The Tax Gap. The IRS estimated the federal net tax gap for 2006 was $385 billion, which took into account tax enforcement and late payments. More recently, it was estimated that $2 trillion in income is unreported annually, increasing the IRS tax gap to $406 billion,  From a percentage standpoint, the IRS tax gap is 18 percent of tax collected.

These studies do not factor in what has been lost by state and local governments. In 2006, California and Hawaii concluded, based on the IRS calculated tax gap, that their state tax gaps were estimated at $6.5 billion and $1 billion respectively in lost annual revenue due to unpaid taxes.

MetroRev tax professionals, however, believe that tax compliance at the state and local levels is significantly less on a percentage basis than at the federal level. The federal government has the advantage that every individual need a social security number and every company has to have an employer identification number simply to operate in the United States. Their existence is prima facie evidence there is a taxable entity doing business in the United States. The states have no such advantage.

Only the most extreme non-compliant taxpayers choose not to file at all with the IRS. But every business and many individuals make a choice as to which states and localities in which they  will file. Many corporations take the position that it is too difficult to comply in every state or locality and for every tax type so they wait until identified to comply.  And they push back on states with complex nexus arguments that do not exist at the federal level.

Existing state and local compliance programs, with ever declining tax compliance budgets, focus extensively on businesses and individuals already in their system. The strategy is to check the mathematical accuracy of filed returns and validate reported income against wage data provided by employers and third-party payroll processors. These efforts, while important, target those taxpayers and constituents who are filing in their respected communities. Very rarely is a cost benefit analysis done on the flood of tax notices and it leaves the average tax payer who wants to comply with a sense that the system is stacked against them.  This makes you question whether these efforts actually encourage taxpayers not to comply.

But financially, it is better for a municipality to identify one non-filer who leads to incremental tax revenue versus targeting numerous generally compliant taxpayers whose returns have minor mathematical errors, etc. States should have robust efforts to identify companies and individuals doing business in their states without license as a starting point.  For example, MetroRev has identified many such non-compliant taxpayers by simply looking at who is doing business with the state under contract. Imagine a corporation doing business with your state but they do not file in your locale. It demonstrates the depth of the problem.

The states generally allow the IRS to identify and handle significant non- compliant taxpayers, as it costs little to piggy back off the IRS. There are a number of problems with this approach. One, IRS audit frequency is dwindling. Two, IRS auditors do not focus on states tax returns. And three, the IRS collection process in many cases renders the company bankrupt leaving states financially on the outside looking in. States need to get ahead of the IRS with tax detection efforts.

One of the MetroRev team’s strength’s is using the information and data available to identify taxpayers who are operating in a certain jurisdiction without proper licensing and tax filings.  They are prepared for the nexus arguments that may be presented and know what questions to ask taxpayers in order to get a complete picture of activity in the state or locality in question.  Each non-filing taxpayer added to a state or local government’s tax records creates the opportunity for new tax revenue for years to come.