Recent GAO Report on the “Tax Gap” Provides Interesting Insight

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The tax gap is the difference between income taxes that should be reported according to the Internal Revenue Code, and the actual income taxes reported. The GAO estimates that the tax gap is around $345 billion.

A September 2008 GAO report on the tax gap has revealed some interesting issues related to the tax gap, and in particular, the reporting of rental real estate by individual taxpayers.

The $345 billion tax gap consists of three types of non-compliance:

– Non-filing ($27 billion)
– Underpayment ($33 billion)
– Underreporting ($285 billion)

Despite the general perception that big businesses are escaping taxes, an analysis of the the $285 billion of underreporting shows that it consists of:

– Individual income tax ($197 billion)
– Employment tax ($54 billion)
– Corporate income tax ($30 billion)
– Estate and excise taxes ($4 billion)

One of the conclusions of the GAO report is that the rules related to rental real estate, which represent a large portion of the individual underreporting segment, are just too complex. The GAO report included the following recommendations for the IRS:

1. Require that mortgage interest statements (Form 1098) include the property address.

2. Require individuals to separately list the basis of land and structure.

3. Require taxpayers to show the exact address of RRE on Schedule E (PDF).

4. Expand the Schedule E instructions to include:
a. When 1099-MISC reporting is required.
b. Resources to help taxpayers separate the basis of land and structure.
c. Information on recordkeeping requirements and the potential penalties for unsubstantiated deductions.

5. Determine whether it would be cost-effective for the IRS to send information to some or all individuals reporting RRE activity.

6. Expand outreach to preparers, tax return preparation software developers and industry groups to inform them of common RRE misreporting problems.

An analysis of the GAO report from the American Institute of CPA’s can be found here.

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