President Joe Biden delivers remarks at the Ford Rouge Electric Vehicle Center in Dearborn, Michigan on May 18, 2021.
Nicholas Kamm | AFP | Getty Images
President Joe Biden calls for a crackdown on wealthy taxpayers who avoid tax by hiding much of their income from the IRS.
Tax compliance is one of the many ways Biden seeks to increase tax revenues for households that earn more than $ 400,000 a year to fund America’s plan for families. The legislation would increase spending on initiatives such as expanded education, childcare and paid holidays.
Under-reported income, largely among the wealthy, is the biggest contributor to the so-called “tax gap,” according to a Treasury Department report released Thursday.
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This difference is the difference between the tax paid and the tax due. It was estimated at $ 584 billion in 2019 and $ 7 trillion over the next decade, according to the Treasury.
About 80% of the tax gap comes from underreported income – much of which is due to “opaque sources of income that flow disproportionately to high incomes,” the Treasury said.
It identifies certain non-work-related income – from businesses like partnerships and sole proprietorships as well as rental income, for example. In these categories, individuals under-report about 55% of their income, according to the ministry.
This means that more than half of their income, on average, is not taxed.
“We don’t know how intentional or unintentional this is. But it’s high,” said Janet Holtzblatt, senior researcher at the Urban-Brookings Tax Policy Center.
This share is much higher than with other sources of income. Employees who earn a salary or wages mistakenly report about 1% of their income, for example.
The difference comes down to reporting by third parties, tax experts said.
Employers deposit an employee’s employment income each year on a W-2, which is distributed to the taxpayer and to the IRS. In this case, the employer acts as a third party verification. (Employees also have tax withheld from their paychecks during the year.)
The same concept is true for investment income. Financial institutions would report a taxpayer’s dividend income on a 1099-DIV tax form, for example.
But there is little to no third-party verification with certain business entities, according to tax experts.
Sole proprietors, for example, self-report their income and expenses to the IRS. In a partnership, any income that is underreported at the company level spills over into the individual income of the business partners, Holtzblatt said. (The IRS has, however, devoted more resources to auditing partnerships in recent years, she added.)
“A self-reporting system has its own inherent flaws,” said Leon LaBrecque, chartered accountant and financial planner at Sequoia Financial Group. “And there is no easy way around this.”
This doesn’t just apply to high earners, however, LaBrecque said. The same concept applies to a restaurant worker or bartender who does not report cash tips as income, for example.
But the IRS can generate more tax revenue by cracking down on the wealthy who underreport their income, he added.
Biden’s tax plan calls for stronger third-party reporting to the IRS, which the administration says is one of the most effective ways to improve tax compliance.
It is also seeking $ 80 billion in IRS funding over the next decade, in part to hire agents capable of conducting complex tax audits on rich and complex business structures. The plan would overhaul the IRS’s technological systems and increase penalties for tax evaders.
The Treasury estimates these changes would raise $ 700 billion over the next decade.