IRS Reports Tax Gap of $385 Million

The US Internal Revenue Service reported Friday that it missed out on $385 billion in tax revenue in 2006. The figure is referred to as the tax gap, a measure of the gap between what the agency should have been paid and what is actually brought in, including the $65 billion collected through audits. The tax gap accounts for the majority of the nation’s annual budget shortfall, according to industry sources. The shortfall is caused by taxpayers underreporting income, underpaying tax liabilities, or not filing a return at all.

Of the three factors, underreporting taxpayers are by far the biggest drain on IRS revenue, accounting for nearly 85 percent of the annual tax gap. The guilty include massive corporations, small businesses and individuals, with small businesses driving the biggest impact, accounting for about a quarter of the tax gap. Tax filers underreport their income in several different ways, whether intended or not, including inflating expenses, claiming fraudulent or excessive deductions, or just omitting income earned in cash.

The IRS did say that compliance is much higher when there is a third party reporting income, as in the W2 forms received by blue collar workers every January. According to the agency’s figures, just 1 percent of income reported as wages or salary was misreported, compared to 56 percent of other forms of income where little or no third-party reporting is involved. The agency does make a valiant attempt to recover unpaid tax revenue, as evidenced by the report that it conducted 62,000 audits on corporations last year, and 1.6 million on individuals. Millionaires were audited at the highest rate, as 12.5 percent of those with seven-figure incomes got special attention for the IRS.

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