Mind the Gap

I just read today that actor Wesley Snipes has been sentenced to three years in jail for a tax evasion conviction. It is assumed that he earned over $13 million in a three-year period, on which he would owe about $2.7 million in taxes. He willfully failed to file a return for those three years, and each conviction carries a maximum sentence of up to one year. It's unfortunate that another high-profile black American (like Michael Vick) was chosen to be the example of maximum enforcement, as this could fuel racial divisiveness in a time when we really need to be moving on. Still, I can not in any way condone tax fraud, just as I refuse to condone cruelty towards animals. Truly the two crimes do not compare, but tax fraud is a big deal to the U.S. economy.

In a class presentation yesterday I heard from two employees of The Inspector General for Tax Administration's office (TIGTA). These are the guys that audit the IRS to make sure it's working efficiently and correctly. They recently conducted an audit of the tax gap. The tax gap represents the difference between what the IRS collects each year and what they should have collected were everyone honest. In 2001, the IRS collected $2.5 trillion dollars in taxes. That is a lot of money, but the number they should have collected is estimated to be $312-354 billion dollars greater.

Through its enforcement actions, the IRS collected about $50 billion of that sum. That leaves a tax shortfall of around $300 billion. If that number sounds large, some economists estimate it may in fact be twice that large. The main cause of this problem: underreporting of income (about 80% of the tax gap). The IRS has an 83% voluntary compliance rate, meaning that by the best estimates available, tax was paid on 83% of the taxable income actually generated in this country.

A classmate likened this to bad debt expense. If a company failed to collect 17% of its receivables, it would not continue to function for long. This may not seem like a national crisis, but it is not good.

By the way, this doesn't factor in tax shelters and massive deductions (abuses of these make up about 10% of the tax gap). This includes just the income that no one reported. There are many abuses, but the one most of my readers will be familiar with is cash businesses. It is widely accepted practice among people with a cash business to under-report income. People seem to think this is right and good. The next time you think to yourself why are they raising taxes again? remember this: if everyone really paid their share, then we'd raise hundreds of billions of dollars without actually raising taxes.

OK, enough of this soapbox. Everyone has the right to their opinion on what a fair amount of taxation should be. I have no answers to that question. If you have a problem with our tax code, you can always move or vote for someone who will change it.

So in the end, I have little sympathy for folks like Mr. Snipes who don't even file tax returns and don't pay their share. I'd like to see more evaders get real punishments, and not just celebs.

Here's another fun tax tidbit: The statute of limitations for an IRS audit is normally three years - this applies if you've exercised due diligence, because if you willfully misrepresent things on your return, the statute runs for seven years. Here's the kicker: the statue only starts running when you file. If I failed to file my 2007 return, the IRS could audit me in 2044 for that year.