Tax gap: IRS comes up $385 billion short

@CNNMoney January 6, 2012: 6:21 PM ET
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NEW YORK (CNNMoney) -- Close to 15% of federal taxes -- or $385 billion -- went unpaid in 2006, according to new estimates by the IRS.

That's the net tax gap number -- meaning what didn't get paid even after the $65 billion the IRS managed to collect through audits.

And it's the closest proxy policymakers have to the country's annual revenue shortfall, said Mark Luscomb, the principal federal tax analyst at CCH, a tax information publisher.

What's driving the shortfall? A whopping 84% of the total tax gap is due to underreporting of income by corporations, small businesses and individuals.

But underreporting by small businesses and others who report business income on the individual tax return is the biggest single culprit, accounting for more than a quarter of the gap.

The distant second and third reasons for the gap are taxpayers who do not file a tax return at all or underpay what they owe.

Whether mistakenly or intentionally, some taxpayers underreport their income by not including all their receipts, overstating their expenses or claiming incorrect amounts of credits, deductions and exemptions.

IRS audited 1 in 8 millionaires

The IRS has noted that compliance among taxpayers is highest when there is third-party reporting of income. So, the basic W2 working Joe who has money withheld automatically from his paycheck typically has a very high compliance rate.

"A net of only 1 percent of wage and salary income was misreported. But amounts subject to little or no information reporting had a 56 percent net misreporting rate," the IRS said in a statement Friday.

Given the more than 140 million returns filed a year, the 22,184 employees working in IRS enforcement can't hope to close the tax gap on their own, especially given the frequently changing tax laws.

Last year, for instance, the agency audited more than 62,000 corporate returns and roughly 1.6 million individual returns, including one in 8 millionaires, the highest enforcement rate for that income group since 2004.

The tax gap, especially in a time of $1 trillion annual deficits, is one reason many on Capitol Hill are calling for tax reform.

"An improved tax code that's simple and fair to all Americans will help close the tax gap, boost our economy and create jobs," Senate Finance Committee Chairman Max Baucus said in a statement. "In an era when we're squeezing the federal budget for every dollar of savings, we have to make every effort to recover these lost funds."

While it's easy to be disconcerted over the size of the tax gap, two things are of note: The voluntary compliance rate among U.S. taxpayers has been fairly steady over the years, and Americans are among the best in the world at paying what they owe the tax man. To top of page

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