IRS Drops Hint on Massive Audit Efforts

The tax gap has jumped by nearly $200 billion compared to previous measurements.

Internal Revenue Service (IRS) building in Washington on June 28, 2023. Madalina Vasiliu/The Epoch Times

The tax gap—the difference between what is owed and paid to the government—widened to $688 billion in tax year 2021, which the IRS claims “underscores the importance” of the need for increased compliance.

For tax year 2020, the IRS estimates the gap to be $601 billion. For 2021, it is estimated to be $688 billion, which is “a significant jump” from previous estimates, according to an Oct. 12 news release. The 2021 tax gap is $192 billion more than estimates from 2014-16 and $138 billion more than 2017-19.

This is the first time the IRS is making tax gap projections on an annual basis. Previously, the number was published once every three years. Moving forward, the IRS plans to publish the data yearly.

As the 2020 and 2021 tax gap numbers are estimates, they can be revised up or down at a later time.

“This increase in the tax gap underscores the importance of increased IRS compliance efforts on key areas,” said IRS Commissioner Danny Werfel. “With the help of Inflation Reduction Act funding, we are adding focus and resources to areas of compliance concern, including high-income and high-wealth individuals, partnerships, and corporations.”

“These steps are urgent in many ways, including adding more fairness to the tax system, protecting those who pay their taxes, and working to combat the tax gap.”

While the IRS focuses on boosting its compliance rate and closing the tax gap, there are concerns that such efforts could affect smaller businesses and low and middle-income households.

Last month, the agency announced that it was looking to fill more than 3,700 positions nationally to assist with “expanded enforcement work” focusing on complex partnerships, large corporations, and high-income earners.

IRS commissioner Mr. Werfel said that the new employees at the agency would not target individuals and entities making less than $400,000 annually.

However, such claims fall flat given that a recent report by the Treasury Inspector General for Tax Administration (TIGTA), an IRS watchdog, pointed out that the agency does not have a “unified or updated” definition of high-income taxpayers.

“The high-income terminology is being used loosely inside the IRS with no common understanding of what the term means,” the watchdog said while pointing out that the agency “still uses $200,000 as the default high-income threshold.”

An annual income of $200,000 is “no longer a reasonable standard for high earners given inflation since 2005,” the TIGTA report stated.

In a May 16 testimony before the Senate Finance Committee, Chris Edwards of the CATO Institute said that the IRS intends to assess the income of businesses without accounting for losses.

Increased audits would likely affect “mainly small to midsize businesses, who actually may have [adjusted gross income] under 400,000.”

IRS’ Compliance Efforts

The $688 billion tax gap for 2021 is the “gross” tax gap. An additional $63 billion in revenues is expected from IRS enforcement efforts and taxpayers’ late payments, which would result in a “net” tax gap of $625 billion.

According to the agency, the voluntary compliance rate (VCR) of tax filers “remains relatively steady.” VCR measures the share of taxes paid voluntarily and corresponds to the “gross” tax gap. The net compliance rate (NCR) measures the share of taxes that are ultimately paid, corresponding to the “net” tax gap.

“The voluntary compliance rate of the U.S. tax system is vitally important for the nation. A one-percentage-point increase in voluntary compliance would bring in about $46 billion in additional tax receipts,” according to the agency.

For tax years 2020 and 2021, the VCR is estimated to be around 85 percent. Adding in IRS’ compliance efforts, this number comes to 86.3 percent for 2021, which is close to the 87 percent rate for tax years 2014-16.

The IRS attributes the slight dip in compliance rates to “changes in the types of income and how that income is reported.” The agency plans to take a “variety of steps” to boost VCR, including improving taxpayer services.

As part of its increased compliance efforts, the IRS announced in July that it was going after “high-income individuals evading taxes.”

“The IRS is working to ensure [that] high-income filers pay the taxes they owe,” the agency said on July 14. “In recent months, our Criminal Investigation team has closed a lengthy list of cases where wealthy taxpayers have been sentenced for tax evasion, money laundering, and filing false tax returns.”

At the time, the IRS stated that it had closed 175 delinquent tax cases for millionaires in the previous months. The agency received $38 million from delinquency cases against wealthy taxpayers.

In August, the IRS said it intends to go after “large, complex partnerships” as part of making business entities pay the tax they owe. Partnerships allow businesses to pass their incomes and losses to their partners, thus avoiding getting taxed as corporations.

As the IRS has not defined what a “large, complex partnership” means, such business structures have risen in popularity.

A report by the Government Accountability Office (GAO) found that only 54 large partnerships out of the more than 20,000 registered ones were audited by the IRS in 2019. This translated into an audit rate of just 0.27 percent, which is below the audit rate for people making $25,000 per year or less.