What is the Tax Gap and Why Does it Cost You Money

The federal tax gap runs over $350 billion a year, but what is the tax gap, where does the tax gap come from, whats being done about the tax gap, and why does the tax gap cost honest taxpayers money? What is the tax gap? The â€Å"tax gap† is the difference between the annual amount of taxes owed and the amount voluntarily paid on time. Where does the tax gap come from? The tax gap comes from three main areas of non-compliance with the tax law: underreporting of taxable income, underpayment of taxes and non-filing of returns. 80 percent of the tax gap comes from taxpayers who either underreport income or overstate expenses.On improper returns filed by individual taxpayers, more than 80 percent understate income, rather than overstate tax deductions.Most of the understated income comes from small business activities, not wages or investment income. What is the extent of the tax gap? While the IRS estimates that 86 percent of all federal income tax due is paid voluntarily and on time every year, the tax gap continues to increase, now averaging over $350 billion annually. Why does the tax gap cost honest taxpayers money? The tax gap costs honest taxpayers money in three ways: It results in higher taxes. Honest taxpayers pay nearly 20 percent more in taxes due to tax cheating. Collecting the underpaid taxes takes time and costs money. Tax rates must be set higher initially in order to cover the shortfall that results from the tax gap.It increases the national federal deficit, which further increases taxes.It reduces the level and quality of service the federal government can be offer. In announcing a 2004  study on the tax gap, former IRS Commissioner Mark W. Everson stated, â€Å"Even after IRS enforcement efforts and late payments, the government is being shortchanged by over a quarter-trillion dollars by those who pay less than their fair share. People who aren’t paying their taxes shift the burden to the rest of us.† What is being done about the tax gap? Since 2001, the IRS has reported taking a number of steps to improve its ability to collect tax gap taxes owed in a timelier manner. The IRS increased its enforcement revenues by nearly 28 percent from $33.8 billion in 2001 to $43.1 billion in 2004. Audits of high-income taxpayers -- those earning $100,000 or more -- topped 195,000 in fiscal year 2004, which is more than double those conducted in 2001. Total audits of all taxpayers topped 1 million in 2004 -- a 37 percent jump from 2001. In addition, the IRS has devised what it calls a Comprehensive Strategy for Addressing the Tax Gap based on four key areas: First, unintentional taxpayer errors and intentional taxpayer evasion should both be addressed.The IRS acknowledges that simplified tax return forms, instructions and procedures would go a long way toward reducing unintentional taxpayer errors, and they continue to work for improvement in this area.Second, sources of noncompliance should be targeted with specificity.Third, enforcement activities should be combined with a commitment to taxpayer service.Fourth, policy positions and compliance proposals should be sensitive to taxpayer rights and maintain an appropriate balance between enforcement activity and imposition of taxpayer burden.