IRS Says Americans Underpaid Taxes by $385 Billion in 2006

The Internal Revenue Service estimates that U.S. companies and individuals failed to pay $385 billion in taxes they owed in 2006, an increase from $290 billion five years earlier.

The agency said the rate of compliance remained almost unchanged at 85.5 percent, down slightly from 86.3 percent in 2001. The IRS announcement today is the first update to the so-called tax gap estimate in five years. The gap grew because the income base expanded between 2001 and 2006, the agency said.

The U.S. recorded a $248.2 billion budget deficit in 2006, according to the White House Office of Management and Budget. If the IRS had collected all of the taxes owed that year, the U.S. could have had a surplus of as much as $136.8 billion.

“This report shows that closing the tax gap needs to be a major focus of tax reform,” Senate Finance Committee Chairman Max Baucus, a Montana Democrat, said in a statement. “In an era when we’re squeezing the federal budget for every dollar of savings, we have to make every effort to recover these lost funds.”

The estimate is a comprehensive measure of the taxes the U.S. is owed and includes income taxes, the estate tax, employment and excise taxes.

Better Estimates

The IRS uses computer models to estimate the amount owed by individuals and businesses that don’t pay their taxes or don’t pay their full tax bill. The agency said it is getting better at estimating the tax gap in part because of better data on small corporations.

The biggest chunk of money that goes uncollected -- $235 billion -- comes from individuals, the IRS said. Of that, $122 billion is estimated to be taxes owed on business income that would be reported on an individual return.

The IRS estimated that $67 billion in corporate income tax wasn’t collected in 2006. Most of that -- $48 billion -- was from large corporations with more than $10 million in assets, the agency said.

The IRS said compliance is highest in sectors where information reporting or withholding are required. Business groups have successfully fought these types of regulations.

Rule Repeal

Congress repealed a rule in November that required governments to withhold 3 percent of payments to contractors. Lawmakers also scrapped a provision of the 2010 health-care law that sought to curb underreporting of income by compelling businesses to report more transactions to the IRS.

Meanwhile, the IRS is delaying a law that mandates overseas banks to withhold from some U.S. customers and a separate law requiring companies that process and settle credit-card transactions to report payment amounts to the U.S.

Lawmakers and regulators should be cautious in rolling back other reporting or withholding requirements, said Elizabeth Dold, a principal at Groom Law Group Chartered in Washington who led the IRS’s information-reporting advisory committee last year.

“Reporting and withholding are two very critical tools to close the tax gap,” she said. “They should be used carefully.”

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