“Price Is Right” Taxes

The IRS reminds us that, “the U.S. income tax system is built on the idea of voluntary compliance. This means that taxpayers are responsible for declaring all of their income, calculating their tax correctly, and filing a tax return on time.” In other words, “the IRS depends upon honest reporting.” (There are people who would have you believe that owing tax is voluntary. You can safely lump them in with people who tell you the earth is flat, or Epstein really killed himself.)

Of course, any game that relies on voluntary compliance also gives players the option to not comply. And so, in any given year, there are millions of Americans who don’t voluntarily file their returns. Some of those miscreants go year after year after year without filing. (Tax professionals love when non-filers walk in the door, shamefaced, and confess years of unfiled returns – cha ching!)

Last week, the IRS announced a new effort to chase down 125,000 cases where high earners, including some making over a million dollars, failed to file. But wait a minute . . . how does the IRS know how much they made when they didn’t file their returns?

It turns out voluntary compliance is great – but there’s a Plan B when it fails. That backup plan takes the form of third-party reporting. Employers send the IRS W-2s to report how much their employees make. Financial service providers send the IRS all sorts of 1099s to report how much they pay out in interest, dividends, annuities, and retirement income. Vendors send a different kind of 1099 to report how much they pay their independent contractors. The bottom line here is that the IRS probably already knows how much you grossed, even before you file your return.

Now the IRS has started mailing notices in those 125,000 cases where they’ve gotten third-party information since 2017, but the recipient hasn’t filed a return. In 25,000 of them, the nonfiler earned a million or more in that period. In the rest, the nonfiler earned $400,000 or more. The total amount of unreported income is over $100 billion.

How much tax will that raise? Well, that brings us to Plan C for our “voluntary” tax system. Unreported doesn’t always mean untaxed. If you’re earning income as an employee, your employer helpfully withholds taxes from your paycheck and sends it to the IRS for you. (Well, at least they’re supposed to. There’s a whole different category of penalties for employers who drop that particular ball, and it sometimes involves prison.) At the end of the year, you file your return to find out how close your employer came to the actual retail price (hopefully without going over) and settle the difference in the form of a refund or small final payment.

Those withholdings mean that loads of high-income doctors, lawyers, and business executives could easily have earned a million or more since 2017, “forgotten” to file 1040s, and maybe even find there are refunds waiting for them to claim.

Bottom line, the IRS announcement suggests there’s a hidden army of Scrooge McDucks out there, gleefully diving into swimming pools filled with untaxed cash, just waiting to rescue the rest of us from trillion-dollar deficits as far as the eye can see. The reality is likely to be far less satisfying for the IRS and those who filed and paid their fair share.

You may think that nonfiler collections have nothing to do with you. But they’re a sign of how much harder the IRS is working to collect every dime our Uncle Sam is owed. That makes careful planning even more important in order to pay the legal minimum. Count on us to help you accomplish that goal!