The wealthiest Americans are failing to report more than a fifth of their taxable income to the Internal Revenue Service, according to new research, using sophisticated forms of tax evasion to avoid paying Uncle Sam.
Unreported income for the top 0.1% is 1.8 times higher than previously estimated, the recent paper from economists and IRS analysts found, while it is 1.3 times higher than originally calculated for the top 1%.
"The tax gap is substantially larger than the IRS estimate," Daniel Reck, a professor at the London School of Economics and one of the authors of the report, told Yahoo Money. "For the top 0.1% of the distribution, our estimates suggest that it's almost doubling the tax gap."
These Americans employ two types of advanced tax evasion strategies — concealed offshore wealth and pass-through businesses — that generate these big tax gaps among the wealthiest.
Offshore tax evasion goes almost undetected in random audits by the IRS. Around 90% of the IRS audits the researchers examined didn't find any unreported foreign assets even though the audited taxpayers owned these types of assets.
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Income from pass-through businesses, which is not subject to the corporate income tax but instead “flows through" to the owners’ tax returns, is also underreported, according to Reck.
"Pass-through business income accounts for much of the increase in measured income inequality in the last three [to] four decades," he said. "It's extremely rare that pass-through business evasion from the business itself underreporting income is ever found in the random audit data."
'The IRS can absolutely do something about this'
The IRS has experienced years of budget cuts and staff reduction with the agency losing over 21,000 employees since 2010. To close the tax gap, the IRS needs to invest in more sophisticated examination techniques and hire more experienced examiners, according to Reck.
"With enough resources and the right focus, the IRS can absolutely do something about this," he said. "What they would need to do is not just increase the overall audit rate at the top of the income distribution, but to invest significantly in more comprehensive audits conducted by more experienced examiners."
The IRS failed to collect over $38.5 billion from individuals making $200,000 or more as of May 2019, the Treasury Inspector General for Tax Administration said in a report recently. Taxpayers who make above $1.5 million paid only 39% on average of what they owe to the IRS, the report found.
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The analysis comes as the Biden administration and Democratic lawmakers are floating several different tax measures related to higher taxes on wealthy Americans and corporations.
President Joe Biden's campaigned on raising the corporate tax rate to 28%; requiring a true minimum tax of 21% on all foreign earnings on U.S. companies; increasing the top individual income tax rate to 39.6% (the current maximum is 37%), and requiring those who make more than $1 million annually to pay the same rate on investment income as they do on their wages. He is expected to soon release an infrastructure bill including the tax hikes.
Denitsa is a writer for Yahoo Finance and Cashay, a new personal finance website. Follow her on Twitter @denitsa_tsekova
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