Mind the Gap

Those of you who have traveled to London, England will likely recognize this phrase as a passenger safety warning on the London Underground. However, in the context of US federal income taxation, this phrase has an entirely different meaning.

The US Treasury / IRS keep track of the "Tax Gap", which is a calculation of the difference between the taxes owed and the taxes paid in a timely manner. According to the IRS, this gap was approximately $350 billion in 2001.

Per the IRS website, "The tax gap can be divided into three components: nonfiling, underreporting and underpayment. Nonfiling occurs when taxpayers who are required to file a return do not do so on time. Underreporting of tax occurs when taxpayers either understate their income or overstate their deductions, exemptions and credits on timely filed returns. Underpayment occurs when taxpayers file their return but fail to remit the amount due by the payment due date."

Many of the head scratching proposals, relating to taxes, are an attempt to close this gap. One of the most recent proposals, expanded 1099 reporting, is an attempt to close this gap. Though this isn't meant to close it in the way that many think it is. This proposal isn't meant to capture unreported income of Wal-Mart or Office Depot, entities which would receive 1099s that they previously didn't. This proposal is meant to reduce the amount of "overstated deductions", particularly small business expenses.

There have been some attempts to repeal this requirement and it may not end up going into effect. I hope that it doesn't, but this is an area that will continue to receive scrutiny from the service as it believes that correcting overstated deductions, especially those related to small business, will go a long way toward shrinking the Tax Gap.