Volume 2 Issue 2006

What is the Tax Gap?  The Tax Gap is a term used to describe the difference between the tax that taxpayers should pay what they actually pay on a timely basis. 

There are three components that make up this gap:

• Nonfiling (failure to file a tax return)

• Underreporting (understating income, overstating deductions)

• Underpayment (failure to fully pay reported taxes owed)

The IRS National Research Program (NRP) measures noncompliance or this Tax Gap.  The NPR in 2001 estimated the Net Tax Gap at between 257 and 298 billion dollars and the noncompliance rate to be 15%-16.6%. Underreporting includes understated income, improper deductions, overstated expenses, and erroneously claimed credits.  Underreporting accounts for more than 80% of the Tax Gap.

Individual income tax noncompliance accounts for about two-thirds of the Tax Gap at a figure of 198-234 Billion Dollars. Understated income, as opposed to overstated deductions, accounts for over 80% of individual underreporting.  A lack of reporting business activities, not wages or investment income, account for most of the understated individual income.  Federal Tax Gap Distribution Chart