- Underreporting (not reporting one's full tax liability on a timely-filed return);
- Underpayment (not timely paying the full amount of tax reported on a timely-filed return); and
- Nonfiling (not filing required returns on time and not paying the full amount of tax that should have been shown on the required return).
A major contributor to the Tax Gap is the "underground economy", described as "the value of goods and services that elude official measurement". We mean the many true "cash" businesses, both legal and illegal in nature, income from which is either grossly under reported or not reported at all. The report indicates that "tax due on illegal-source income" is "not included in the tax gap". Imagine the size of the true Tax Gap if illegal income was included!
Income from "entrepreneurial" activity is taxable whether the activity is legal or illegal. The income of a drug dealer or prostitute is subject to tax just as the income of a barber or the owner of a corner deli is taxed. Remember, it was the IRS and not the cops that finally got Al Capone!
Considering the massive federal deficit, Congress is going to look very closely at ways to reduce the Tax Gap, as well it should (although it should also look into spending less money).
The report discusses methods to "Reduce Opportunities for Evasion" by implementing and expanding information reporting authorities.
"To improve and minimize error, Treasury and the IRS have been focused on implementing several new information reporting regimes recently authorized by Congress."
Two "new information regimes" are identified -
"Credit and debit card payments to business. Starting in January 2011, organizations that process credit and debit card payments for merchants must annually report the amount of these payments to the recipients and the IRS". I personally have no problem with this new "regime".
"Cost basis reporting. Starting in 2011, brokerage firms must annually report cost basis and holding period information to customers and to the IRS in addition to gross proceeds from securities transactions". I do believe that, as a tax preparer, no one single item of tax law enacted in the new millennium has pleased me more than this new "regime". Unfortunately the starting date is still years off, and it will really be several more years after 2011 before complete cost basis reporting will occur. Taxpayers must still maintain good timely records of all investment purchases.
The report also discusses several controversial proposals included in the Administration's FY 2010 budget -
1. Require businesses to issue Form 1099s for payments for services of $600 or more to corporations. Currently Form 1099-MISC for "nonemployee compensation" and the like do not have to be issued to corporations.
2. Require landlords to issue Form 1099s for payments made to "any service provider or contractor that performs work on rental properties."
3. Require contractors to provide their Taxpayer Identification Number (TIN) to the businesses form which they receive payments, similar to employees providing Social Security numbers to employers, and also require businesses to "verify" the validity of the TIN. If a contractor does not provide a valid TIN the business would be required to withhold tax from payments made to the contractor. This is very similar to a NJ law that applies to a NJ business who pays a contractor to repair or improve business property.
4. Increase by 100% the current per-return penalties for failure to file most information returns.
5. Require that all corporations and partnerships that must file a "Schedule M-3" file their 1120 or 1065 electronically.
6. Require tax preparers who file more than 100 tax returns (I assume 1040 series) in a calendar year to file these returns electronically.
Here is my 2+ cents on the above proposals -
1. I have no real problem with expanding the 1099 requirement to include corporations.
2. A great many "landlords" are individual taxpayers (1040 filers) with a 2-family or 3-family home who live in one unit and rent out the other(s), or who seasonally or annually rent out vacation property. I oppose adding additional unfamiliar recordkeeping and form file requirements for such "individual" taxpayers, especially if penalties are to be doubled.
I have no problem with rental activities that are truly a business, such as corporations and partnerships that own and rent apartment buildings or commercial properties, being subject to this requirement - but not John and Mary who rent out the 2nd floor of their home.
3. I would not oppose the requirement for a business to verify the accuracy of a contractor's TIN or EIN upfront only if the IRS provided a simple and easily accessible online procedure for doing so, and the "business" that is required to do so is limited to a true "trade or business" activity and not broadened to include individual landlords discussed under Item #2.
However, while I know full well why the IRS wants it done (and cannot really argue with their thinking), I do not at all like the idea of forcing businesses to withhold federal income tax on non-wage payments.
If businesses are already required to issue a Form 1099 to all entities to whom they pay $600 or more for services why is this additional procedure necessary?
4. While I do agree that penalties are necessary to "encourage" timely and accurate filing, I also believe that in many cases the excessive nature of some penalties also encourages non-filing and non-payment. IRS penalties and interest can accrue to such a state that the accumulation is substantially greater than the actual tax due. As a result many taxpayers, individuals and businesses alike, simply "walk away" from tax obligations - obligations that may have been paid either partially or in full if the P+I accumulation was not so intimidating. This is why I support a federal tax amnesty program, and why I am hesitant to increase existing penalties.
5. I would not oppose this requirement if the IRS provided the affected taxpayers with a free way of submitting the returns directly to the IRS online at the Service's website. See my comments on #6 for more details.
6. I am not against electronically filing tax returns. I file NJ tax returns electronically via the free online NJWebFile service whenever appropriate. Actually I am required to file full-year resident state income tax returns electronically by NJ law, unless the client tells me not to do so by giving me a signed "Opt-Out" form. I do this because it is free to do this. I do not need to spend thousands of dollars initially and hundreds more annually for updates for tax preparation software in order to be able to file returns electronically. And I do not have to go through an excessive registration process, provide my fingerprints, and undergo a background check to do so. I simply go to the NJWebFile site and begin to enter the appropriate required information. Any NJ full-year resident can go to the website and file using NJWebFile.
I would gladly submit my clients 1040s (and 1040As) electronically if all I had to do was go to a page within the IRS website and provide the information directly to the IRS with no charge. I would still prepare the actual tax return manually, but would enter the numbers from the manual return as required in the free IRS online filing system.
I have no intention of giving anyone my fingerprints, or of being subjected to an invasive background check. These requirements do not exist for preparers filing paper returns and also should not exist for those filing electronically.
If the IRS is going to require that preparers who file 100 or more 1040 series returns must submit the returns to the government electronically then it also MUST allow the returns to be submitted free of charge with no need to purchase expensive outside software and no additional requirements. And because there are individual taxpayers who may not trust, with or without foundation, electronic submissions to be adequately secure, the IRS must also allow a tax preparer's client to "Opt Out" of electronic filing just as NJ does.
Other components of the IRS "Strategic Plan" for dealing with the Tax Gap, identified in the report, include -
- Make a Multi-Year Commitment to Research,
- Continue Improvements in Information Technology,
- Improve Compliance Activities,
- Enhance Taxpayer Service,
- Reform and Simplify the Tax Law, and
- Coordinate with Partners and Stakeholders.
I am extremely pleased that "Reform and Simplify the Tax Law" is included - an acknowledgement that one of the significant factors in the existence of such a big Tax Gap is the mucking fess that Congress has made of the Tax Code. It is difficult to comply with tax law when tax law is so confusing.
Under "Coordinate with Partners and Stakeholders" the subject of regulation and education of tax preparers, a recent hot topic around the tax blogosphere, is discussed.
I expect that the campaign to reduce the Tax Gap will result in more audits in all areas. This will very likely include increased audits of individual income tax returns that report material Schedule C activity, especially 1040s with continuous and/or substantial Schedule C losses.
So what do you think about the "Tax Gap" and the proposals for dealing with it?