Collecting taxes remains a challenge for IRS as 'Tax Gap' grows

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Every large or small business knows that collecting revenue from recalcitrant clients can be a trying task. How much more difficult a chore, then, must the Internal Revenue Service face when its client base effectively includes every company and employed individual in the United States?

New data from the IRS show that the quantity of unpaid taxes , also known as the net  'Tax Gap,' increased from $290 billion in 2001 to $385 billion in 2006. The IRS stated that the broadening gap mostly came from "the underreporting and underpayment forms of noncompliance." Underpayment rose by 38 percent, while underreporting increased by 32 percent.

The IRS data also illustrate that underreporting increased more in the corporate sector than for individuals - either because corporate finances are more complex or because it's easier to use tricky accounting for a company than for a single person. By contrast, underpayment is almost entirely an individual behavior.

In 2006, individuals underreported about 16 percent more than they had in 2001, while corporations underreported at more than twice their 2001 rate. For small corporations with assets of less than $10 million, the rate was nearly 4 times higher.

Bruce Bartlett - an advisor to Reagan and a Treasury official in Bush Sr.'s presidency, as well as an advocate of tax reform - writes in the NYTimes  that staff cuts at the IRS represent a more likely culprit behind the rising levels of underreporting and underpayment than tax rates. After all, marginal tax rates decreased from 2001 to 2006 as a result of the Bush tax cuts, which would generally reduce incentives to cut corners on filing. However, over the last two decades the the IRS has lost more than a quarter of its employees, Bartlett points out, even as the population rose by 53 million.

In total, the IRS employs about 22,000 employees in enforcement, or 25 percent of its workforce. Last year the agency audited 1 in every 8 millionaires, according to Accounting Today . The data suggest, however, that it may begin to focus on small and large corporations, especially as deficits continue to rise.

Increased complexity - every year, Congress seems to increase rather than decrease the tax code's complexity - represents another problem. As the recession set in, freelance work became more prevalent . Individuals scrambled to find work where they can find it and companies took advantage of these more pliable, 'flexible' workforces. Filing with the IRS as an independent contractor, though, is a notoriously tricky and complicated task - practically everybody knows someone who's been tripped up by the increased FICA contributions or the quarterly schedule.

While tax collection shouldn't be a political issue - the U.S. isn't Greece - it's tough to imagine much muscle being put behind collection efforts in an election year, though the president could probably score some points by pushing for increased efforts to audit financial institutions. Congress, however, remains split . It's unlikely that Democrats and Republicans will find compromise over the issue of helping the IRS collect the last 15 percent of what it's owed.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: News Headlines , Taxes , US Markets

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