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US Income ‘Tax Gap’ Widens

The Internal Revenue Service estimated that Americans underpaid their taxes by $385 billion for tax year 2006 in its latest report on the nation’s “tax gap”—an estimate of taxes owed but not paid.

As in the last report, released five years ago, the largest single element of noncompliance was unreported income from small businesses.

The agency said U.S. taxpayers—both individuals and corporations—paid 85.5{982ecbb84816c6d9f589e8211ea46f8047ba0a57e5c66df0879b0b268bf06ad5} of what they owed in 2006, compared with 86.3{982ecbb84816c6d9f589e8211ea46f8047ba0a57e5c66df0879b0b268bf06ad5} for 2001, when the tax gap stood at $290 billion. It typically takes the IRS five years to complete a tax-gap study.

IRS spokesman Frank Keith called the change “statistically level,” because the new report found the gap was 14.5{982ecbb84816c6d9f589e8211ea46f8047ba0a57e5c66df0879b0b268bf06ad5} of taxes owed but not paid, compared with 13.7{982ecbb84816c6d9f589e8211ea46f8047ba0a57e5c66df0879b0b268bf06ad5} in the 2006 report.

According to the report, the net tax gap for individuals, $235 billion, was more than three times that for all corporations. The largest single element of noncompliance, $122 billion, was attributable to undeclared income by businesses reported on Schedule C and F of individual returns—that is, small businesses and farms.

Mr. Keith noted that the report didn’t include recent efforts to address the tax gap though laws requiring credit-card firms and others to tell the IRS about payments to merchants. The law has also been changed to require cost-basis reporting by brokers after investment sales, in order to prevent underreporting of investment income.

“All our research indicates that if income is subject to third-party reporting or withholding, compliance improves significantly,” Mr. Keith says.

The report also doesn’t incorporate knowledge gleaned from the IRS’s limited amnesty programs of 2009 and 2011 for U.S. taxpayers with undeclared offshore accounts, Mr. Keith says.

For more information on underpayments, including a Tax Gap Map, see IRS notice IR-2012-4 at

Write to Laura Saunders at

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