The Federal Tax Gap

The federal tax gap imposes an unfair burden on many taxpayers, and the Department of the Treasury and the IRS are committed to narrowing the gap between what is owed and what is paid. The tax gap is defined as the aggregate amount of true tax liability imposed by law for a given tax year that is not paid voluntarily and timely. In a report prepared by the IRS, new initiatives to improve tax revenue collection, both through improved voluntary compliance and through effective enforcement were proposed.

The IRS collects 96 percent of the government’s total receipts, approximately $2.7 trillion in FY 2008. The vast majority of those revenues come from taxpayers who voluntarily report and pay the taxes that they owe. The IRS has estimated the overall voluntary compliance rate to be approximately 84 percent.

Despite the voluntary compliance rate and vigorous enforcement by the IRS, a significant amount of revenue remains unreported and unpaid. In 2005, the IRS estimated this gross tax gap to be approximately $345 billion. After subtracting revenue obtained through enforcement actions and other late payments, the IRS estimated the net tax gap to be approximately $290 billion. These estimates, which remain the most recent estimates available, were conducted using data collected in tax year 2001 and before.

Noncompliance takes three forms:

Underreporting (not reporting one’s full tax liability on a timely-filed return);

Underpayment (not timely paying the full amount of tax reported on a timely-filed return); and

Nonfiling (not filing required returns on time and not paying the full amount of tax that should have been shown on the required return).

Underreporting (in the form of unreported receipts and overstated expenses) constitutes over 82 percent of the gross tax gap. The single largest sub-component of underreporting involves the individual income tax, which represents more than 50 percent of the total tax gap. Underpayment constitutes nearly 10 percent, and nonfiling almost 8 percent of the gross tax gap.

The U.S. Treasury developed a seven-component strategy for reducing the tax gap. The components of that strategy are:

1. Reduce Opportunities for Evasion (Implement and Expand Information Reporting Authorities)

2. Make a Multi-Year Commitment to Research (Measuring the Tax Gap)

3. Continue Improvements in Information Technology

4. Improve Compliance Activities (Multi-Year Investment in IRS Enforcement)

5. Enhance Taxpayer Service (Providing Innovative Online Services, Streamline Written Communications with Taxpayers)

6. Reform and Simplify the Tax Law

7. Coordinate with Partners and Stakeholders (Tax Return Preparer Review, Enhanced Collaboration with Partners and Stakeholders)

Since the publication of the last tax gap report, the IRS published a new strategic plan for FY 2009-2013. The strategic plan outlines the service and enforcement goals of the IRS, along with the strategic foundations that underpin both. The plan recognizes that the IRS must excel at both service and enforcement. The plan also outlines five long-term measures for evaluating the IRS’s progress in achieving its goals, and which directly relate to the tax gap strategy.

Need help to resolve your tax problem? Call attorney Mitchell A. Port at (310) 559-5259 for a free phone consultation.