Don't Mess With Taxes

Photo by Brett Jordan on Unsplash

One of the Internal Revenue Service key jobs, collecting taxes, is continually stymied by those who don’t pay what they owe.

The IRS calls this difference between projected true tax liability and the amount of tax that is actually paid on time the Tax Gap. And the agency says it’s growing.

An analysis of owed vs. payment projections for tax year 2022 shows an expected gross Tax Gap of $696 billion. The 2022 projection, released last week, is an increase of $200 billion over tax years 2014-2016. 

This latest tax gap amount reflects an increase over the tax year 2014-2016 estimates, as well the tax year 2017-2019 projections.

That’s why the new Tax Gap projection of $696 billion earns this weekend’s By the Numbers [dis]honor.

Other numbers less daunting: However, the IRS analysis, officially titled Tax Gap Projections for Tax Years 2021 and 2022 (IRS Publication 5869), did include some not-so-bad news.

The increase for 2022 is similar to the 41 percent increase in the economy since the 2014-2016 time period as measured by the Gross Domestic Product (GDP), noted the IRS.

Even better, the IRS said the new Tax Gap study also showed the voluntary compliance rate among taxpayers remaining steady at 85 percent. The IRS also pointed out that the Tax Gap increase ultimately reflects growth in the economy and changes in the sources of income, not a change in taxpayer behavior involving filing or paying their taxes.

The IRS also emphasized that the new Tax Gap projections reflect the time period before the agency began increasing tax compliance work following passage of the Inflation Reduction Act in August of 2022.

Since then, the IRS has stepped up compliance activity in a variety of areas with the additional funding, including the collection of $1.3 billion from high-income non-filers in the IRS’ initial new enforcement effort.

Gross Tax Gap: The analysis looks at the gross Tax Gap. That covers three key areas – non-filing of taxes, underreporting of taxes and underpayment of taxes.

Non-filing means tax due is not paid on time by those who do not file on time. For tax year 2022, that amount was $63 billion, representing 9 percent of the gross Tax Gap.

Underreporting, which reflects tax understated on timely filed returns, accounted for $539 billion in tax year 2022. That was 77 percent of the gross Tax Gap.

Underpayment, or tax that was reported on time, but not paid on time, accounted in tax year 2022 for $94 billion. That was 14 percent of the gross Tax Gap.

Net tax gap: Then there’s the net Tax Gap. This comes from late payments and IRS enforcement efforts that reduce the gross amount.

For tax years 2021 and 2022, the IRS projects these payments and collection efforts will generate an additional $90 billion for both years combined. That will whittle down the Tax Gap to projected $617 billion in 2021 and $606 billion in 2022.

Between tax years 2017-2019 and tax year 2022, the estimated tax liability increased by about 27 percent, roughly the same increase as the gross and net Tax Gaps. Much of these increases in true total tax liability and the gross tax gap can be attributed to economic growth, according to the IRS.

Voluntary compliance rate steady: The tax year 2021 and 2022 Tax Gap projections translate to about 85 percent of taxes paid voluntarily and on time. That’s consistent with recent levels, said the IRS.

After IRS compliance efforts and other late payments are factored in, the projected share of taxes eventually paid is 86.9 percent for tax year 2022, down slightly from the 87 percent for tax years 2014-2016, according to the tax agency.

The IRS also is taking steps to increase third-party information reporting, for example, 1099 form issuance, which studies have consistently shown results in higher taxpayer compliance.

The additional Inflation Reduction Act funds also will help improve voluntary compliance, according to the IRS. The IRS steps in this area include improving taxpayer services and offering new technology tools to work in concert with additional compliance work.

The IRS said it also is using various other taxpayer service programs aimed at supporting accurate tax filing and helping address the tax gap. These include working with businesses and partner groups such as IRS’ Volunteer Income Tax Assistance (VITA) and Tax Counseling for the Elderly (TCE) programs, as well as a variety of education and outreach efforts.

Any increase in the voluntary compliance rate could pay off handsomely. The IRS says a one-percentage-point increase in voluntary compliance would bring in about $46 billion in additional tax receipts.

“We need to focus both on compliance efforts to enforce existing laws as well as improving service to help taxpayers with their tax obligations to help address the Tax Gap,” said IRS Commissioner Danny Werfel. “While our recent work will not be fully reflected in the Tax Gap analysis for several years, we will continue to provide routine, interim updates on how enhanced enforcement on complex areas of tax evasion and delinquency impacts compliance.”

You also might find these items of interest:

• IRS employees & contractors owe $46 million in taxes
• Former IRS execs say they know how to close Tax Gap
• Tax Gap likely $1 trillion, thanks largely to cryptocurrency

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