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Closing the Tax Gap: IRS Initiative Targets Non-Filers Among High-Income Americans

Issue# 1116


It's rare to encounter someone who doesn't wish they could reduce their tax burden. A recent initiative from the IRS holds the promise of making that wish a reality, albeit over time.


One significant reason behind the high tax payments of some Americans is the tax gap—the disparity between owed taxes and actual payments. The IRS estimates this gap to be around $496 billion, stemming from various factors such as underreported income, inflated credits and deductions, inadequate tax payments, and failure to file returns.


To address this gap, the IRS aims to tackle the issue of non-filers, a substantial problem in itself. According to the Journal of Accountancy, over 125,000 high-income taxpayers—those earning over $400,000 annually—have neglected to file their federal income tax returns since 2017. Among these, roughly 25,000 individuals earn over $1 million annually, while the remaining 100,000 fall between the $400,000 and $1 million income brackets.


The IRS identifies these non-filers through received information returns, such as W-2s and 1099s, which indicate sufficient income necessitating tax filings. However, for various reasons, these individuals have chosen not to file.


Who exactly needs to file tax returns? Generally, if your income surpasses specific thresholds, the IRS expects you to file. Typically, if your income is lower than the standard deduction available for your filing status, filing may not be necessary, although exceptions exist for dependents and individuals with self-employment income exceeding $400.


The likelihood of requiring filing is notably higher for high-income individuals, especially those with various information returns on file, such as W-2s and 1099s.


Recently, the IRS received increased funding under the Inflation Reduction Act of 2022, part of which is allocated to address the issue of high-income non-filers directly. The agency plans to issue notices to approximately 125,000 high-income Americans who haven't filed tax returns since 2017. Recipients of these notices must either file a federal income tax return or provide the IRS with an explanation for their exemption from filing.


Taxpayers receiving these notices generally have eight weeks to respond; failing to meet this deadline could result in an IRS audit or, in severe cases, criminal prosecution.


The consequences of procrastination in filing taxes can be severe. The IRS imposes a failure-to-file penalty on late tax returns, typically amounting to 5% of the unpaid tax bill for each month or partial month the return is overdue, capped at 25% of the unpaid tax bill. Additionally, a failure-to-pay penalty of 0.5% of the unpaid tax bill per month or partial month applies until the tax liability is fully paid, also capped at 25% of the unpaid tax bill.


Interest on the outstanding balance is also charged by the IRS, currently at a rate of 8% per year, compounded daily for the first and second quarters of 2024. Moreover, the IRS may file a substitute for return (SFR) in cases of prolonged non-filing, resulting in potentially higher tax bills due to the absence of information on deductions and expenses.


Whether prompted by an IRS notice or seeking to ensure compliance, professional guidance can help mitigate penalties and legal complications associated with back tax obligations.

Disclaimer: This article is for informational purposes only and does not constitute financial, legal, or tax advice. It is always recommended to consult with a qualified professional or financial advisor to make decisions regarding your individual financial situation. The information provided in this article is based on the laws and regulations in effect as of 2023 and may be subject to change. Ahmad Yama Bassam, the author of this article, is the managing partner at A.Y. Bassam & Co. LLP, A Professional Tax, Accountancy, Business Advisory & Payment Solutions Firm, based in California.

Managing tax laws is challenging, but we're here to help. At A.Y.Bassam & Co. LLP, we provide accurate, relevant, and legally compliant tax guidance tailored to your business needs. Our experts can help you maximize deductions, minimize liabilities, and optimize your tax position. Don’t miss critical tax-saving opportunities.

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