Tax & Accounting Blog

$385 Billion in Unpaid Federal Tax Falls into the Tax Gap, New IRS Study Reports

1099, Information Reporting for Wealth Management, ONESOURCE, Tax Information Reporting, TIN Compliance, Trust Tax, Withholding Management January 16, 2012

The IRS has released a new set of tax gap estimates for tax year 2006 (the most recent year for which these figures are available). The tax gap is defined as the amount of tax liability faced by taxpayers that is not paid on time. Much of the tax gap amount is never paid, largely due to taxpayers underreporting their income. Tax gap concerns keep leading policymakers and legislators back to recommendations for payers to do more tax information reporting – and perhaps do it earlier or in “real time,” as has been mentioned by IRS Commissioner Doug Shulman in his vision statement, which would have the IRS receive all information returns from third parties (W-2s, 1099s, etc.) before individual taxpayers filed their returns.     

The new tax gap estimate for 2006 represents the first full update of the report in five years, and it shows the nation’s compliance rate is essentially unchanged from the last review, which covered tax year 2001. It shows that only one percent of wage and salary income reported on Forms W-2 does not get reported on taxpayers’ individual income tax returns, but 56 percent of income for which there has been no information reporting (not reported on a Form 1099 or W-2, etc.) is misreported on the income tax returns of the taxpayers who received the income.

The voluntary compliance rate (the percentage of total tax revenues paid on a timely basis) for tax year 2006 is estimated to be 83.1 percent.  That resulted in a tax gap of $450 billion of unpaid federal taxes. IRS audit and enforcement, and late payments by taxpayers, brought in $65 billion, but that still resulted in a tax gap estimated at $385 billion of federal tax money legitimately owed for that year but not paid.

As was the case in the previous tax gap report for 2001, the underreporting of income remained the biggest contributing factor to the tax gap in 2006. Underreporting across taxpayer categories accounted for an estimated $376 billion of the gross tax gap in 2006, up from $285 billion in 2001. Tax non-filing accounted for $28 billion in 2006, up from $27 billion in 2001. Underpayment of tax increased to $46 billion, up from $33 billion in the previous study.