IRS reports $688B tax gap in 2021.
The Widening Tax Gap: IRS Calls for Increased Compliance
The tax gap—the difference between what is owed and paid to the government—has reached a staggering $688 billion in tax year 2021, according to the IRS. This significant increase from previous estimates highlights the urgent need for improved compliance.
For tax year 2020, the IRS estimated the gap to be $601 billion. However, the latest projections for 2021 reveal a substantial jump to $688 billion, surpassing previous estimates by $192 billion from 2014-16 and $138 billion from 2017-19.
This is the first time the IRS is providing annual tax gap projections, as they were previously published every three years. Moving forward, the IRS plans to release this data on a yearly basis.
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While the IRS focuses on closing the tax gap and improving compliance, concerns arise regarding the potential impact on smaller businesses and low to middle-income households.
Last month, the agency announced its intention to hire over 3,700 positions nationwide to assist with expanded enforcement work targeting complex partnerships, large corporations, and high-income earners.
IRS Commissioner Danny Werfel assured that individuals and entities earning less than $400,000 annually would not be targeted. However, a recent report by the Treasury Inspector General for Tax Administration (TIGTA) revealed inconsistencies in the IRS’s definition of high-income taxpayers.
According to Chris Edwards of the CATO Institute, the IRS plans to assess business income without considering losses, potentially impacting small to midsize businesses with adjusted gross income under $400,000.
IRS’ Compliance Efforts
The $688 billion tax gap for 2021 represents the “gross” tax gap. Additional revenues of $63 billion are expected from IRS enforcement efforts and late payments, resulting in a “net” tax gap of $625 billion.
The voluntary compliance rate (VCR) of tax filers, which measures the share of taxes paid voluntarily, remains relatively steady at around 85 percent for tax years 2020 and 2021. With the inclusion of IRS compliance efforts, the rate reaches 86.3 percent for 2021, close to the 87 percent rate from tax years 2014-16.
The IRS attributes the slight dip in compliance rates to changes in income types and reporting methods. To boost the VCR, the agency plans to take various steps, including improving taxpayer services.
As part of its increased compliance efforts, the IRS has announced its focus on high-income individuals evading taxes. Recent months have seen the closure of numerous cases involving tax evasion, money laundering, and false tax returns by wealthy taxpayers.
In August, the IRS revealed its intention to target large, complex partnerships to ensure proper tax payment. However, the lack of a clear definition for such partnerships has led to their popularity as a means of avoiding corporate taxation.
A report by the Government Accountability Office (GAO) found that only 54 out of over 20,000 registered large partnerships were audited by the IRS in 2019, resulting in an audit rate of just 0.27 percent. This rate is lower than the audit rate for individuals earning $25,000 or less per year.
What potential impact could increased tax enforcement have on low to middle-income households?
The Epoch Times suggests that the IRS may pivot towards scrutinizing partnerships and high-income earners to narrow the tax gap.
While it is crucial to address the tax gap and ensure compliance across the board, it is essential to consider the potential effects on small businesses and low to middle-income households. These groups may already be struggling with financial challenges and increased tax enforcement could further burden them.
One concern is that increased enforcement efforts could disproportionately affect small businesses. Smaller businesses often have fewer resources to navigate complex tax regulations and may find it more challenging to comply with increased scrutiny. The additional burden could hinder their growth and profitability, potentially leading to workforce reductions and economic instability.
Moreover, low to middle-income households may also feel the impact of increased enforcement measures. These households already face financial constraints, and any additional tax burdens could further strain their resources. It is crucial to ensure that the approach to closing the tax gap considers the financial capacities of these households and provides adequate support and guidance.
Efforts to improve compliance must strike a balance between enforcement and support. While robust enforcement is necessary to address tax evasion and promote fairness, it is equally important to provide guidance and resources to individuals and businesses to help them fulfill their tax obligations.
Education and outreach programs can play a vital role in promoting compliance. The IRS can partner with community organizations, professional associations, and tax advisors to provide workshops, webinars, and resources that help individuals and businesses understand their tax responsibilities and navigate the complexities of the tax system. By increasing awareness and understanding, taxpayers are more likely to willingly comply and avoid unintentional violations.
Moreover, the IRS must ensure that its enforcement actions are transparent and fair. Clear guidelines should be established to define audit triggers and selection criteria to minimize the possibility of arbitrary targeting. Ensuring that enforcement actions are based on objective criteria and adequate evidence will enhance public trust in the tax system and discourage tax evasion.
Additionally, it is essential to address systemic factors that contribute to the tax gap. Simplifying the tax code and making it more accessible can reduce confusion and increase compliance. The IRS should work in collaboration with lawmakers to identify and rectify areas of the tax code that may inadvertently facilitate noncompliance or create loopholes that allow tax evasion.
The widening tax gap demands immediate attention and action. The IRS’s commitment to increasing compliance is commendable, as it plays a crucial role in maintaining a fair and functioning tax system. However, it is imperative that enforcement efforts consider the potential impact on small businesses and low to middle-income households. By adopting a balanced approach that combines enforcement with support and education, the IRS can effectively close the tax gap while ensuring fairness and equitable treatment for all taxpayers.
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