Auditors: Taxpayers May Owe More than IRS Thinks

An IRS calculation that taxpayers shortchanged the government by $345 billion in 2001 may understate the problem, Treasury Department inspectors said Tuesday.

Auditors studied IRS research methods and concluded that the tax agency does not have enough information to completely and accurately measure a figure known as the tax gap, an estimate of the amount taxpayers owe but don't pay.

Included in estimates of the tax gap are taxes owed by people who did not file tax returns, people who underreported their income, and people who reported the taxes due accurately but never paid.

"In all three compliance areas across the major tax gap segments, there are concerns about whether the tax gap projections are complete and accurate," said the report from the Treasury Department Inspector General for Tax Administration, which provides independent oversight of the tax agency.

For estimates based on taxpayers who did not file returns, the IRS did not update estimates of unpaid estate taxes, nor did the tax agency estimate missing corporate, employment or excise taxes. That means "substantial amounts are not included in the estimates provided," auditors said.

The IRS identified underreporting as a serious problem contributing to the tax gap. Even so, their estimate may be incomplete because "substantial amounts" may be missing from several areas. For example, the IRS carried over old information about corporate underreporting and employment taxes.

And an IRS estimate that it eventually will collect $55 billion of the $345 billion tax gap is based on formulas using historical data, and the formulas have not been updated recently, auditors said.

The IRS spent three years studying thousands of individual tax returns, looking especially closely at higher-income taxpayers, to update portions of its 2001 tax gap estimate. The audits were completed last fall.

In the current phase of the research project, the IRS expects to fill one piece of the missing data by looking at S-corporations, enterprises that do not pay corporate income tax but instead pass income and taxes through the business to individual shareholders. That study will take two to three years to complete.

In its response to auditors, the IRS said it wants to build on research already done to improve estimates of the tax gap, but the agency may not have enough money to commit to future studies.

IRS Commissioner Mark Everson has said the research project enabled tax collectors to update the systems for detecting unpaid taxes and selecting returns for audit.

The inspectors looked into the estimates after Sen. Max Baucus of Montana, the top Democrat on the Senate Finance Committee, challenged tax collectors to strive toward collecting 90 percent of taxes owed, voluntarily and timely, by the end of the decade.

"The IRS will have a hard time closing the tax gap as long as they don't know what the tax gap really is," Baucus said.