Taxpayers fail to pay hundreds of billions of dollars in taxes every year. This tax gap—the difference between tax amounts that taxpayers should pay and what they actually pay voluntarily and on time—has been a persistent problem for decades. However, the amount of the tax gap can fluctuate over time due to things like changes in taxpayer behavior, Internal Revenue Service (IRS) enforcement activities, updated methods for estimating the tax gap, changes in economic activity, and changes in tax law and administration.
IRS's Annual Average Tax Gap Estimate for Tax Years 2014-2016
The tax gap occurs when taxpayers, whether intentionally or inadvertently, fail to accurately report tax liabilities on tax returns (underreporting), fail to pay taxes due from filed returns (underpayment), or fail to file a required tax return altogether or on time (nonfiling).
Estimated Average Annual Gross Tax Gap by Type of Noncompliance and Tax (Tax Years 2014-2016)
Reducing the tax gap will require multiple strategies—such as increasing the number of IRS audits and improving taxpayer services. However, IRS has faced decreased budget and staffing levels over the past decade, as well as increasing responsibilities (e.g., administering stimulus payments during the COVID-19 pandemic). To help, in 2022 Congress provided IRS with nearly $80 billion over 10 years to modernize taxpayer services and enforce tax laws. However, there are a number of additional issues that both IRS and Congress could address to reduce the tax gap and improve compliance with tax laws.
- IRS previously set specific, numeric goals for improving taxpayer compliance, but has moved away from that approach. Re-establishing such quantitative goals could help improve voluntary compliance.
- IRS receives information from employers, banks, and other third-parties about taxpayers. The extent to which individual taxpayers accurately report their income is closely aligned with whether third parties (e.g., employers) report income information to these taxpayers and to IRS. IRS should work to expand third-party information reporting to improve compliance—especially related to self-employed individuals who continue to represent the largest share of the individual underreporting tax gap.
- IRS wants to improve taxpayer experiences and services. However, it does not have performance goals specifying desired improvements. For example, one IRS division has broad plans to monitor the taxpayer experience and address identified issues. But it does not have performance goals with measures that would indicate whether the taxpayer experience had improved—e.g., a goal of reducing telephone assistance wait times by a specified amount. The agency could also improve its management of IT systems and investments.
- The Return Review Program is one of IRS's key systems for detecting tax fraud and preventing bad refunds—preventing about $4.4 billion in bad refunds during the 2017 filing season. IRS monitors the program's performance and adjusts it to address new threats, but it could improve and expand use of the program. For example, it could increase the amount of data available to the program, including digitizing paper returns. Congress could also require that tax returns prepared electronically but filed on paper include a scannable code printed on the return.
- Businesses are not always required to report the payments they make to other businesses. These include nonemployees (such as contractors) who are supposed to report this income on their own taxes—and often do not. If Congress required businesses to report the amounts they paid to all businesses, they would be more likely to report this income on their taxes. Additionally, only some rental real estate property owners must file returns, which can lead to confusion and underpayment of required taxes (such as payments real estate owners make to service providers).
- IRS does not have the authority to establish professional requirements for all paid tax preparers, so it created a program to educate preparers who submit returns with tax credit errors. IRS's program aims to improve the accuracy of tax returns, but it can only reach a small fraction of paid preparers. Congress could grant IRS the explicit authority to establish professional requirements for paid preparers to help increase the accuracy of tax returns.
- Congress could provide IRS with the authority (with appropriate safeguards) to correct math errors and discrepancies between what the taxpayer reported and other sources of information (such as government databases). Doing so would enable IRS to correct obvious noncompliance in a manner that is less intrusive and burdensome to taxpayers than audits—and could also help taxpayers who underclaim tax benefits to which they are entitled.
Tax Gap: Modest Reductions in the Gap Could Yield Large Fiscal Benefits
Abusive Tax Schemes: Additional Steps Could Further IRS Efforts to Detect and Deter Promoters
Paid Tax Return Preparers: IRS Efforts to Oversee Refundable Credits Help Protect Taxpayers but Additional Actions and Authority Are Needed
Tax Compliance: IRS Audit Trends for Individual Taxpayers Vary by Income
Tax Compliance: Trends of IRS Audit Rates and Results for Individual Taxpayers by Income
IRS Free File Program: IRS Should Develop Additional Options for Taxpayers to File for Free
Abusive Tax Schemes: IRS Could Improve Its Reviews of Offshore Insurance Audits and Investigations
Tax Administration: Better Coordination Could Improve IRS's Use of Third-Party Information Reporting to Help Reduce the Tax Gap
Abusive Tax Schemes: Offshore Insurance Products and Associated Compliance Risks
Taxpayer Compliance: More Income Reporting Needed for Taxpayers Working through Online Platforms
Virtual Currencies: Additional Information Reporting and Clarified Guidance Could Improve Tax Compliance
Tax-Law Enforcement: IRS Could Better Leverage Existing Data to Identify Abusive Schemes Involving Tax-Exempt Entities