A General Accounting Office report requested by Snowe, chair of the Senate Committee on Small Business and Entrepreneurship, and issued Wednesday, confirmed that the IRS is working to correct errors that occurred in the program whereby the agency attempted to match Schedule K-1 forms it receives to taxpayers' individual tax returns and identify those who might be under reporting their income.

"The success of the K-1 Matching Program depends on the IRS's ability to develop a program that identifies taxpayers who are not meeting their tax obligations while imposing the least inconvenience possible on compliant taxpayers and small business owners," said Snowe. "While I support fully the agency's efforts to enforce the tax laws, the IRS must strive to preserve not only its own resources but also those of our nation's taxpayers, especially the thousands of small business owners who operate their business in the form of flow-through entities."

During the first year of the program, a significant number of taxpayers received notices from the IRS questioning the accuracy of their reported income and requiring them to prove that they had, indeed, filed their returns correctly.

In a letter to IRS Commissioner Mark Everson, and Dale Hart, Commissioner of the SB/SE Division, Snowe and Senator Kit Bond (R-Mo.) wrote that implementation of the new K-1 Matching Program standards has the potential for "sharply reducing the number of under-reporter notices that the IRS sends to compliant taxpayers without sacrificing enforcement efforts."

"We applaud your goal of reducing the number of these notices sent to compliant taxpayers...by at least 50 percent and urge you to explore additional steps such as promoting voluntary compliance with K-1 reporting requirements in order to reach or exceed that goal," Snowe and Bond wrote.

The GAO report, "Changes to IRS's Schedule K-1 Document Matching Program Burdened Compliant Taxpayers" (GAO-03-667), explains that although the IRS intended originally to focus on only two categories of income that are easily identified on tax returns, namely interest and dividends, the IRS determined during the testing of the program that this approach was ineffective because it could not separate underreported K-1 interest and dividend income from the other underreported income such as the income that banks pay.

In tax year 2000, the IRS processed more than 18 million Schedule K-1s reflecting $1.2 trillion in income to partners, S-corporation shareholders, and trust beneficiaries. Schedule K-1, an equivalent for a partner or an S-corporation shareholder to a Form W-2 or 1099 received by an employee, reports information from the operation of the partnership or S corporation such as income or loss, dividends and interest paid, and certain expenses.

In their letter, Snowe and Bond also asked the IRS to provide the Committee with a report that details the progress and effectiveness of revisions to the K-1 Matching Program by August 30, 2003.