The IRS has released a new tax gap projection, indicating that the projected gross tax gap increased to $688 billion for tax year 2021, a significant jump from previous estimates.

The IRS reported that this is the first year in which it has provided tax gap projections for single tax years, rather than multi-year periods, as well as the beginning of tax gap updates on an annual basis. The latest estimate indicates an increase of more than $192 billion from the prior estimates for tax years 2014-2016 and a rise of $138 billion from the revised projections for tax years 2017-2019. 

"This increase in the tax gap underscores the importance of increased IRS compliance efforts on key areas," said IRS Commissioner Daniel Werfel. "With the help of Inflation Reduction Act funding, we are adding focus and resources to areas of compliance concern, including high-income and high-wealth individuals, partnerships and corporations. 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."

The IRS explained that the $688 billion gross tax gap represents "the difference between estimated 'true' tax liability for a given period and the amount of tax that is paid on time." It noted that the tax gap estimates and projections cannot fully account for all types of noncompliance. In addition, the projections ... are based largely upon the compliance behavior estimated from the most recent set of completed audits (from tax years 2014-2016). That estimated compliance behavior is projected forward to taxpayers in tax years 2020 and 2021."

The agency added that payments and Ienforcement efforts "are projected to generate an additional $63 billion on tax year 2021 returns, resulting in a projected net tax gap of $625 billion. Between tax years 2014-2016 and tax year 2021, the estimated tax liability increased by about 38 percent, roughly the same increase as the gross and net tax gaps. Much of these increases in tax liability and the tax gap can be attributed to economic growth."

The tax year 2020 and 2021 tax gap projections amount to roughly 85 percent of taxes paid voluntarily and on time, which is in line with recent levels, according to the IRS. "After IRS compliance efforts are factored in, the projected share of taxes eventually paid is 86.3 percent for tax year 2021, down slightly from the 87 percent for tax years 2014-2016." the IRS reported. "This drop in compliance does not factor in any changes in compliance behavior; instead, it is due to changes in the types of income and how that income is reported to the IRS."

The IRS noted that the gross tax gap includes three components:

• Nonfiling, meaning tax not paid on time by those who do not file on time: $77 billion in tax year 2021, up from $41 billion in tax years 2017-2019.

• Underreporting, which reflects tax understated on timely filed returns: $542 billion in tax year 2021, up from $445 billion in tax years 2017-2019.

• Underpayment, meaning  tax that was reported on time, but not paid on time: $68 billion in tax year 2021, up from $64 billion in tax years 2017-2019.

The IRS said that it intends to use funding from the Inflation Reduction Act to take a variety of steps to help improve voluntary compliance "by improving taxpayer services and offering new technology tools to work in concert with additional compliance work." In 2022, the latest year for which data is available, the agency collected more than $4.9 trillion in taxes, penalties, interest and user fees.

The IRS reported that third-party reporting of income significantly raises voluntary compliance with the tax laws. And the rate of voluntary compliance rises even more when income is also subject to withholding. It added, "The voluntary compliance rate of the U.S. tax system is vitally important for the nation. A one-percentage-point increase in voluntary compliance would bring in about $46 billion in additional tax receipts."