The Federal Tax Gap: Overview, Analysis, and Policy Options

November 30, 2023 R47858

Unpaid Federal Taxes and the Federal Tax Gap: November 30, 2023
Overview, Analysis, and Policy Options
Brendan McDermott
The federal tax gap is a measurement of the amount of federal taxes that taxpayers legally owe
Analyst in Public Finance
but do not pay on time in a given year. The Internal Revenue Service (IRS) estimates that the

average annual gross tax gap from 2014-2016 was $496 billion, or 15% of taxpayers’ true tax
liability. The net tax gap, which accounts for late payments and revenues raised through

enforcement, averaged $428 billion, or 13% of true tax liability.
In addition to formally estimating the tax gap based on data that may take years to generate and analyze, the IRS publishes
cruder projections of the tax gap for more recent years. The IRS projects that in 2021, the gross tax gap was $668 billion
while the net gap was $625 billion, and in 2020 the gross gap was $601 billion and the net gap was $539 billion. The agency
also estimates that from 2017 to 2019, the gross tax gap averaged $550 billion, while the net tax gap averaged $480 billion.
While the dollar amounts of the tax gap have increased in recent years as the amount of total receipts has grown, the rate of
noncompliance (i.e., the gross tax gap) has remained fairly constant. Roughly 85% of taxes are paid on time, while about
15% are not. The tax gap includes both deliberately evaded taxes and those that taxpayers do not pay because of unintentional
errors.
Tax Gap Analysis
The tax gap has three major components, defined as follows:
• Underreporting: a taxpayer underreports their true tax liability, either by underreporting income subject to
taxation, improperly claiming tax benefits, or some combination of these activities.
• Underpayment: a taxpayer correctly reports their true tax liability, but fails to pay it on time (i.e., by the
filing deadline or by a valid extension date).
• Nonfiling: a taxpayer does not file a tax return even though they are legally required to do so.
Underreporting accounts for the 80% of the estimated gross tax gap for 2014-2016. Taxpayers are far more likely to
underreport income that third parties, such as employers or financial institutions, do not report to the IRS. Sources of such
income include sole proprietorships, rents, and royalties. The IRS has little information on the distribution of the federal tax
gap by income level, but research suggests that high earners likely fail to pay the largest share of their income.
Underreporting Accounts for the Majority of the Tax Gap

Source: IRS, Federal Tax Compliance Research: Tax Gap Estimates for Tax Years 2014-2016, Publication 1415, October 2022.
Notes: Annual average from 2014 to 2016.
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Enforcing the tax code more strongly would generate revenue for the federal government, which it could use to reduce the
national debt, reduce the tax liability on those who pay voluntarily, or increase spending. Taxpayers may also be more likely
to comply voluntarily if they believe the government is likely to enforce the code. However, complying with the tax code
costs the public the time needed to complete a tax return or the money to hire a preparer to do so. Enforcing the code also
requires the federal government to spend on technology and staff, although most estimates suggest that increasing
enforcement spending would raise more than twice the revenue that it would cost in spending.
Policy Options to Reduce the Tax Gap
Congress and the IRS could use a number of methods to reduce the tax gap, if they seek to do so. These options fall under the
following categories:
• Audits and Enforcement: Congress and the IRS could strengthen existing enforcement mechanisms, both
to identify nonpayment and compel taxpayers to comply.
• Information Reporting: Congress could expand third-party reporting and withholding to more sources of
income, and/or require taxpayers to provide more evidence validating their eligibility for certain tax
benefits.
• Tax Simplification: Congress could simplify the tax code so there are fewer opportunities for gaming or
legitimate error.
• Taxpayer Services: Congress and the IRS could bolster taxpayer services so taxpayers make fewer errors
on their returns.
• Regulation of Paid Tax Preparers: Congress could give the IRS authority to regulate paid tax preparers,
who make some errors more often than other filers.

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he Internal Revenue Service (IRS) estimates that taxpayers failed to pay 15% of their legal
tax liability on time from 2014 to 2016. Late payments and enforcement actions recoup an
T additional 2% of the public’s true tax obligation. Unpaid taxes contribute to the United
States’ federal deficit, and their accumulation over time may require policymakers to raise more
revenue from those who comply with the tax code. This report describes the sources of unpaid
federal taxes—also known as the tax gap—and lends context to the measure’s implications by
presenting information on how the IRS constructs it. This report also describes popular proposals
to reduce the tax gap.
Key Elements of the Tax Gap
The tax gap is commonly measured in two ways:
• The gross tax gap is the amount of tax that individuals and businesses owe but do
not pay on time, absent additional collections from enforcement action. From
2014 to 2016, the average annual gross tax gap was $496 billion, or 15% of true
tax liability.1
• The net tax gap is the amount of tax that taxpayers owe but do not pay, after
including late payments and collections through enforcement actions. From 2014
to 2016, the average annual net tax gap was $428 billion, or 13% of true tax
liability.2
The tax gap reflects the estimated amount of
unpaid federal taxes. The estimate does not
Evasion or Honest Mistake?
account for the budgetary costs to the federal
Some of the tax gap reflects deliberate tax evasion, in
government of administering the tax code or
which taxpayers intentionally fail to pay the taxes they
owe. However, the figure also captures payments that
compliance costs borne by taxpayers, such as
individuals and businesses fail to make because of
the cost of their time preparing and filing
honest errors. It is unclear what percentage of the net
returns and their efforts to record their taxable
tax gap is due to evasion as opposed to error.
income and qualifications for deductions and
credits.
There are three ways individuals and businesses can fail to pay the taxes they owe:3
1. Underreporting of Tax: A taxpayer (e.g., an individual or business) files their
tax return, but underreports their true tax liability. Underreporters may either
report that they received less income subject to taxation than they actually did, or
claim more in deductions, credits, or other tax benefits than the law allows, or
some combination of these two. According to the IRS, underreporting comprised
$398 billion of the average annual gross tax gap between 2014 and 2016, as
illustrated in Figure 1. This represented 80% of the $496 billion gross tax gap.
The majority of the underreporting tax gap, $278 billion, is attributable to
underreporting of the individual income tax. Underreporting by pass-through
businesses (which pay the individual income tax) was responsible for an
estimated $130 billion or 26% of the gross tax gap.

1 Internal Revenue Service (IRS), Federal Tax Compliance Research: Tax Gap Estimates for Tax Years 2014-2016,
Publication 1415, October 2022, pp. 6-7, available at https://www.irs.gov/pub/irs-pdf/p1415.pdf [Hereinafter “IRS, Tax
Gap Estimates”].
2 Ibid.
3 Ibid., p. 13.
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2. Underpayment of Tax: A taxpayer files their tax return and correctly reports
their tax liability, but then underpays the IRS. Underpayment comprised an
estimated 12% of the annual gross tax gap from 2014 to 2016.
3. Nonfiling of Returns: A taxpayer fails to file a tax return when they are required
to do so. Nonfiling represented an estimated 8% of the annual gross tax gap from
2014 to 2016.
Figure 1. Sources of Underreporting Tax Gap
Underreporting accounted for an estimated 80% of the average annual gross tax gap from 2014 to 2016.

Source: IRS, Federal Tax Compliance Research: Tax Gap Estimates for Tax Years 2014-2016, Publication 1415,
October 2022.
Notes: Totals may not add due to rounding. Underreported tax liability accounted for 80% of the total gross tax
gap. “Large” corporations are those with gross assets worth more than $10 mil ion. The IRS estimated that
estate tax underreporting cost the government an average of an additional $1 bil ion in lost annual revenues
from 2014 to 2016.
In addition to formally estimating the tax gap and analyzing its components based on data that
may take years to generate and analyze, the IRS publishes estimates of the tax gap for more
recent years. The IRS projects the gross tax gap was $688 billion in 2021, $601 billion in 2020,
and averaged $550 billion from 2017 to 2019. It also projects the net tax gap was $625 billion in
2021, $539 billion in 2020, and averaged $481 billion from 2017 to 2019.4 These estimates
incorporate more recent administrative data on the nonfiling tax gap, but generally assume that
underreporting (the main driver of the tax gap) continued at the rates estimated for 2014-2016 and
that underpayment continued at the rate observed from 2017 to 2019.5 More detail on
methodology is available in the Appendix.

4 IRS, Federal Tax Compliance Research: Tax Gap Projections for Tax Years 2020 & 2021, Publication 5869, October
2023, p. 10.
5 Ibid., pp. 19-20.
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Incompleteness and Caveats
The IRS’s estimate of the tax gap is a useful tool for understanding the scale and nature of tax evasion and error.
However, like all estimates, it is subject to limitations, and it is important to understand these limitations when
interpreting it and applying it to policy debates.
Noncompliance and Other Behaviors Not Included in the Estimate
The IRS states that “the [tax gap] estimates cannot ful y represent noncompliance in some components of the tax
system, particularly as it relates to corporate income tax, income from flow-through entities, foreign or il egal
activities, and digital assets, because data are lacking.”6 Additionally, the tax gap does not estimate nonfiling by
corporate filers. Since these activities are not included in the tax gap estimates, improving tax compliance in these
areas would raise revenue but would not change the estimate of the tax gap.
Imprecision of Amount of True Tax
Some research suggests the tax gap estimate may fail to identify some unpaid federal taxes among taxpayers with
very high incomes.7 Further, while the IRS estimates the individual underreporting tax gap using the results of a
semirandom sample of audits conducted through its National Research Program (NRP), its estimate does not
account for reversals of those findings by supervisory review or taxpayer appeal. This omission could bias the
estimate upward.8 The IRS’s attempts to account for noncompliance that its auditors miss can amplify this effect.9
Age and Adequacy of Data
Some of the data that the IRS used to estimate the tax gap for 2014-2016 predate that period significantly, raising
questions about their applicability to the period.10 Further, due to budget constraints, the agency performed few
NRP audits in 2016, limiting their usefulness. The IRS says it intends to use funds that the Inflation Reduction Act
(IRA; P.L. 117-169) appropriated to improve the quality of its data and analytics.11
Avoidance
Evasion and error, which the tax gap measures, are not the only forms of nonpayment of taxes in which
policymakers may be interested. Taxpayers may change their behavior to legally avoid accruing a high tax liability,
rather than il egally evade taxes they do owe. For example, taxpayers may choose to partake in an activity to
qualify for a tax credit or deduction. Tax avoidance can reduce federal tax revenues, yet it does so by legally
reducing the avoider’s true tax liability, so the tax gap does not measure it.
Analysis
Available data indicate that tax nonpayment is more common for taxes on sources of income (and
for tax expenditures) for which there is limited third-party information to verify claims. In other
words, if taxpayers know the IRS has no information on a form of income, they may be more
likely to underreport income from that source. In addition, research suggests that income
underreporting is more common among the highest-income taxpayers, who may be more likely to
receive these less-visible forms of income.

6 Ibid., p. 3.
7 John Guyton et al., “Tax Evasion at the Top of the Income Distribution: Theory and Evidence,” National Bureau of
Economic Research, Working Paper 28542 (March 2021) [Hereinafter “Guyton et al., ‘Tax Evasion at the Top of the
Income Distribution’”].
8 Daniel Hemel, Janet Holtzenblatt, and Steven M. Rosenthal, “The Tax Gap’s Many Shades of Gray,” Tax Policy
Center, February 2022, pp. 7-8 [Hereinafter “Hemel, Holtzenblatt, and Rosenthal, ‘The Tax Gap’s Many Shades of
Gray’”].
9 Ibid., pp. 10-11.
10 For example, the IRS estimates the distribution and frequency of employment tax underpayment based on findings
from its last Employment Tax Study, which it conducted in 2010.
11 IRS, Internal Revenue Service Inflation Reduction Act Strategic Operating Plan: FY2023-2031, Publication 3744,
April 2023, p. 98, https://www.irs.gov/pub/irs-pdf/p3744.pdf [Hereinafter IRS, IRA Strategic Operating Plan].
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Distribution of the Tax Gap by Source of Income
Taxpayers are likelier to report their income subject to tax accurately when a third party, such as
an employer or financial institution, also reports that income to the federal government. The IRS
estimates that individual filers report 99% of income earned through wages or salaries accurately.
For such income, employers not only report workers’ compensation to the IRS, they also withhold
workers’ estimated income tax liability from their paychecks, and remit those taxes to the IRS. In
contrast, filers underreport 55% of their income that is not subject to information reporting, such
as that earned from sole proprietorships, rents, and royalties (Figure 2).
Figure 2. Estimated Share of Income Unreported, By Visibility of Income

Source: IRS, Federal Tax Compliance Research: Tax Gap Estimates for Tax Years 2014-2016, Publication 1415,
October 2022.
Notes: Income subject to substantial reporting and withholding includes wages and salaries. Income subject to
substantial reporting, but not withholding, includes pensions and annuities, unemployment compensation,
dividend income, interest income, state income tax refunds, and taxable Social Security benefits. Income subject
to some reporting includes partnership and S corporation income, capital gains, and alimony income. Income
subject to little or no reporting includes income from sole proprietorships, rents and royalties, farm income,
Form 4797 income for the sale of business property, and other income.
Third-party information reporting discourages noncompliance, since the IRS can easily check
whether one’s reported income is accurate. The reporter also typically sends the payer a record of
their reported income, which generally ensures the payer knows their income from that source
and files their return accurately. Withholding estimated tax owed from the payer’s income further
likely ensures the filer will pay all legally required taxes on their income.
The different reporting rates for different sources of income suggest that individuals with similar
total incomes that come from different sources may have different likelihoods of underpaying
their federal tax liability. For example, an engineer who earned a $500,000 salary would have that
income reported to the IRS by their employer, and the employer would withhold the appropriate
income tax and remit it to the IRS, making the engineer much more likely to pay their income
taxes on that salary than a sole proprietor who earned $500,000 through their business.12

12 For more on underreporting by sole proprietorships, see Government Accountability Office (GAO), Sole Proprietor
(continued...)
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Similarly, a worker who received their compensation in cash with no accompanying information
return may be more likely to underreport their income than a worker who earned the same amount
through wages that their employer reported to the IRS.
The IRS identifies underreported income through the National Research Program (NRP), which
conducts semirandom audits.13 However, NRP audits miss some underreporting from opaque
income sources, particularly if some auditors are more experienced or skilled than others. The
IRS tries to account for unreported income its NRP auditors miss through a process called
detection-controlled estimation (DCE). Under DCE, the IRS effectively estimates how much
underreporting all auditors would have detected for a given source of income had they been as
successful as the most successful auditors, subject to other limitations. For example, if the IRS
estimated that some auditors found 5% underreporting for a given income source while others
found 10%, the IRS would assume the true rate is 10%.14 Independent research suggests applying
DCE methodology roughly tripled the estimates of underreported income from 2006 to 2013,
primarily from less-visible income sources.15
Distribution of the Tax Gap by Income Level
While the IRS does not estimate the distribution of the tax gap by taxpayers’ income levels,
research has found that those with high incomes are responsible for most misreported income.
Johns and Slemrod (2010) studied the income distribution of unpaid taxes using NRP audits from
2001. They found that, on average, the highest-income 5% of households were responsible for
51% of all misreported adjusted gross income.16 DeBacker et al. (2020) found that NRP returns
from 2006 to 2014 showed a similar distribution.17
These estimates may understate the underreporting of income by the highest-income taxpayers.
Guyton et al. (2021) estimated that random audits such as those conducted through the NRP often
fail to detect evasion through forms common among high-income individuals, such as offshore
bank accounts and pass-through businesses. The researchers found that operational audits of a
sample of the 0.01% of taxpayers who reported the most income in 2010 found more
noncompliance than the tax gap estimation methodology suggested existed among that entire
group. This finding suggests DCE failed to identify significant nonpayment among the highest
earners.18 The researchers also found that NRP audits of taxpayers failed to identify offshore
wealth for 93% of filers who soon thereafter reported international bank accounts because of

Compliance: Treasury and IRS Have Opportunities to Reduce the Tax Gap, GAO-24-105281, October 19, 2023,
publicly released November 15, 2023.
13 The audits are “semirandom” because the sample disproportionately selects filers in groups that often have more
complicated taxes or that past studies have shown are more likely to underreport their income.
14 DCE also assumes a distribution of true underreporting and applies its estimates of detection rates among various
examiners to that assumed “true” distribution. For a more detailed description of DCE, see Brian Erard and Jonathan
Feinstein, “The Individual Income Reporting Gap: What We See and What We Don’t,” 2011 IRS-Tax Policy Center
Research Conference, June 22, 2011, https://www.irs.gov/pub/irs-soi/11resconindincome.pdf.
15 Guyton et al., “Tax Evasion at the Top of the Income Distribution,” pp. 9, 11.
16 Andrew Johns and Joel Slemrod, “The Distribution of Income Tax Noncompliance,” National Tax Journal, vol. 63,
no. 3, September, 2010, p. 406. Households were sorted by their “true” adjusted-gross income, after accounting for
underreported income. While high-income filers underpaid more in tax relative to their income, lower earners had more
unpaid taxes relative to tax liability, as they typically owed less in taxes.
17 Debacker et al., “Tax Noncompliance and Measures of Income Inequality,” Tax Notes Federal, February 17, 2020,
pp. 1114-1115.
18 Guyton et al., “Tax Evasion at the Top of the Income Distribution,” p. 11.
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unrelated changes in tax policy. This amount exceeds what normal annual turnover in offshore
account ownership could explain.19
The authors’ stylized model estimated that the lowest-earning 50% of taxpayers fail to report 7%
of their income, while most of the highest-earning 1% fail to report 20%-25% of their income.
The underreporting percentage then falls to 15% for the highest-earning 0.01%.20
Policy Options for Reducing the Federal Tax Gap
Policymakers may seek to identify policy changes that would encourage taxpayers to comply
with the tax code. Due to the limitations with tax gap estimates, such policies may or may not
reduce the measured tax gap, even if they improve tax compliance.
Expanding existing mechanisms, including both audit and nonaudit options, could further
encourage enforcement. Given that taxpayers underreport income from sources that withhold and
remit taxes to the IRS much less often than income from other sources, policymakers could also
look for opportunities to encourage or require withholding for more sources of income. Other
options include simplifying the tax code, expanding taxpayer services, and strengthening
regulations on paid tax preparers to prevent errors.
Expand Existing Enforcement Mechanisms
The IRS could increase the frequency and expand the scope of existing enforcement mechanisms
meant to encourage compliance with the tax code, including audits, math error authority, and
information reporting. Enforcement actions can generate revenue directly. In 2022, the
Congressional Budget Office (CBO) projected that increasing spending at the IRS by $79.6
billion—including $45.6 billion for enforcement activities—through the Inflation Reduction Act
(IRA; P.L. 117-169) would generate $203.7 billion in additional revenue over the same period.21
Enforcement may also raise revenue indirectly, by encouraging voluntary compliance with the tax
code. If taxpayers believe that the IRS is likely to catch evasion or error, they may be more likely
to accurately report their liability on time. If so, enforcement
would reduce the tax gap by more than the amount collected
Degree of Penalties
through the enforcement action itself.
Some theorize that increasing the
penalties on proven tax evaders would
Audits (Examinations)
deter others from evading their own
taxes.22 However, researchers have
The IRS selects some tax returns for targeted examinations
done few studies on whether making
that are meant to ensure that the taxpayer has accurately
punishments for evasion more severe
reported their tax liability. In an examination, taxpayers
encourages would-be evaders to pay
provide the IRS with additional information on their income
their taxes.23
or eligibility for credits or deductions, which the agency

19 Ibid., p. 17.
20 Ibid., pp. 34-35. These authors suggest this decline may result from the highest-income filers earning more income
from capital gains, rather than opaque business income. See pp. 29-30. Their sensitivity analyses also suggest the
highest-earning 0.01% could misreport more offshore income than the authors estimate. See pp. 23-25.
21 CBO, Estimated Budgetary Effects of H.R. 5376, the Inflation Reduction Act of 2022, August 5, 2022, p. 3.
22 Joel Slemrod and Shlomo Yitzhaki, “Tax Avoidance, Evasion, and Administration,” in Handbook of Public
Economics, ed. A.J. Auerbach and Martin Feldstein, vol. 3 (2002), pp. 1430-1438.
23 Slemrod, “Tax Compliance and Enforcement.”
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uses to verify or correct the taxpayer’s filing. Examinations empower the IRS to verify that
taxpayers are paying their true tax liability, which can raise revenue directly. Taxpayers’
awareness that they may be subject to an audit might also encourage voluntary compliance.
The Costs and Benefits of Audits
Audits may encourage voluntary compliance with the tax code by affirming to taxpayers that the
IRS is likely to catch evasion or error. If so, enforcement would reduce the tax gap by more than
the amount collected through the enforcement action itself.
Being audited appears to encourage some taxpayers to better comply with the tax code in
subsequent years. A 2023 study found that taxpayers of all income levels who are subject to an in-
person audit report more income on average for at least 14 years after the audit took place.24
Additionally, a Spanish study showed that Spanish businesses avoided growing to a size that
would make them more likely to face an examination, suggesting that the possibility of an audit
may affect the behavior of taxpayers who have never faced an audit themselves.25
In some circumstances, audits may discourage voluntary compliance. For example, in the year
after a random audit, self-employed taxpayers who were found to owe additional tax reported
roughly 64% more income, yet those who the audit cleared reported 15% less. That decline
deepened to 21% three years after the audit.26
Another study also found that those with self-reported income initially claimed more income in
the year after a random audit than a control group did, but reported less than that control group
within five years. Potentially sophisticated taxpayers—namely older taxpayers, those in the top
income quintile, and those who used professional tax preparers—followed a similar pattern of
initial increase and subsequent decline. The fact that audits were random may have kept taxpayers
from thinking the audit indicated their preexisting behavior invited close scrutiny. If so, they
would be more likely to return to preexisting evasion (or possibly to pursue it more aggressively)
once the audit ended.27
Research on preaudit contacts from tax agencies has found similar results. One study of
Minnesota taxpayers showed that those with high incomes, and particularly with self-employment
or farm income, reported less income after receiving a letter stating their return would be “closely
examined.” The authors theorized this could be because high-income filers may see less value in
reporting certain income to avoid an audit once they view an audit as inevitable.28

24 Will Boning et al., “A Welfare Analysis of Tax Audits Across the Income Distribution,” Policy Impacts, June 14,
2023, pp. 19-20. The authors note that their result is not statistically significant for the highest-income 1% of tax filers.
However, the point estimate for the deterrence effect for such filers is comparable to that of other high-income filers.
25 Almunia, Miguel and David Lopez-Rodriguez, “Under the Radar: The Effects of Monitoring Firms on Tax
Compliance,” American Economic Journal: Economic Policy, vol. 10, no. 1 (February 2018), pp. 1-38.
26 Beer, Sebastian et al., “Do Audits Deter or Provoke Future Tax Noncompliance? Evidence on Self-employed
Taxpayers,” CESifo Economic Studies, vol. 66, no. 3 (September 2020), pp. 248-264.
27 Jason DeBacker et al., “Once Bitten, Twice Shy? The Lasting Impact of IRS Audits on Individual Tax Reporting,”
The Journal of Law and Economics, vol. 61, no. 1 (February 2018), pp. 19-23. The authors found no strong effect on
reporting of wage and salary income or of capital gains and losses. However, they found that Schedule E income
(which includes opaque sources such as partnership, S corporation, and rental income) followed a similar pattern to
self-employment income, although the decline in reporting in the outyears was not statistically significant.
28 Slemrod, Joel, Marsha Blumenthal, and Charles Christian, “Taxpayer Response to an Increased Probability of Audit:
Evidence From a Controlled Experiment in Minnesota,” Journal of Public Economics, vol. 79, no. 1 (2001), pp. 476-
481. The authors acknowledge their sample of high-income taxpayers was relatively small, at 321 filers. The authors
also note one possible reason this effect is limited to high-income filers would be if such filers were more likely to
think they can influence the outcome of their audit.
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Because the tax gap represents unmet legal obligations, some may consider the existence of any
gap to be a policy problem deserving of remediation. However, others argue that the cost of
eliminating it entirely would outweigh the benefits. Slemrod summarized this drawback by saying
that “just as it is not optimal to station a police officer at each street corner to eliminate robbery
and jaywalking completely, it is not optimal to completely eliminate tax evasion.”29
The tax gap does not account for the inevitable costs associated with enforcing and complying
with the tax code. The IRS spent an average of $4.8 billion per year on enforcement from 2014 to
2016, the years of the tax gap estimate.30 The CBO projects that Congress will appropriate
approximately $68 billion to the IRS from FY2024 to FY2033 for enforcement of the tax code, in
addition to much of the $45.6 billion expenditure Congress made for tax enforcement through the
IRA.31 Complying with the tax code also creates costs for taxpayers, such as the time required to
calculate one’s tax liability and prepare and submit forms to the IRS (or pay a preparer to do so),
which the tax gap does not reflect.
Trend in Audits and the Inflation Reduction Act
The IRS has said it intends to use some of the enforcement funds it received through the IRA to
expand audit coverage for large corporations, partnerships, and filers with high incomes or large
wealth, and for other “areas where audit coverage has declined,” such as employment taxes,
excise taxes, and estate taxes. The agency says it will not audit households and small businesses
earning below $400,000 per year at a higher rate than it did in 2018, the most recent tax year for
which the agency has completed audits.32
These audits would reverse a decline in audit rates from 0.9% of domestic individual income tax
returns with positive income in tax year 2010 to 0.3% in 2019.33 Audit rates fell most among
high-income filers.34 These decreases followed a 26% fall in inflation-adjusted outlays on
enforcement from FY2010 to FY2022.35
The Fiscal Responsibility Act (P.L. 118-5) rescinded $1.4 billion in funding for enforcement and
another spending priority funded by the IRA, operations support. The White House reportedly
also agreed to rescind an additional $10 billion each during the FY2024 and FY2025
appropriations cycles.36
Math Error Authority
Congress could provide the IRS with expanded “math error authority,” which would allow the
IRS to correct certain items on a tax return before a refund is issued. Math error authority is the

29 Joel Slemrod, “Tax Compliance and Enforcement,” Journal of Economic Literature, vol. 57 no. 4 (December 2019),
p. 907.
30 IRS, Statistics of Income Tax Stats: IRS Data Book, Table 30, March 2023 [Hereinafter “IRS, IRS Data Book”].
31 CBO, Spending Projections by Budget Account, May 2023. The IRS could begin spending the Inflation Reduction
Act funds during FY2022, so some of the funds were spent prior to the start of this window.
32 U.S. Congress, Senate Committee on Finance, The President’s Fiscal Year 2024 IRS Budget and the IRS’s 2023
Filing Season, hearings, 118th Cong., 1st sess., April 19, 2023.
33 2010 figure from GAO, Tax Compliance: Trends of IRS Audit Rates and Results for Individual Taxpayers by Income,
GAO-22-104960, May 17, 2022 [Hereinafter “GAO, Tax Compliance: Trends of IRS Audit Rates and Results for
Individual Taxpayers by Income”]. 2019 figure from IRS, IRS Data Book, Table 19.
34 GAO, Tax Compliance: Trends of IRS Audit Rates and Results for Individual Taxpayers by Income.
35 See CRS In Focus IF12394, The Internal Revenue Service’s Strategic Operating Plan to Spend $79 Billion in
Inflation Reduction Act Funding, by Brendan McDermott and Gary Guenther.
36 See CRS Insight IN12172, Changes to IRS Funding in the Debt Limit Deal, by Brendan McDermott.
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legal right to assess tax that exceeds what a taxpayer put on their filing without a formal
deficiency notice under certain specific circumstances. For example, taxpayers can calculate their
tax liability incorrectly, make a clerical error, or provide an incorrect Social Security Number or
Taxpayer Identification Number. Taxpayers have 60 days to request that the IRS abate or reverse
a correction that it made using math error authority. In such cases, the IRS automatically abates
any additional tax and does not require taxpayers to submit any additional information along with
this request. However, the IRS can still then conduct a traditional examination.37
Proponents argue that expanding math error authority empowers the IRS without the IRS and the
taxpayer incurring as much time and paperwork burden as they would under a normal deficiency
notice. Past Administrations have at times requested that Congress expand the IRS’s math error
authority to enable the agency to fix more issues promptly.38
Some observers, such as the National Taxpayer Advocate (NTA), have expressed concerns that
the math notice process gives taxpayers fewer rights to contest a decision than the examination
process does, particularly because many find the IRS’s math error notices unclear.39 While
taxpayers typically have 90 days to contest notices of deficiency, they have only 60 days to
contest math error notices.40 The NTA has also said that applying math error authority to complex
tax circumstances could increase the chances of IRS error that could burden taxpayers.41
Information Reporting
Lawmakers could expand information reporting on activities into which the IRS has little
visibility. To do so, they could require third parties to provide the IRS with more information the
agency can use to automatically verify the claims taxpayers make on their tax returns, including
the amount of income they earn as well as their eligibility for credits or deductions.
Information reporting enables the IRS to identify more income underreporting or improper tax
expenditure claims routinely using computing technology, without the need to conduct an
examination. Further, if taxpayers know the IRS can automatically check whether the taxpayer
has misrepresented themselves on their filing, they may be less likely to attempt to do so. As
noted in the section “Distribution of the Tax Gap by Source of Income,” the majority of the tax
gap results from taxpayers underreporting their tax liability, and underreporting is most common
for opaque sources of income.
Critics of expanded information reporting have expressed concerns. Some worry that the IRS
would violate taxpayers’ privacy by collecting too much information on them.42 Others say that
the requirements would put undue burdens on the third parties who would report the information,

37 IRS, National Taxpayer Advocate, “NTA Blog: Math Error Part I,” updated February 6, 2023, available at
https://www.taxpayeradvocate.irs.gov/news/nta-blog-math-error-part-i/.
38 For example, see U.S. Department of the Treasury, General Explanations of the Administration’s Fiscal Year 2017
Revenue Proposals, February, 2016, p. 225.
39 IRS, National Taxpayer Advocate, 2023 Purple Book: Compilation of Legislative Recommendations to Strengthen
Taxpayer Rights and Improve Tax Administration, Publication 5286, December 31, 2022, pp. 16-20, available at
https://www.irs.gov/pub/irs-pdf/p5286.pdf [Hereinafter “National Taxpayer Advocate, 2023 Purple Book”].
40 26 U.S.C. §6213(a)-(b).
41 National Taxpayer Advocate, 2023 Purple Book, pp. 18-20.
42 For example, see Mitch McConnell, “McConnell: Biden wants to give the IRS the OK to snoop on your bank
account. Don’t let him,” Courier Journal, October 5, 2021, available at https://www.courier-journal.com/story/opinion/
2021/10/05/mitch-mcconnell-dont-let-joe-biden-irs-snoop-bank-account/5990038001/ [Hereinafter “McConnell,
‘McConnell: Biden wants to give the IRS the OK to snoop on your bank account. Don't let him’”].
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or on the IRS, which might struggle to process the information on its antiquated information
technology systems.
For example, the Patient Protection and Affordable Care Act (P.L. 111-148) included a
requirement that businesses report payments to corporations in excess of $600, as they must do
for payments such as salaries, interest, and profits. However, lawmakers later repealed this
requirement before it took effect.43 President Obama cited the paperwork burden the requirement
could have placed on small businesses as his motivation for repealing the requirement.44
Recent Expansions
Proposed Bank Reporting
Congress has attempted to expand
Requirements
information reporting in recent years. P.L.
The Biden Administration proposed creating new
117-58, the Infrastructure Investment and
reporting requirements for most bank accounts as part
of the Build Back Better Act, an early version of what
Jobs Act, required cryptocurrency brokerages
became the IRA.45 Such a rule would have given the IRS
(popularly known as “wallets”) to report their
more information on taxpayers’ income from sources
customers’ profits or losses using Form 1099-
for which the IRS is unlikely to detect evasion or filing
B starting in tax year 2023. It also required
errors. However, opponents claimed this reporting
businesses to report cryptocurrency
requirement would violate taxpayers’ right to privacy.46
Others proposed narrowing the requirement to avoid
transactions of greater than $10,000 to the
making compliance exceedingly burdensome for the
IRS, the same rule that applies to cash
IRS.47 President Biden later proposed setting the
transactions. These rules will give the IRS
threshold at $10,000 and excluding both payments for
more information on cryptocurrency
salaries and federal benefits.48 However, Congress did
not include any new reporting requirement in the IRA.
transactions, making evasion of any federal
taxes on such transactions more difficult. The
IRS’s tax gap estimate may not reflect revenue generated through these reforms because it does
not account for evasion done using cryptocurrency.
Congress also required third-party payment services (e.g., Paypal, Venmo, and CashApp) to
report more information on commercial transactions conducted through their platforms as part of
P.L. 117-2, the American Rescue Plan Act of 2021. Federal tax law did not previously require
these services to report the value of inflows and outflows to their customers’ accounts if those
flows were below $20,000 annually or involved fewer than 20 transactions. Under the new rule,
the services must report inflows and outflows on all accounts with gross flows above $600. The
rule only applies to payments for goods or services.49 This reporting requirement will give the
IRS more information on some taxpayers’ business income, among the largest components of the
tax gap. Congress scheduled this change to take effect for tax year 2022. However, the IRS has

43 The Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011
(P.L. 112-9) made this change.
44 U.S. National Archives and Records Administration, Office of the Federal Register, “Bill Signings and Vetoes:
Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011,” April 14,
2011, available at https://www.govinfo.gov/app/details/DCPD-201100255.
45 U.S. Department of Treasury, The American Families Plan Tax Compliance Agenda, May 2021, pp. 18-21.
46 McConnell, “McConnell: Biden wants to give the IRS the OK to snoop on your bank account. Don't let him.”
47 Steven M. Rosenthal, “Biden’s Effort to Close the Tax Gap Is Well-Intentioned but Flawed,” Tax Policy Center,
May 3, 2021.
48 Jeff Stein, “Democrats to Scale Back Treasury’s IRS Bank Reporting Plan Amid GOP Uproar,” The Washington
Post, October 18, 2021.
49 See CRS In Focus IF12095, Payment Settlement Entities and IRS Reporting Requirements, by Anthony A. Cilluffo.
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delayed implementation for two years “to facilitate an orderly transition” to the new system, and
intends to use a threshold of $2,000 rather than $600 in 2024.50
Proposals for Further Expansion
The GAO has encouraged the IRS to establish centralized leadership capable of assessing and
adapting its use of information returns to meet the agency’s needs.51 Additionally, the Treasury
Department has proposed requiring American banks to report more information on their foreign
customers to the IRS. The United States has information-sharing arrangements with foreign
governments on bank accounts that citizens in one country hold in another. The purpose of these
arrangements is to share information that will enable tax agencies to identify tax evasion through
offshore accounts. These agreements often rest on the principle of reciprocity: foreign
governments provide information regarding accounts within their borders in exchange for
information from the U.S. government on accounts at U.S. banks. Treasury wants to strengthen
reporting requirements for domestic banks to enable the United States to share more information
with foreign governments in exchange for information on Americans’ foreign bank accounts.52
Tax Expenditure Transparency
In addition to understating their income, taxpayers can underreport their tax liability by claiming
deductions or credits for which they do not qualify. Taxpayers must sometimes verify their
eligibility for credits by giving the IRS certain information. For example, to claim a child for the
Earned Income Tax Credit (EITC), a taxpayer must provide that child’s Social Security number.
However, other tax credits and deductions do not require the taxpayer to provide any information
justifying the claim.
For example, taxpayers who spend the funds they hold in 529 plans do not need to pay federal
taxes on gains on those savings provided the funds are spent on qualified education expenses. Yet
most taxpayers do not need to substantiate this information during filing season. Taxpayers
typically only need to substantiate eligibility if they face an audit.
Requiring information returns that verify whether taxpayers qualify for various tax benefits may
discourage filers from claiming benefits erroneously. However, such a requirement would create
an additional filing responsibility for taxpayers and additional costs for third parties that report
the information, as well as for the IRS. The need for new filings may discourage some taxpayers
from claiming tax benefits for which they are eligible.

50 IRS, Notice 2023-74, November 21, 2023, available at https://www.irs.gov/pub/irs-drop/n-23-74.pdf.
51 GAO, Tax Enforcement: IRS Can Improve Use of Information Returns to Enhance Compliance, GAO-24-107095,
November 15, 2023.
52 U.S. Department of the Treasury, General Explanations of the Administration’s Fiscal Year 2024 Revenue
Proposals, March 9, 2023, pp. 197-199.
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Simplify the Tax Code
Lawmakers could also attempt to reduce the
Do Taxpayer Services Help Taxpayers
tax gap by simplifying the tax code.
Comply?
Complexity complicates the filing process and
Some have also suggested that improving the IRS’s
can confuse even professional tax preparers.
taxpayer services could enable taxpayers to get
In 2014, GAO sent employees posing as
answers to more questions prior to filing their tax
taxpayers to 19 tax preparers and asked them
returns, thus avoiding errors that contribute to the tax
gap. The IRS says that it offers “taxpayer service
to prepare their tax returns. Only two of the
programs aimed at supporting accurate tax filing and
paid tax preparers correctly identified the
helping address the tax gap. These range from working
fictional taxpayer’s refund.53
with businesses and partner groups to a variety of
education and outreach efforts.” However, little
One way to simplify the code would be to
research exists on whether—or how—improving
eliminate ambiguities that can either confuse
taxpayer services can encourage tax compliance.
taxpayers and cause errors or give plausible
P.L. 117-169 provided the IRS with $3.2 bil ion through
deniability to would-be tax evaders. For
FY2031 for taxpayer services, partially in response to
example, the IRS expects businesses and
poor service during the unique circumstances of the
COVID-19 pandemic. The IRS intends to use these
workers to consider a number of factors in
funds to expand customer service operations, offer
determining whether a worker is an employee
more guidance that interprets tax law, and modernize
or an independent contractor. While employers
its individual tax databases so customer service
withhold and remit estimated income taxes for
representatives can better understand a given
their employees, they do not do so for
taxpayer’s history of payments and interactions with
the agency.
independent contractors, making those
workers more likely to underreport the income
on their tax returns. As a result, ambiguity in the definition of an employee creates opportunities
for tax underpayment.54
Opportunities for error and evasion can also arise from complexities in the structure of the tax
system itself, rather than ambiguities in definitions. For example, the federal government applies
payroll taxes to wage income, but not returns to capital.55 Business owners must distinguish what
income they receive is compensation for their labor and what is profit, yet there may be no
objective way to delineate the two. The tax code thus gives the owners an incentive to avoid
paying the payroll taxes by attributing more of their income to returns to capital.
Simplifying the tax code can reduce the cost of taxpayer compliance, which could prevent errors.
However, simplifying could also eliminate distinctions that Congress considers meaningful, and
thus eliminate desired nuance in the tax code. Depending on the details, simplification could
either raise revenue, be revenue neutral, or cost the federal government revenue.

53 GAO, In a Limited Study, Preparers Made Significant Errors, GAO-14-467T, April 8, 2014, p. 9.
54 See CRS Report R46765, Worker Classification: Employee Status Under the National Labor Relations Act, the Fair
Labor Standards Act, and the ABC Test, by Jon O. Shimabukuro.
55 See CRS Report R47062, Payroll Taxes: An Overview of Taxes Imposed and Past Payroll Tax Relief, by Anthony A.
Cilluffo and Molly F. Sherlock. Note that the net investment income tax is a 3.8% surtax on investment income above a
threshold that funds the Medicare Hospital Insurance Trust Fund, since such income is not subject to the payroll tax
that funds that trust fund. In this way, the surtax functions as a partial replacement to that payroll tax. For more, see
CRS In Focus IF11820, The 3.8% Net Investment Income Tax: Overview, Data, and Policy Options, by Mark P.
Keightley.
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Strengthen Regulations on Tax Preparers
Lawmakers could also regulate the competence of paid tax preparers and commercial tax
preparation software. GAO reports that nearly 84 million taxpayers, or 43% of all filers, hired
paid tax preparers in tax year 2021. While some of these preparers were professionals (e.g.,
certified public accountants) who had to meet minimum competency requirements, 53% of
returns prepared by professional preparers were done by “unenrolled” preparers who were not
subject to IRS registration, competency testing, or education requirements. Another 62.5 million
taxpayers used commercial software to prepare their own returns.56
Currently, most paid preparers are not credentialled and hence are not required to meet any
standards or take required trainings. In 2011, the IRS announced it would begin requiring all paid
tax preparers to meet minimum competency requirements. However, a group of tax preparers
sued, and the U.S. District Court for the District of Columbia held that the IRS had overstepped
its legal authority in regulating all paid tax preparers. The District of Columbia Circuit Court of
Appeals upheld this decision.57 (The IRS still offers a voluntary process for paid tax preparers to
obtain an official IRS credential.)
The IRS imposes some regulations on commercial tax software, but the agency does not test the
quality of this software routinely.58 Congress could give the IRS explicit authority to establish and
enforce minimum standards for paid preparers, and the IRS could review the quality of
commercial tax software more extensively.
Requiring all preparers to pass minimum competency standards could reduce errors on tax filings,
and thus the tax gap, because returns prepared by paid tax preparers have historically had more
errors than returns prepared by regulated preparers or IRS-trained volunteers. Since unenrolled
preparers are disproportionately likely to serve low-income clients and clients of color, such
reforms could prove particularly effective for preventing errors and penalties for these groups. In
2021, 79% of returns that claimed the EITC and were filed by a paid preparer on behalf of a client
were completed by unenrolled preparers. Those returns accounted for 90% of audited returns and
92% of dollars adjusted in EITC audits among all returns that were filed by paid preparers and
claimed the EITC.59
Nearly all returns are filed electronically, often with some sort of commercial software. Hence
regulating commercial software more closely could also avoid confusing prompts that cause
taxpayer errors.60
Some opponents of regulations on tax preparers argue that such rules would prove burdensome
for small preparers, giving large preparers an unfair advantage.61 If true, this effect could limit

56 GAO, Paid Tax Return Preparers, GAO-23-105217, November 30, 2022, p. 8.
57 Loving v. IRS, 742 F.3d 1013 (D.C. Cir. 2014).
58 IRS, Taxpayer Advocate Service, Earned Income Tax Credit: Making the EITC Work for Taxpayers and the
Government, Publication 4054-D, June 2019, p. 28 [Hereinafter “IRS, Earned Income Tax Credit: Making the EITC
Work for Taxpayers and the Government”].
59 IRS, Taxpayer Advocate Service, Annual Report to Congress, 2022, Publication 2104, December 31, 2022, pp. 128-
140.
60 IRS, Earned Income Tax Credit: Making the EITC Work for Taxpayers and the Government, p. 23.
61 For example, see Nan Smith, “Coalition Opposes Burdensome Tax Preparer Occupational Licensing Proposals,” R
Street, October 28, 2021, https://www.rstreet.org/outreach/coalition-opposes-burdensome-tax-preparer-occupational-
licensing-proposals/.
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options and raise prices for consumers. Others have proposed limiting new regulations to
currently noncredentialed preparers.62
The Taxpayer Advocate Service, Biden Administration, and Trump Administration each proposed
granting the IRS the statutory authority to regulate all paid tax preparers.63 Proposals to tighten
regulation of paid preparers have also included increasing penalties for tax preparers who make
errors and for taxpayers who hire “ghost preparers,” those who fail to identify themselves to the
IRS on the tax return.
The IRS is also currently piloting an e-filing service, called “Direct File,” that would compete
with private e-filers. The program will operate in 13 states during the 2024 filing season. This
competitive pressure could represent another means by which the IRS could influence the
behavior of private tax preparation services. However, opponents question its likely cost-
effectiveness.64
Conclusion
The IRS estimates that taxpayers failed to pay 15% of their federal tax liability—an average of
$496 billion annually—on time between 2014 and 2016. Underreported income taxes composed
80% of these unpaid federal taxes, particularly among income sources that are not subject to
third-party withholding and reporting to the IRS. Underpayment explained another 12% of the
total, while nonfiling accounted for the remaining 8%. Late payments and enforcement recouped
an average of $68 billion annually, or 2% of the public’s tax liability.
These unpaid taxes cost the federal government revenue that it could use to reduce the federal
debt, lower taxes, or increase spending. Enforcing the tax code also costs the federal government
financial resources, although recent estimates indicate that marginal increases in enforcement
spending generate significantly more revenue than they cost.
While the tax gap is the best available estimate of unpaid federal taxes, it is incomplete. Research
suggests that the semirandom audits the IRS uses to estimate underpayment fail to identify some
underpayment by very high-income filers. The estimate does not include some forms of evasion,
such as unpaid taxes on illegal activity, nor does it claim to measure legal tax avoidance.
Furthermore, the tax gap relies on some modeling assumptions and older data sources that may
bias both the total estimate and the form those unpaid taxes take.
To encourage tax compliance, policymakers could expand existing enforcement activity, such as
examinations or math error authority. The IRA included $45.6 billion through FY2031 to bolster
tax enforcement. However, Congress has already rescinded some of those funds and agreed to
rescind more during the FY2024 and FY2025 appropriations cycles. Other options include
requiring third-party information reporting on more sources of income, strengthening regulations
on tax preparers, and simplifying the tax code to prevent honest errors.

62 For example, see Letter from Troy K. Lewis, CPA, Chair of the American Institute of Certified Public Accountants,
to the Honorable Kevin Brady, Chairman of the House Committee on Ways and Means, and to Sander Levin, Ranking
Member of the House Committee on Ways and Means, December 4, 2015, available at https://us.aicpa.org/content/
dam/aicpa/advocacy/tax/downloadabledocuments/2015-12-4-aicpa-comments-on-hr-4141-final.pdf.
63 National Taxpayer Advocate, 2023 Purple Book, pp. 5-8; U.S. Department of the Treasury, General Explanation of
the Administration’s Revenue Proposals for FY2024, pp. 181-184; Office of Management and Budget, An American
Budget: Budget of the U.S. Government for Fiscal Year 2019, February 2018, p. 91.
64 For more, see CRS Insight IN12270, Current Status of an IRS Free Direct Electronic Filing Option, by Gary
Guenther.
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Appendix. How the IRS Estimates the Tax Gap
The tax gap is the difference between the true tax liability and how much the IRS actually
collects. Although the IRS knows how much revenue it collects, it must estimate taxpayers’ true
tax liability to determine the size of the tax gap. The IRS calculates each component of the tax
gap differently. Some calculations rely solely on publicly available data and administrative data,
whereas the agency produces others using economic models. The IRS collects new data to
estimate the largest portion of the tax gap, underreporting of individual income, by semirandomly
selecting returns for audit.65
The IRS intends to use some of the funds made available by P.L. 117-169 to use “new data and
enhanced analytics” to better understand the tax gap.66 As a result, the methods detailed below
may change in the coming years.
Individual Income Taxes
Nonfiling
The IRS uses data on household income and administrative data on tax filing to determine what
share of households do not file tax returns even though they are required to do so. Specifically,
the agency links data from the Census Bureau’s American Community Survey—which gives
detailed information on household income—to its own tax return data. The IRS calculates each
nonfiler’s tax liability and subtracts amounts withheld to determine the individual nonfiling tax
gap.67
Underreporting
Estimating individual income tax underreporting requires approximating filers’ “true” tax
liability. The agency does so using the examinations it conducts through its National Research
Program (NRP), a semirandom sample of examinations that the IRS conducts principally to
calibrate its models that select individual returns for examinations.
The NRP examines roughly 14,000 returns annually. Since this level is approximately one-third
of the number of returns the IRS audited through its prior process—known as the Taxpayer
Compliance Measurement Program—the IRS pools its data over three-year periods. The sample
disproportionately selects filers in groups that often have more complicated taxes, such as self-
employed individuals, to help ensure the data on these groups are adequately specific.
NRP auditors may fail to identify every instance of underpayment. To account for any such
underpayment, the IRS applies a process called detection-controlled estimation (DCE). DCE
compares noncompliance detection rates for different tax issues among various examiners to try
to account for the possibility that some auditors, such as those who are more experienced, identify
more underpayment than others do. This calculation produces an estimate of the probability of a
taxpayer underreporting income for each tax item.68 The IRS then uses those probabilities to

65 The selection process is “semirandom” rather than truly random because the IRS is more likely to select taxpayers
with tax items that are frequently misreported than other taxpayers.
66 IRS, IRA Strategic Operating Plan, pp. 36, 98.
67 IRS, Tax Gap Estimates, pp. 15-16.
68 For more on DCE, see Brian Erard and Jonathan Feinstein, “The Individual Income Reporting Gap: What We See
and What We Don’t,” 2011 IRS-Tax Policy Center Research Conference, June 22, 2011, https://www.irs.gov/pub/irs-
soi/11resconindincome.pdf.
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estimate the dollar value of underreported income tax liability in the population.69 Independent
researchers found that using DCE roughly tripled the estimated level of underreported income
taxes.70
This methodology does not identify tip income that recipients fail to report. Because customers
often tip workers in cash, tips are subject to less information reporting than other wage and salary
income, making them more prone to underreporting. The IRS assumes that tip income has the
same noncompliance rate as that of sole proprietor income.71
Underpayment
Tax filings include each taxpayer’s stated tax liability. The IRS can compare this stated liability to
the actual amount of revenue it collects from each taxpayer to determine how much stated tax
liability taxpayers failed to pay.
Corporate Income Taxes
Nonfiling
The IRS does not report a calculation methodology for corporate nonfiling, and implicitly
assumes that corporate nonfiling contributes nothing to the tax gap.
Underreporting
The IRS does not randomly audit corporations to determine their true corporate income tax
liability. Instead, the agency estimates corporate tax underpayment based on its normal
(“operational”) examinations and models of corporate tax underpayment. It does so separately for
small corporations (those that report less than $10 million in assets) and larger corporations. The
IRS stresses “there is considerable uncertainty surrounding the estimates of this component of the
tax gap because of data limitations, lack of information from which to develop a reasonable
method to adjust for undetected noncompliance, and other issues.”72
The model used to estimate underreporting by small corporations attempts to estimate five
different equations jointly, using data on actual operational examinations. The IRS says that it
audits less than 1% of small corporations in a given year, and thus uses data from a longer period
to get a larger sample. The tax gap estimate for 2014-2016 is based on data from examinations of
small corporations from tax years 2009 to 2016.73
The IRS models unpaid large corporate tax liability by assuming that such liability follows a
“Pareto distribution,” meaning that most recommended additional taxes are concentrated in a
small number of firms. The agency says it can make such an assumption if two conditions hold.
First, firm size and corporate income must follow a similar distribution. Second, underreporting is
roughly as common and significant in firms with low income as high income. Axtell (2001)
examined these assumptions using 1997 data, and found that they held. With an estimate of the

69 IRS, Tax Gap Estimates, pp. 18-19.
70 Guyton et al., “Tax Evasion at the Top of the Income Distribution: Theory and Evidence,” p. 60, as cited in Hemel,
Holtzenblatt, and Rosenthal, “The Tax Gap’s Many Shades of Gray,” p. 6.
71 IRS, Tax Gap Estimates, p. 18.
72 Ibid., pp. 21-22.
73 Ibid., p. 22.
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distribution of noncompliance in place, the IRS uses the results of operational audits to estimate
the volume of noncompliance across the population of large corporations.74
Underpayment
Tax filings include each corporate taxpayer’s stated tax liability. The IRS can compare this stated
liability to the actual amount of revenue it collects from each corporate filer to determine how
much stated tax liability corporations failed to pay.
Employment (Payroll) Taxes
Nonfiling
Generally, the IRS can determine if businesses failed to file appropriate returns for employment
taxes (also known as payroll taxes) using the same methodology as it uses for individual income
tax nonfiling. The same is true for unpaid self-employment taxes. The IRS considers situations in
which businesses withhold employment taxes but fail to remit them to the IRS in a timely manner
to be underpayment cases rather than nonfiling cases.75
Underreporting
The IRS uses data from an employment tax study to estimate the underpayment of employment
taxes (also known as payroll taxes) for most workers. This study was officially a component of
the NRP and used the same semirandom design. Since the study was last conducted from 2008 to
2010, the IRS adjusts the results using current population estimates. The IRS also applies its
estimate of underreported tip income from the calculation of individual income tax
underreporting to any employment taxes that employers and employees would owe on tip income.
Due to a lack of data, the figure does not include underpayment of employment taxes to
household and agricultural workers.76
While employers and employees typically pay equal amounts of employment taxes on a given
worker’s wages, self-employed workers pay their entire self-employment tax themselves. As a
result, the IRS can use the same methodology to estimate underreporting of self-employment tax
liability as it does for individual income tax underreporting.77
Underpayment
Tax filings include each taxpayer’s stated tax liability. The IRS can compare this stated liability to
the actual amount of revenue it collects from each taxpayer to determine how much stated tax
liability taxpayers failed to pay.

74 Ibid., p. 23.
75 Ibid., p. 16.
76 Ibid., pp. 23-24.
77 Ibid.
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Estate Taxes
Nonfiling
The IRS does not report a calculation methodology for estate tax nonfiling, and implicitly
assumes that estate tax nonfiling contributes nothing to the tax gap.
Underreporting
The IRS says that it estimates the value of underreported estate taxes using “’risk-based’
operational examination data and an econometric approach” that is “similar to the methodology
used for the small corporation income tax gap estimates.”78
Underpayment
Tax filings include each taxpayer’s stated tax liability. The IRS can compare this liability to the
actual amount of revenue it collects from each estate to determine how much tax liability these
estates failed to pay.

Author Information

Brendan McDermott

Analyst in Public Finance

Disclaimer
This document was prepared by the Congressional Research Service (CRS). CRS serves as nonpartisan
shared staff to congressional committees and Members of Congress. It operates solely at the behest of and
under the direction of Congress. Information in a CRS Report should not be relied upon for purposes other
than public understanding of information that has been provided by CRS to Members of Congress in
connection with CRS’s institutional role. CRS Reports, as a work of the United States Government, are not
subject to copyright protection in the United States. Any CRS Report may be reproduced and distributed in
its entirety without permission from CRS. However, as a CRS Report may include copyrighted images or
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copy or otherwise use copyrighted material.

78 Ibid., p. 24.
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