Bridging the tax gap: Is reporting the key?


News flash: Some people still aren't paying their taxes.

As breaking news goes, that ranks right up there with "The Sky Is Blue."

Still, some interesting stats related to the tax gap are seeping out of Washington, courtesy of the IRS.

You remember the tax gap, right? That's the difference between what people owe and what they actually pay. In 2006 -- the most recent year for which data is available -- that number was $385 billion, a full $95 billion more than the IRS's last tax gap numbers from 2001.

That's a pretty big number, and the growth from '01 to '06 seems alarming.

But consider this: According to the IRS, the compliance rate remained statistically unchanged -- 85.5 percent in 2006 vs. 86.3 percent in 2001.

What's the difference?

"On a relative basis, the tax gap is largely in line with the growth in total tax liabilities," the IRS reports. "In addition, some growth in the tax gap estimate is attributed to better data and improved estimation methods."

The question remains, though: What do we do about it?

I think the IRS answered that question for us. The agency's report cited "underreporting of income" as the biggest contributor to the tax gap. How big? It accounted for about 84 percent of the gross tax gap in 2006.

"Compliance is highest where there is third-party information reporting and / or withholding," the IRS reports. "For example, most wages and salaries are reported by employers to the IRS on Forms W-2 and are subject to withholding. As a result, a net of only 1 percent of wage and salary income was misreported. But amounts subject to little or no information reporting had a 56 percent net misreporting rate in 2006."

So how is the IRS responding?

In this Forbes article, Ashlea Ebeling says the response begins with the IRS's bid to register and oversee all paid tax return preparers.

The next step, though, centers on information reporting -- or, rather, a lack thereof. "Cost basis reporting ... new merchant card reporting requirements ... and new reporting requirements for U.S. individuals with financial accounts oversees will help the IRS keep an eye out for offshore tax avoidance," Ebeling writes. "Despite all the complaints from the business community about information reporting, it’s a friendlier way to combat the tax gap than through increased enforcement efforts."

We'll see how friendly all of this is once it hits the election spin cycle. Friendly or not, it'll certainly be interesting. And by "interesting," I mean "nauseating."

In the mean time, what, if anything, do you think we need to do to close the tax gap?


Bill Sheridan