What is the tax gap, and how does it impact IRS actions?

The Internal Revenue Service (IRS) helps collect taxes under federal policy. Both individuals and businesses file annual income tax returns. They may also make estimated payments to the IRS to cover their tax obligations.

Despite business owners and individuals recognizing that they must pay income taxes, there are some parties who try to avoid their income tax obligations. Attempts at tax evasion and other forms of tax fraud create a significant tax gap. That tax gap is part of what incentivizes the IRS to aggressively pursue those who have failed to pay what they owe in taxes.

Taxpayers facing income tax controversies may need to understand the tax gap if they hope to respond to the controversy effectively. Contact William G. Yarborough today to speak with an experienced Greenville tax evasion lawyer.

What is the tax gap? 

The IRS can roughly estimate the amount of income tax that individuals and businesses should pay. Looking at all wages and domestic business revenue can provide a rough estimate of what the IRS should receive in income tax payments.

The tax gap is the difference between the amount of tax revenue the IRS should collect and the actual amount paid promptly. According to the IRS and organizations that review tax policy, the tax gap typically amounts to between 13% and 18% of the estimated tax revenue for the federal government each year. In 2022, for example, the tax gap was a shocking $696 billion.

How the tax gap influences IRS action

A difference of hundreds of billions in tax revenue can have a major impact on government budgets and the federal deficit. As such, the IRS may try to hold businesses and individuals accountable if they underreport their income, underpay their taxes, or otherwise attempt to illegally evade income tax obligations.

The IRS scrutinizes income tax returns by comparing them with documents provided by employers and financial institutions. Discrepancies can trigger audit requests and other enforcement actions. Particularly in cases where tax issues appear to be the result of intentional actions, the IRS may aggressively pursue those who underpay their income taxes.

Not only do taxpayers risk audits and face an obligation to pay the balance due on their income taxes, but they may also be at risk of interest and penalties. In more serious cases, the IRS may even refer cases out to federal prosecutors.

Explaining Your Income

The fact that the IRS expects to collect a certain amount in taxes does not mean they are entitled to collect it. There are legitimate reasons why you might have paid less than the IRS expects:

• Business deductions. Your business could have had much higher deductions this year than before. Maybe you increased salaries or pay for independent contractors, or your marketing expenses surged. Consequently, taxable income should go down if you claim these deductions. You can explain the higher deductions in your audit.
• Tax credits. You might have claimed legitimate tax credits that were unavailable in previous years. These credits will lower taxable income, resulting in less tax liability.

These are two simple reasons why your income might have stayed the same, but your tax liability decreased. Remember to have supporting documentation to back up an increase in business expenses, and reach out to an attorney as you prepare for an audit.

Tax Evasion Meaning & Defenses

Tax evasion is a serious offense. Internal Revenue Code § 7201 states that it is a felony to willfully attempt to evade or defeat a tax. IRS tax evasion penalties include a maximum $250,000 fine for individuals and up to 5 years in prison, or both.

To obtain a conviction, the government will need to show you “willfully” took some affirmative act to either avoid the assessment of a tax or to avoid paying it. Because of the tax gap, the government is certainly scrutinizing returns and could pull you into an audit if it suspects you have underreported income.

Here are some common defenses to a tax evasion charge:

• You do not owe a tax. There isn’t a crime if you do not owe the federal government taxes. You might have paid everything you owed. Here is where proving larger business expenses could prove useful.
• You did not willfully try to evade taxes. It is not enough to show that you failed to report income or made some mistake when claiming deductions. After all, any mistake could be unintentional. The government needs to prove a willful attempt to evade taxes.
• There is insufficient evidence of a crime. There might not be enough evidence of the crime to support a conviction. As in other criminal cases, the IRS needs proof beyond a reasonable doubt to obtain a conviction.
• Reliance on incorrect expert advice. Your CPA could have recommended a deduction that you were not entitled to take. Relying on expert advice goes toward determining whether a defendant had criminal intent.
• Violation of constitutional rights. The IRS could have searched your belongings without a warrant or committed some other violation of your rights. We could request dismissal of the charges.

Contact an Experienced Tax Evasion Lawyer in Greenville, SC

Receiving a notice from the IRS can ruin anyone’s day. It is important to respond quickly and in a deliberate manner to protect yourself. Contact William G. Yarborough, Attorney at Law, to discuss your case.

Those facing tax controversies may need help dealing with the IRS and resolving their issues. Learning about the tax gap and how common tax evasion is can help people understand why the IRS typically responds so assertively when the organization suspects tax evasion or fraud. Contact us today to schedule a private consultation with our office.