Americans owe $688 billion in unpaid taxes. That makes audits of super-rich more 'urgent,' IRS says.

By Andrew Keshner

The IRS is ramping up audits and enforcement against rich households and corporations after a funding boost.

America's unpaid tax bill keeps growing and is now surpassing half a trillion dollars each year, according to new estimates from the Internal Revenue Service.

Individual taxpayers, businesses and corporations collectively owed $688 billion in unpaid taxes for the returns due last year, up from $601 billion the year before that, the federal tax collector said in Thursday projections about the gap between taxes owed and taxes actually paid.

The ballooning unpaid bill in tax years 2021 and 2020 is also up from an average $550 billion each year from tax year 2017 to tax year 2019, the agency said in its projections.

Thursday's numbers add new fuel to ongoing debates about unpaid taxes, who's not paying taxes, and how the IRS can recoup the money.

The IRS is ramping up audits and enforcement against rich households and corporations after a major funding boost through the Inflation Reduction Act, enacted last summer.

"This increase in the tax gap underscores the importance of increased IRS compliance efforts on key areas," IRS Commissioner Danny Werfel said in a statement.

The tax gap is not a measure of illegal activity. It doesn't capture criminal tax evasion. The gap is an estimate of the difference between the amount the agency actually collects in taxes and the amount the IRS could collect if taxpayers fully reported all of their taxable income and the agency fully taxed it.

After enforcement and late payments, the IRS estimates it will rake back $63 billion of the $688 billion unpaid bill for 2021.

Last month, the IRS said it was focusing on approximately 1,600 millionaires who had tax debts of at least a quarter of a million dollars. The agency said it was also turning its sights on hedge funds, large law firms and partnerships.

On Wednesday, Microsoft (MSFT) put out a Securities and Exchange Commission filing about a notice it received from the IRS. The tax agency said Microsoft allegedly owed $28.9 billion in back taxes, plus interest and fines for tax years 2004 through 2013. Microsoft said it will "vigorously contest" the IRS claim.

Measuring the tax gap is an inexact science and there's a range of numbers. The Biden administration's Treasury Department has previously estimated it's around $600 billion each year, pinning the blame for more than a quarter of the missing tax dollars on the top 1% of households.

Former IRS Commissioner Charles Rettig once said the gap could be up to $1 trillion each year, considering the missing money that cryptocurrency holders should be reporting.

The latest numbers are based on models and past data that pre-date the wider spread of cryptocurrency into the economy so it's difficult to measure the full impact of non-compliance from crypto holders, IRS officials noted.

Thursday's large estimated increases in the tax gap are explained by the growing pool of tax money that's been fueled by an economy generating more income in recent years, said Barry Johnson, deputy chief data and analytics officer.

The major driver of unpaid tax bills isn't that taxpayers aren't filing their returns, it's the under-reporting of taxable income. Despite the projected increase in the tax gap, the voluntary compliance rate -- which measures the amount of taxes paid on time against the full tax tab -- has remained around 85% for years, IRS estimates show.

The IRS can only tax the income that it knows about, the agency says. Wages, salary and tips are subject to withholdings and plenty of documentation that the IRS can easily see. This source of income accounted for 1% of the estimated tax gap in 2021, the IRS said.

But money generated through income sources with little or no documentation, such as income from certain business partnerships and LLCs, accounted for nearly one-quarter of the tax gap in the 2021 tax year, the IRS noted.

Richer taxpayers tend to be the ones reporting income through parts of the tax code will slim or little documentation, Treasury Department officials have said.

Under-reported and under-paid corporate income taxes accounted for less than 10% of the projected tax gap in 2021. Business income and non-business income connected to individual income tax returns accounted for more than 40% of the gap.

The IRS announced plans last month to hire 3,700 employees to focus on large corporations and partnerships. The latest tax gap projections were a reminder of the need to step up enforcement, Werfel said. "These steps are urgent in many ways, including adding more fairness to the tax system, protecting those who pay their taxes and working to combat the tax gap."

-Andrew Keshner

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10-14-23 1159ET

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