The gross tax gap is the difference between true tax liability for a given tax year and the amount that is paid on time. It is comprised of the nonfiling gap, the underreporting gap, and the underpayment, or remittance, gap. The net tax gap is the portion of the gross tax gap that will never be recovered through enforcement or other late payments (IRS, The tax gap).
Two things follow from that wording and both matter in practice. The measure starts from liability under existing law, so a deduction the law grants is not part of it. And it is silent about intent: a return understated by an honest error and one understated deliberately land in the same component.
The Three Components
The gross tax gap comprises nonfiling, tax not paid on time by those who do not file on time; underreporting, tax understated on timely filed returns; and underpayment, tax that was reported on time but not paid on time. For tax year 2022 the projected figures are $63 billion, $539 billion and $94 billion (IRS, Tax Gap Projections for Tax Year 2022, Publication 5869).
The three are not variations on one failure. Nonfiling is a missing return. Underreporting is a return that arrived and understated the liability. Underpayment is a return that arrived, stated the liability correctly, and was not paid. A firm’s controls for each are different, and only the middle one is a preparation quality problem.
Gross, Net, and the Two Compliance Rates
The projected annual gross tax gap for tax year 2022 is $696 billion. The net tax gap is the gross tax gap less tax that subsequently will be paid, either voluntarily but late or collected through IRS administrative and enforcement activities, and a projected $90 billion of the gross tax gap eventually will be paid, resulting in a net tax gap of $606 billion for that year (IRS, Publication 5869).
Each of those has a rate beside it. The voluntary compliance rate is a ratio measure of relative compliance, defined as the amount of tax paid voluntarily and timely divided by total true tax, expressed as a percentage, and the projected rate for tax year 2022 is 85.0 percent. The net compliance rate is defined as the sum of tax paid voluntarily and timely and enforced and other late payments, divided by total true tax, and the projected rate is 86.9 percent (IRS, Publication 5869).
Quoting one rate without saying which one is the common error. They answer different questions: what came in on its own, and what came in at all.
Where the Gap Sits by Type of Tax
For tax year 2022 the projection puts individual income tax at $514 billion of the gross tax gap, employment tax at $127 billion, corporate tax at $50 billion and estate tax at $5 billion (IRS, The tax gap). Individual income tax is also the largest share of the net figure, contributing $447 billion to the net tax gap for that year (IRS, Publication 5869).
The employment tax component includes self-employment tax (IRS, Publication 5869), which is why the number is larger than a firm expecting only withheld payroll tax would guess. What the withheld side is composed of is set out in payroll tax.
Visibility Is What Moves the Number
The single most useful finding in the tax gap work is not a total. It is that compliance tracks whether a third party already told the IRS about the income.
Findings from tax gap analyses have consistently shown that compliance is higher when amounts are subject to information reporting and even higher when also subject to withholding. The extent of coverage by information reporting and/or withholding is called visibility, because incomes that are reported to the IRS are more visible to both the IRS and taxpayers. Analysis for the tax year 2014 to 2016 time frame shows that misreporting of income amounts subject to substantial information reporting and withholding is 1 percent of income. For amounts subject to substantial information reporting but not withholding, it is 6 percent. For income amounts subject to little or no information reporting, such as nonfarm sole proprietor income, it is 55 percent (IRS, Publication 5869).
That spread is the reason a client whose income arrives on a form and a client whose income does not are different engagements, whatever the fee says. The forms that create the visible end are covered in the two nonemployee information returns, and the taxpayer at the invisible end is the one drawn in sole proprietor.
A Projection Is Not an Estimate
The published figures for recent years are projections rather than measurements, and the IRS says why.
A particular challenge for tax gap estimation is the time it takes to collect certain compliance data, especially data on underreporting that comes from completed examinations. Waiting for that data allows the estimates to reflect the compliance behavior for the years of the estimates, but by then the time frame of the estimates can be several years prior to the year of the tax gap release. Projections were developed as a bridge between those competing priorities (IRS, The tax gap).
The bridge has an assumption inside it, and the assumption is stated plainly: the projection methodology assumes that reporting compliance behavior has not changed since the tax year 2014 to 2016 time frame (IRS, Publication 5869). The publication still lists real behaviour among the things that move the figure over time, alongside the overall level of economic activity, changes in the composition of that activity, changes in tax law and tax administration practices, and updated data and improved methodologies (IRS, Publication 5869). Both are true at once: behaviour is one of the listed causes, and the projection method is not built to detect a change in it.
The projections of the underreporting tax gap generally reflect the level of the tax gap that takes into account the growth in the reported tax or the reported amount of line items on tax returns, while assuming compliance behavior has not changed from prior years (IRS, The tax gap). So a move in the headline between two projected years is carrying the growth in reported amounts before it carries anything else.
What the Tax Gap Is Not
It is not what the government will fail to collect. That is the net figure, and the two are $90 billion apart for tax year 2022, so a citation that does not say which one is being used is not usable (IRS, Publication 5869).
It is not a measure of evasion. The definition turns on liability that was not paid on time and says nothing about why (IRS, The tax gap), so the line that does turn on intent has to be drawn elsewhere, and it is drawn in tax avoidance vs tax evasion and in tax evasion vs tax fraud.
It is not revenue the law gives away. The gap is measured against true tax liability (IRS, The tax gap), and a provision that reduces liability on purpose moves that baseline rather than the gap sitting above it. The separate accounting for those provisions is covered in tax expenditure.
Common Questions
What was owed, minus what was paid on time. The gross version stops there; the net version then subtracts the part that will eventually come in late or through enforcement (IRS, The tax gap).
For tax year 2022 the projection is $696 billion gross and $606 billion net, with $90 billion of the gross figure expected to be paid eventually (IRS, Publication 5869). Those are projections for a single tax year rather than a running total, and they arrive late by design: the time frame of the estimates can be several years prior to the year of the tax gap release (IRS, The tax gap).
Underreporting, at $539 billion of the $696 billion gross figure for tax year 2022 (IRS, Publication 5869). It is also the component that a return preparer’s work touches most directly, because it is the one that lives on a filed return rather than in a missing one or an unpaid balance.
Accountably places trained offshore accountants and tax preparers inside US CPA and EA firms, and a firm can put a block of its own return preparation and information reporting work through a trial task before anything client facing depends on it.
