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IRS needs to improve its Tax Gap estimation methodology

Gap between scrabble tiles G and P_brett-jordan-ulqQgJRGVNc-unsplash

Turnabout, it seems, is fair tax play.

The Internal Revenue Service expects preciseness from us taxpayers. Now, says a government watchdog, the tax agency itself needs to do a better job of collecting and calculating Tax Gap numbers.

The Tax Gap is the amount of money the IRS estimates the U.S. Treasury is legally owed but which the agency has been unable to collect. The IRS' most estimates, released last October, found an average annual gross Tax Gap of $496 billion from 2014 to 2016. In that report, the IRS also projected an average annual gross tax gap of $540 billion from 2017 through 2019.

This revenue loss was a major impetus for passage of the nearly the $80 billion allocated the IRS over the next decade as part of last year's Inflation Reduction Act.

However, a recent Treasury Inspector General for Tax Administration (TIGTA) audit report found that the IRS likely is missing more tax revenue, largely because of the methodology the tax agency uses to come up with its figures.

Trouble with 2 of 3 Tax Gap components: The TIGTA report notes that the gross Tax Gap is made up of three categories. There's the underreporting amount, the underpayment sector, and the nonfiling gap.

TIGTA focuses on the IRS' ability to accurately estimate the tax shortfalls from underreported income, which is the largest portion of the gross Tax Gap, and nonfiling.

The third component, underpayment, doesn't rely on estimates. It is counted based on tax liability reported on timely-filed returns, but which is not paid on time.

The underreporting component of the tax gap, according to TIGTA, doesn't include estimates of excise taxes or the income taxes of estates and trusts. It also neglects data from various corporate taxes, such as from Form 1120-F, U.S. Income Tax Return of a Foreign Corporation.

As for the nonfiling component, TIGTA says the IRS overlooks estimates of corporate income taxes, excise taxes, income taxes of estates and trusts, and the unrelated business income tax from Form 990-T, Exempt Organization Business Income Tax Return, filings. In addition, notes the report, the estimate for employment tax nonfiling only includes the self-employment tax.

Lacking structure: The TIGTA reports notes that while the IRS has high-level quality and research guidelines, they do not discuss the Tax Gap estimates. Notably, say TIGTA, the agency's Office of Research, Applied Analytics and Statistics (RAAS) does not have documented policies or procedures for producing the Tax Gap estimates.

"In lieu of documented procedures, RAAS has developed technical papers for each component of the Tax Gap estimates, which provide varying levels of specificity on the data sources and methodologies used," according to TIGTA.

Issues due to unwritten Tax Gap policies_TIGTA report graphic
TIGTA graphic from Report Number: 2023-10-016

In addition, the report charges that RAAS does not have written policies, procedures, or guidance to specify the frequency of issuing Tax Gap estimates or help RAAS analysts meet internal milestones for developing the Tax Gap estimates. Instead, RAAS relies on its staff’s experience with developing previous Tax Gap estimates to meet internal milestones.

Given the tenuous state of IRS personnel in recent years, TIGTA says such an unstructured process "raises concerns about the potential for a lapse in quality, timeliness, and continuity of operations following an unexpected departure of subject matter expert(s)."

Gaps in timely reports: TIGTA also pointed out that the Tax Gap estimates are not so timely.

Tax gap timeliness gaps_TIGTA report graphic
TIGTA graphic from Report Number: 2023-10-016

Data used to develop the Tax Gap estimates come from a variety of sources such as audits performed through the National Research Program (NRP), operational audits, and IRS systems. RAAS management told TIGTA that the decision was made in calendar year 2014 to develop and release Tax Gap estimates on a three-year cycle reflecting an average annual Tax Gap covering non-overlapping time frames of three tax years. This decision was driven by the implementation of annual NRP samples, which started with the 2006 tax year.

Under the current report cycle, Tax Gap reports are issued approximately every three years, with a multiyear lag between the tax year(s) used for the estimates and the year the estimates are published.

The table below illustrates the amount of time between the tax years analyzed and the years that they were published.

Tax Gap Data and Report Publication

Tax Year(s) Analyzed

Publication Year





2008 – 2010


2011 – 2013


2014 - 2016


Source: IRS Tax Gap page from the website, December 2022

"The multiyear lag in issuing the Tax Gap estimates results in estimates that do not reflect the current Tax Gap, thereby limiting their usefulness for IRS leadership, Administration officials, and congressional stakeholders," wrote TIGTA.

Those lagging Tax Gap publication years — 2007, 2012, 2016, 2019, and 2022 — also are this week's By the Numbers figures.

Currently, TIGTA added, RAAS has limited alternatives available to improve the timeliness of the Tax Gap estimates.

RAAS management told TIGTA that since the objective of the Tax Gap estimates is to measure taxpayer noncompliance, those estimates should be based on actual audit data. Therefore, the availability of underlying data used to develop the Tax Gap estimates, which varies significantly by component, determines the timeline for issuing the Tax Gap reports.

TIGTA recommendations: The IRS watchdog made six recommendations. They are —

1. Coordinate with IRS business operating divisions to create and implement a formalized strategy to identify, prioritize and develop estimates for areas of noncompliance that are not currently addressed in the Tax Gap Estimates.

2. Improve the transparency of the Tax Gap estimates in future revisions of the Tax Gap report by including and enhanced discussion of the limitations of the Tax Gap estimates, including the types of taxpayer noncompliance that are not included in the estimates and those types that may not be fully captured.

3. The Chief Data and Analytics Officer, RAAS, should develop consolidated, written policies and procedures for developing the Tax Gap to help ensure repeatability, timeliness, quality, and continuity of the Tax Gap estimates and improve oversight.

4. Develop written policies and processes to formalize the internal and external reviews of the Tax Gap estimates.

5. Reestablish an advisory group to review any updates to the Tax Gap methodology that would significantly affect the estimates.

6. Develop a formal process for documenting the advisory group's feedback on the Tax Gap estimates, including making a high-level summary of its feedback available to the public.

IRS officials, in response to the report, agreed with five of the six recommendations and partially agreed with one. The one where the IRS hedged was Number 3, the development consolidated, written policies and procedures.

The IRS says it already produces technical papers that address its methodology for estimating various Tax Gap components. These docs, according to the IRS, "ensure the repeatability, quality, and continuity of the estimates."

However, the IRS agreed there are opportunities to improve and consolidate this relevant material, and said it would load the procedural documents and the code for running Tax Gap estimation into a single project folder.

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