Archive for Wednesday, March 30, 2005

IRS measures $300 billion tax gap

Underreporting of income by individuals largest part of problem

March 30, 2005


— The government is missing out on more than $300 billion in unpaid taxes every year, and part of the problem appears to be that the tax laws are so confusing.

"Complexity obscures understanding," said IRS Commissioner Mark Everson. "Those who try to follow the law but cannot understand their tax obligations may make inadvertent errors or ultimately throw up their hands and say, 'Why bother?'"

Individuals who report less income than they earn, either intentionally or not, contribute most to the tax gap, the Internal Revenue Service said in a report Tuesday. The president has appointed a panel to recommend ways that taxes can be made simpler and fairer.

The government also is losing hundreds of millions of dollars each year because IRS computers don't record interest due on penalties for those unpaid taxes.

The IRS estimated the tax gap, the difference between taxes owed and taxes due, after auditing 46,000 people and combining those findings with older estimates of unpaid corporate, payroll and unemployment taxes.

The report Tuesday estimated the gap at $312 billion to $353 billion for 2001, about 15 percent of the total taxes owed. Taxpayers were slightly less likely to comply with tax laws than they had been at the time of the latest previous study, completed in 1988.

"This research confirms that the vast majority of Americans pay their taxes honestly and accurately," said Everson. "People who aren't paying their taxes shift the burden to the rest of us."

The IRS recovered $55 billion of the unpaid taxes through audits and late payments, leaving a net gap between $257 billion and $298 billion -- about the same amount as the government expects to spend on Medicare this year.

The majority of unpaid-tax cases involved individuals, not businesses. Among the people who contributed to the tax gap, most understated their income, especially business income.

Excessive deductions, exemptions, credits and other adjustments accounted for $25 billion to $30 billion of the tax gap.

The audits found frequent mistakes reporting alimony income, unemployment compensation and state income tax refunds.

Everson said the tax agency would probably never collect every dollar owed.

"No one should think we can totally eliminate the gap," he said. "That would take draconian measures and make the government too intrusive."

Separately, J. Russell George, the Treasury Department's inspector general for tax administration, reported that the government loses huge sums every year because IRS computers don't charge interest on penalties for unpaid tax.

But thousands of taxpayers whose accounts are monitored by hand, not by computer, do pay the interest, raising concerns that the tax agency doesn't treat taxpayers consistently.

"This practice results in inconsistent treatment of some taxpayers who have to pay interest on the penalties," the report concluded.

By the inspector general's estimate, more than 125,000 taxpayers in special circumstances, whose accounts are tracked by hand, were charged more than $8.7 million in interest through 2003 on penalties applied in 2001 and 2002.

They included taxpayers who got special extensions on tax filing and payment deadlines, such as people affected by natural disasters and military personnel serving in combat zones.

The investigators estimated that the IRS could have charged more than $817 million in interest in 2002 if its computers applied the penalties to taxpayer accounts quarterly.

The IRS agreed to start applying the penalties annually beginning in 2006. The Treasury auditors strongly suggested that Congress rewrite the law to allow the IRS to charge interest without sending additional notices once a taxpayer has been notified that he owes the penalties for failing to pay.

Commenting has been disabled for this item.