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IRS notes ‘significant noncompliance’

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WASHINGTON — The Internal Revenue Service said Tuesday that taxpayers shortchanged the government by $345 billion in 2001, with the biggest problem among people failing to report income from business ventures.

Sole proprietors, independent contractors, self-employed workers and others who report business income on their individual tax returns accounted for $109 billion in missing taxes. They failed to report 43 percent of the business income.

Within that category, taxpayers with farm income did not pay $6 billion in taxes, failing to report 72 percent of that income. Non-farm proprietors did not pay $68 billion in taxes, failing to report 57 percent of that income.

"That is a very, very significant noncompliance rate," IRS Commissioner Mark Everson told reporters. "We do not have specific conclusions as to how much of this is willful or confusion."

The measure of the tax gap, the difference between taxes owed and taxes paid, refines a figure released last year that estimated taxpayers failed to pay between $312 billion and $353 billion in 2001.

The determination that taxpayers did not pay $345 billion in taxes means more than 16 percent of the money owed that year went uncollected. The IRS said it can recoup about $55 billion through late payments and collection activities, leaving a net tax gap of $290 billion.

The IRS measured the tax gap after a three-year study of tax returns filed for 2001 by 46,000 individuals and families. The tax agency undertook the research project to get a better understanding of taxpayer compliance with the law. The tax gap figure combines findings from individual audits with previous estimates of unpaid corporate, payroll and unemployment taxes.

"It could very well be higher, in that we have not updated the corporate tax piece," Everson said.

In the current phase of the research project, the IRS intends to audit 5,000 randomly selected S-corporations, enterprises that do not pay corporate income tax but instead pass income and taxes through the business to individual shareholders. The audits include those shareholders.

The study of individuals showed taxpayers much more likely to report income when an employer, bank or other institution separately submitted the information to the IRS. Individuals reported 99 percent of their wage, salary and tip income, for example.

But taxpayers omitted 64 percent of money categorized as other income, which includes things like prizes, awards and gambling winnings.

About $27 billion in unpaid taxes were attributed to roughly 13.6 million people who failed to file a tax return.

The IRS said the information will help it better focus its audits, and that tax collectors can be expected to pay more attention to areas that account for a significant source of income and a high rate of underreporting.

Everson said the complexity of tax laws means people have a difficult time determining what they owe, and simplifying tax laws would help reduce the amount of unpaid taxes.

A presidentially appointed panel recommended ideas for simplifying the nation's tax laws last fall. The Treasury Department plans to analyze the recommendations and report their findings to President Bush. Secretary John Snow has not set a timetable for advancing a tax overhaul.

Bush also laid out ideas for reducing the tax gap in the 2007 budget recently submitted to Congress.

Everson highlighted two ideas. One would require more reporting to the IRS of business payments made through credit cards and debit cards. Another would require more reporting and tax withholding of some government payments to vendors.

Everson appears Wednesday before the Senate Budget Committee to discuss the tax gap.

On the Net: Internal Revenue Service: www.irs.gov