Direct Marketing Association, The v. Huber

Filing 50

RESPONSE to 15 MOTION for Preliminary Injunction with Incorporated Memorandum of Law filed by Defendant Roxy Huber. (Attachments: # 1 Exhibit 1, # 2 Exhibit 2, # 3 Exhibit 3, # 4 Exhibit 4, # 5 Exhibit 5, # 6 Exhibit 6, # 7 Exhibit 7, Part 1, # 8 Exhibit 7, Part 2, # 9 Exhibit 7, Part 3, # 10 Exhibit 7, Part 4, # 11 Exhibit 7, Part 5, # 12 Exhibit 7, Part 6, # 13 Exhibit 7, Part 7, # 14 Exhibit 8, # 15 Exhibit 9, # 16 Exhibit 10, # 17 Exhibit 11, # 18 Exhibit 12, # 19 Exhibit 13, # 20 Exhibit 14, # 21 Exhibit 15, # 22 Exhibit 16, # 23 Exhibit 17)(Scoville, Stephanie)

United States

of America

Department of the Treasury
Internal Revenue Service

Date:

Gel
••.

1 2; LUIIJ.
2010

CERTIFICATE OF OFFICIAL RECORD
I certify that the annexed: is a true copy of the United States Department of the Treasury report titled, “Reducing
"Reducing
I
Compliance,”
2,2007,
the Federal Tax Gap, A Report on Improving Voluntary Compliance ," dated August 2, 2007, as published on
www.irs.gov,
the Internal Revenue Service website www.irs.ciov, consisting of one hundred (100) pages - - - - - - - - -

the custody of this office.

I
IN WITNESS WHEREOF, I have hereunto set my
hand, and caused the seal of this office to be affixed,
written.
on the day and year first above written .
By the direction of the Secretary of the Treasury:

Anna Marie Robles
Senior Disclosure Specialist, Disclosure Office 11
Communications Liaison & Disclosure

Catalog Number 19002E
Catalog Number 1 9002E

(Rev. 12-92)
Form
Form 2866 (Rev. 12-92)

D014
Exh.7

Reducing the Federal
Tax Gap
A
A Report on Improving Voluntary
Compliance

Internal Revenue Service

US.
u.S. Department of the Treasury

August 2, 2007

D015
Exh.7

Reducing the Federal
Reducing the Federal
Tax Gap
Tax Gap
A Report on Improving
A Report on Improving
Voluntary Compliance
Voluntary Compliance

Table of Con n
Tbe Contents
EXECUTIVE
EXECUTIVE
SUMMARY
SUMMARY

1
I

UNDERSTANDING
THE TAX GAP
6
VOLUNTARY
COMPLIANCE

17

COMPONENTS

19

SUMMARY

57
57

APPENDIX
Initiative Timeframes 58
Initiative Timeframes 58
GLOSSARY
GLOSSARY

97
97

D016
Exh.7

EXECUTNE SVJMARY
EXECUlllVE SUMMARY
INTRODUCTION
INTRODUCTION
In Fiscal Year (FY) 2006, federal receipts totaled over $2.4 trillion. More than 95 percent of the
In Fiscal Year (FY) 2006, federal receipts totaled over $2.4 trillion. More than 95 percent of the
net receipts were collected by the Internal Revenue Service (IRS) through its administration of
net receipts were collected by the Internal Revenue Service (IRS) through its administration of
the income, employment, transfer, and excise tax provisions of the Internal Revenue Code.
the income, employment, transfer, and excise tax provisions of the Internal Revenue Code.
Virtually all of these receipts were collected through a tax system under which taxpayers
Virtually all of these receipts were collected through a tax system under which taxpayers
voluntarily report and pay their taxes with no direct enforcement and minimal interaction with the
voluntarily report and pay their taxes with no direct enforcement and minimal interaction with the
government.
government.
The overall compliance rate achieved under
The overall compliance rate achieved under the United States revenue system is quite high. For
United States revenue system is quite high. For
2001 tax year,
IRS estimates
after factoring in late payments and recoveries from
the 2001 tax year, the IRS estimates that, after factoring in late payments and recoveries from
IRS enforcement activities, over 86 percent of tax liabilities were collected. Nevertheless, an
Nevertheless,
large
unacceptably large amount of the tax that should be paid every year is not, such that compliant
be
disproportionate
taxpayers bear a disproportionate share of the revenue burden, and giving rise to the "tax gap."
“tax gap.”
The gross tax gap was estimated to be $345 billion in 2001. After enforcement efforts and late
payments, this amount was reduced to a net tax gap of approximately $290 billion.
approximately
The Treasury Department and IRS are committed to improving current compliance levels and
continuing to address all forms of noncompliance. The IRS Oversight Board has adopted an 86
noncompliance.
percent voluntary compliance goal by 2009 and Senate Finance Committee Chairman Max
Baucus has asked for a 90 percent voluntary compliance goal by 2017. This report sets forth
steps that will be taken to improve compliance and enhance the IRS’ ability to measure
IRS'
compliance. Once implemented, these steps will improve the IRS' ability to gauge progress in
implemented,
in
IRS’
achieving specific long-term compliance objectives.
This report outline steps that the IRS will take to increase voluntary compliance and reduce the
voluntary
tax gap. It builds on the Comprehensive Strategy for Reducing the Tax Gap (the Treasury
It
Comprehensive
Gap (the Treasury
Strategy) that was released in September 2006 by the Treasury Department’s Office of Tax
Strategy)
in September 2006
Department's
of
Policy and provides more detail for that strategy.
Policy
more detail for
The IRS regularly addresses compliance improvement measures in its planning and budgeting
The IRS regularly addresses compliance improvement measures in its planning and budgeting
processes. The Administration’s annual budget request identifies the resources the IRS will
processes. The Administration's annual budget
identifies the resources the IRS will
need to meet specific performance goals to achieve its strategic priorities. This document
need to meet specific performance goals to achieve its strategic priorities. This document
combines and addresses current tax gap efforts. In addition, the IRS has long been conducting
combines and addresses current tax gap efforts. In addition, the IRS has long been conducting
research in compliance and the tax gap, and resulting data is incorporated throughout this
research in compliance and the tax gap, and resulting data is incorporated throughout this
document.
document.
The steps outlined in this report are, in many respects, only initial steps toward improving
The steps outlined in this report are, in many respects, only initial steps toward improving
compliance. As described below, one of the primary challenges that the IRS faces in improving
compliance. As described below, one of the primary challenges that the IRS faces in improving
compliance is to get a better understanding of the current sources of noncompliance by
compliance is to get a better understanding of the current sources of noncompliance by
improving research in this area. Until that understanding is clarified, efforts to improve
improving research in this area. Until that understanding is clarified, efforts to improve
compliance may be misdirected and progress may not be measurable. The IRS has taken
compliance may be misdirected and progress may not be measurable. The IRS has taken
significant steps in this direction, most importantly through the National Research Program
significant steps in this direction, most importantly through the National Research Program
(NRP), which is the source of updated estimates of compliance among individual taxpayers for
(NRP), which is the source of updated estimates of compliance among individual taxpayers for
2001. The IRS is committed to furthering its work in this area through updated individual
2001. The IRS is committed to furthering its work in this area through updated individual
taxpayer NRP examinations and a current study focusing on compliance among Subchapter S
taxpayer NRP examinations and a current study focusing on compliance among Subchapter S
corporations (S corporations).
corporations (S corporations).

11
D017
Exh.7

In implementing the steps set forth in this document, it is important to have realistic expectations
In implementing the steps set forth in this document, it is important to have realistic expectations
and perspectives. Based on the limited information available, compliance rates appear to have
and perspectives. Based on the limited information available, compliance rates appear to have
remained
stable
remained relatively stable at around 85 percent for decades. To make a meaningful
85 percent for
To make meaningful
improvement in this number without a fundamental change in the relationship between
improvement in this number without a fundamental change in the relationship between
and the government
require a long-term, focused effort. Implementation of the
taxpayers and the government will require a long-term, focused effort. Implementation of the
in
and in
steps outlined in this document and in the Administration's Fiscal Year (FY) 2008 Budget
Administration’s Fiscal
(FY)
Budget
request
IRS
be subject
uncertainties
request for the IRS will be subject to the uncertainties associated with the annual budget
budget
recognized
process. Moreover, it must be recognized that the causes of noncompliance are numerous and
portion
that only a portion of the tax gap results from intentional avoidance or evasion of the law. An
law.
equally or perhaps more important part of the problem lies in the growing complexity of the tax
laws,
laws, which will continue to frustrate efforts to improve compliance.
The Administration is committed to working with Congress and other stakeholders to reduce the
tax gap. The Administration's FY 2008 Budget request includes $11.1 billion for the IRS, a 4.7
Administration’s
$1 1.1
percent increase over the budget enacted for FY 2007. A total of $410 million is for new
enforcement initiatives as part of a strategy to improve compliance by:
•

Increasing front-line enforcement resources;

•

Increasing voluntary compliance through improved taxpayer service options and
enhanced research;

•

Investing in technology to reverse infrastructure deterioration, accelerate
modernization, and improve the productivity of existing resources; and

•

Implementing legislative and regulatory changes.

Since 2001 (the tax year studied by the NRP), IRS tax collections have increased significantly,
audit rates have improved across all taxpayer segments, and measurements of taxpayer service
have risen to historic levels. While specific data is not available, there is every reason to believe
that these improvements have contributed to a general shift away from aggressive tax planning
a
and an improvement in compliance levels over the past six years. In calling for a significant
increase in IRS funding, the Administration’s budget recognizes, however, that much work
Administration's
remains to be done. Based on historic experience, the IRS estimates that the overall return on
IRS
new investments in compliance averages 4:1, with an additional indirect impact resulting from
the improved overall compliance that comes from more targeted and effective enforcement of
improved
enforcement
the tax law. However, direct spending on compliance improvements does not lend itself to
However,
does not lend itself
traditional revenue-estimating analysis, given the difficulty in quantifying the effect that such
difficulty in quantifying
improvements have on taxpayer behavior.
improvements
taxpayer

This report provides detail on how the additional funds requested in the Administration’s FY
detail
how
in
Administration's FY
2008 Budget will build on improvements the IRS has made in recent years to taxpayer service,
2008 Budget
build
IRS has made in
service,
modernization, and enforcement, all of which are critical elements in the long-term strategy to
modernization, and
of which are critical elements in
long-term strategy
improve compliance. In particular, this report describes six separate initiatives in the FY 2008
improve compliance. In particular, this report describes six separate initiatives in the FY 2008
Budget request that are aimed at improving enforcement. The report also details how additional
Budget reqLlest that are aimed at improving enforcement. The report also details how
funds requested will be targeted to improving taxpayer service, including implementation of the
requested
be
to improving taxpayer service, including implementation of the
recommendations made in the recently released Taxpayer Assistance Blueprint (TAB). In
recommendations made in the recently
Taxpayer Assistance Blueprint (TAB). In
addition, the report outlines how additional funds will accelerate implementation of IRS
addition, the report outlines how additional funds will accelerate
of IRS
modernization programs, to permit better document matching, faster and more accurate
modernization programs, to permit better document matching, faster and more accurate
processing of returns, and more timely access to taxpayer account information. A detailed
processing of returns, and more timely access to taxpayer account information. A detailed

2
2
D018
Exh.7

timeline for implementing
various programs is included as an Appendix to this report.
timeline for implementing these various programs is included as an Appendix to this report.
The Treasury Department and IRS will continue to evaluate resource demands for improving
The Treasury Department and IRS will continue to evaluate resource demands for improving
taxpayer compliance. In addition, future
requests will identify ways to
taxpayer compliance. In addition, future budget requests will identify ways to utilize resources
resources
efficiently and effectively target enforcement efforts to areas
efficiently and effectively to target enforcement efforts to areas where they will have the greatest
they
have the greatest
direct
indirect impact on compliance. The steps for improving compliance
direct and indirect impact on compliance. The steps for improving compliance that are detailed
are detailed
in this
continue to evolve over time as our
in this report will continue to evolve over time as our understanding of the problem improves and
of
problem improves and
in the economy and changes in
law present new compliance challenges.
as changes in the economy and changes in the tax law present new compliance challenges.

Department’s
The Treasury Department's Comprehensive Strategy for Reducing the Tax Gap
Four
Four key principles guided the development of the Treasury Strategy and continue to guide IRS
efforts to improve compliance:
•

First, both unintentional taxpayer errors and intentional taxpayer evasion should be
addressed
addressed.

•
•

Second, sources of noncompliance should be targeted with specificity.

•

Third, enforcement activities should be combined with a commitment to taxpayer
service.

•

Fourth, policy positions and compliance proposals should be sensitive to taxpayer
rights and maintain an appropriate balance between enforcement activity and
imposition of taxpayer burden.

These principles point to the need for a comprehensive, integrated, multi-year strategy to reduce
the tax gap. Guided by these key principles, the Treasury Strategy outlines seven components
which form the basis for the detailed compliance improvement efforts set forth in this document:

1. Reduce Opportunities for Evasion. The Administration’s FY 2008 Budget request contains 16
Administration's
16
legislative proposals to reduce evasion opportunities and improve the efficiency of the IRS.
Three of these proposals were recently enacted in modified form. The 16 provisions would
result in an estimated $29.5 billion of additional revenues over the next ten years. The Treasury
Department and the IRS also continue to use the regulatory guidance process to address both
procedural and substantive issues to improve compliance and reduce the tax gap.
2. Make a Multi-Year Commitment to Research. Research is essential to identify sources of
Multi-Year
is
noncompliance so that IRS resources can be targeted properly. Regularly updating compliance
IRS
properly.
updating
research ensures that the IRS is aware of vulnerabilities as they emerge. New research is
IRS is aware
they emerge. New
is
needed on the relationship between taxpayer burden and compliance and on the impact of
the
burden
and
impact of
customer service on voluntary compliance. Research also is essential to establish accurate
also
establish accurate
benchmarks and metrics to assess the effectiveness of IRS efforts, including the effectiveness
and metrics assess the
of IRS efforts,
of the Treasury Strategy.
of
Treasury Strategy.
3. Continue Improvements in Information Technology. Continued improvements to technology,
3. Continue Improvements in Information Technology. Continued improvements to
including continued development of and additions to Modernized e-File, will provide the IRS with
including continued development of and additions to Modernized e-File, will provide the IRS with
better tools to improve compliance through early detection, better case selection, and better
better
to improve
through early detection, better case selection, and better
case management.
management.

3
3
D019
Exh.7

4, Improve Compliance Activities. IRS actions have produced a steady climb in enforcement
4. Improve Compliance Activities. IRS actions have produced a steady climb in enforcement
revenues since 2001, and an increase in both the number of examinations and the coverage
revenues since 2001, and an increase in both the number of examinations and the coverage
rate in virtually every major category. By further improving examination, collection, and
rate in virtually every major category. By further improving examination, collection, and
document matching activities, the IRS will be better able to prevent, detect, and remedy
document matching activities, the IRS will be better able to prevent, detect, and remedy
noncompliance. These activities will increase compliance not only among those directly
noncompliance. These activities will increase compliance - not only among those directly
contacted by the IRS, but also among those who will be deterred from noncompliant behavior as
contacted by the IRS, but also among those who will be deterred from noncompliant behavior as
a consequence of a more visible IRS enforcement presence. Aided by results from the recent
a consequence of a more visible IRS enforcement presence. Aided by results from the recent
NRP study of individual taxpayers, the IRS continues to reengineer examination and collection
NRP study of individual taxpayers, the IRS continues to reengineer examination and collection
procedures and invest in technology, resulting in efficiency gains and better targeting of
procedures and invest in technology, resulting in efficiency gains and better targeting of
examination efforts. These efficiency gains
into
examination coverage,
examination efforts. These efficiency gains translate into expanded examination coverage,
higher audit yields, and reduced burden on compliant taxpayers.
and reduced burden
—

5. Enhance
Service. Service is especially important to help taxpayers avoid
5. Enhance Taxpayer Service. Service is especially important to help taxpayers avoid
unintentional errors. Given the increasing complexity of the tax code, providing taxpayers with
assistance and clear and accurate information before they file their tax returns reduces
post-filing
IRS
unnecessary post-filing contacts, allowing the IRS to focus enforcement resources on taxpayers
resources
intentionally
who intentionally evade their tax obligations. The IRS also is working to provide service more
efficiently and effectively through new and existing tools, such as the IRS website. The
Taxpayer Assistance Blueprint (TAB), which was completed in April 2007, outlines a five-year
strategic
strategiC plan for taxpayer service. The TAB includes a process for assessing the needs and
preferences of taxpayers and partners and a decision model for prioritizing service initiatives
and funding.
6. Reform and Simplify the Tax Law. Simplifying the tax law would reduce unintentional errors
unintentional

caused by a lack of understanding. Simplification would also reduce the opportunities for
understanding. Simplification
intentional evasion and make it easier for the IRS to administer the tax laws. For example, the
Administration’s
Administration's FY 2008 Budget request includes proposals to simplify tax credits for families
and tax treatment of savings by consolidating existing programs and clarifying eligibility
requirements. These initiatives will continue to be supplemented by IRS efforts to reduce
requirements.
supplemented
taxpayer burden by simplifying forms and procedures.
7.
1. Coordinate with Partners and Stakeholders. Enhanced coordination is needed between the
Partners
Stakeholders.
needed

IRS and state and foreign governments to share information and compliance strategies.
strategies.
Expanded coordination also is needed with practitioner organizations, including bar and
organizations,including
and
accounting associations, to maintain and improve mechanisms to ensure that advisors provide
accounting
and improve mechanisms
appropriate tax advice. Through contacts with practitioner organizations, the Treasury
tax
Through contacts with practitioner organizations,
Department and IRS learn about recent developments in tax practice and hear directly from
and IRS learn about
developments in tax
and hear directly
practitioners about taxpayer concerns and potentially abusive practices. Similarly, contacts with
practitioners about taxpayer concerns and potentially abusive practices.
contacts with
taxpayers and their representatives, including small business representatives and low-income
taxpayers and their representatives, including small business representatives and low-income
taxpayer advocates, provide the Treasury Department and the IRS with needed insight on ways
taxpayer advocates, provide the Treasury Department and the IRS with needed insight on ways
to protect taxpayer rights and minimize the potential burdens associated with compliance
to protect taxpayer rights and minimize the potential burdens associated with compliance
strategies.
strategies.
The IRS Strategic Planning Process
The IRS StrategiC Planning Process
The more detailed steps outlined for improving compliance are, in part, contingent upon the
The more detailed steps outlined for improving compliance are, in part, contingent upon the
budget process for FY 2008 and beyond. Accordingly, adoption of the Administration’s
budget process for FY 2008 and beyond. Accordingly, adoption of the Administration's
proposed FY 2008 Budget for the IRS along with the enactment of the legislative
proposed FY 2008 Budget for the IRS along with the enactment of the legislative
recommendations included as part of that budget are critical components of the strategy to
recommendations included as part of that budget are critical components of the strategy to
reduce the tax gap.
reduce the tax gap.

4
4
D020
Exh.7

The IRS has an extensive annual strategic planning process through which each of its operating
The IRS has an extensive annual strategic planning process through which each of its operating
divisions develop and estimate resource requirements needed to achieve functional priorities
divisions develop and estimate resource requirements needed to achieve functional priorities
and performance
based on budget allocations. Detailed action plans,
and performance targets based on budget allocations. Detailed action plans, which are part of
are part of
IRS’
planning process
the IRS' strategic planning process and are coordinated with this report, identify specific subare coordinated
report, identify
sub
measures
goals and measures as well as accountable parties. Progress toward these plans is monitored
parties. Progress
plans is monitored
internally
the
Department and the
internally and reported to the Treasury Department and the Office of Management and Budget
Management
Budget
(0MB)
the year.
(OMB) throughout the year.
Return
Return to Table of Contents

5
5
D021
Exh.7

DERTADII ThE GA
UNDERSTAND~NG THE TAX GAP
The Internal Revenue Code places three primary obligations on taxpayers: (1) to file timely
The Internal Revenue Code places three primary obligations on taxpayers: (1) to file timely
returns; (2) to make accurate reports on those returns; and (3) to pay the required tax
returns; (2) to make accurate reports on those returns; and (3) to pay the required tax voluntarily
and timely. Taxpayers are compliant when they meet these obligations. Noncompliance - and
and timely. Taxpayers are compliant when they meet these obligations. Noncompliance and
the tax gap results when taxpayers do not meet these obligations.
the tax gap - results when taxpayers do not meet these obligations.
—

—

The
gap is
aggregate amount of
The tax gap is defined as the aggregate amount of true tax liability imposed by law for a given
liability imposed by law
a given
tax year that is not paid voluntanly and timely. True tax liability for
tax year that is not paid voluntarily and timely. True tax liability for any given taxpayer means
given taxpayer means
the amount of tax
be determined
the amount of tax that would be determined for the tax year in question if all relevant aspects of
tax year question if all relevant aspects
law
the tax law were correctly applied to all of the relevant facts of that taxpayer's situation. For a
taxpayer’s situation,
variety of reasons, this amount often differs from the amount of tax that a taxpayer reports on a
not
return. The taxpayer might not understand the law, might make inadvertent mistakes, or might
misreport intentionally.
intentionally.
To be paid voluntarily, a tax liability must be paid without direct IRS intervention. Taxpayers
have the responsibility to determine and report their correct tax liability, and to make sure that
amount is paid (whether through withholding, estimated tax payments, payments with a filed
return, etc.). The IRS focuses its enforcement where it is needed most, but the overall rate of
tax compliance in the United States is as high as it is because the vast majority of taxpayers
meet their obligations with little or no involvement from the IRS. To be paid timely, a tax liability
must be paid in full on or before the date on which all payments for the given tax year were
legally due.
It is important to emphasize that IRS estimates of the tax gap are associated with the legal
sector of the economy only. Although tax is due on income from whatever source derived, legal
is
or illegal, the tax attributable to income earned from illegal activities is extremely difficult to
estimate. Moreover, the government’s interest in pursuing this type of noncompliance is,
government's
noncompliance
ultimately, to stop the illegal activity, not merely to tax it.
ultimately,
Although they are related, the tax gap is not synonymous with the “underground economy.”
is
"underground economy."
Definitions of the “underground economy” vary widely. However, most people characterize it in
the "underground economy"
However, most
it in
terms of the value of goods and services that elude official measurement. Furthermore, there
of the value of goods and services
elude official measurement. Furthermore, there
are some items in the “underground economy” that are not included in the tax gap (such as tax
are some
in the "underground economy"
not included in the tax gap (such as
due on illegal-source income), and there are contributors to the tax gap that no one would
due on
income), and
are
gap
one
include in the “underground economy” (such as the tax associated with overstated exemptions,
include in the "underground economy" (such as the tax associated with overstated exemptions,
adjustments, deductions, or credits, or with claiming the wrong filing status). The greatest area
adjustments, deductions, or credits, or with claiming the
status). The greatest area
of overlap between these two concepts is sometimes called the “cash economy,” in which
of overlap between
two
is sometimes
the "cash economy," in which
income (usually of a business nature) is received in cash, which helps to hide it from taxation.
income (usually of a business nature) is received in cash, which helps to hide it from taxation.
Equally important, the tax gap does not arise solely from tax evasion or cheating. It includes a
Equally important, the tax gap does not arise solely from tax evasion or cheating. It includes a
significant amount of noncompliance due to tax law complexity that results in errors of
significant amount of noncompliance due to tax law complexity that results in errors of
ignorance, confusion, and carelessness. This distinction is important even though, at this point,
ignorance, confusion, and carelessness. This distinction is important even though, at this point,
the IRS does not have sufficient data to distinguish clearly the amount of noncompliance that
the IRS does not have sufficient data to distinguish clearly the amount of noncompliance that
arises from willful, as opposed to unintentional, mistakes. Moreover, the line between
arises from willful, as opposed to unintentional, mistakes. Moreover, the line between
intentional and unintentional mistakes is often a grey one, particularly in areas such as basis
.intentional and unintentional mistakes is often a grey one, particularly in areas such as basis
reporting, where a taxpayer may know that his or her reporting is inaccurate but does not have
reporting, where a taxpayer may know that his or her reporting is inaccurate but does not have
ready access to accurate information. This is an area where additional research is needed to
ready access to accurate information. This is an area where additional research is needed to
improve understanding.
improve understanding.

6
6
D022
Exh.7

MEASURING THE TAX GAP
MEASURING THE TAX GAP
Historically, estimates of federal tax compliance were based on special studies, including the
Historically, estimates of federal tax compliance were based on special studies, including the
Taxpayer Compliance Measuremen Program (TCMP), which covered income and selfTaxpayer Compliance Measurementt Program (TCMP), which covered income and selfemployment taxes and groups of taxpayers, and consisted of line-by-line audits of random
employment taxes and groups of taxpayers, and consisted of line-by-line audits of random
samples of returns. These studies provided the IRS with information on compliance trends and
samples of returns. These studies provided the IRS with information on compliance trends and
allowed the IRS to update audit selection formulas regularly. However, this method of data
allowed the IRS to update audit selection formulas regularly. However, this method of data
gathering was extremely burdensome on the taxpayers whose returns were selected. As a
gathering was extremely burdensome on the taxpayers whose returns were selected. As a
result of concerns raised by taxpayers, Congress, and other stakeholders, the last TCMP audits
result of concerns raised by taxpayers, Congress, and other stakeholders, the last TCMP audits
were done in 1988.
were done in 1988.
The IRS conducted several much narrower compliance studies between 1988 and 2001, but
The IRS conducted several much narrower compliance studies between 1988 and 2001, but
nothing that would provide a comprehensive perspective on the overall tax gap. Until recently,
nothing that would provide a comprehensive perspective on the overall tax gap. Until recently,
tax
have been
all of these subsequent estimates of the tax gap have been rough projections that basically
projections that basically
assume no
among the major tax gap
assume no change in compliance rates among the major tax gap components even though the
even though
magnitude of these projections reflects growth in tax receipts in these major tax gap categories.
growth in
The NRP, which the IRS has used to estimate the most recent tax gap updates, arose out of a
most
a
desire to find a less intrusive means of measuring tax compliance. The IRS used a focused
statistical selection process that resulted in the selection of approximately 46,000 individual
approximately
income tax returns for Tax Year (TY) 2001 - somewhat fewer than previous compliance studies,
even though the population of individual tax returns had grown over time.
—

Like the compliance studies of the past, the NRP was designed to allow the IRS to meet certain
objectives - to estimate the overall extent of reporting compliance among individual income tax
audit-selection
filers and to update the audit-selection formulas. It also introduced several innovations
designed to reduce the burden imposed on taxpayers whose returns were selected for the study.
—

The first NRP innovation was to compile a comprehensive set of data to supplement what was
a comprehensive
reported on the selected returns. The sources of the “case building” data included third-party
of
"case building"
information returns from payers of income (e.g., Form W-2 and Form 1099) and prior-year
1099)
returns filed by taxpayers. Also, for the first time, the IRS added data on dependents obtained
by
IRS added data
from various government sources, as well as data obtained from public records (e.g., current
government
as data obtained
(e.g.,
and prior addresses, real estate holdings, business registrations, and involvement with
prior addresses,
and
corporations). Together, these data reduced the amount of information requested from
corporations). Together, these data reduced the amount of information requested from
taxpayers, with some of the selected taxpayers not requiring any contact from the IRS. In effect,
of the selected taxpayers not requiring any contact
IRS. In effect,
taxpayers, with
these data allowed the IRS to focus its efforts on return information that could not otherwise be
these data allowed the IRS to focus its efforts on return information that could not otherwise be
verified. This pioneering approach was so successful it is being expanded in regular operational
verified. This pioneering approach was so successful it is being expanded in regular operational
audit programs.
audit programs.
A second major NRP innovation was to introduce a “classification” process, whereby the
A second major NRP innovation was to introduce a "classification" process, whereby the
randomly selected returns and associated case-building data were first reviewed by experienced
randomly selected returns and associated case-building data were first reviewed by experienced
auditors (referred to as classifiers) who identified not only which issues needed to be examined,
auditors (referred to as classifiers) who identified not only which issues needed to be examined,
but also the best way to handle each return in the sample. In this way, each return was either:
but also the best way to handle each return in the sample. In this way, each return was either:
(1) accepted as filed, without contacting the taxpayer at all (although, sometimes, minor
(1) accepted as filed, without contacting the taxpayer at all (although, sometimes, minor
adjustments were noted for research purposes); (2) selected for correspondence audit of up to
adjustments were noted for research purposes); (2) selected for correspondence audit of up to
three focused issues; or (3) selected for an in-person audit where there were numerous items
three focused issues; or (3) selected for an in-person audit where there were numerous items
that needed to be verified. In addition, the classifiers identified compliance issues that the
that needed to be verified. In addition, the classifiers identified compliance issues that the
auditor was required to evaluate, although the examiners had the ability to expand the audit to
auditor was required to evaluate, although the examiners had the ability to expand the audit to
investigate other issues as warranted.
investigate other issues as warranted.

7
7
D023
Exh.7

Other NRP innovations included streamlining the collection of data, providing auditors with new
Other NRP innovations included streamlining the collection of data, providing auditors with new
tools to detect noncompliance, and involving stakeholders (including representatives of tax
tools to detect noncompliance, and involving stakeholders (including representatives of tax
professional associations) in the design
professional associations) in the design and implementation of the study. Clearly, the NRP
implementation of the study. Clearly,
NRP
much less burdensome on
approach was much less burdensome on taxpayers than the old TCMP audits, which examined
old
line item
return.
every line item on every return.

GAP
TAX GAP ESTIMATES
As noted above, for the 2001 tax year, the overall gross tax gap was estimated to be
be
approximately $345 billion, corresponding to a noncompliance rate of 16.3 percent. After
16.3 percent.
late payments,
accounting for enforcement efforts and late payments, the amount was reduced to $290 billion,
corresponding to a net noncompliance rate of 13.7 percent.
13.7
Noncompliance takes three forms:

•
•

not filing required returns on time (nonfiling);

•

one’s
not reporting one's full tax liability on a timely filed return (underreporting); and

•

not timely paying the full amount of tax reported on a timely return (underpayment).

The IRS has separate tax gap estimates for each of these three types of noncompliance.
Underreporting (in the form of unreported receipts and overstated expenses) constitutes over 82
percent of the gross tax gap, up slightly from earlier estimates. Underpayment constitutes
nonfihing
nearly 10 percent and nonfiling almost 8 percent of the gross tax gap.

Nonfiling
The nonfiling gap is defined as the amount of true tax liability that is not paid on time by
taxpayers who do not file a required return on time (or at all). It is reduced by amounts paid on
a
time, such as through withholding, estimated payments, and other credits. The nonfiler
population does not include legitimate nonfilers (Le., those who have no obligation to file).
(i.e.,

Underreporting
The underreporting gap is defined as the amount of tax liability not voluntarily reported by
underreporting
is
not
taxpayers who file required returns on time. For income taxes, the underreporting gap arises
on
income
from three errors: underreporting taxable income, overstating offsets to income or to tax, and
underreporting
income, overstating offsets income
and
net math errors. Taxable income includes such items as wages and salaries, rents and
net math
Taxable
includes such items as wages and
and
royalties, and net business income. Offsets to income include income exclusions, exemptions,
and net
income. Offsets income
income
exemptions,
statutory adjustments, and deductions. Offsets to tax are tax credits. Net math errors involve
adjustments, and deductions.
tax
involve
arithmetic mistakes or transcription errors made by taxpayers that are corrected at the time the
arithmetic mistakes or
errors made
that are
at
the
return is processed. In addition to developing an estimate of the aggregate underreporting gap,
is processed. In addition to developing an estimate of the aggregate underreporting gap,
it is possible to break aspects of this estimate down into measures of the underreporting gap
it is possible to break aspects of this estimate down into measures of the underreporting gap
attributable to specific line items on the tax return.
attributable to specific line items on the tax

8
8
D024
Exh.7

U nderayment
Underpayment
The underpayment gap is the portion of the total tax liability that taxpayers report on their timely
The underpayment gap is the portion of the total tax liability that taxpayers report on their timely
filed returns but do not pay on time. This arises primarily from insufficient remittances from
filed returns but do not pay on time. This arises primarily from insufficient remittances from
taxpayers themselves. However, it also includes employer under-deposits of withheld income
taxpayers themselves. However, it also includes employer under-deposits of withheld income
tax. In the case of withheld income tax, it is the responsibility of the employees to report the
tax. In the case of withheld income tax, it is the responsibility of the employees to report the
corresponding tax liability on timely filed returns, and it is the responsibility of their employers to
corresponding tax liability on timely filed returns, and it is the responsibility of their employers to
deposit those withholdings with the government on time.
deposit those with holdings with the government on time.

THE TAX GAP MAP
THE TAX GAP MAP
Figure 1
Figure 1 summarizes the key components of the tax gap and how they relate to one another. It
gap
It
“Tax
Map.”
has come to be known as the "Tax Gap Map." As the Tax Gap Map indicates, the IRS estimates
2001,
that, for 2001 , approximately $55 billion of the gross tax gap will eventually be paid through
enforcement or other late payments, leaving a net tax gap of about $290 billion. This projection
of what will eventually be paid is based on fiscal year tabulations of past enforcement revenue
and on prior studies of amounts that are paid late without enforcement efforts. Obviously, this
projection depends directly on actions that both the IRS and taxpayers will take in the future,
and the past is not likely to be a perfect predictor of that. Moreover, the IRS does not have good
data on the amounts that are paid late without enforcement efforts. Consequently, this estimate
of enforcement revenues and other late payments is necessarily subject to some uncertainty.
“good”
The Tax Gap Map distinguishes between "good" and "weak" estimates. For example, the
“weak”
corporation income tax estimates are acknowledged as weak because compliance behavior
mid-i 980s,
may have changed since the mid-1980s, which is the last time the IRS collected data on
corporate compliance. Moreover, the underreporting tax gap is estimated as the difference
between true tax liability and reported amounts. Determining true tax liability for large multimulti
national corporations can be difficult, given the complexity of the tax law, economic activities
undertaken by these taxpayers, and the difficulty of making any kind of statistically valid
assumptions based on a limited population of taxpayers. Weaknesses in general arise from two
a
causes: using old data and using data and methods that do not adequately reflect the full extent
of noncompliance.
Figure 2 organizes these estimates by type of tax and by type of noncompliance. As with tax
2 organizes
by type
by type noncompliance.
with tax
gap estimates for prior tax years, the overall tax gap is dominated by the underreporting of
gap
prior tax years, the overall tax gap is
by
underreporting of
individual income tax, which results in part from the dominant role that the individual income tax
individual income
which results in part
the dominant
that
individual
tax
plays in overall federal tax receipts.
plays in overall federal tax receipts.
The individual income tax accounted for about half of all tax receipts in 2001. Individual income
The individual income tax
for about half of all tax
in 2001. Individual income
tax underreporting, however, was approximately $197 billion, or about 57 percent of the overall
tax underreporting, however, was approximately $197 billion, or about 57 percent of the overall
tax gap. While a comparison with 1988 data would suggest a slight decrease in individual
tax gap. While a comparison with 1988 data would suggest a slight decrease in individual
income tax reporting compliance, it is important to remember that the data tell nothing about the
income tax reporting compliance, it is important to remember that the data tell nothing about the
years just before or just after TY 2001 and, as such, cannot show whether compliance trends
years just before or just after TY 2001 and, as such, cannot show whether compliance trends
today are improving or getting worse. Moreover, many aspects of the data and estimating
today are improving or getting worse. Moreover, many aspects of the data and estimating
methodologies used now are not comparable to earlier studies. In addition, broader changes in
methodologies used now are not comparable to earlier studies. In addition, broader changes in
the economy over the past 20 years have made comparisons between the data difficult.
the economy over the past 20 years have made comparisons between the data difficult.

9
9
D025
Exh.7

Figure 1
Figure 1

TAX GAP MAP for Tax Year 2001 (in $ Billions)
MAP
(in
Tax Paid Voluntllrfly & Timely ,

$1,167

TotalTax
llabUity

(Vc>luntiuy Compl"".::.

Rate, VCR .. n 1%)

$2,112

5I]-

...IT.. GIIp
(t.... kat CoIIIctIO)

- ,.,....

GIOIS Tu Gap; "'"
( N -........ Rftol NCR -,.",;,)

$210

S55 "

I

I

I

Nonfiling t
$t1

I

hIHIIDI
......... T..

~

*1iJ

""*- Ta¥ t ,

as

I

_r_

--

~

...

#;

'"

I

Ta>t:
#;

em.

$5
t.atge

Iue'11 ..

Tax

.11

1#

r.
$4

I

.. ..
$1

C>Hita

•n

IEatlm_ln &ItJ So.....
Have Seen UpMlINI
HB".,
Baaedon DeU_ TY01
Sued 011 De&kdYY1
WRP Aewits

s-.

rax
It

l~j

I
I ..,...,.,...

~.,.

SUA

COrpcnIon
lntonlitTa

su

[ 'x1Ii,..
T.

Act Arn
c:J "-~s

....

c:J Reasmatl& Estin""''''''
czi easa Ebrae
c:JWe.ker E5llmale •
EZ Wake Etnae
• IRS d C<:<\1inue 10 ooIlec!!ale psymoolS
onue to oc’bect e pityrneto
or TYOI or yearo
Th atogory
!or TY01 for Y""'" to """"'. This ta1egory
inc1u<ies tx pod tate by laXpa)'efS wbxt
kde \ax plli4lafO<
toxpyoo ~
IRS enfaceffillOl! cb*t. ftr
S nbcenw - . For o:>mpMisoo.
$14.39 Ytz WJiS calle~ solely \!'rougiI
t24.3b fA !aX wat ood ao4oty bwc
OO1Ioroemenl a fY2001 •
in FY2tto.

E--.
TIaI
R.1

Ill&dM

1-.
11.1

rupdsled usn g C’US aaan
uw’ Cansus!all !alion

r

a
tnRewaiat Sa’4ce

II

bclu

Certainty of the EstImates
Estimates

$f•

Unemployment
Ta

~
~

tax

~

j

faa

AdI-.

Exclse

UI

~

COfp<)lafiIllll
(O¥er$1tMJ

US

51

~III
f_

FICA

~

(!.Inder $tOM)

-

~nl

I

Small

~

Income Tax

1215

~

J

"

I

""denwp0t6,.

esomates

aat

Fata tC7

Figure 2

Tax Year 2001 Gross Tax Gap by Type of Tax and Type of Noncompliance (in $ billions)

la
Ir

'.f<
4

Type of Tax
MTIIX

.Nonhh#
NDiTIIIIng

.O/IP
Individual Income Tax
Individual
Corporation Income
Corporation Income
Tax
Employment Tax
Employment Tax
Estate&GiftTax
Estate & Gift Tax

25
25

I

TOTAL
Underrepo,ting Undeipaymeni
Un!/IIt18pt1III
PtItr:MI
Percent
AmDtI7t
~
.
DitIHJuIItJn
ib#i
197
197
245
71 .1%
23.4
23.4
245
71.1%

Type of . . '··
Type"'Noncompliance

~

~

#

30
30

2.3
2.3

32
32

9.3%
9.3%

#

54
54

5.0
5.0

59
59

2
2

4
4

2,1
2.1

8
8

17.0%
17.0%
2.4%
2.4%

Excise Tax
Excise Tax
#
0.5
1
0.1%
#
0.5
1
0.1%
TOTAL
TOTAL
27
345
285
27
285
33.3
33.3
345
Percent Distribution
7.8%
Percent Distribution
82,5%
9.7%
100.0%
82.5%
7.8%
9.7%
100.0%
* Since the underpayment gap figures are generally actual amounts rather than estimates, they are
Since the underpayment gap figures are generally actual amounts rather than estimates, they are
presented here to the closest $0.1 billion.
presented here to the closest $0.1 billion.
# No estimates are available for these components.
No estimates are available for these components.
Amounts may not add to totals due to rounding.. See Figure 11 regarding the reliability of estimates.
Amounts may not add to totals due to rounding See Figure regarding the reliability of estimates.

*

10
10
D026
Exh.7