The tax gap is the Internal Revenue Services (IRS) approximation of the total amount of taxes outstanding. The calculation of this figure is a massive endeavor and only occurs every five years or so. As of 2006, the voluntary compliance rate through the U.S. was relatively unchanged at approximately 83%. Internal Revenue Service, The Tax Gap, available at IRS
Among the factors contributing to a less-than-perfect voluntary compliance rate, underreporting of taxes is by far the largest factor, and the underreporting of personal income tax is by far the largest underreporting factor. Underreporting of corporate income tax and employment tax are also substantial detractors from expected tax revenues. Internal Revenue Service, Tax Gap Map, available at https://www.irs.gov/pub/newsroom/tax_gap_map_2006.pdf
In order to undertake this monumental data collection and analysis, the IRS collects 14,000 returns for individual income tax research audits, i.e. random audits on an annual basis. These figures are representative of the larger population, and can then be combined over multiple years to obtain a larger sample.
Various methodologies are employed to collect the data. For example, individual income tax underreporting is collected using Detection-Controlled Estimation (DCE) to account for income that taxpayers do not report on their tax returns, which National Research Program auditors are unable to detect.
Clearly the methodologies are not 100% accurate, but they provide a fair estimate of the efficacy of the revenue collection infrastructure that the IRS oversees. Ultimately, the goal is to improve voluntary compliance, which is by far the most efficient and effective means for increasing federal tax revenues. To illustrate, the IRS collects nearly $2.7 trillion in tax revenues, only about $50 billion of which is revenue obtained through enforcement actions. Internal Revenue Service, Update on Reducing the Federal Tax Gap and Improving Voluntary Compliance, available at https://www.irs.gov/pub/newsroom/tax_gap_report_-final_version.pdf.
According to a recent New York Times article, “[t]he bulk of unreported income is among unincorporated businesses, which can much more easily hide income from the I.R.S. than workers who primarily earn wages from which their employers withhold taxes.” Bruce Bartlett, “The ‘Tax Gap,’” New York Times, available at https://economix.blogs.nytimes.com/2012/01/10/the-tax-gap/.
Whether underreporting of personal income tax or corporate and employment tax, it is clear that underreporting is the major cause of the tax gap, and that issue will be the primary focus of future IRS initiatives to close the tax gap.
Please keep in mind the information and advice presented in this blog is not intended to be used as formal legal advice. Contact a tax professional for personalized tax advice pertaining to your specific situation. While we try and answer all parts of the question when we write our blogs, sometimes there may be some left unanswered. If you have any questions about your problems with the IRS, SBOE, FTB, or BOE, or tax law in general, call RJS Law at (619) 595-1655.