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February 16, 2006

The tax scientists at the IRS have finished their "research" audits of 2001 tax returns and have reported their findings: a lot of folks don't pay all of their taxes.

The IRS last week estimated that the gross "tax gap" stands at $345 million annually. The IRS recaptures about $55 billion of this through enforcement actions, leaving a net gap of $290 billion.

Underreporting is inversely proportional to whether the income is subject to third-party reporting, and is worst for sole proprietors, as this IRS chart illustrates:

Source: IRS

The Senate Budget Committee yesterday had a hearing on ways to reduce the gap. Comptroller General David Walker said that capital gains enforcement should be tightened. He criticiced IRS Commissioner Mark Everson for saying it wasn't a priority because he believed capital gains account for only $11 billion of the gap: "I would also respecfully suggest that $11 billion is a lot of money."

Taxpayer Advocate Nina Olson advocates requiring stockbrokers to report basis information to customers - an idea that makes a lot of sense. While it would be a cost to brokers and their customers, it would save the customers the time of digging up the information themselves, or the cost of paying their tax preparers to figure it out. It would also mean fewer calls for brokers to return to tax preparers upon returning from their spring break vacations.

The tools needed to close the gap are there for all to see. Comproller General Walker gets it:

Walker said the tax gap should be attacked over a sustained period using strategies including regularly studying noncompliance, simplifying the tax code, improving service, and improving enforcement tools like withholding, information reporting, and penalties.

"Ultimately if you want to minimize the tax gap, you're going to have to reform the overall tax system to make it as simple as possible," he said.


IRS Release on Tax Gap

Tax Analysts Free Coverage

Tax Analysts subscriber-only coverage

TaxProf coverage of hearings, with links to testimony.

Tax Policy Blog

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