Americans failed to pay record $688 billion in taxes in 2021, IRS says. Look for more audits.

Americans failed to pay $688 billion in taxes on their 2021 returns, a record level, according to a new estimate from the IRS. The agency said that it is taking "urgent" steps to increase compliance such as auditing more high-income taxpayers as well as businesses and partnerships. 

The $688 billion estimate reflects the first time the IRS is providing information about the so-called tax gap on an annual basis, with the agency noting in a Thursday statement that it plans to continue providing the data on a yearly basis. The number reflects an increase of more than $138 billion from estimates for tax years 2017 to 2019, the agency said. 

The IRS is ratcheting up audits on wealthy taxpayers, part of its directive after receiving billions in new funding through the Inflation Reduction Act (IRA). The agency has said it wants to go after higher earners who skirt their tax obligations in order to help close the tax gap and raise more money for federal coffers, which will be used for programs like the IRA's $370 billion in green energy investments. 

"This increase in the tax gap underscores the importance of increased IRS compliance efforts on key areas," IRS Commissioner Danny Werfel said. 

"These steps are urgent in many ways, including adding more fairness to the tax system, protecting those who pay their taxes and working to combat the tax gap," he added.

The IRS has said it won't increase audits on households earning less than $400,000 annually.

What is a tax gap?

The tax gap is the difference between the estimated taxes that are owed and what is actually paid on time, the IRS said. 

It includes three key shortfalls: Taxes that aren't filed, taxes that are underreported and taxes that are underpaid.

About 85% of taxes are paid voluntarily and on time, the IRS noted.

Why are Americans underpaying their taxes?

Nonfiling occurs when people don't file their annual tax returns on time, and so taxes aren't paid on time. This can happen for a number of reasons, according to accounting firm Simpson & Simpson Accounting.

For instance, some people don't file due to avoidance if they are worried about owing a big tax debt. Others fall behind due to crises in their lives, like a divorce or death in their family, some get overwhelmed with details, Simpson & Simpson said.

In 2021, about $77 billion in taxes were unpaid due to nonfiling, the IRS said. 

Underreporting is when people don't report all their income, such as when people who are paid in cash fail to report that on their annual returns, which can result in lower taxes than they actually owe. Underreporting accounted for $542 billion of 2021's tax gap, the IRS said.

Underpayment indicates taxes were reported, but filers failed to pay what they owe on time. That can happen to freelancers or gig workers who pay quarterly estimated taxes if they don't correctly estimate their taxes and underpay, or to people who owe the IRS but delay paying the IOU. Underpayment accounted for $68 billion of the 2021 tax gap, the IRS said.

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