January 19th, 2012 by Stephanie Erickson
We all just can’t stop talking about the tax gap – but with good reason. Considering the difference in what is owed to the IRS, and what they actually collected in 2006 has increased 30% over five years, to $450 billion; it’s definitely something to talk about. Additionally, the national budget deficit in 2006 was $248 billion; compare that to the tax gap number and people begin to have issues. It needs to be explained who’s responsible, why it’s happening, and what the IRS and/or Congress can do to improve this tax gap problem.
So first, let’s break it down. According to the IRS, the tax gap is comprised of three different areas in which taxpayers are noncompliant. There’s non-filing, which amounts to $28 billion lost per year from taxpayers who don’t file their required tax forms. Then there’s underreporting – taxpayers who don’t report income or overstate their deductions or credits on tax returns – amounting to $376 billion per year. Finally, underpayment amounts to $46 billion per year when taxpayers don’t pay what they owe. As you can see, the majority of non-compliance comes from underreporting, resulting in 83% of the tax gap. Specifically, individuals and small businesses comprise 49% of underreporting, causing $179 billion in lost tax revenue. These small business owners and independent contractors don’t receive information statements from the IRS, and thus, are usually only 44% compliant. So how to solve the issue of underreporting? The IRS agrees that tax reform and tax simplification would decrease the tax gap, but only auditing and information statement requirements would better address non-compliance.
Still, the IRS is moving forward. They’ve set a goal for 86% compliance for the year 2009 since a mere 1% change in the voluntary compliance rate would result in $27 billion per year in additional tax revenue. This isn’t to say the IRS hasn’t already tried: from 2001 to 2006, their compliance enforcement budget increased 36% from $3.4 billion to $4.65 billion. However, the total number of taxpayers only increased 11% from 2001 to 2010 and, as we know, the tax gap still increased by 30 percent in 2006.
In addition, they are increasing their own compliance efforts to decrease the tax gap any way they can. In 2010, they started 6 million compliance inquiries to underreporters, resulting in $1,670 per individual tax return. The new 1099-K requirements (reporting credit card and third-party payments) will bring an estimated $1 billion per year in tax revenue. They are also working on worker reclassification, specific audit areas, S corporations overstating losses, small business and high-income taxpayer audits, offshore voluntary compliance, state information, and practitioner education and penalties for negligence. With their recent budget cuts, the IRS is being forced to take a cost-effective approach and focus on areas where the most tax revenue can be collected. However, a dramatic decrease in the tax gap still requires more effort than just what the IRS is doing; they’ll also need the help of Congress and legislative changes to ultimately simplify the tax code. With an approaching election and underpopularity of tax legislation, this poses a big challenge for the IRS.
Convey provides tax information reporting services and software to businesses to make IRS compliance clear and uncomplicated. U.S. federal tax advice contained in this web site is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter that is contained in this document. (iii) The taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor.