TAX GAP
Limiting Sole Proprietor Loss Deductions Could Improve Compliance
but Would Also Limit Some Legitimate Losses


About 5.4 million or 25 percent of all sole proprietors reported losses in 2006. Ninety-five
percent of these loss filers deducted some or all of their losses against other income,
deducting a total of $40 billion. According to IRS estimates last made for 2001, 70 percent
of the sole proprietor tax returns reporting losses had losses that were either fully or partially
noncompliant. About 53 percent of aggregate dollar losses reported in 2001 were
noncompliant. This noncompliance would correspond to billions of dollars of lost tax
evenue.

IRS’s compliance programs address only a small portion of sole proprietor expense
noncompliance. Despite investing nearly a quarter of all revenue agent time in 2008,
IRS was able to examine (audit) about 1 percent of estimated noncompliant sole proprietors.
These exams are costly and yielded less revenue than exams of other categories of taxpayers,
in part because sole proprietorships are small in terms of receipts. Another enforcement
program that primarily uses third-party information to electronically verify compliance is
not effective because little expense information is reported by third parties.

http://cryptome.org/gao-09-815.pdf