Canadians working to make golf
a tax deductible business expense
Today's Tax Tip

Tax Gap holds steady: 17 percent of taxpayers don't pay all they owe

The U.S. tax system is not, as some folks mistakenly characterize it, a voluntary tax system. Payment of taxes is required by law.

Tax protesters, please keep your comments civil, concise and on topic.

What is voluntary is compliance.

Essentially, the Internal Revenue Service relies on all of us individual taxpayers to report our income, calculate our tax liability correctly, file our returns on time and, if we owe when we file, pay those amounts.

True, in most cases income taxes are withheld from paychecks. But the IRS depends on workers to make sure that amount is correct or close to it.

It's also true that the IRS has some effective tax sticks, aka penalties, to go along with tax carrots, such as tax credits and deductions that can lead to refunds, to get us to voluntarily comply.

Still, some people don't. They are contributors to the tax gap.

The tax gap is defined by the IRS as the amount of true tax liability faced by taxpayers that is not paid on time.

17 pct tax gap 2006The tax gap got a lot of attention back in 2006 when the IRS did its first analysis of unpaid taxes in 15 years. That study used 2001 tax data.

The IRS recently re-evaluated the tax gap based on 2006 data and found that the voluntary compliance rate for 2006 remained essentially unchanged from five years before at 83.1 percent.

Or, coming at it from the other side, the tax noncompliance rate for 2006 was 16.9 percent.

That means around 17 percent of taxes owed remained unpaid. And that percentage of income tax missing from the U.S. Treasury is this week's By the Numbers figure.

Dollar cost to collections: So what does that percentage of unpaid taxes mean in dollars?

Overall, the IRS found that taxpayers had not paid $450 billion on time in 2006. The tax agency eventually collects around $65 billion via audits and late payments.

That produced a net tax gap for 2006 of $385 billion, said the IRS, which is $95 billion higher than the $290 billion net tax gap previously estimated for 2001.

Why the gap? The IRS noted that the tax gap growth is largely in line with the growth in total tax liabilities.

Plus, said the agency, some growth in the tax gap estimate is attributed to better data and improved estimation methods.

That said, some old-fashioned reasons remain as the best explanations of why Uncle Sam still isn't getting all the tax money he is owed: nonfiling, underreporting and underpayment.

"As was the case in 2001, the underreporting of income remained the biggest contributing factor to the tax gap in 2006," said the IRS in its release accompanying the new data. The complete breakout:

  • Under-reporting 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.

For those who prefer a visual representation, the IRS put together a Tax Gap Map illustrating who didn't pay and how they avoided their taxes in 2006.

Tax gap TY2006

Third party help: The IRS also took advantage of the updated tax gap data to lobby for increased third-party reporting. This is more 1099s to taxpayers that are copied to the IRS so that money is harder to hide.

Overall, noted the IRS, compliance is highest where there is third-party information reporting and/or withholding. 

The agency cited wages and salaries that are reported by employers to the IRS on Forms W-2 and are subject to withholding. In these cases, said the IRS, a net of only 1 percent of wage and salary income was misreported.

On the other hand, said the IRS, amounts subject to little or no information reporting had a 56 percent net misreporting rate in 2006.

You also might find these items of interest:


Feed You can follow this conversation by subscribing to the comment feed for this post.

Steven J Fromm

Great post here and this is huge problem. As for the third piece, the underpayment, this can be deceptive. I have seen in my practice of tax law, that clients do not pay past taxes because they used the taxes due to live on. This is sort of a form of self welfare, if you will. These taxpayers used all of their income to live on and never paid the taxes and still have no income to pay back the older taxes. There are ton of old tax liabilities and tax liens out there that are completely worthless. My though is that every form of income should required some significant withholding at the source to attack this problem, but how feasible is this really?

The comments to this entry are closed.