IRS Releases First Fact Sheet To Address Business Income Tax Gap; More To Come

By Lisa Nadal, CCH Staff Writer, and Paul N. Gada, CCH Toolkit Staff Writer

It is common knowledge that not all taxpayers pay their full share of taxes owed to the government. What is not yet commonly known, however, is that the amount of taxes being underpaid is increasing. Reversing this trend is currently a high priority hot topic for the IRS.

Earlier this year, the IRS released the final 2001 tax gap figures based on estimates from the IRS's National Research Program (NRP). The tax gap is the difference between what taxpayers should have paid and what they actually paid on a timely basis.

The new estimate reveals that a tax gap of $345 billion exists for tax year 2001. This is on the high end of the previously released estimates in March 2005 of $312 billion to $353 billion for the year. Through enforcement activities, the IRS was able to collect $55 billion of that 2001 shortfall to reduce the gap to $290 billion for 2001.

The latest numbers are the result of a three-year study of about 46,000 tax returns filed by individuals in 2001. The last major study of its sort was conducted in 1988.

At a press briefing on February 14, 2006, IRS Commissioner Mark W. Everson reported that "the good news from the report is that 85.5 percent of the tax money owed is coming in correctly." He added that "the vast majority of Americans pay their taxes accurately; [however, they] are shortchanged by those who don't pay their fair share."

To help taxpayers learn the errors of their ways, the IRS has designed a series of fact sheets to address the issues uncovered by the recently released tax gap report. Since the largest component of the tax gap was attributed to unreported and underreported income and over half ($109 billion) of this was traced to understated net business income, the IRS addressed the business income issue first.

The first fact sheet (available here) addresses the issue of underreported receipts and how to determine gross income for a small business or self-employed taxpayer. A later fact sheet will discuss overstated business expenses.

Tools to more accurately determine income and expenses are available to assist small business owners and the self-employed track and report income. Some of these are the use of a formal set of books and records with strong internal controls, accounting/financial computer software, and separate bank accounts for business and personal income and expenses. Other tools are available on the IRS's website such as the "Small Business and Self-Employed One-Stop Resource" and the "Online Learning and Educational Products."

Non-business taxpayers should hold off breathing a sigh of relief that the IRS is focusing solely on business taxpayers. The latest figures reveal a $56 billion tax gap for non-business income and a $10 billion tax gap related to wages, salaries, and tips. The immediate future holds more fact sheets for all taxpayers. More importantly, the IRS will begin tightening the screws via audits and other enforcement efforts to get taxpayers in line.

Related items:

IRS Reports $345 Billion in Taxes Went Unpaid for 2001 Tax Year

Taxpayers' Failing Grade on Tax Topics Could Be Costly: Survey

IRS Programs Come Under Fire

New Tax Year Means Many Tax Changes to Consider

Posted July 20, 2006.