IRS Reports an Increase in the Tax Gap

The Internal Revenue Service reported that the average annual tax gap has increased to $458 billion for tax years 2008-2010, compared to $450 billion for tax year 2006.

The voluntary compliance rate was 81.7 percent for tax years 2008-2010, compared to 83.1 percent in tax year 2006. The IRS periodically estimates the tax gap, which provides a broad view of compliance with federal tax laws. The report found there has been no significant change in the amount of the tax gap or the rate of compliance since the last report was issued for tax year 2006.

“The figure of $458 billion doesn’t account for the revenue brought in through enforcement activities, such as audits and document matching,” IRS Commissioner John Koskinen said during a conference call with reporters Thursday. “After factoring in those activities, the average net tax gap for this period is estimated to be $406 billion per year. This continues to show that both solid taxpayer service and effective enforcement are needed for top-notch tax administration.”

Koskinen noted that factors such as third-party information reporting and withholding tend to increase the compliance rate. “The compliance rate is very high for income that is subject to third-party information reporting, and higher still when you also have withholding,” he said. “The study found that when there is information reporting, such as 1099s, income is underreported only about 7 percent of the time. That number drops to 1 percent for income subject to both third-party reporting and withholding. But the number jumps to 63 percent for income not subject to any third-party reporting or withholding.”

The small increase in the estimated size of the tax gap and small decrease in the voluntary compliance rate are largely attributable to improvements in the tax gap estimation methodology, and do not represent a significant change in underlying taxpayer behavior, according to the IRS. The changes also reflect the overall decline in the nation’s tax revenues due to the severe recession during the time period covered by the study, as well as changes in the mix of income sources that have different compliance rates.

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