Academic journal article Entrepreneurial Executive

Fixing the Tax Gap: Electronic Means for the Internal Revenue Service to Embrace

Academic journal article Entrepreneurial Executive

Fixing the Tax Gap: Electronic Means for the Internal Revenue Service to Embrace

Article excerpt


The Internal Revenue Service ("IRS") is the government agency responsible for the collection of taxes and enforcement of the tax laws. Abiding by its duty, the IRS today "collects more than $2 trillion in tax revenue [each year], and deals with more Americans than any other institution, public or private" (Rossotti, 2000). Considering its annual budget of $11 billion, it is admirable that the IRS manages to collect revenue approximately a hundred times more than its cost (Rossotti, 2000). Nonetheless, due to its position and place in our society, the IRS continues to be the subject of intense scrutiny. In evaluating the IRS, the government found that public expected the IRS "to do a far better job in serving the public" (Rossotti, 2000). Subsequently, the IRS worked on improving itself to meet these expectations.

Still, the IRS primarily focuses on its mission statement: collecting the proper amount of tax (Rossotti, 2000). Even with the IRS's enforcement of the tax laws, some taxpayers fail to pay their fair share of the taxes, contributing to the tax gap. This tax gap refers to the yearly difference between the taxes due and the amount actually paid, which is estimated to be approximately $345 billion dollars (U.S. Department of the Treasury [Treasury], 2007). While people fail to pay their taxes for various reasons, problems arise when a number of these people purposely cheat and do not pay their fair share. In particular, the largest portion of the tax gap is comprised of small businesses and self-employed taxpayers (Treasury, 2007). Incidentally, these taxpayers go unpunished because their incomes are not be subject to the information reporting requirements, come in the form of cash not easily detected, or both (Treasury, 2007).

To address these issues, Congress and the IRS instituted a number of improvements to reduce the tax gap. These improvements included: simplifying the tax code, increasing information reporting requirements, employing harsher penalties, and using other methods. Particularly, the information reporting requirements have been attributed to one of the main factors for the United States' high tax compliance rate (U.S. Government Accountability Office [GAO], 2007).

The problem with enforcing the tax laws is the asymmetric information advantage held by the taxpayers (Lederman, 2010). Typically, the taxpayers know the facts of their tax situations or at least have ready access to that information. In contrast, the government must play catch-up and obtain that information from either the taxpayer or other third parties. These information reporting requirements provide the IRS with the necessary information to evaluate whether taxpayers are paying their taxes. Recently, Congress enacted new legislation to increase the information reporting requirement for electronic payments, Internal Revenue Code section 6050W ("6050W"), Returns Relating to Payments Made in Settlement of Payment Card and Third Party Network Transactions.

Since January 1, 2011, 6050W imposes new information reporting requirements on financial institutions and businesses by requiring them to report to the IRS the net dollar amount paid through credit cards, debit cards, and stored-value cards (collectively referred to as "electronic card payments") in a calendar year. This requirement intends to crack down on the businesses that fail to report accurately their gross income (Treasury, 2006). Thus, it should reduce the tax gap because the new requirements allow the IRS to compare aggregate net payments through the electronic card payments reported by the businesses with the amounts reported by financial institutions. Additionally, the legislation may strengthen the public's image in the IRS's ability to enforce the tax laws, thereby increasing the perception that the tax system is fair and that people comply with their taxes (Johnson, 2003).

This Article evaluates the effect of 6050W and its likely influence on the underreporting aspect of the tax gap. …

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