The “tax gap” is the amount of unreported income. The IRS measures this through approximately 14,000 random audits each year. The IRS recently released a report of the tax gap based on 2006 returns. The last time the IRS issued a similar report used 2001 tax returns.
The IRS concluded that 83.1% of taxes were voluntarily reported. The corollary is that approximately 17% of taxes were not reported. The IRS indicates its audits, matching, and other compliance efforts generated around 2.4% of the missing 17%, leaving approximately 14.5% of taxes unreported and uncollected.
Generally, where there is good information reporting of income (such as W-2s, and Form 1099s) to the IRS, or where there are larger businesses involved, the level of compliance is much higher. When there is both information reporting and tax withholding, the level of tax compliance is even higher. In this article, we summarize the major areas of unreporting, and what can be done to solve these problems.
Here are the largest items of unpaid taxes:
- By far, the largest amount of the tax gap comes from individual income tax underreporting of business income. This involves individual-operated businesses such as a coin-operated Laundromat, owner-operated restaurant, a gardener or other service business. An eBay reseller might also be representative of these types of businesses.
- The second largest type of underreporting involves those improperly classified as independent contractors, with payroll taxes not paid. For more information, see this article that provides information regarding a federal amnesty program and the criteria of what constitutes an independent contractor.
- The third largest problem involves individual credits that are improperly taken. As an example, see this article regarding inappropriate refundable tax credits.
- The fourth area of abuse is inappropriate personal income tax deductions and exemptions.