Tax Gap Jumps to $688B, IRS Projects

The Internal Revenue Service released new tax gap projections Thursday for tax years 2020 and 2021 showing that the projected gross tax gap increased to $688 billion in tax year 2021, a significant jump from previous estimates.

"The $688 gross tax gap is the difference between estimated 'true' tax liability for a given period and the amount of tax that is paid on time," the agency explained.

The new estimate, according to the agency, "reflects a rise of more than $192 billion from the prior estimates for tax years 2014-2016 and a rise of $138 billion from the revised projections for tax years 2017-2019."

IRS Commissioner Danny Werfel said the increase in the tax gap "underscores the importance of increased IRS compliance efforts on key areas."

With the help of Inflation Reduction Act funding, the agency is "adding focus and resources to areas of compliance concern, including high-income and high-wealth individuals, partnerships and corporations," Werfel said. The goal is "adding more fairness to the tax system, protecting those who pay their taxes and working to combat the tax gap."

Tax Gap Details

Late payments and IRS enforcement generated $63 billion in 2021, the IRS reported.

The gross tax gap covers three key areas —nonfiling, underreporting and underpayment of taxes.

The tax gap estimates and projections "cannot fully account for all types of noncompliance," the IRS states.

Late payments and IRS enforcement efforts are projected to generate an additional $63 billion on tax year 2021 returns, resulting in a projected net tax gap of $625 billion, the agency said.

"Between tax years 2014-2016 and tax year 2021, the estimated tax liability increased by about 38 percent, roughly the same increase as the gross and net tax gaps. Much of these increases in tax liability and the tax gap can be attributed to economic growth," the IRS states.

Voluntary Compliance

The tax year 2020 and 2021 tax gap projections translate to about 85% of taxes paid voluntarily and on time, which is in line with recent levels.

After IRS compliance efforts are factored in, the projected share of taxes eventually paid is 86.3% for tax year 2021, down slightly from the 87.0% for tax years 2014-2016. This drop in compliance does not factor in any changes in compliance behavior; instead, it is due to changes in the types of income and how that income is reported to the IRS.

The gross tax gap, the IRS explained, comprises three components:

Nonfiling, which means tax not paid on time by those who do not file on time: $77 billion in tax year 2021, up from $41 billion in tax years 2017-2019.
Underreporting, which reflects tax understated on timely filed returns: $542 billion in tax year 2021, up from $445 billion in tax years 2017-2019.
Underpayment, or tax that was reported on time but not paid on time: $68 billion in tax year 2021, up from $64 billion in tax years 2017-2019.

With the help of Inflation Reduction Act resources, the IRS reiterated that it will be addressing voluntary compliance by improving taxpayer services and offering new technology tools in concert with additional compliance work.

In 2022, the latest year for which data is available, the IRS states that it collected more than $4.9 trillion in taxes, penalties, interest and user fees.