While the majority of businesses and individuals voluntarily comply with the nation's tax laws, many do not. For those that do not, the Internal Revenue Service's (IRS) enforcement programs collected more than $40 billion in taxes from businesses and individuals last year.

Despite these efforts, the IRS has a significant gap between what taxpayers should pay and what is collected. The IRS estimates that the annual net tax gap — the amount of taxes that go unidentified and uncollected each year — amounts to nearly $300 billion.

In particular, IRS records show that more than 1.6 million businesses in the United States owed over $58 billion in unpaid federal payroll taxes, including interest and penalties, as of Sept. 30, 2007. Of that amount, 70 percent of all unpaid payroll taxes are owed by businesses with more than a year (four tax quarters) of unpaid federal payroll taxes, and over a quarter of unpaid payroll taxes were owed by businesses that accumulated tax debt for more than three years (12 tax quarters), the Government Accountability Office (GAO) has found.

Many of these businesses have gotten away with criminally avoiding paying federal payroll taxes for more than a year due to the IRS's lax oversight, according to the GAO's 75-page report.

In total, these companies have cheated the federal government out of $40 billion in owed taxes.

One of the factors of this tax gap is unpaid payroll taxes. Employers are required to withhold from their employees' wages amounts for individual federal income taxes, Social Security and Medicare (i.e., Federal Insurance Contributions Act, or FICA). While the majority of businesses pay the taxes withheld from employees' salaries, as well as the employer's matching amounts, a significant number of businesses do not.

Of the $282 billion in cumulative, identified, unpaid taxes owed to the federal government as of Sept. 30, 2007, IRS records show that more than $58 billion (over 20 percent) is owed for unpaid payroll taxes.

Meanwhile, much of the unpaid payroll tax debt has been outstanding for several years.

The GAO cites a construction firm that owed $2.5 million over a 12-year span was engaged in both check kiting and money laundering. Of all industries the GAO analyzed, the construction industry was found to owe the most in unpaid payroll taxes.

The owner of an automotive firm, for instance, continued to draw about a six-figure income from his business and owned substantial real property while the business accumulated more than $3.5 million in unpaid federal payroll taxes over a 10-year period. For the last decade, this business withheld taxes from its employees but remitted less than a quarter of the taxes actually owed. The IRS found the owner of the company "willful and responsible for not remitting the taxes."

Moreover, the report has determined that more than 9,000 owners of businesses have failed to pay federal payroll taxes for two or more companies they own.

In another case, a manufacturing business owes almost $1.5 million in unpaid payroll taxes for over 40 tax quarters. The owner underreported tax liabilities and was found willful and responsible for not remitting payroll taxes from two other businesses. The IRS found that business monies may be flowing into personal accounts, and that the owner has hidden business assets in his own name in order to prevent IRS seizures. The owner also gave business assets to a relative who has used them to start a new business.

Another manufacturing firm, which the revenue officer described as a "sweat shop," owes almost $1 million of payroll tax for almost 40 quarters and more than $400,000 in non-payroll tax. The IRS found the owner has closed several businesses with tax debt when investigated. The owner's latest business has not filed payroll returns since 2005.

The report also notes that some businesses used the cash that should have gone to taxes to underbid competitors on contracts.

While many violators had the ability to pay — owning multimillion-dollar homes, luxury cars and real estate on tropical islands — they were not forced to do so because of the IRS's focus on voluntary compliance or its failure to file tax liens against tax debtors' property.

The GAO has recommended six steps the IRS should take to enforce compliance, including more aggressive early use of its lien capabilities, ranging up to legal action and seizure in the most egregious cases. In comments on a draft of this report, the IRS concurred with all six recommendations and agreed that all appropriate tools must be used to bring payroll tax offenders into compliance.

In a separate GAO study, released today, two-thirds of U.S. corporations were found to have paid no federal income taxes from 1998 to 2005 and about 68 percent of foreign companies doing business in the U.S. avoided corporate taxes over the same period.

Collectively, the companies reported trillions of dollars in sales, according to the GAO's estimate.

Resources

Tax Compliance: Businesses Owe Billions in Federal Payroll Taxes (GAO-08-617)
Government Accountability Office, July 29, 2008

Tax Administration: Comparison of the Reported Tax Liabilities of Foreign- and U.S.-Controlled Corporations, 1998-2005 (GAO-08-957)
Government Accountability Office, Aug. 12, 2008