The Tax Gap

The difference between the tax that taxpayers should pay and
what they actually pay on a timely basis

Includes three components:

Nonfiling (failure to file a tax return)
Underreporting (understating income, overstating deductions)
Underpayment (failure to fully pay reported taxes owed)

An understanding of the Tax Gap and its components allows the

legislative and executive branches of government to make better
decisions about tax policy and the allocation of resources for
tax administration

National Research Program

The IRS National Research Program (NRP) measures

noncompliance that makes up the Tax Gap.

Detailed research on taxpayer compliance was last conducted

for Tax Year 1988.

The NRP has now completed its initial assessment of individual

taxpayer compliance for Tax Year 2001. The research sample
covered 46,000 tax returns, including an oversampling of high
income returns. The research provides a statistically valid
representation of the overall population. NRP has not updated
the corporate Tax Gap.

Current data are preliminary, so Tax Gap estimates are shown

as ranges. As refinements are made to the analysis, some
estimates may change. It is unlikely, but possible, that the final
estimates of the Tax Gap will fall outside the established range.
2

Estimated TY2001 Federal Tax Gap

(in Billions of Dollars)

Gross Tax Gap*

312 353

Enforced and Late Payments

(55)

Net Tax Gap

257 298

Noncompliance Rate

15.0% 16.6%

Compares to $311 billion estimate for 2001 using rules from 1988 and earlier studies.

Preliminary Results

Two Views of the Tax Gap

By Type of Noncompliance
Nonfiling
Underreporting
Underpayment

By Type of Tax
Income
Individual
Corporation
Employment
Self-Employment
FICA and Unemployment
Estate
Excise

The NRP for TY2001 addresses the underreporting of income

and self-employment taxes by individual taxpayers.
4

Underreporting Noncompliance is the

Largest Component of the Tax Gap
$350

(Billions)

250 - 292

$300
$250
$200
$150
$100
$50

30

32

Underreporting sources:
understated income
improper deductions
overstated expenses
erroneously claimed credits

$0
Nonfiling

Underreporting Underpayment

Preliminary estimates of noncompliance from underreporting account for

more than 80% of the Tax Gap.
5

Individual Income Tax is the Single Largest

Source of the Annual Tax Gap
$300
$250

(Billions)

Individual Tax Gap includes:

nonfiling
underreporting

198 - 234

$200
$150
73 - 78

$100

32

$50

$0
Individual

Employment

Corporation

Estate & Excise

non-business income
business income
overstated deductions,
credits, exemptions

underpayment

Preliminary NRP results indicate that the individual income tax accounts
for about two-thirds of the Tax Gap.

Individuals are the Dominant Source of

the Underreporting Gap
$240
$200

(Billions)

Understated income, not

overstated deductions, accounts
for over 80% of individual
underreporting.

150 - 187

$160
$120
66 - 71

$80

30

$40

$0
Individual

Employment

Corporation

Estate & Excise

Business activities, not

wages or investment income,
account for most of the
understated individual income.

2001 FEDERAL TAX GAP

(in Billions of Dollars)
Gross Tax Gap
312 - 353

Nonfiling
30

Underreporting
250 - 292

Underpayment
32

Individual
Income Tax

Employment
Tax

Corporation
Income Tax

Estate & Excise

Taxes

150 - 187

66 - 71

30

Underreported
Non-Business
Income
42 - 57

Self-Employment
Tax
51 - 56

Large
Corporations
25

Underreported
Business
Income
83 - 99

FICA &
Unemployment
Taxes
15

Overstated
Adjustments,
Deductions,
Exemptions, and
Credits 25 - 30

Estimates
Actual amounts or updated in NRP study

Small
Corporations
5

Reasonable estimates
Older, weaker estimates

Bolded Boxes Updated

Using Preliminary Tax
Year 2001 NRP Results

Net tax gap after recoveries of 55 = 257 - 298

Composite 2001 Individual Tax Return

(Dollars in Billions)

9
9

2001 Individual Income Tax Gap

Major Contributors Ranked by Dollars
Form 1040 Line
Total

Preliminary Estimate*
($ Billions)
150 187

Non-Business Income
Other income (gambling winnings, awards, etc.)
Wages, salaries, tips, etc.
Net capital gains, distributions, other gains
Taxable pension, annuities, IRA distributions
Taxable interest and dividend income
Miscellaneous

42 57
14 18
13 15
69
48
35
<3

Business Income
Non-farm proprietor net income
Partnership, S-Corp, estate and trust net income
Rent, royalty net income
Farm net income

83 99
59 65
16 24
78
23

Offsets to Income or to Tax

25 30
Deductions
15 18
Credits
11 14
Exemptions
5
Adjustments: All Other
<1
Adjustments: 1/2 of Self-Employment Tax
-6 to -7
* Line item estimates subject to significant changes; detailed analyses to be completed by the end of 2005.

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2001 Individual Income Tax Gap

Major Contributors Ranked by Misreporting Percentage
Form 1040 Line

Non-Business Income
Alimony income
Unemployment compensation
State income tax refunds
Taxable pension, annuities, IRA distributions
Taxable interest and dividend income
Taxable Social Security benefits
Wages, salaries, tips, etc
Net capital gains, distributions, other gains
Other income (gambling winnings, awards, etc.)
Business Income
Non-farm proprietor net income
Partnership, S-Corp, estate and trust net income
Rent, royalty net income
Farm net income

Tax Gap
($ Billions)

Preliminary Misreporting %*

<1
<1
<1
48
35
1
13 15
69

21.0 23.8
8.3 15.3
5.9 6.5
4.1 7.4
3.9 5.7
3.9 4.0
1.2 1.4
n/a

14 18

n/a

59 65

n/a

16 24
78
23

n/a
n/a
n/a

Offsets to Income or to Tax

Credits
11 14
17.1 22.5
Deductions
15 18
5.2 6.0
Exemptions
5
4.8 5.0
Adjustments: All Other
<1
n/a
-6
to
-7
Adjustments: 1/2 of Self-Employment Tax
n/a
* Line item estimates subject to significant changes; detailed analyses to be completed by the end of 2005.
n/a not available

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Next Steps

Refine estimates from the individual taxpayer study to further

update Tax Gap estimates. Comprehensive estimates should
be completed by the end of 2005.

Update estimates for other areas of the Tax Gapfirst area to

be addressed is reporting compliance study of flow-through
entities (S-Corporations and partnerships).

Use data from the individual taxpayer study to build new audit
models and develop other ways to address noncompliance.

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Individual Audits
1,942,000

2,000,000
1,750,000
1,519,000

1,500,000
1,193,000

1,250,000

1,100,000
1,008,000

1,000,000

849,000
732,000

750,000

744,000

618,000

500,000
FY-96 FY-97 FY-98 FY-99 FY-00 FY-01 FY-02 FY-03 FY-04
13

High Income Audits

225,000

210,000
200,000

195,000

200,000

175,000

164,000

150,000

139,000
128,000

125,000

112,000
100,000

100,000

92,000

75,000
FY-96 FY-97

FY-98 FY-99

FY-00 FY-01

FY-02

FY-03 FY-04
14

Criminal Prosecutions Recommended

4,000
3,750

3,817
3,605
3,527

3,500
3,250

3,120

3,037

3,000
2,750
2,541
2,434

2,500

2,335

2,250

2,133

2,000
FY-96

FY-97

FY-98

FY-99

FY-00 FY-01

FY-02

FY-03

FY-04

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IRS Enforcement Revenue

Dollars in Billions
$50.0
43.1

$40.0

38.0

37.6

37.2
35.2
32.9

33.8

33.8

34.1

$30.0

$20.0

$10.0

$0.0
FY-96

FY-97

FY-98

FY-99

FY-00

FY-01

FY-02

FY-03

FY-04
16

Allocation of Enforcement Resources

Dollars in Millions

2006 Initiatives
Total = $ 265 M

Base Enforcement Resources

Total = $6,628 M

C o r p o r at io ns
$6 3 M
( 2 4 %)

C o r p o r at i o ns
$1, 13 4 M
( 17%)

Small B usi nesses

$9 7 M
( 3 7%)
Hi g h I nco me
I nd ivi d uals
$9 8 7 M
( 15%)

Smal l B usinesses
$2 ,6 72 M
( 4 1%)

Ot her Ind i vid uals

$3 4 M
( 13 %)

Ot her Ind i vid ual s

$6 8 2 M
( 10 %)
C r i mi nal A ct i vit y
$73 9 M
( 11%)

T ax Exemp t &
Go ver nment Ent i t i es
$4 13 M
( 6 %)

Hig h Inco me
Ind ivi d uals
$4 6 M
( 17%)

C r iminal A ct ivit y
$11
( 4 %)

T ax Exemp t &
Go ver nment Ent it ies
$14 M
( 5%)

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