Real Estate Tax Deduction: Taxpayers Face Challenges in Determining What Qualifies; Better Information Could Improve Compliance
Published: 2009-05-13T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: 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.
section_title: What GAO Found
paragraphs: 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.

section_title: Letter
paragraphs: Voluntary compliance with federal tax laws is a critical component of the  federal tax system. Each year, however, a gap arises between tax amounts  that were voluntarily reported and paid on time and those that should have  been paid. The Internal Revenue Service’s (IRS) most recent estimate is  that the gross federal tax gap for tax year 2001 was $345 billion.
In 2006, the Joint Committee on Taxation identified overstated real-estate  tax deductions as a potential area of taxpayer noncompliance that could  be improved to reduce the tax gap, referencing our 1993 report in which  we had determined that taxpayers may have overstated the federal income  tax deductions they claimed for real-estate taxes. In our 1993 report, we  stated that two reasons for noncompliance were: (1) real-estate tax bills  that did not distinguish between deductible taxes and nondeductible user  fees; and (2) inadequate IRS education and enforcement activities with  respect to the deduction for real-estate taxes.
In 2006, individuals’ federal deductions of real-estate taxes amounted to  about $156 billion. Because of your interest in the extent, if any, to which  individual taxpayers may have overstated their federal income tax  deduction for real-estate tax payments by including nondeductible real- estate-related charges and the reasons for any overstated deductions, you  asked that we do the following:    Describe factors that contribute to the inclusion of nondeductible charges  in real-estate tax deductions.
Describe the extent that taxpayers may be overstating real-estate tax  deductions by including nondeductible charges.
Describe the extent that IRS examinations of real-estate tax deductions  focus on the inclusion of nondeductible charges.
Assess possible options for improving voluntary taxpayer compliance with  the real-estate tax deduction.
subsections: section_title: Background
paragraphs: Real-estate taxes in the United States are levied by a number of different  taxing authorities, including state and local governments, but mostly by  local governments. Local governments, such as counties, can levy and  collect taxes on behalf of smaller jurisdictions within their boundaries. For  example, a county could collect real-estate taxes on behalf of a city within  the county. In 2006, local-government property tax revenue was about  $347 billion, compared to about $12 billion for state-government property  tax revenue. Local governments can use property tax revenues to fund  local services, such as road maintenance and law enforcement. In 2006,  property taxes made up an average of 45 percent of general own-source  revenue for local governments nationwide.
According to the Congressional Research Service, the real-estate tax  deduction was the most frequently itemized federal income tax deduction  claimed by individual taxpayers from 1998 through 2006; the deduction  was claimed on approximately 31 percent of all individual tax returns, and  on about 87 percent of all returns with itemized deductions. The real- estate tax deduction provides a benefit to homeowners and also provides  an indirect federal subsidy to local governments that levy this and other  deductible taxes, since it decreases the net cost of the tax to taxpayers.  Deductible real-estate taxes also may encourage local governments to  impose higher taxes, which may allow them to provide more services than  they otherwise would without the deduction. In 2006, individual taxpayers  claimed about $156 billion in real-estate taxes as an itemized deduction.  By allowing taxpayers to deduct qualified real-estate taxes, the federal  government forfeits tax revenues that it could otherwise collect.
Taxpayers can claim paid real-estate taxes as an itemized deduction on  Schedule A of the federal income tax return for individuals. In addition,  the Housing and Recovery Act signed July 30, 2008, included a provision  that allowed non-itemizers to deduct up to $500 ($1,000 for joint filers) in  real-estate taxes paid for tax year 2008. Taxpayers can also deduct paid  real-estate taxes on other parts of the tax return, including as part of a  deduction for a home office or in calculating net income from rental  properties. For purposes of this report, references to the real-estate tax  deduction mean the itemized deduction on Schedule A.
Taxpayers may deduct state, local, and foreign real-property taxes from  their federal tax returns if certain conditions are met. Taxpayers may  only deduct real-estate property taxes paid or accrued in the taxable  year. To be deductible, real-estate taxes must be imposed on an interest  in real property. Taxes based on the value of property are known as ad  valorem. Further, real-estate taxes are only deductible when they are  levied for the general public welfare by the proper taxing authority at a  like rate against all property in the jurisdiction. Real-estate-related  charges for services are not deductible. Examples of such charges for  services include unit fees for water usage or trash collection. In addition,  taxpayers may not deduct taxes assessed against local benefits of a kind  tending to increase the value of their property. Such local benefit taxes  include assessments for streets, sidewalks, and similar improvements.  However, local benefit taxes can be deductible if they are for the purpose  of maintenance and repair of such benefits or related interest charges.
IRS estimates that on income tax returns for 2001, all overstated  deductions taken together resulted in $14 billion in tax loss. IRS estimated  the amount of misreporting of deductions, but did not estimate the  resulting tax loss for each deduction. However, according to data from  IRS’s National Research Program, which is designed to measure individual  taxpayer reporting compliance, in 2001 about 5.5 million taxpayers  overstated their real-estate tax deductions, which resulted in a total  overstatement of about $5.0 billion. The median overstatement was $436,  or about 23 percent of the median claimed deduction amount of $1,915.  We estimate that 38.8 million taxpayers claimed this deduction in 2001.  While about 5.5 million taxpayers overstated their deductions, about 3.3  million understated their deductions. Taken as a whole, about 8.8 million  taxpayers on average overstated their deductions by about $85 each,  which resulted in a net total overstatement of about $2.5 billion.
Taxpayers can overstate or understate their real-estate tax deductions in a  number of ways. For example, they can overstate their deduction by not  meeting such eligibility requirements as property ownership and payment  during the tax year, or by inappropriately deducting the same taxes on  multiple parts of the income tax return. Taxpayers can also overstate by  claiming such real-estate tax-related amounts as local benefit taxes and  itemized charges for services, which, as noted earlier, are not deductible.  Taxpayers can also understate their real-estate deduction. For example,  first-time homeowners may understate this deduction because they are not  aware that they are entitled to claim it. Similarly, taxpayers who buy and  sell a home in the same year could understate this deduction out of  confusion over how much in taxes they can deduct for the old and new  homes.
Our 1993 report found that a majority of the local real-estate tax bills that  we reviewed included nondeductible items, such as service charges, in  addition to deductible real-estate taxes. Our report also indicated that  local governments had increased their use of service charges in reaction to  events that had reduced their revenues, such as local laws that restricted  growth in real-estate taxes. By increasing user fees to finance services,  local governments could keep their tax rates lower. We also reported that  some local jurisdictions did not clearly indicate nondeductible items on  real-estate tax bills and combined all types of payments (e.g., deductible  and nondeductible real-estate taxes) into a total amount, which may lead  taxpayers to claim this total amount on the bill as deductible and thereby  overstate their deduction.
Most taxpayers rely upon either paid preparers or tax software to file their  tax returns. Recent estimates indicate that about 75 percent of taxpayers  used either a paid preparer (59 percent) or tax software (16 percent) to file  their 2007 taxes. Any evaluation of the factors that contribute to  taxpayers overstating the real-estate tax deduction would need to take  paid preparers and tax software into consideration.
section_title: Scope and Methodology
paragraphs: To describe factors that contribute to the inclusion of nondeductible  charges in real-estate tax deductions, we conducted a number of analyses  and spoke with various external stakeholders, as follows.
To determine what information local governments report on real-estate  tax bills relating to federal deductibility, we surveyed a generalizable  sample of over 1,700 local governments. We also reviewed about 500  local-government real-estate tax bills provided to us by survey  respondents. We also interviewed officials with organizations  representing local governments, including the National Association of  Counties; the National Association of County Collectors, Treasurers, and  Financial Officers; and the Government Finance Officers Association. To  determine what mortgage servicers report on mortgage documents, we  interviewed representatives from the mortgage industry from the  Consumer Mortgage Coalition, the Mortgage Bankers Association, and the  three largest mortgage servicing companies in 2007.
We reviewed three IRS publications for tax year 2007 that provide  guidance to individual taxpayers claiming the real-estate tax deduction as  an itemized deduction on their federal income tax returns: the instructions  for IRS Form 1040, Schedule A, the form and schedule where taxpayers  can deduct real-estate taxes and other items from their taxable income;  IRS Publication 17, which provides information for individuals on general  rules for filing a federal income tax return; and IRS Publication 530, a  guide for homeowners. We checked whether each of these publications  explained the factors that taxpayers need to consider in determining  deductibility and guided taxpayers on where they could obtain additional  information necessary for determining deductibility.
To determine the extent that tax-preparation software and paid  professional tax preparers assisted taxpayers in only claiming deductible  real-estate taxes, we reviewed online software versions of the three largest  tax-preparation software programs in 2008—TaxAct, TaxCut, and  TurboTax—and interviewed representatives from those three companies  and representatives from the National Association of Enrolled Agents.
We used the results of our survey of over 1,700 governments to determine  the extent to which local governments send real-estate tax bills with  certain generally nondeductible charges. To get an indication of the extent  to which taxpayers may be overstating their real-estate tax deductions by  including such nondeductible charges, we conducted case studies on five  large local governments, collecting and analyzing tax data from them and  IRS. Specifically, we worked with IRS to determine which charges on the  five local governments’ tax bills were likely deductible. While conducting  these five case studies of taxpayer noncompliance in claiming the real- estate tax deduction, we identified challenges in determining what charges  qualify as deductible real-estate taxes. Then, to the extent possible, for two  jurisdictions we compared the amounts that were likely deductible to the  amounts the taxpayers claimed as deductions on Schedule A of their 2006  federal tax returns. Appendix III provides details on the methodology for  this case study, including jurisdiction selection.
To describe the extent that IRS examinations of the real-estate tax  deduction focus on potential overstatements due to taxpayer inclusion of  nondeductible charges, we reviewed IRS guidance for examiners related  to the real-estate tax deduction, and interviewed IRS examiners about the  standard procedures and methods they use for auditing this deduction. We  reviewed guidance in the Internal Revenue Manual, which serves as the  handbook for IRS examiners, to determine how clearly it instructs  examiners to verify the deductibility of charges on real-estate bills when  auditing this deduction. Our interviews with IRS examiners focused on the  extent to which examiners determine the deductibility of charges on real- estate bills when auditing this deduction, challenges faced by examiners  auditing this deduction, and whether examiners have information about  local jurisdictions with large nondeductible charges on their real-estate tax  bills. The examiners we interviewed included examiners and managers  based in IRS offices across the United States.
To assess possible options for improving voluntary taxpayer compliance  with the real-estate tax deduction, we interviewed members of  organizations representing local governments and IRS officials about  potential options. We also identified potential options along with their  benefits and trade-offs based on our other work for this report.
We conducted this performance audit from October 2007 through May  2009, in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.
section_title: Taxpayers Face Challenges Determining What Real-Estate Taxes They Can Deduct for Their Federal Income Tax Returns
paragraphs: Local governments generally do not inform taxpayers what charges on  real-estate tax bills qualify as deductible real-estate taxes, which creates a  challenge for taxpayers attempting to determine what they can deduct.  Groups representing local governments told us that local governments do  not identify on real-estate tax bills which charges are deductible, and our  review of almost 500 real-estate tax bills supplied by local governments  supports this. In our review, we found no instances where the local  government indicated on the bill what amounts were deductible for  federal real-estate tax purposes. Furthermore, while IRS requires various  entities to provide information about relevant federal tax items to both  taxpayers and IRS on statements known as information returns, local  governments are not required to provide information returns on real-estate  taxes paid.
Local government groups told us that local governments do not identify  what taxes are deductible because they cannot easily determine whether  their charges meet federal deductibility requirements. They said that local  government tax collectors do not have the background or expertise to  determine what items are deductible according to federal income-tax law  and may lack information necessary for making such determinations for  charges billed on behalf of another taxing jurisdiction. As a result, local  governments did not want to make such determinations.
Taxpayers with mortgages may also receive information about real-estate  tax bill charges paid on their behalf by mortgage servicers, but this  information generally does not identify what taxes can be deducted. To  protect a mortgage holder’s interest in a mortgaged property, mortgage  servicers often collect funds from property owners whose mortgages they  service (borrowers) and hold them in escrow accounts. They then draw  from the funds to pay real-estate taxes and related charges on the  properties as they are due. Mortgage servicers provide borrowers with  annual statements summarizing these and other deposits and withdrawals  of escrow account funds. In addition, mortgage servicers have the option  of reporting such escrow payments on information returns relating to paid  mortgage interest, but can choose to report other information instead.
Mortgage industry representatives we spoke with stated that when  reporting escrow payments, mortgage servicers usually report the total  amount paid at any given time to local governments from escrow accounts  and do not itemize the specific types of charges paid for, regardless of the  statement used. As a result, any nondeductible charges paid for would be  embedded in this payment total and reported as “property taxes” or “real- estate taxes” on mortgage servicer documents, including IRS forms.
According to mortgage industry representatives, mortgage servicers only  report a total because most only track and receive information on the total  payment amount due. Mortgage servicers are interested in total amounts  because local governments can place a lien on a mortgaged property if all  billed charges are not paid. In addition, not all mortgage servicers receive  detailed information about charges. Our survey of local governments on  real-estate tax billing practices showed that an estimated 43 percent of  local governments provide mortgage companies with only total amounts  owed for requested properties.
That annual mortgage statements report only totals is significant because  not all property owners receive tax bills. Based on responses to our local  government survey, an estimated 25 percent of local governments do not  send property owners a copy of their tax bill if the taxpayer escrows their  taxes through a mortgage company. Even though real-estate tax bills do  not indicate what charges are deductible, tax bills can contain information  on the types of charges assessed on a property, which is a starting point  for taxpayers in determining what they can deduct.
subsections: section_title: Determining What Items Qualify as Deductible Real- Estate Taxes Can Be Complicated and Require Significant Effort
paragraphs: In the absence of information identifying deductible real-estate taxes,  determining whether certain amounts on the tax bills are deductible can  be complex and require significant effort. Taxpayers generally cannot be  assured that their real-estate tax bill has enough information to determine  which of the charges listed are deductible for federal purposes. Deductible  real-estate taxes are any state, local, or foreign taxes on real property  levied for the general public welfare by the proper taxing authority at a  like rate against all property in the jurisdiction. Charges for services and  charges for improvements tending to increase the value of one’s property  are generally not deductible.
However, even if a real-estate tax bill labels a charge as a “tax” or “for  services,” the designation given by a local government does not determine  whether a charge on a real-estate tax bill is deductible. For example, a  charge that is labeled a tax on a local real-estate tax bill, but is not used for  public or governmental purposes such as police or fire protection, likely  would not be deductible; whereas a charge that is labeled a fee could be  considered a deductible tax if the charge is imposed at a uniform rate  based on the value of the real estate and is used for the general public  welfare. Complicating the matter is that local benefit taxes, which are  generally not deductible, can be deductible if the revenue raised is used to  maintain or repair existing improvements. Figure 1 depicts some of the  questions that taxpayers need to be able to answer for each real-estate-tax- related charge they wish to deduct. Taxpayers who are unsure how to  answer these questions (as well as others) with respect to a given charge  cannot be assured of the charge’s deductibility.
Because determining what qualifies as deductible can be complex, we  asked IRS’s Office of Chief Counsel to help us determine the deductibility  of amounts on tax bills in five large local governments as part of case  studies on taxpayer compliance with the real-estate tax deduction. We  asked attorneys in IRS’s Office of Chief Counsel what information they  would need to determine whether charges that appear on real-estate tax  bills in the jurisdictions were deductible. IRS’s Office of Chief Counsel  indicated that it would need information on the questions indicated in  figure 2.
To provide IRS with this information, we searched local government Web  sites for information on each charge that appeared on tax bills. We also  interviewed local government officials, collected and analyzed additional  documentation related to the charges, and identified sections of local  statutes that provided the authority to impose the charges on the local tax  bills. We summarized this information in summary documents that totaled  over 120 pages across the five selected local governments.
Despite this level of effort, the information was not sufficient to allow IRS  to make a judgment as to the deductibility of all of the charges in the five  selected jurisdictions. While local government officials we spoke with  provided us with significant support in our research, some of the  information we asked for was either unavailable or impractical to obtain  due to format or volume. The main challenge we faced was that each of  the five local governments had over 100 taxing districts—cities, townships,  school districts, special districts, etc.—and gathering detailed information  for each district, such as how each district calculates the rate it charges,  was difficult and time-consuming. As a result, IRS attorneys were not able  to make determinations on some charges in three of the five jurisdictions.
Because individual real-estate tax bills in these jurisdictions would likely  include only a subset of the amounts we researched, taxpayers in these  jurisdictions would not necessarily need to apply the same total level of  effort that we did. However, they would still face similar challenges in  determining whether the amounts on their tax bills qualified as deductible.  For example, one county official told us that not all charges are itemized  on their tax bills and as a result, it is nearly impossible for a taxpayer in  her county to find out the nature and purpose of those charges for which  they are assessed.
section_title: Taxpayer Guidance for Deducting Real-Estate Taxes Explains What Taxpayers Can Deduct, but Does Not Direct Taxpayers to Consult Appropriate Resources to Determine Deductibility
paragraphs: IRS instructions and guidance for taxpayers on claiming the real-estate tax  deduction explain generally what taxpayers can deduct, but lack more  specific information on how to comply. IRS instructions for claiming the  real-estate tax deduction on the federal income-tax return for individuals  explain that real-estate taxes are deductible if they are based on the value  of property, they are assessed uniformly on property throughout the  jurisdiction, and proceeds are used for general governmental purposes.  The instructions also indicate that per-unit charges for services and  charges for improvements that tend to increase the value of one’s property  are generally not deductible. The IRS general guide for individuals filing an  income tax return and the IRS guide for first-time homeowners similarly  explain what taxpayers can deduct, and also provide examples of  nondeductible charges for services and local benefit taxes.
However, these three IRS publications do not inform taxpayers that they  should check both real-estate tax bills and available local government  resources with information about the nature and purpose of specific  charges. While the two IRS guides alert taxpayers that they should check  real-estate taxes bills, IRS’s instructions for deducting real-estate taxes are  silent on what taxpayers need to check. None of the publications inform  taxpayers that they may also need to consult local government Web sites,  pamphlets, or other available documents with information about the  nature and purpose of specific charges to determine what amounts qualify  as deductible real-estate taxes. Without specific instruction to do  otherwise, taxpayers could believe that they are getting deductible  amounts from their mortgage servicer.
Searching for more information may not be conclusive for all charges, but  may be sufficient for determining the deductibility of many charges, as we  found while examining charges in five local governments with IRS.  Similarly, even though some taxpayers may be unable to determine the  deductibility of a few charges on their tax bills after consulting available  local government resources, they likely need such information on other  charges to comply with requirements of the real-estate tax deduction.  Taxpayers need to know that they may need to consult available local  government resources because more information may be required before  they can determine which charges they can deduct from their tax bill.
section_title: Tax-Preparation Software and Paid Tax Preparer Assistance May Not Be Sufficient to Help Ensure That Taxpayers Only Deduct Qualified Real- Estate Taxes
paragraphs: Tax-preparation software and assistance provided by paid tax preparers  may not be sufficient to help ensure that taxpayers only deduct qualified  real-estate taxes. At the time of our review, two of the three most  frequently used tax-preparation software programs for 2008—TaxAct,  TaxCut, and TurboTax—did not alert taxpayers to the fact that not all  charges on real-estate tax bills may qualify as deductible real-estate  taxes. The sections of these two programs where users entered real- estate taxes paid lacked an alert informing users that not all charges that  appear on a real-estate tax bill may qualify as deductible real-estate taxes.  While all three of the programs contained information about what  qualified as deductible real-estate taxes in various screens, users had to  proactively click on buttons to access these sections to learn that some  charges on their tax bill may not have been deductible.
One software-program representative indicated that alerts need to be  carefully tailored to have the intended effect. He cautioned that too much  information can actually have undesirable effects that do not lead to  improved compliance. Specifically, to the extent that they are not relevant  to taxpayers whose bills do not contain nondeductible items, overly broad  or irrelevant alerts can result in taxpayers reading less, thereby creating  confusion, causing errors to be made, and unnecessarily increasing  taxpayer burden by increasing the time and complexity involved in  taxpayers preparing their returns.
Nevertheless, software-program representatives we spoke with were  receptive to potential improvements that could be made to their software  programs. Prior to our review, none of the three largest software programs  contained an alert informing users that not all items on real-estate tax bills  may be deductible. In addition, one of the three programs did not discuss  the fact that deductible real-estate taxes are based on the assessed value  of property and that charges for services and local benefit taxes are  generally not deductible. In response to our discussions with them on  these issues, all three tax software programs made changes to their  programs. One program added an alert to users indicating that not all  charges on real-estate tax bills may be deductible and the other two  programs added information about what qualifies as real-estate taxes or  made such information more prominent in the guidance accessible from  their sections on real-estate taxes.
Paid preparers we spoke with indicated that they invested only limited  time and energy making sure that taxpayers included only qualified real- estate taxes in their deductions. Most taxpayers do not understand that  some charges assessed against a property may not be deductible, and  often only provide preparers with mortgage interest statements or  cancelled checks to local governments that contain only total payment  amounts, making it difficult for the preparers to identify potentially  nondeductible charges. Some preparers indicated that from their  experience such charges are relatively small, and may have negligible  impacts on a taxpayer’s tax liability, especially after other parts of the tax  return are considered. As a result, even if they thought that clients may be  claiming nondeductible charges, they often did not consider identifying  such charges to be worth the effort. The paid preparers that we spoke with  also indicated that more information from local governments or IRS on  what taxes are deductible would be helpful in improving taxpayer  compliance with the deduction.
section_title: Many Bills Contain Generally Nondeductible Charges, and Taxpayers in Two Jurisdictions Likely Overstated Their Deductions, but the Full Extent of Overstatement Is Unknown
paragraphs: As mentioned earlier, deductible real-estate taxes are generally ad  valorem or based on the assessed value of property. We used the ad- valorem/non-ad-valorem distinction as a rough proxy to indicate potential  deductibility in our survey of local governments’ real-estate billing  practices. The ad-valorem/non-ad-valorem distinction is not a perfect  indicator of deductibility, since, under certain circumstances, some ad- valorem charges could be nondeductible and some non-ad-valorem  charges could be deductible. However, based on the information we  provided, IRS’s Office of Chief Counsel determined that all non-ad- valorem charges in our case study jurisdictions were not deductible.
We estimate that almost half of local governments nationwide included  charges on their real-estate tax bills that were generally not deductible,  based on responses to our survey. We surveyed a sample of over 1,700  local governments identified as collecting real-estate taxes and asked them  whether their real-estate tax bills included non-ad-valorem charges, that  is, charges that are not based on the value of property and therefore  generally not deductible. Examples of such charges include fees for trash  and garbage pickup. Based on responses, we estimate that 45 percent of  local governments nationwide included such charges on their tax bills.  The property taxes collected by local governments with non-ad-valorem  charges on their bills represented an estimated 72 percent of the property  taxes collected by local governments nationwide.
Of the local governments surveyed that included non-ad-valorem charges  on their bills, only 22 percent reported that they label such charges as non- ad valorem. As a result, even if taxpayers owning real estate in the other  78 percent of these locations review their tax bills, they may not be able to  identify which charges, if any, are non-ad valorem and likely  nondeductible.
subsections: section_title: Full Extent of Overstated Real-Estate Taxes from Claiming Nondeductible Items Is Unknown Due to Data Limitations
paragraphs: In identifying how much taxpayers may have overstated real-estate tax  deductions from individual taxpayers claiming nondeductible charges, we  encountered data limitations that constrained our analysis and made it  impossible to develop nationwide estimates of these overstatements.  Some of the main limitations follow:    The jurisdictions we selected did not maintain their tax data in a way that  allowed us to itemize all of the charges on individuals’ tax bills. They also  did not always maintain information on those charges necessary for IRS  and us to determine deductibility. As a result, we were not able to account  for all potentially nondeductible ad-valorem charges. Similarly to the  approach we took in our survey of local governments, we categorized all  ad-valorem charges as deductible and all non-ad-valorem charges as  nondeductible in identifying how much taxpayers overstated their real- estate tax deductions.
The selected jurisdictions also did not track the real-estate tax liabilities  and payments by individuals’ Social Security number (SSN), which is the  unique identifier used in the IRS tax return data for each taxpayer.  Consequently, we used available information—name, address, and zip  code—to calculate for each taxpayer the total amount billed by the local  government and compare the amount billed to the amount claimed as a  real-estate tax deduction on Schedule A of the taxpayer’s return. This  process was very time- and resource-intensive.
We could not explicitly account for other income tax deductions or  adjustments to income that could influence the amount taxpayers are  eligible to claim on the Schedule A, such as the home-office deduction and  rental real-estate income. IRS did not have information readily available  on how much real-estate taxes taxpayers in our case-study jurisdictions  claimed as a home-office deduction, nor did it have information on the  locations of other rental real-estate properties owned by a taxpayer, which  could have been in multiple jurisdictions. We aimed to mitigate these  issues by only analyzing records where (1) the amount claimed in the IRS  data was roughly equivalent to the total amount billed to the taxpayer in  the local government data, or (2) the amount claimed was less than 15  percent greater than the total billed amount.
Because of these limitations, we were able to match only 42 percent of the  individuals (195,432 of 463,066) who itemized their real-estate tax  deductions on their tax returns to the data we received from two counties,  as table 1 shows (see app. III for a more detailed discussion of our  methodology). The counties—Alameda County, California and Hennepin  County, Minnesota—were among the largest taxing jurisdictions in the  United States that had non-ad-valorem charges, such as fees for services,  special assessments, and special district charges, on their real-estate tax  bills in 2006.
Table 2 shows that of the 195,423 matched taxpayer records in the two  counties, 56 percent, or 109,040 individuals had non-ad-valorem charges  on their local bills. However, over 99 percent of the Alameda County bills  had non-ad-valorem charges compared to only about 10 percent of the  Hennepin County bills.
section_title: Taxpayers in Two Jurisdictions Collectively May Have Overstated Millions of Dollars in Real- Estate Tax Deductions by Including Nondeductible Charges
paragraphs: Our analysis of the 109,040 individuals in the two counties who had non- ad-valorem charges on their bills that could be matched to IRS data  indicates that almost 42,000 (38.3 percent) collectively overstated their  real-estate tax deductions by at least $22.5 million (i.e., “very likely  overstated”) for tax year 2006. When one includes over 37,000 taxpayers  who had non-ad-valorem charges and overstated their deductions up to 15  percent greater than their total amounts billed in 2006 (i.e., “likely  overstated”) the amount of potential overstatement increases to $46.2  million. Table 3 summarizes the results on overstated deductions from  claiming nondeductible charges for the two counties.
While 72.4 percent of taxpayers (78,916 of 109,040) with non-ad-valorem  charges that we could match to tax returns overstated their real-estate tax  deduction, these overstated amounts on average only involved amounts in  the hundreds of dollars. According to our analysis, the median “very likely”  overstatement was $414 in Alameda County and $241 in Hennepin County.  The median “likely” overstatement was $493 for Alameda County and $179  for Hennepin County.
It is important to recognize that these overstated deduction amounts are  not the tax revenue loss. The tax revenue loss would be much less and  depend, in part, on the marginal tax rates of the individuals who  overstated their deductions as well as other factors that we did not have  the data or resources to model appropriately. Those factors would include  the amount of real-estate taxes and local-benefit taxes that should be  allocated to other schedules on the tax return and other attributes such as  the amount of refundable and nonrefundable credits. As a result, while  many taxpayers are erring in claiming nondeductible charges, the small  tax consequences of such overstatements may not justify the cost of IRS  enforcement efforts to pursue just these claims.
section_title: Examinations of Real- Estate Tax Deduction Focus on Other Noncompliance Rather Than on the Inclusion of Nondeductible Charges
paragraphs: IRS’s guidance to examiners does not require them to check  documentation to verify that the entire real-estate tax deduction amount  claimed on Schedule A of Form 1040 is deductible. Such documentation  would indicate whether taxpayers claim nondeductible charges. Rather,  IRS’s guidance gives examiners discretion on which documentation to  request from taxpayers to verify the real-estate tax deduction. Examiners  are authorized to request copies of real-estate tax bills, verification of legal  property ownership, copies of cancelled checks or receipts, copies of  settlement statements, and verification and an explanation for any special  assessments deducted. Because of the discretion in the guidance,  examiners are not required to request or examine each form of  documentation.
The guidance also does not direct examiners to look for all potentially  nondeductible charges in real-estate tax bills. Some IRS examiners we  interviewed considered Form 1098 for mortgage interest paid to be  appropriate documentation if the taxpayer failed to provide a real-estate  tax bill because this form could demonstrate that the taxpayer paid the  taxes through an escrow account set up with the mortgage company.  However, as noted earlier, Form 1098 shows payments to local  governments for all real-estate tax-related charges billed, including any  nondeductible charges. In other words, Form 1098 does not conclusively  demonstrate deductibility.
Rather than focusing on the nature of charges claimed, IRS examinations  of real-estate tax deductions focus on other issues, such as evidence that  the taxpayer actually owned the property and paid the real-estate taxes  claimed during the year in question. IRS examiners told us that they focus  on proof of ownership and payment because, in their experience, taxpayer  noncompliance with these requirements could result in larger  overstatements. For example, a taxpayer residing in the home owned by  his or her parent(s) could incorrectly claim the real-estate tax deduction  for the property. It is also common for first-time homebuyers to  improperly claim the full amount of real-estate taxes paid for the tax year,  even though the seller had paid a portion of these taxes.
Examinations of the real-estate tax deduction usually take place as part of  a broader examination of inconsistent claims across the individual tax  return. In examining deductions on the Schedule A, IRS examiners have  found cases in which some taxpayers incorrectly include real-estate taxes  as personal-property taxes on Schedule A, sometimes deducting the same  tax charges as both personal-property taxes and real-estate taxes.  Furthermore, IRS examiners might find claims on other parts of the return  that prompt them to check the real-estate tax claimed on Schedule A, or  find overstated real-estate tax deductions on Schedule A that indicate  noncompliance elsewhere on the return. For instance, a taxpayer might  claim the real-estate tax deduction for multiple properties on Schedule A,  but fail to report any rental income earned from these properties on the  Schedule E form, which is used to report income or loss from rental  income. Also, a taxpayer might claim the total amount of real-estate  taxes paid on Schedule A, but improperly claim these taxes again as part  of the business expense deductions on the Schedule E or Schedule C  forms, or both. IRS guidance instructs taxpayers to deduct only real- estate taxes paid for their private residences on Schedule A, and to dedu any real-estate taxes paid on rental properties on Schedule E. If taxpaye use a part of their private residence as the principal place for conducting  business, they should divide the total real-estate taxes paid on the  property accordingly, with the portion of real-estate taxes paid for the  business deducted on Schedule C.
As noted earlier, the format and the level of detail about charges on local  real-estate bills vary greatly across local governments. IRS examiners told  us that they do not focus on the deductibility of most real-estate charges  when auditing real-estate tax deductions because determining  deductibility from looking at such bills can take significant time and effort.  They also said that when they detect apparent nondeductible charges  claimed in the real-estate tax deduction, the amounts are usually small. As  a result, the examiners we interviewed generally contended that  determining the deductibility of every charge on a bill could be an  inefficient use of IRS resources. Examiners reasoned that the amount of  nondeductible charges on a real-estate tax bill would have to be quite high  to justify an examination and adjustment of tax liability.
IRS does not have information about which local governments are likely to  have large nondeductible charges on their real-estate tax bills. IRS  examiners also told us that if they had this information, they could use it  to target any examination of the real-estate tax deduction toward large  deductions claimed by taxpayers in these specific jurisdictions. Several  examiners told us that they look for large nondeductible charges that are  commonly claimed as real-estate taxes, but they only know about these  nondeductible items from personal experience. For example, IRS  examiners located in Florida and California indicated that some taxpayers  attempt to improperly deduct large homeowners’ association fees as part  of the real-estate tax deduction. Absent information about potentially  nondeductible charges, some examiners told us that when they are  examining a real-estate tax deduction, they might research taxpayer  information accessible from the respective county assessor’s Web site,  such as information about real-estate bill charges, or from other databases,  such as how many properties a taxpayer owns and the amount of taxes  paid for each property.
section_title: Some Options Could Improve Compliance with the Real-Estate Tax Deduction; Better Information Is Needed to Assess Other Options
paragraphs: Various options could help address one or more of the identified problems  that make it hard for individual taxpayers to comply by only claiming  deductible charges when computing their real-estate tax deduction, and  improve IRS’s ability to check compliance. Given the general difficulty in  determining deductibility, one option would be to change the tax code.  Changing the tax code could affect both taxpayers who overstate and  those who understate their deductions. Depending on the public policy  goals envisioned for the real-estate tax deduction, policymakers may wish  to consider changes to balance achieving those goals and make it simpler  for individuals to determine how much of their total amount for local  charges can be deducted. Changing the law to help taxpayers correctly  claim the deduction could be done in different ways. However, assessing  such changes to the law and their effects was beyond the scope of this  review. Thus, we have not included nor will we further discuss in this  report an option for changing the tax code.
Assuming no statutory changes are made to clarify how much of local  charges on real-estate tax bills can be deducted, table 4 lists some broad  options under three areas involving improved information, guidance, and  enforcement to address the problems. The options we discuss are  concepts rather than proposals with details on implementation and likely  effects. These options would likely affect both those taxpayers who  overstate and those who understate their real-estate tax deductions. A  combination of these options would be needed to address the four main  problems.
In considering the options, it is important to know how many individual  taxpayers claim nondeductible charges from real-estate tax bills and how  much federal revenue is lost. Such knowledge could signal how urgently  solutions are needed. However, the extent of taxpayer noncompliance and  related federal revenue loss is not known, and we could not estimate this  with the resources available for our review. If many taxpayers overstate  the deduction and the aggregate revenue loss is high enough, pursuing  options to reduce noncompliance would be more important. Conversely,  fewer taxpayers making errors and lower revenue losses might lead to a  decision to not pursue any options or only options that have minimal costs  and burdens. Ultimately, policymakers in concert with tax administrators  will have to judge whether concerns about noncompliance justify the  extent to which options, including those on which we make  recommendations, should be pursued to help taxpayers comply.
Compliance could be measured in different ways, which could yield better  information at increasing cost. For example, IRS has research programs  that are designed to measure compliance. One option is to modify IRS’s  National Research Program (NRP) studies that IRS planned to launch in  October 2007, which were designed to annually examine compliance on  about 13,000 individual tax returns. NRP staff could begin to collect  information through this annual study to compute how much of the overall  amount of noncompliance with claiming the real-estate tax deduction is  caused by taxpayers claiming nondeductible charges. If pursued, IRS  would need to consider how much additional time and money to invest in  its annual research to measure taxpayer compliance in claiming only  deductible charges in the real-estate tax deduction. IRS also could  consider focusing its compliance efforts on local governments that put  large nondeductible charges on real-estate tax bills.
Lacking information on the potential compliance gains compared to  potential costs and burdens makes it difficult to assess whether most  options are justified. Even so, some of these options could improve  compliance with the real-estate tax deduction while generating lower  costs and burdens for IRS and third parties. Although we did not measure  the benefits and costs, the following discussion describes key trade-offs to  be considered for each option, such as burdens on IRS, local governments,  and other third parties, as well as implementation barriers.
subsections: section_title: Providing More Information about Local Charges
paragraphs: Taxpayers are responsible for determining which charges are deductible.  The burden to be fully compliant can be significant, depending on how  many charges are on the real-estate tax bill, how quickly information can  be accessed on how the charge is computed and used, and how long it  takes taxpayers to use that information to determine deductibility. In the  absence of data, a simple illustration can provide context, recognizing that  taxpayer experiences would vary widely. To illustrate, if we use an IRS  estimate that roughly 43 million taxpayers claimed the real-estate tax  deduction in 2006, and assume that each taxpayer spent only 1 hour to  access and use information about charges on the bill to make  determinations about deductibility, then a total of 43 million taxpayer  hours would be used to calculate this deduction. If we further assume that  the value of a taxpayer’s time averaged $30 per hour, which is the figure  used by the Office of Management and Budget, the value of this  compliance burden on taxpayers for the real-estate tax deduction would  total $1.29 billion.
The options for providing information about the local charges generally  would lessen the burden on individual taxpayers while likely increasing  compliance levels. However, depending on the option, the burden would  shift to local governments. Although the local-government representatives  we interviewed did not have data on the costs for any option and said that  the costs and burdens could vary widely across local governments, they  had views on the relative burdens for each option. Figure 3 provides a  rough depiction of this burden shifting.
Given the complexity of determining the federal deductibility of local  charges, a problem we found was that taxpayers are not told how much of  the total amount of charges on the local bill can be deducted. Two options  for reporting information on deductible charges are (1) information  reporting, or (2) changing the local real-estate tax bills.
Information reporting on deductible amounts  Requiring information reporting in which local governments determine in  their opinion which charges are federally deductible and report the  deductible amount to their taxpayers and to IRS would provide very  helpful information related to deductibility. A barrier to any information  reporting is that 19 of the 20 local-government tax collectors that we  interviewed did not maintain records by a unique taxpayer identifier, such  as the SSN. For IRS to check compliance in claiming only deductible  charges, IRS would need an unambiguous way of matching the local data  to the federal data, which traditionally relies on the SSN. Local- government representatives said significant challenges could arise in  collecting and providing SSNs to IRS, given concerns about privacy, and  possible needed changes to state laws.
Local-government representatives that we interviewed viewed information  reporting as having the highest costs and burdens of the options that we  discussed for providing additional information to taxpayers. One example  of a potentially high cost that local governments would incur is the cost  associated with computer reprogramming to enable them to report the  information. One way to reduce the costs for many local governments  would be to require information reporting for larger local governments  only or for those that have nondeductible charges on their real estate bills.  Requiring information reporting only selectively would eliminate the cost  for some local governments, but would not reduce the costs for those that  still have to report to IRS and would not eliminate concerns about  providing the SSN.
Reporting deductible amounts on local real-estate tax bills  Another option for providing taxpayers with information about  deductibility would be to report the deductible amounts on the local  government bills provided to taxpayers only. This would eliminate the  concerns about collecting and providing SSNs as well as the costs of  reporting to IRS. Local-government representatives we interviewed said  that their costs still could be high if major changes are required to local  computer systems and bills. For example, they might have to regroup and  to subtotal charges based on deductibility. Furthermore, not all local  governments provide a copy of their bills to taxpayers who pay their real- estate taxes through mortgage escrow accounts. These taxpayers would  need to receive an informational copy of their bills or be alerted to the  nondeductible charges in some other manner.
Whether providing information on deductibility through information  reporting or changing local bills, a major concern for local governments  was determining deductibility. Local-government representatives  expressed concerns about local governments protecting themselves from  legal challenges over what is deductible, given the judgment necessary to  determine deductibility. Local-government representatives and officials  told us that local governments do not want to become experts in the  federal tax code and would oppose making any determination of  deductibility without assistance.
subsections: section_title: Providing a List to IRS on the Types of Charges on Local Real-Estate Tax Bills
paragraphs: Given local governments’ concern about determining deductibility, local  governments could provide information to IRS about the types of charges  on their bills and IRS could use that information to help local governments  determine deductibility, reducing their burden and concern somewhat  while increasing costs to IRS. Even if IRS took on the responsibility of  determining the federal deductibility of local government real-estate  charges, local governments probably would still need to be involved. The  IRS officials that we spoke with for the purpose of this job did not have  extensive knowledge about charges on local tax bills. Local-government  representatives indicated that local governments’ willingness to work with  IRS would greatly depend on IRS’s approach. After determining  deductibility, IRS and local governments could pursue cost-effective  strategies for making information on deductibility available to taxpayers,  such as posting this information on their respective Web sites.
IRS’s processing costs could be large if tens of thousands of local  governments reported on many types of specific charges. Even if IRS had  some uniform format for local governments to use in reporting, the  amount of information to be processed likely would be voluminous and  diverse given variation in local charges. IRS also would incur costs to  analyze the information and work with local governments that appear to  have nondeductible charges. These IRS costs would vary with the breadth  and depth of involvement with the selected local governments. IRS could  mitigate costs if it could identify jurisdictions with significant dollar  amounts of nondeductible charges, and work only with those jurisdictions.
section_title: Changing Real-Estate Tax Bills to Provide Information about Local Charges
paragraphs: In addition to not being given information on which local charges were  deductible, another problem we found was that taxpayers do not receive  enough information about the charges on real-estate tax bills to help them  determine how much to deduct. Knowing about the basis for the charges,  how the charges were used, and whether they applied across the locality  are key pieces of information that could help taxpayers determine  deductibility. We found that some local governments provided some of  this information on their real-estate tax bills but many did not.
An alternative for informing taxpayers about local charges would be for  local governments to identify which charges on its tax bills are ad valorem  and non-ad valorem. Our work with IRS attorneys on the charges on tax  bills in five large counties indicated to us that non-ad-valorem charges  usually would be nondeductible because they generally are not applied at  a uniform rate across a locality. Similarly, many ad-valorem charges would  be deductible but with exceptions, such as when charges were not applied  at a uniform rate across the locality or when they generated “local  benefits” for the taxpayer. Because not all ad-valorem charges are  deductible and not all non-ad-valorem charges are nondeductible,  taxpayers still would be required to make the determinations.
If taxpayers claimed only the ad-valorem charges listed on their bills,  compliance would likely improve for those who otherwise would deduct  the full bill amount that includes nondeductible charges. Local  governments that do not currently differentiate ad valorem from non–ad  valorem would incur costs that would vary with how much the bill needs  to change and the space available to report the information. However,  representatives of local governments with whom we spoke saw this option  as less burdensome than determining and reporting the deductible  amounts.
section_title: Changing Local Bills to Provide Disclaimers That Some Charges May Not Be Deductible
paragraphs: A final option involving information on local tax bills could generate the  lowest costs but would provide less information for taxpayers than other  options related to changing local tax bills. That option is for local  governments to place disclaimers on real-estate tax bills to alert taxpayers  that some charges may not be deductible for federal income tax  purposes. Local-government representatives said that the direct costs  would be minimal to the extent that the disclaimer was brief and that  space was available on the bill. Adding pages or inserts to the bill would  increase printing, handling, and mailing costs. Because the disclaimers  would not provide any information to taxpayers to help them determine  deductibility, some taxpayers would likely seek that information by calling  the local governments. Handling a large volume of calls could be costly for  local governments.
section_title: Improving Guidance to Taxpayers
paragraphs: Even if taxpayers were to receive more information about the local  charges on their real estate bills, we found that taxpayers may not receive  enough guidance from IRS and third parties to help them determine how  much to deduct and to alert them to the presence of nondeductible  charges. For example, although IRS’s guidance to taxpayers discusses  what qualifies as deductible real-estate taxes, we found a few areas in  which it was incomplete given that determining deductibility can be  complex. Furthermore, third parties in the mortgage and tax-preparation  industries did not regularly alert taxpayers through disclaimers and other  information that not all charges may be deductible.
Options for helping taxpayers to apply information in order to determine  which local charges are deductible include (a) enhancing IRS’s existing  guidance to individual taxpayers, and (b) having IRS engage in outreach to  mortgage-servicer and tax-preparation industries about nondeductible  charges and about any enhanced IRS guidance.
subsections: section_title: Enhancing IRS’s Guidance to Taxpayers
paragraphs: Although IRS’s guidance publications provided basic information to  taxpayers about what could be deducted as a real-estate tax and the types  of charges that could not be deducted, we found areas that, if improved,  might help some taxpayers to comply. Those include    placing a stronger disclaimer early in the guidance to alert taxpayers about  the need to check whether all charges on their real-estate tax bill are  deductible; across the IRS publications we reviewed, such an explicit  disclaimer either was made near the end of the guidance or not at all;    clarifying that a real-estate tax bill may not be sufficient evidence of  deductibility if the bill includes nondeductible charges that are not clearly  stated; our work showed that some bills could not be relied upon to prove  deductibility but we found nothing that explicitly told taxpayers that they  could not always rely on the bills as such evidence; and    providing information or a worksheet on possible steps to take to obtain  information about whether bills include nondeductible charges and what  those charges are; to the extent that taxpayers may not know where to  find the information necessary to determine whether any charges on their  local bills are nondeductible, the guidance could suggest steps to help  taxpayers start to get the necessary information.
The cost of IRS enhancing its guidance would vary based on the extent  that IRS made changes in its written publications and electronic media,  but these changes would not necessarily be costly to make. Taxpayer  compliance could improve for those who have nondeductible charges on  their local bills but who are not aware about the nondeductible charges  and how to find them. Taxpayers also could spend some time and effort to  discover whether any of the local charges are nondeductible but that time  and effort would largely be a onetime investment unless the local  government changes the charges on the real estate bills from year to year.
section_title: Having IRS Outreach to Third Parties on Disclaimers and IRS’s Guidance
paragraphs: IRS could conduct outreach to two types of third parties that provide  information or offer assistance to individual taxpayers about the real- estate tax deduction. First, IRS could engage mortgage servicers in how  they might alert taxpayers that real-estate payments made through escrow  accounts could include nondeductible charges, including those reported  on IRS forms. The trade-offs discussed for putting disclaimers on local  real-estate tax bills would apply here as well. Mortgage servicers would  likely use a generic disclaimer on all escrow statements because currently  the servicers do not receive information about nondeductible local  charges that appear on the bills and usually only receive total amounts to  be paid. However, if mortgage servicers happen to receive itemized  information about local charges from local governments, they could report  these details on escrow statements to inform taxpayers who may not  receive a copy of their local real estate bill because their local charges are  paid through the escrow. Doing so would generate some computing costs  for the servicers.
Also, IRS could reach out to the tax-preparation industry—those who  develop tax-preparation software as well to those who help individuals  prepare their tax returns. The goals would be to ensure that those who  provide guidance to taxpayers are alerted to the potential presence of  nondeductible charges on real-estate tax bills and to ensure that they  understand IRS’s guidance, particularly if it is enhanced. IRS also could  solicit ideas on ways to improve guidance to help individual taxpayers.  The tax-preparation software companies could incur some costs if  conversations with IRS result in revisions to their software. Other types of  tax preparers, such as enrolled agents, would likely not incur many  monetary costs but may experience resistance from individual taxpayers  who do not wish to comply.
section_title: Enhancing IRS Enforcement of Compliance
paragraphs: If the implementation barriers to information reporting on this deduction  were resolved and local governments were required to report information  on real-estate taxes to IRS, IRS could expand its existing computer- matching system to include the real-estate tax deduction. If this option  were chosen, IRS would incur the costs of processing and checking the  adequacy of the local data, developing matching criteria, generating  notices to taxpayers when significant matching discrepancies arise, and  providing resources to interact with taxpayers who respond to the notices.
However, such matching programs have proven to be effective tools for  addressing compliance.
IRS already conducts tens of thousands of examinations annually that  check compliance in claiming the real-estate tax deduction. IRS could do  more examinations of this deduction. However, the costs involved may not  be justified given the current lack of information about the extent of  noncompliance caused by claiming nondeductible charges and the  associated tax loss.
Given that IRS is already doing so many examinations that audit the real- estate tax deduction, an option that could be less burdensome for IRS  would be to ensure that its examiners know about this issue of  nondeductible local charges whenever they are assigned to audit the  deduction. Specifically, IRS could require its examiners to verify the  deductibility of real-estate charges claimed whenever the examiners are  examining a real-estate tax deduction with potentially large, unusual, or  questionable nondeductible items. Currently, examiners have the  discretion to request evidence on the deductibility of real-estate charges,  but are not required to request it. Furthermore, the guidance to examiners  lists cancelled checks, mortgage escrow statements, Forms 1098 on  mortgage interest amounts, and local government real-estate tax bills as  acceptable types of evidence of deductibility. However, none of these  documents necessarily confirm whether all local charges can be deducted.  Since IRS is already examining the deduction, the marginal cost to IRS  would stem from the fact that some examinations might take slightly  longer if examiners take the time to ask taxpayers to provide the correct  type of evidence to substantiate their real-estate tax deduction. However,  this cost could be justified to ensure compliance with the existing law. IRS  also may incur some costs to expand its existing training if examiners are  not adequately informed about the deduction.
section_title: A Targeted Option to Improve Information, Guidance, and Enforcement
paragraphs: We identified one option that cuts across the problems facing both  taxpayers and IRS and targets actions in the three areas of improving  information, guidance, and enforcement. As discussed earlier, local  governments could provide IRS a list of the types of charges on local real- estate tax bills that IRS could then use to help local governments  determine deductibility if some charges appear to be nondeductible.
However, that would impose reporting costs on all local governments and  could inundate IRS with a lot of information to process, analyze, and use.
In this crosscutting option, IRS would limit its data collection to larger  local governments that have apparent larger nondeductible charges on  their real-estate tax bills. Our work initially focused on 41 of the largest  local governments because they were most likely to have large property  tax revenue and because smaller local governments would have a harder  time compiling the information.
IRS could choose from a number of ways to identify larger local  governments that appear to have larger nondeductible charges on their  bills. A starting point could be the Census data we used to identify those  local governments that collect the most property tax (see app. III of this  report). Using these data, IRS could identify the larger local governments  on which IRS could focus its data-collection efforts. For example, as an  alternative to, or in addition to, requiring local governments to report the  types of charges listed on their local bills, as discussed earlier, IRS could  send a survey to selected local governments; collect the data through its  annual NRP research on individual tax compliance for a sample of tax  returns; choose to do a separate research project; collect data from annual  operational examinations that touch on the real-estate tax deduction; or  query its employees on the types of charges on their own local tax bills.
Having received information from local governments, IRS could identify  local governments whose bills have nondeductible charges that are large  and unusual enough to make noncompliance and larger tax revenue losses  likely to occur. Knowing which local governments have large  nondeductible charges, IRS could also consider whether and how to use  the data in a targeted fashion. IRS’s costs would vary with the uses  pursued and the number of local governments involved. IRS could use this  data to    design compliance-measurement studies for those localities;    begin outreach with these local governments to help determine deductible  charges and help affected taxpayers correctly compute the deduction;  target guidance such as mailings or public service announcements to  direct taxpayers to a list of nondeductible charges, or create a tool to help  taxpayers determine a deductible amount for a locality;    outreach with other third parties such as tax preparers and mortgage  servicers to help them better inform and guide taxpayers; and     check the real-estate tax deduction for individual tax returns that have  been selected for examination from taxpayers in those localities or, at a  minimum, use the information when considering whether to examine one  of these returns.
section_title: Conclusions
paragraphs: To fully comply with the current federal law on deducting local real-estate  taxes, many individual taxpayers would need to apply significant effort to  determine whether all charges on a real-estate tax bill are federally  deductible. However, it is likely that some taxpayers do not invest  sufficient time or energy in trying to comply with federal law for  determining deductibility, or may not understand how to comply, or both.  Nevertheless, the total compliance burden taxpayers would bear to  properly comply is one useful reference point for judging the merits of  alternative means of increasing compliance.
Taxpayers are responsible for determining which charges are deductible,  and the burden to be fully compliant can be significant. This burden to  properly comply with current federal law could be shifted from taxpayers  to local governments, IRS, or third parties, or some combination of each.  Along a continuum, this burden shifting could be major, such as through  information reporting, or fairly minor, such as through providing taxpayers  with better information or guidance to help them determine deductibility.  In either case, taxpayer compliance is likely to improve and the overall  compliance burden to society could possibly be lower to the extent that  IRS, local governments, and other third parties can reduce the costs of  overall compliance through economies of scale.
Because the extent of the compliance problem is not known and some of  the options we identified could significantly increase local-government or  IRS burdens in order to achieve significant compliance gains, a sensible  starting point is options that impose less burden shifting. Providing  taxpayers better guidance on how to comply, including the information  sources they need to consider, is among the least burdensome and costly  means to address noncompliance with the real-estate tax deduction.  Because taxpayers still would have to exercise considerable effort to  comply fully, improved guidance may not materially reduce  noncompliance. Providing taxpayers somewhat better information, such  as real-estate bills that clearly identify ad-valorem and non-ad-valorem  charges would shift more burden to local governments, but likely would  have a larger effect on reducing noncompliance. Providing taxpayers  traditional information reports, that is, documents that clearly identify  federally tax deductible charges, would shift considerable burden to local  governments and possibly IRS, but also would considerably reduce  taxpayers’ compliance burden and likely result in significant compliance  gains. If local governments, possibly with IRS assistance, could determine  deductibility for less cost than the sum of each taxpayer’s costs in doing  so, the net compliance burden for society may go down even as  compliance increases.
Significant reductions in noncompliance might also be achieved with  minimum shifting of burdens through targeted use of the identified options  for addressing noncompliance. Targeting, however, requires information  about localities where there are significant risks of taxpayers claiming  large nondeductible charges. If IRS learned which jurisdictions have the  largest dollar amounts of nondeductible charges on their bills, it could  take a number of targeted actions, such as outreach to the local  governments to help them determine deductible charges, targeted  outreach to taxpayers in those jurisdictions to help them correctly  compute the deduction, targeted outreach to the tax-preparation and  mortgage-servicer industries, and targeted examinations of the real-estate  tax deduction in these localities. Low-cost options are available to obtain  this information, such as collecting tax bills as part of examinations of the  real-estate tax deduction that already occur annually.
In terms of IRS’s examinations, IRS could send a more useful signal to  taxpayers of the importance of ensuring that only deductible real-estate  taxes are claimed if IRS examinations more frequently covered which  charges are deductible. At a minimum, IRS can take steps to ensure that its  examiners know about the problems with nondeductible charges and how  to address the noncompliance.
section_title: Recommendations for Executive Action
paragraphs: We are making 10 recommendations to the Commissioner of Internal  Revenue:  To enhance IRS’s guidance to help individual taxpayers comply in claiming  the correct real-estate tax deduction, we recommend that the  Commissioner of Internal Revenue    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;    clarify that real-estate tax bills may be insufficient evidence of  deductibility when bills include nondeductible charges that are not clearly  stated; and    provide information or a worksheet on steps to take to get information  about whether bills include nondeductible charges and about what those  charges are.
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, we recommend that the Commissioner of Internal  Revenue 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;    mortgage servicers to discuss adding disclaimers to their annual  statements that some charges may not be deductible; and  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.
To improve IRS’s guidance to its examiners auditing the real-estate tax  deduction, we recommend that the Commissioner of Internal Revenue  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; and  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.
To learn more about where tax noncompliance is most likely, we  recommend that the Commissioner of Internal Revenue  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; and  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.
section_title: Agency Comments and Our Evaluation
paragraphs: On April 22, 2009, IRS provided written comments on a draft of this report  (see app. IV). IRS noted that the report accurately reflects the difficulty  that many taxpayers face when local jurisdictions include nondeductible  charges on real-estate tax bills, particularly when these charges can vary  and are not described in detail. IRS also noted that determining  deductibility can be complex and that neither the local real-estate tax bills  nor mortgage service documents tell taxpayers what amounts are  deductible.
IRS agreed with 7 of our 10 recommendations and identified actions to  implement them. Specifically, IRS agreed with 2 recommendations on  enhancing guidance to taxpayers, saying it would change various  publications to (1) highlight an alert to taxpayers to check for  nondeductible charges on their real-estate tax bills and (2) caution that the  bills may be insufficient evidence of deductibility.
IRS also agreed with three recommendations on outreach to third parties  to ensure that taxpayers are getting the best information possible to  comply in claiming the real-estate tax deduction. IRS agreed to contact  local governments, mortgage servicers, and tax software firms to explore  options to alert taxpayers that some charges might not be deductible. IRS  also said it would work with local governments to clarify charges on their  real-estate tax bills.
Further, IRS agreed with two recommendations on learning more about  where noncompliance in claiming nondeductible charges is most likely  and then taking action to improve compliance. IRS agreed to identify a  cost-effective way to identify local governments that have potentially large  nondeductible charges on their real-estate tax bills. After identifying these  local governments, IRS also agreed to reach out to them to help determine  the deductibility of their charges and help the affected taxpayers correctly  claim the deduction. As part of this set of actions, IRS agreed to reach out  to the tax preparation and mortgage servicing industries with customers in  these localities.
IRS disagreed with three recommendations. However, for one of the  recommendations, IRS did agree to take action consistent with the intent  of the recommendation. We recommended that IRS enhance its guidance  to taxpayers by providing information or a worksheet on steps taxpayers  could take to find out if any charges on a real-estate tax bill are  nondeductible. IRS said its Publication 17 already had a chart providing  guidance on which real-estate taxes can be deducted but agreed to add a  caution advising taxpayers that they must contact the taxing authority if  more information is needed on any charge. We believe such an action will  enhance IRS’s current education efforts related to this issue and may help  improve taxpayer compliance, especially if the addition provides guidance  on situations in which a taxpayer may need to contact the taxing authority.
The other two recommendations IRS disagreed with related to improving  IRS’s guidance to its staff who audit the real-estate tax deduction. IRS did  not agree to revise the guidance to clarify that mortgage escrow  statements, cancelled checks, Forms 1098, and real-estate tax bills may  not be sufficient evidence of deductibility. IRS also did not agree that  examiners should ask taxpayers for evidence of deductibility whenever  they are auditing the deduction and believe that the taxpayers have  claimed nondeductible charges that are large, unusual, or questionable.  IRS said that the guidance for examiners is sufficient and that examiners  are to use their judgment and consider all available evidence in coming to  a determination.
We appreciate that examiners must exercise judgment about the scope of  an audit. However, in reviewing over 100 examination files and in talking  with examiners, we found that not all examiners focus on the deductibility  of the real-estate charges or ask the taxpayer for adequate evidence of  deductibility, even in situations where deductibility may be in question.  Therefore, when examiners have reason to believe that taxpayers claimed  nondeductible charges that are large, unusual, or questionable, we  continue to believe they should ask taxpayers for adequate support. We  also continue to believe that the guidance to examiners should clearly  state that real-estate bills should be examined and that other information  on the nature and purpose of tax bill charges may also be needed. This  improved guidance may be especially pertinent when IRS has  implemented our recommendations to identify local governments with  large nondeductible charges on their bills and to take related actions to  help taxpayers comply. If IRS does targeted examinations of taxpayers in  those localities, the IRS examiners will need to clearly understand what  evidence is required to determine the deductibility of the various charges  on the real-estate bills to ensure that taxpayers are correctly claiming the  real-estate tax deduction.
As agreed with your office, unless you publicly announce its contents  earlier, we plan no further distribution of this report until 30 days from its  issue date. At that time, we will send copies to the Chairman and Ranking  Member, Senate Committee on Finance; Chairman and Ranking Member,  House Committee on Ways and Means; the Secretary of the Treasury; the  Commissioner of Internal Revenue; and other interested parties. This  report will be available at no charge on the GAO Web site at  http://www.gao.gov.
If you or your staff have any questions, please contact me at (202) 512-9110  or brostekm@gao.gov. Contact points for our Offices of Congressional  Relations and Public Affairs may be found on the last page of this report.  Key contributors to this report are found in app. V.
section_title: Appendix I: Methodology for Survey of Local Governments
paragraphs: To learn about real-estate tax billing practices and the proportion of local  government entities with potentially nondeductible charges on their real- estate tax bills, we conducted a mail-based sample survey of 1,732 local  governments primarily responsible for collecting real-estate taxes due on  residential properties. In designing the sample for our survey, we used the  survey population of the U.S. Census Bureau’s Quarterly Property Tax  Survey (QPTS) as our sample frame. The QPTS is a mail survey the  Governments Division of the U.S. Census Bureau conducts quarterly to  obtain information on property taxes collected at the local governmental  level. The QPTS is part of a larger data-collection effort that the Census  Bureau conducts in order to make estimates of state and local tax revenue.  According to QPTS data, 14,314 local governments bill for property taxes.
The QPTS itself uses a stratified, one-stage cluster sample of local  governments in 606 county areas with 16 strata. In designing a sample  based on the QPTS for our survey, we also used a stratified, one-stage  cluster design. Specifically, of the 606 county areas included in the QPTS  sample, we selected 192 county areas representing 18 strata. Our sub- sample consists of a random selection of approximately 30 percent of the  county areas in the 18 GAO strata with a minimum of 5 county areas  selected in each stratum. All of the local governments within the selected  county areas are included in the sample. The total number of local  governments included in the sample was 1,732. Before constructing our  sample, we checked to make sure that QPTS sample data provided to us  by the Census Bureau were internally consistent and reliable for our  purposes.
In our survey, we asked the local governments whether they included non- ad-valorem charges on their real-estate tax bills, how they differentiated  non-ad-valorem charges from ad-valorem charges, and whether and how  they alerted taxpayers to the presence of non-ad-valorem charges on the  bills. We also asked the local governments for a sample residential real- estate tax bill that included information about all possible charges for  which property owners in that jurisdiction could be billed.
We conducted two pretests of our draft survey instrument with officials  from Alexandria, Virginia, and Montgomery County, Maryland, to ensure  that (1) the survey did not place an undue burden on the respondent’s  time, (2) the questions and terminology were clear and unambiguous, (3)  the respondents were able to obtain data necessary to answer the survey  questions, and (4) our method for requesting sample bills matched any  preferences offered by the respondents.
In late April 2008, we mailed questionnaires to our survey sample  population using addresses of the local government entities provided to us  from the Census Bureau’s Governments Division. At the end of May, we  sent a reminder letter with an additional copy of the questionnaire to all  governments in our survey from which we had not yet received a  response. If a survey respondent’s answers required clarification (e.g., if a  respondent did not follow the directions given in the survey), a follow-up  call was conducted. Survey answers were then edited to reflect the  additional information obtained in the calls.
Of the 1,732 surveys sent, we received 1,450 responses for an unweighted  response rate of 84 percent. Response rates for the jurisdictions in each of  our 18 strata ranged from 67 percent to 100 percent. All percentage  estimates from our survey are surrounded by 95 percent confidence  intervals.
In addition to sampling error, the practical difficulties of conducting any  survey may introduce errors commonly referred to as nonsampling errors.  For example, difficulties in how a particular question is interpreted, in the  sources of information that are available to respondents, or in how the  data are entered into a database or were analyzed, can introduce  unwanted variability into the survey results. We took steps in the  development of the questionnaire, the data collection, and the data  analysis to minimize these nonsampling errors. For example, a social  science survey specialist helped us design the questionnaire. Then, as  stated earlier, the draft questionnaire was pretested with two local  jurisdictions. Data entry was conducted by a data entry contractor and a  sample of the entered data was verified. Finally, when the data were  analyzed, independent analysts checked all computer programs.
section_title: Appendix II: Methodology for Review of Real- Estate Tax Bills
paragraphs: One of the objectives of this report was to describe factors that contribute  to the inclusion of nondeductible items in real-estate tax deductions. In  our 1993 report, we determined that one cause of taxpayers overstating  their deductions was confusing real-estate tax bills that don’t clearly  distinguish taxes from user fees. To update our previous work and to  determine the extent to which real-estate tax bills currently distinguish  between taxes on real property and user fees, we reviewed a sample of  real-estate tax bills from local governments across the United States. This  appendix outlines the methodology that we used to review these bills.
The sample of real-estate tax bills that we reviewed was a subset of the  responses to our mailed survey of local governments, which was a  stratified, random sample of 1,732 localities (see app. I). A question in our  survey asked whether the local government included non-ad-valorem  items in their bills, which are generally nondeductible. In another part of  our survey, we asked respondents to attach a sample of a real-estate tax  bill to their completed survey. We received a total of 1,450 responses to  our survey. We did not generalize the results of this bill review because  not all survey respondents provided bills as requested, and because we  did not know how the bills that were submitted had been selected by the  respective responding governments. We received over 643 bills from  governments which included nondeductible charges on their bills. Of these  bills, we deemed 486 to be usable. We performed two reviews of the  usable bills.
First, we used three criteria to determine if a real-estate tax bill clearly  distinguished taxes from user fees:  1.  Does the bill differentiate ad-valorem from non-ad-valorem charges?  2.  Are all the charges in the bill clearly identified and explained?  3.  Does the bill contain a disclaimer warning that some of the charges  included in the real-estate tax bill may not be deductible for federal tax  purposes?
A bill met our first criterion if either of the following applied:    The bill differentiated by labeling each item as ad valorem or non–ad  valorem.
The bill provided millage rates for items.
A bill met our second criterion if all of the line items were individually  broken out AND either of the following applied:    Line item descriptions were spelled out and clearly identified.    Additional information or explanations regarding line items are available  in paper form or electronically.
A bill met our third criterion if either of the following applied:    The bill contained a disclaimer stating that all items appearing on the bill  may not be deductible.
The bill contained a disclaimer stating that taxpayers should consult IRS  code and publications or their tax advisor for assistance in determining  deductibility.
Through our review, we found that about 60 percent of the bills satisfied  our first criterion, with almost all of these using millage rates to  differentiate ad-valorem from non-ad-valorem charges. Only about 30  percent of bills satisfied our second criterion. The main reason bills did  not meet our second criterion was because line-item descriptions were not  easily identifiable (e.g., a taxpayer could not determine the respective  charge’s use based solely on the information on the bill). None of the bills  satisfied our third criterion.
In our second bill review, we determined whether the real-estate tax bills  provided taxpayers with either of the following:    A total for the charges that are deductible for federal income tax purposes.     A warning that some of the charges on the bill may be nondeductible for  federal income tax purposes.
Of the 486 usable bills we reviewed, none satisfied either of these two  criteria.
Although our sample of real-estate tax bills is not representative of local  governments nationally, the results of our review illustrate that many  taxpayers would face challenges in determining what is deductible if they  were to rely solely on the information provided on their real-estate tax  bills.
section_title: Appendix III: Methodology for Case Studies of Taxpayer Noncompliance
paragraphs: This appendix describes the methodology, including sample selection, we  used to (1) determine the deductibility of charges on tax bills in five  counties: Alameda County, California; Franklin County, Ohio; Hennepin  County, Minnesota; Hillsborough County, Florida; King County,  Washington; and (2) calculate the extent of overstated deductions in two  of those counties—Alameda County, California and Hennepin County,  Minnesota—for tax year 2006.
subsections: section_title: Sample Selection
paragraphs: We derived our list of local governments that collect property taxes from  the survey population of the U.S. Census Bureau’s Quarterly Property Tax  Survey (QPTS). The QPTS sample consists of local governments in 606  county areas with 312 of those counties selected with certainty. The 312  counties had a population of at least 200,000 people and annual property  taxes of at least $100 million in 1997. We decided that large counties would  be best for this study because they were more likely to have large property  tax revenue and to maintain property tax data in electronic formats that  we could more easily obtain and manipulate than paper records. We  started with the 41 largest counties based on property tax revenue. We  randomly sorted these 41 large collectors and picked the first 5 from the  sorted list that fit the team’s inclusion criteria:  (1) presence of user fees, special assessments, special district taxes, or  other non-ad-valorem items on real-estate tax bills for most or all  residential property owners;  (2) willingness of the local government to participate; and  (3) usability and reliability of the data.
Using these criteria, we selected Alameda County, California; Franklin  County, Ohio; Hennepin County, Minnesota; Hillsborough County, Florida;  and King County, Washington for our initial analyses.
section_title: Deductibility Determinations
paragraphs: We collaborated with officials from the Internal Revenue Service’s (IRS)  Office of Chief Counsel to determine the deductibility of charges on the  five counties’ real-estate tax bills. IRS agreed to review information we  provided about the charges on these tax bills in order to provide an  opinion on the deductibility of the charges. IRS did not seek additional  information from the counties regarding the charges, and IRS based its  determinations solely on the materials we submitted. Additional  information could result in conclusions different from those IRS reached  as a result of the data we provided IRS.
Prior to assembling information for IRS’s review, we interviewed officials  from IRS’s Office of Chief Counsel to gain a better understanding of what  information IRS needed to make the determinations. IRS officials provided  a list of the types of information they would need to determine whether a  particular assessment levied by a taxing jurisdiction was a deductible real- property tax. Specifically, IRS asked us to provide information related to  the following for each charge:  (1) Is the tax imposed by a State, possession, or political subdivision  thereof, against interests in real property located in the jurisdiction for the  general public welfare?  (2) Is the assessment an enforced contribution, exacted pursuant to  legislative authority in the exercise of the taxing power? Is payment  optional or avoidable?  (3) The purpose of the charge. Is it collected for the purpose of raising  revenue to be used for public or governmental purposes?  (4) Is the tax assessed against all property within the jurisdiction?  (5) Is the tax assessed at a uniform rate?  (6) Whether the payer of the assessment is entitled to any privilege or  service as a result of the payment. Is the assessment imposed as a payment  for some special privilege granted or service rendered? Is there any  relationship between the assessment and any services provided or special  privilege granted?  (7) Is use of the funds by the tax authority restricted in any way? Are the  funds earmarked for any specific purpose?  (8) Is the assessment for local benefits of a kind tending to increase the  value of the property assessed? Does the assessment fund improvements  to or benefiting certain properties or certain types of property? If so, is a  portion of the assessment allocable to separately stated interest or  maintenance charges?
IRS officials also indicated that the following materials would be helpful in  making their determinations:  (1) A copy of the statute imposing the tax.  (2) Materials published by the local government or tax-collecting authority  describing the levy, including taxpayer guides, publications, or manuals  describing the tax.  (3) The forms and instructions relating to the tax.  (4) A printed copy of the Web pages maintained by the jurisdictions  related to the tax.
To collect this information, we interviewed county officials and reviewed  documentation either provided by county officials or found on county Web  sites. Most of the selected counties’ Web sites provided tax rate tables or a  list of the taxing authorities for the ad-valorem charges found on the tax  bills; some also had information for the non-ad-valorem charges. For each  of the year 2006 tax bill charges, we searched the counties’ Web sites and  used online search engines to collect supporting documentation. We also  searched state constitutions and statutes to identify the legal authority for  each charge on real-estate tax bills; to a varying degree, county officials  provided citations to the specific statutes that provided the legislative  authorities for the charges. In addition to the real-estate tax information  found online, we interviewed local tax officials in each of the five local  counties to gather the requested information.
Based on the materials we submitted, IRS concluded that some charges  were deductible, some were nondeductible, and others required  information for IRS to determine their deductibility. Table 1 below  summarizes the results of IRS’s determinations.
section_title: Computation
paragraphs: Using IRS data on real-estate tax deductions claimed by taxpayers in the  selected counties and county data on real-estate taxes billed to property  owners, we identified how much taxpayers likely overstated their real- estate tax deductions by claiming nondeductible charges in two  counties—Alameda County, California, and Hennepin County,  Minnesota—for tax year 2006. We restricted our analysis to these two  counties due to limitations in resources. While taxpayers can claim  deductions for real-estate taxes paid on multiple IRS schedules, we limited  our analysis to the amount claimed on IRS Form 1040, Schedule A, which  generally does not include deductions for real estate used for business  purposes.
We used the SAS SQL procedure (PROC SQL) to merge the IRS data to the  tax-roll data we received from our two selected counties. To conduct the  match, we parsed the last name, first name, street address, city, state, and  zip code from the IRS data and the local data. We conditioned the PROC  SQL merge to include in the output data set only those records in which  the parsed first names, last names, and zip codes matched.
Prior to the match, we controlled for taxpayers who own multiple  properties within each of our selected jurisdictions by using a unique  identifier for each taxpayer and subtotaling the taxpayers’ ad-valorem and  non-ad-valorem charges by the unique identifier. To the extent we were  able, we used existing, numerical identifiers in the data—such as property  number and account numbers—to produce a subtotal for each taxpayer.  When the numeric identifiers available in the data were not available, we  used the parsed name and address fields to create a unique identifier.
After the PROC SQL merge, we controlled for duplicate records by  keeping only those records where the last name, first name, street address,  city, state, and zip codes matched. It is still possible that some duplicates  exist in the data, since the names and address fields were recorded in  disparate ways in the data we received from the counties. We used  programming logic to parse the names; due to the inconsistencies in the  names and address fields in the data, the name and address information  may not have parsed the same way for all taxpayers.
For each taxpayer that we were able to match to the county data, we  compared the amount the taxpayer claimed as a real-estate tax deduction  on the Schedule A return to the total ad-valorem amount each taxpayer  was billed by the county and which was due in 2006. We then calculated  the difference between the amount claimed on Schedule A and the ad- valorem portion of the amount billed by the county for each taxpayer. As  indicated above, we worked with IRS to determine which charges billed by  the county were deductible under federal tax law. The counties we  selected for analysis did not maintain their tax data in a way that would  allow us to itemize all of the charges, particularly the ad-valorem charges,  on individuals’ tax bills. As a result, we were not able to take into account  ad-valorem charges that may not be deductible in our lower-bound  computation of overstated real-estate tax deductions. Instead, we used the  ad-valorem portion of the amount billed as a proxy for the deductible  amount. While the proxy is imperfect, it is our understanding that the non- ad-valorem charges in our selected counties were not imposed at a  uniform rate and thus did not appear to be deductible as taxes under  Section 164 of the Internal Revenue Code. Given the limitations of the  data, this approach allowed us to take into account those charges that are  least likely to be deductible. Also, the approach produced a lower-bound  computation of potential noncompliance in our two counties. We can only  produce a lower-bound computation due to uncertainty of noncompliance  for those taxpayers where we could not match IRS and local records.
To develop the lower-bound computations of potential noncompliance, we  excluded those taxpayers whose claimed deduction was greater than 1.15  times the total amount billed; this was chosen as a cutoff point to account  for taxpayers who may own multiple properties and therefore deduct on  their federal tax return a higher amount than is shown on the local tax  bills. We also excluded taxpayers whose claimed deduction was less than  the ad-valorem portion of the amount billed by the county (within a small  margin of error), since we did not have conclusive data to determine  whether the taxpayers held only a partial ownership in the real estate  covered by the local bill.
We then summed the difference between the claimed Schedule A  deduction and the ad-valorem portion of the amount billed by the county  to develop a lower-bound computation of noncompliance for the  population of taxpayers in each county that we were able to match to the  county data.
For the purposes of our analysis, we created two separate categories for  those taxpayers who claimed a deduction that was approximately equal to  the billed amount up to 1.15 times the total amount billed. We defined  those taxpayers who claimed a deduction within $2 of the full amount  billed, when the bill contained non-ad-valorem amounts, as “very likely  overstated.” We defined those taxpayers who claimed a deduction that  was greater than $1 less than the total ad-valorem amount billed but less  than 1.15 times the total billed amount as “likely overstated.”
section_title: Appendix IV: Comments from the Internal Revenue Service
section_title: Appendix V: GAO Contact and Staff Acknowledgments
subsections: section_title: Acknowledgments
paragraphs: In addition to the contact named above, Tom Short (Assistant Director),  Paula Braun, Jessica Bryant-Bertail, Tara Carter, Hayley Crabb, Sara  Daleski, Melanie Helser, Mollie Lemon, and Albert Sim made contributions  to this report. Stuart Kauffman, John Mingus, Karen O’Conor, and Andrew  Stephens also provided key assistance.