Wealthy Taxpayers Misreport Income More

A recent study of unpublished Internal Revenue Service data has found that wealthier people are hiding their income at greater rates than those in lower income brackets.

The paper, "The Distribution of Income Tax Noncompliance," by University of Michigan economics professor Joel Slemrod and IRS economist Andrew Johns, found that when taxpayers were arrayed by their "true" income, defined as reported income adjusted for the underreporting estimated by the IRS tax gap methodology, the ratio of aggregate misreported income to true income generally increases with income. The misreporting peaks among taxpayers with adjusted gross income between $500,000 to $1 million, who understate their incomes by about 21 percent, and is lower than the peak ratio for individuals with income above $1 million.

"Much of the distributional pattern of noncompliance is related to the fact that, on average, high-income taxpayers receive their income in forms that have higher noncompliance rates," such as self-employment business income, according to the report. An estimated 57 percent of nonfarm proprietor income is not reported, a total of $68 billion, accounting for more than a third of the total estimated underreporting for the individual income tax. When taxpayers are split into two groups, above and below $100,000, the net misreporting percentage is much higher for the higher-income taxpayers: 15.2 percent for those with true income above $100,000, and 7.0 percent for those with true income below $100,000, said the report. The IRS has been making an effort to close the estimated $345 billion tax gap, but the study does not indicate whether those efforts have succeeded very much. "We can't tell if recent IRS initiatives have changed what we find significantly one way or the other," Slemrod told WebCPA.

He hopes to update the study once more recent data becomes available. "The data we used is from the latest IRS tax gap study, for tax year 2001," he said. "They are updating this, so later data will be available at some point in the future, so we might be doing it again."