The U.S. government has a problem called the tax gap. The tax gap is the difference between total taxpayers’ liability and the actual amount of taxes paid. It is tax revenue that should be collected according to the tax code but is not. The gap comprises unfiled taxes, unreported income and underpaid taxes. The IRS can recover some of that. The net tax gap is the portion that is not recovered through enforcement or late payments.
The IRS currently reports that the gross tax gap for tax years 2011-2013 was $441 billion. (According to the IRS, “Estimating the tax gap is inherently challenging and requires assessing the merits of alternative methods, assumptions, and data sources.”) Expecting to collect $60 billion of that ultimately, the IRS projects that the net tax gap for the period would be $381 billion.
A Treasury model extrapolates from those figures to project a gross gap in 2019 of $584 billion. Supposing the IRS collects $80 billion, it leaves a net gap of $500 billion. To be clear, that’s 500,000 million! Even for Washington D.C., that’s a lot of money. The IRS wants to close that gap.
The Tax Gap and 1099s
A large part of that gap is unreported income, which is the driver behind IRS 1099 reporting. The IRS does not rely solely on taxpayers to report their income, but on paying organizations to report the income paid to taxpayers. That’s where 1099s come in. Companies report payments to employees on IRS form W-2. They must also report a variety of payments made to non-employees on various 1099s. The IRS matches up 1099s with taxpayer 1040s and other taxpayer forms to determine if the taxpayer has reported and paid taxes on all their income.
But in recent years, cuts to the IRS budget have made it more challenging for the IRS to keep up. Over the last decade, the IRS has cut personnel by 22 percent. However, the new bipartisan infrastructure bill includes a $40 billion boost to the IRS budget.
If the bill becomes law, the administration claims the $40 billion invested in the IRS will return $140 billion in new revenue for a net gain of $100 billion. The Congressional Budget Office, on the other hand, projects it will bring in $103 billion for a net gain of $63 billion. Either way, it’s well short of half a trillion dollars.
Tighten Up Payment Reporting
Be that as it may, it behooves organizations to tighten up their tax reporting. That means ensuring they gather W-9s or W-8s from vendors to certify their tax and reporting status and flag reportable vendors in the master file to ensure they issue a 1099 (or 1042-S) in compliance with IRS rules.
If you’ve gotten by with less than strict compliance in the past few years, past performance is no guarantee you will get by in the future. Expect IRS audits to increase. Of course, it won’t happen overnight. There’s some time to get things in order. But if getting complete tax information on vendors and ensuring full 1099 compliance has slipped on your priority list, it may be time to refocus.
And to learn how to easily and securely collect W-9s and W-8s to ease your payment reporting, contact us.