Why is This Topic Important to Wealth Managers? Today we discuss one issue that is a concern to most taxpayers. The Tax Gap—The difference between the amount of taxes due and those actually paid. The blogticle provides information and facts which makes for interesting discussion among wealth managers and clients.
The Government Accountability Office (GAO) recently released a report on the tax gap and taxpayer compliance and complexity. The report summarizes that the tax code compliance issues caused by complexity resulted in an increase to the overall tax gap.
It is no surprise that the federal tax system contains complex rules. These rules may be necessary, for example, to ensure proper measurement of income, target benefits to specific taxpayers, and address areas of noncompliance. However, these complex rules also impose a wide range of recordkeeping, planning, computational, and filing requirements upon businesses and individuals.
It has been shown in the past and is also no secret that complying with these requirements costs taxpayers time and money. In 2005 GAO reported that even using the lowest available compliance cost estimates for the personal and corporate income tax, combined compliance costs would total $107 billion (roughly 1 percent of gross domestic product) per year; other studies estimate costs 1.5 times as large. In addition, economic efficiency costs, which are reductions in economic well-being caused by changes in behavior due to taxes, are estimated to be even larger.
Although many taxpayers have simple forms of income, others do not—especially those who receive income from capital gains, rents, self-employment, international and other sources—and they may be required to do complicated calculations and keep detailed records.
Tax expenditures add to tax code complexity in part because they require taxpayers to learn about, determine their eligibility for, and choose between tax expenditures that have similar purposes. Tax expenditures also complicate tax planning because taxpayers must “predict” their own future circumstances as well as future tax rules to make the best choice among provisions.
Taxpayer errors also contribute to the tax gap. For example, in 2001 taxpayers underreported $6.3 billion in net income due to misreported Individual Retirement Arrangement (IRA) distributions. In addition, taxpayers may underclaim benefits to which they are entitled. According to GAO’s past analysis, of tax filers who appeared to be eligible for a higher-education tax credit or tuition deduction in tax year 2005, about 19 percent, representing about 412,000 returns, failed to claim any of them.
The Internal Revenue Service (IRS) has estimated that the gross tax gap—the difference between taxes owed and taxes paid on time—was $345 billion in 2001.
The gross tax gap is an estimate of the difference between the taxes—including individual income, corporate income, employment, estate, and excise taxes—that should have been paid voluntarily and on time and what was actually paid for a specific year.
Of the estimated $345 billion tax gap for tax year 2001, IRS estimated that it would eventually recover about $55 billion of that through late payments and enforcement actions, for a net tax gap of $290 billion.
The estimate is an aggregate of estimates for the three primary types of noncompliance: (1) underreporting of tax liabilities on tax returns; (2) underpayment of taxes due from filed returns; and (3) nonfiling, which refers to the failure to file a required tax return altogether or on time.
Tomorrow’s blogticle will discuss issues related to life insurance.
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