THE TAX GAP
What is the tax gap? This is the difference between the amount of tax that should be paid and the amount of tax that is paid. The IRS estimates the tax gap to be $460 billion. The majority of this amount, about $390 billion, is due to under-reporting which includes the understatement of income and the overstatement of deductions and credits. The remaining balance of this gap is due to unfiled tax returns (about $30 billion) and taxes due that are noncollectable (about $40 billion.)
The IRS is constantly evaluating this number and their policies and procedures in an effort to minimize this gap. They look at how they utilize their resources and constantly reallocate those resources in an effort to maximize revenue collection. However, not everyone agrees on how the IRS resources are best utilized. Some think that the IRS should go after the “big fish.” These are the taxpayers that have substantial amounts of underpaid tax. Audits of these taxpayers usually result in larger amounts of revenue collected. Then why does the IRS spend so much time auditing the “little guy?” Their theory is that, while the audit may result in a smaller amount of revenue collection, it creates the fear of an audit which results in much greater tax compliance. Which approach results in greater revenue collection? No one really knows for sure.
Audits alone will not fix the tax gap problem. Multiple approaches are needed to successfully address this issue. Another area the IRS continues to evaluate is the income reporting requirements such as 1099’s. The IRS has continually increased these reporting requirements. For example, credit card processing companies are now required to issue 1099’s if certain thresholds are met. A few years ago this was not the case. Payments to attorneys in excess of $600 are also a relatively new 1099 filing requirement. The IRS knows that if income is reported on a 1099, W-2, or some other reporting form, it is very difficult for a taxpayer to get away with not reporting such income.
As far as the workload of the IRS is concerned, there is more work than they can handle. The IRS identifies taxpayers that either have under-reported their income or that owe money that they have not paid. Unfortunately, due to the lack of resources, many of these cases are not being worked. Some of these cases are taken out of the IRS inventory altogether. Again, we have to ask ourselves “Are the IRS resources being utilized in a manner that will maximize revenue collection?”
Most of us do not know the next series of changes the IRS will make regarding the tax gap problem. However, we can be assured that there will be changes. There always are.