase their ability to identify returns with compliance issues. 

To describe the benefits and challenges of increasing e-filing of K-1s, we 

discussed this issue with IRS officials and officials from seven 

organizations that represent the taxpayer community. We selected the 

organizations based on prior GAO knowledge and referrals from some of 

the organizations that we contacted. From IRS officials, we obtained 

estimates of the cost to transcribe K-1 information, to help identify the 

potential cost savings if K-1s were e-filed. We also discussed IRS’s current 

requirements for mandating e-filing K-1s and IRS’s experience in enforcing 

these requirements, and obtained data on penalties levied for failure to efile required K-1s. Finally, we discussed IRS’s current and future ability to 

electronically process an increase in the number of e-filed flow-through 

entity returns, including K-1s. We also contacted all 19 of the software 

companies that offer e-filing for flow-through entities and received e-mail 

responses from just over half of the companies. From officials with the 

software companies, we obtained their current fees for preparing and efiling flow-through entity returns and K-1s.

To determine how many flow-through entities filed on a calendar year basis 

we used the 2001 Partnership and Corporation Statistics of Income (SOI) 

samples.3

 The SOI partnership data we used included the entire sample, 

but the SOI corporation data we used were limited to the flow-through SCorps. Because these are probability samples, the SOI estimates are 

subject to sampling error. We produced estimates from these samples 

using SOI’s sampling weights and methods that are appropriate for 

stratified probability samples. In this report we present these estimates as 

3

 SOI last published information for estate and trust returns for tax year 1997.
Appendix I

Objectives, Scope, and Methodology

Page 30 GAO-04-1040 Schedule K-1 Matching Program

intervals, reporting the lower bound on one-sided 95 percent confidence 

intervals.4

We did our work at IRS headquarters in Washington, D.C., as well as at the 

Ogden, Utah, Processing Center and the Oakland, California, Area Office 

from April 2003 through July 2004 in accordance with generally accepted 

government auditing standards.

Data Reliability We assessed whether the information contained in the K-1 databases, the 

two SOI databases, and the Audit Information Management System (AIMS) 

database were sufficiently reliable for the purposes of this report. We 

ensured that the copies of all five databases we received from IRS were 

identical to the original databases based on record counts and analyses of 

control totals, comparison to published data, or both. In addition, we 

performed electronic tests on the each database to search for missing data 

and obvious errors.

For the original K-1 database from which the two cleaned versions we used 

originated, we assessed IRS’s procedures for processing and transcribing 

Schedule K-1 data. We also assessed other procedures and methodologies 

IRS research analysts used to remove duplicate records and obvious errors 

from transcribed monetary fields. We anticipated the K-1 database would 

have some reliability issues because our engagement was designed in part 

to assess the sufficiency of the data transcription effort. While large 

monetary transcription errors were removed from the “money-cleaned” 

database, additional, undetectable transcription errors of amounts within 

normal ranges may remain.

For the AIMS 2002 Closed Case database, we relied exclusively on 

variables that allowed us to identify agreed closed case partnerships and SCorps, as this was the population of cases from which we drew our sample. 

We interviewed IRS personnel who manage the AIMS databases and found 

that groups in IRS conducting examinations are required to validate 

annually that completed examination cases are actually shown as having 

been closed. In addition, we collected data from original returns during our 

data collection effort and compared those data to data contained in the 

4

 Additional information regarding the IRS’s SOI program and its stratified probability 

samples is available on the Internet at www.irs.gov/taxstats/.
Appendix I

Objectives, Scope, and Methodology

Page 31 GAO-04-1040 Schedule K-1 Matching Program

AIMS database. We found no indication that our sample contained 

ineligible cases.

SOI samples are widely used for research purposes. We have documented 

for recent reports5

 that IRS performs a number of quality control steps to 

verify the internal consistency and completeness of SOI sample data. The 

agency uses similar quality control procedures for all types of SOI samples. 

For example, the agency performs electronic tests to verify the 

relationships between values on the returns selected as part of the SOI 

samples and manually edits data items to correct for problems, such as 

inaccurate and missing items. Because we used the partnership and 

corporate samples only to determine the percentage of partnerships and SCorps that were calendar year filers, we needed no more than four 

variables from each database to make this analysis. We checked these 

variables for completeness and accuracy and found no missing or out of 

range values.

On the basis of our data reliability reviews of the five IRS databases, we 

believe all five contain data that are sufficiently reliable for the purposes of 

this report. 

5

 GAO, Tax Administration: Comparison of the Reported Tax Liabilities of Foreign- and 

U.S.-Controlled Corporations, 1996-2000, GAO-04-358 (Washington, D.C.: Feb. 27, 2004). 

GAO, International Taxation: Tax Haven Companies Were More Likely to Have a Tax Cost 

Advantage in Federal Contracting, GAO-04-856 (Washington, D.C.: June 30, 2004).
Page 32 GAO-04-1040 Schedule K-1 Matching Program

Appendix II

Comments from the Internal Revenue Service ApendxiI
Appendix II

Comments from the Internal Revenue Service

(440139) Page 33 GAO-04-1040 Schedule K-1 Matching Program
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