Tax gap grows as IRS enforcement slows

Tax Hot Topics - Tax gap grows as IRS enforcement slowsThe IRS has released new estimates showing that the annual “tax gap” has grown from $385 billion to $406 billion.

The tax gap represents the IRS’s best estimate of the difference between what taxpayers actually owe in taxes versus what the IRS actually collects. The IRS bases its estimates on the results of exhaustive audits of randomly selected taxpayers, as part of its research program. The IRS also uses the program to adjust its audit selection program, which is conducted through computer scoring, information return matching, issue-specific examinations and other methods.

The most recent estimates come from audits performed for tax years 2008, 2009 and 2010. They show an annual net tax gap of $406 billion after $52 billion in enforcement revenue for a net compliance rate of 83.7%. This is down from the last estimate in 2012, based on 2006 numbers. IRS enforcement actions in 2006 were estimated to bring in $65 billion, resulting in a $385 billion net tax gap and an 85.5% net compliance rate.

Under-reporting of individual business income remains the largest culprit, contributing an estimated $125 billion to the tax gap. The new numbers do not reflect the new reporting requirements on gross business receipts from payment network and payment card transactions, which lawmakers enacted after 2004 tax gap estimates shocked them into legislative action.

Lawmakers responded to the 2004 estimates with several legislative changes, including expanding general information reporting on the Form 1099-MISC to include payments over $600 to corporations and for goods. These changes were repealed before they took effect, but the payment network and payment card reporting on Form 1099-K under Section 6050W began in 2011. The next tax gap estimates will likely show whether the additional reporting requirements are having much effect on underreporting.

Recent tax gap estimates have not had the same legislative impact as the 2004 numbers. Congressional response to the new numbers was fairly tepid, and the new numbers appear unlikely to spur major action.

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