New IRS analysis shows only half of Schedule C income is reported

New data based on analysis of the Internal Revenue Service's (IRS) National Research Program Individual Reporting Compliance Study of 2001, on which the agency's estimate of the "Tax Gap" is based, show that only one-half of Schedule C income and only 88 percent of capital gains are reported, David Cay Johnston, writing for Tax Notes says. Johnston obtained the data ahead of IRS publication.

The new data compares "Reported" adjusted gross income (AGI), with "True" AGI levels. The researchers arrived at "true" AGI, according to Johnston, by auditing "specific items (as opposed to the old TCMP or audit from hell audits which made you prove every line. They then applied these findings on differences between reported and true income using standard statistical methodologies."

Johnston says that in the case of capital gains reporting, where the IRS accepts the taxpayer's estimate of basis without requiring independent verification, the number may not reflect reality.

The research suggests that income categories and tax brackets for individuals earning more than $40,000, who underreport income and capital gains, are distorted. Many of these individuals belong in higher tax brackets and would owe more taxes based on higher rates.

The data also shows that individuals who report negative incomes are not audited, because the IRS assumes they do not owe taxes, Johnston says, but that may not be the case.

The IRS compiled statistics from 46,000 returns for 2001.

Mr. Johnston forwarded the Definitions and Methodology statements which accompany the report to AccountingWEB. The Definitions statement provides a general overview of the goals and conclusions of the new research.

In order to demonstrate the significance of choosing a reference point for compliance analysis, this report provides net misreporting percentages and tax gap estimates for selected types of income, offsets to income, and credits by levels of both self-reported AGI and true AGI. Comparing compliance rates across levels of adjusted gross income (AGI) leads to different conclusions depending on whether taxpayers are grouped by the level of AGI that they reported versus the level of AGI that they should have reported. Taxpayers who underreport income self-report lower levels of AGI than their true AGI. Therefore, estimates of noncompliance across self-reported levels of AGI may be biased upwards for some AGI levels and downwards for others.

 

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