The new Tax Gap Map: not much has changed

On Thursday, the IRS released new federal tax gap estimates, including a new Tax Gap Map (on page 3 here). It’s been a while; the previous estimates were calculated in December 2011, for tax year 2006. The principal new addition to the Tax Gap Map is that the estimate of the net tax gap (the gross tax gap reduced by enforced and late payments) is now broken down by type of tax. Also, the new release is different in that it doesn’t focus on a single tax year but rather averages for tax years 2008-2010.

The new estimates show an estimated gross tax gap of $458 billion—compared to $450 billion for 2006—and an overall “voluntary compliance rate” of 81.7% of tax liability, compared to 83.1% for 2006. At first glance, these figures suggest that voluntary compliance is declining and that the tax gap is growing. However, the IRS explains on page 2 of its report that these differences “are driven by improvements in the accuracy and comprehensiveness of the estimates through updates in methods and the inclusion of new tax gap components.” In particular, the IRS explained that “[h]ad the improvements not been made, the TY 2008–2010 tax gap estimates would have been slightly lower than the previous TY 2006 estimates.” (Emphasis added.) And although only about half of the decline from the estimated 83.1% rate to the new estimate of 81.7% is due to changes in methodology, the IRS explains the many factors that may change over time, the remaining 0.7% percentage point difference can’t be relied upon to indicate a real decline in voluntary compliance. Jim Alm & Jay Soled have argued that the tax gap may decline over time, for a variety of reasons, including the increasing use of electronic-payment mechanisms, which result in much more visible transactions than cash does, although they acknowledge that there are countervailing trends, as well, including the underfunding gap the IRS has been struggling with.

The single biggest contributor to the federal tax gap, in terms of dollars, according to the IRS’s estimates, remains underreporting by individuals of business income, at $125 billion (very similar to the $122 billion figure for 2006). Think cash transactions. It remains clear that third-party information reporting makes a huge difference. Page 5 of the IRS release shows that in a nice bar graph. While the IRS estimated that wages and salaries, which are subject to both information reporting and withholding, experienced the lowest net misreporting rate, at 1%, income subject to substantial information reporting experiences a fairly low 7% misreporting rate. By contrast, income subject to little or no information reporting has a 63% misreporting rate. That last category includes such things Continue reading “The new Tax Gap Map: not much has changed” →

More on Charitable Organizations and Marijuana

By Benjamin Leff

Last Friday, Phil Hackney posted on this blog about IRS Denial 201615018 (4/8/16), in which the IRS denied tax-exempt status under section 501(c)(3) to an organization that planned to support the cultivation and distribution of medical marijuana in a state in which such activities were legal. As Phil pointed out, the IRS held, among other things, that an organization whose purpose is the distribution of marijuana cannot be tax exempt under section 501(c)(3) because “a section 501(c)(3) organization cannot be created for a purpose that is illegal.” This position is not new. The IRS took a similar position way back in 2012.

Phil and I pretty much agree about the law. We both think that the IRS is probably right that under current law an organization whose charitable purpose includes engaging in illegal activities does not qualify for tax-exempt status under section 501(c)(3). Phil says that the law is “absolutely clear on this front,” which I think is a little bit of an overstatement, but that’s a quibble at best. The reason for this certainty is that the United States Supreme Court has held that an organization that had racially discriminatory admissions or dating policies could not qualify for tax-exemption under the so-called public policy doctrine, a common-law doctrine that applies to charitable trusts. The argument for denying tax-exemption for illegal activities is a part of the public policy doctrine, the rationale being that nothing more clearly defines a jurisdiction’s fundamental public policies than its laws, and so illegal activities must violate public policy.

Phil and I also agree on the “enforcement approach” that should ideally underlie the public policy doctrine. We agree that when the IRS is called upon to apply the public policy doctrine, it should do so according to the brightest possible lines. It should maintain “hard and fast” rules. That is because the room for abuse is so great in this area, since the suspect organizations are almost always advancing unpopular or counter-majoritarian values.

Where Phil and I disagree is whether “illegality” provides an adequately bright line to satisfy this enforcement approach. I think that even where conduct is facially “illegal,” there is ambiguity about whether it violates a fundamental public policy, and the IRS should hesitate before making a decision on that score. When it errs in applying the public policy doctrine, it should always err in favor of the organization. That is because when an organization’s conduct is illegal, there is always another enforcement entity that is empowered to enforce the law and prevent the illegal conduct. The IRS should grant tax-exempt status and then defer to the substantive enforcement entity to use whatever sanctions are at its disposal to enforce the law … if it chooses to do so.

Continue reading “More on Charitable Organizations and Marijuana” →

Dark Days: Blindfolding Nonprofit Regulators

By: Philip Hackney.

The Ways and Means Committee voted Thursday in favor of a bill, H.R. 5053, that would seriously hamper the ability of the IRS to enforce charitable tax law and nonprofit tax law generally. It is a bad-no-good-bill, that comes from folks who champion protection from the IRS, but whose real motive is to make it possible for wealthy individuals to act without hindrance in influencing political campaigns and politics generally. It emanates not from a place of conservatism, but a place of reactionarism and plutarchism (neither of which are words, but both of which probably should be :)). The Koch brothers support this bad bill for a reason.

The Bill will harm IRS regulation and make our already relatively secret-and-subject-to-corruption political contribution system more secret and more subject to corruption (the issue that democrats and interest groups focused upon in attacking the bill). The harm though can be expected to extend to the ability of the federal government and states to regulate individuals using nonprofits to accomplish their ends. Sometimes people running nonprofits do bad things. It will increase the dark in which our regulators try to police the nonprofit sector. Unfortunately, the IRS leant a hand to those trying to give donors greater secrecy as high level officials discussed eliminating schedule B back in December 2015. It is still not clear to me what they were thinking, but I genuinely hope we do not make such a foolish choice. As explained below, we have long recognized a regulatory need for this particular information.

What does this dastardly, seemingly well-intentioned, bill do? Continue reading “Dark Days: Blindfolding Nonprofit Regulators” →