IRS Reports Record $688 Billion Tax Gap in 2021 – Anticipate Increased Audits

In a record-breaking development, Americans collectively failed to pay an estimated $688 billion in taxes on their 2021 returns, according to the IRS. This striking figure has prompted the IRS to take “urgent” measures to enhance compliance, including increased audits targeting high-income individuals, businesses, and partnerships.

For the first time, the IRS is providing annual data on the tax gap, with plans to continue this reporting in the future. This eye-opening $688 billion estimate represents a significant increase of over $138 billion compared to the estimates for tax years 2017 to 2019.

One key strategy employed by the IRS to close this gap is ramping up audits on wealthy taxpayers. This initiative is a direct response to the funding boost provided by the Inflation Reduction Act (IRA). By focusing on higher earners who may be avoiding their tax obligations, the IRS aims to bridge the tax gap and generate additional revenue for federal programs, including the IRA’s substantial $370 billion investment in green energy initiatives.

IRS Commissioner Danny Werfel emphasized the urgency of these steps, citing their importance in ensuring fairness within the tax system, protecting law-abiding taxpayers, and combatting the tax gap.

It’s important to note that the IRS does not intend to increase audits for households earning less than $400,000 annually.

Understanding the Tax Gap

The tax gap represents the disparity between estimated owed taxes and the actual timely payments made to the IRS. It comprises three primary components: non-filing, underreporting, and underpayment.

• Non-filing: This occurs when individuals fail to file their annual tax returns on time, resulting in delayed tax payments. Reasons for non-filing can vary, from concerns about substantial tax debts to personal crises such as divorce or bereavement.
• Underreporting: Underreporting transpires when individuals do not fully disclose their income, often seen when those paid in cash neglect to report these earnings on their returns. This practice can lead to lower tax payments than what is actually owed.
• Underpayment: Underpayment signifies that taxes have been reported but not paid in a timely manner. This situation can affect freelancers or gig workers who miscalculate their estimated taxes or individuals who owe the IRS but delay settling their dues.

It’s worth noting that approximately 85% of taxes are paid voluntarily and on time, highlighting the importance of addressing these compliance challenges to close the tax gap.