At tax time, lots of money under table

From gambling to painting to child care, not all income gets shared with the IRS.

Danielle L. teaches private swim lessons on Long Island. The $30 per 30 minutes she charges is just "a little extra" on the side. Bryan M. likes to play poker, and so far this year the student has made about $8,000. And painter Jack K. charges $600 in cash to brighten a room. It's more, however, if he gets paid by check.

What all three have in common is that none of them declares these earnings to the IRS. And they are not unusual.

As of midnight Friday, when most Americans will have filed their taxes, the IRS estimates there is a "tax gap" of over $300 billion a year, about 15 percent of total tax revenues - money that should be paid but is not finding its way to the US Treasury.

That's a lot of cash under the table, golf fees written off as expenses, and inflated charitable gifts. It's equal to 75 percent of the annual budget deficit, two-thirds of Defense Department spending, or what the US spends on Medicare in a year.

"The tax gap has two implications. First, the billions that don't come in that should come in further increase the nation's indebtedness and burdens future generations," Mark Everson, the IRS commissioner, says in an interview. "Secondly, you discourage compliance when someone else is getting away with it and breaking the law."

Tuesdsay, using new IRS data, the Economic Policy Institute released a study of tax cheating, or what it termed "Do-it yourself tax cuts." The Washington, D.C., group called the compliance problem "a crisis in US tax enforcement," and said closing the gap "is one of the best bargains available in economic policy."

The problem may only get worse, as an increasing number of Americans become subject to the Alternative Minimum Tax (AMT). Some projections suggest that 35 million people will be paying the AMT by 2010, according to Nina Olson, the National Taxpayer Advocate.

The AMT "discourages compliance," says Mr. Everson, "in the sense that people go through a calculation of their tax and at the end we say ... 'just kidding, you really owe $2,200 more.' "

The IRS "tax gap" estimates comes from a three year study called the National Research Program for tax year 2001. The tax agency audited 46,000 individual returns and then extrapolated how much money was not paid, on a national basis, for all 131 million Americans who file. In 2001, all taxpayers paid $1.767 trillion on time - or between 83.4 to 85 percent of the amount the IRS estimates was due. The tax gap, the IRS estimated, is between $312 billion and $353 billion

The IRS numbers show the bulk of the gap coming from underreporting of income, such as people working off the books, or taking too many deductions. A smaller portion was due to non-filing and underpayment. The tax most often underreported is the individual income tax.

The study was a wake-up call for the agency, which increased its spending on enforcement after a period of lower funding for IRS agents. Since 2001, it doubled its audits of those earning $100,000 or more and increased its overall audits 37 percent over 2001. And the audits have been successful: The IRS estimates that enforcement activities, plus late payments, recovered about $55 billion of the tax gap.

Some of the money recouped came from a crackdown on wealthy people using improper tax shelters. Last month, for example, the IRS announced it had collected $3.2 billion from a scheme it called "Son of Boss." One individual alone owed $100 million, and the average owed involving this scheme was $1 million. There are still 400 people who invested in the tax shelters who chose not to participate in the settlement and another 200 didn't qualify. The IRS estimates it will collect another $300 million from "Son of Boss."

More people may be feeling the hot breath of the tax collector on them soon. Congress appropriated $48 million for the IRS to use private collection firms in 2006. "All I can tell you is, we are extremely cognizant of the fact that we need to be attentive to taxpayer rights here,," Everson said at a recent Monitor Breakfast.

Many people just don't feel compelled to pay taxes. Even though the IRS is still analyzing the data, Everson believes the bulk of the tax gap is underreporting of income.

Danielle, for example, considers her swim lessons the same as babysitting. "A little kid selling lemonade on the street isn't going to fill-out a W2 form, and I'm not going to tell the government about the swim lessons," she says. "When I work as a lifeguard or swim team coach for a town I expect to be taxed because it's for an organization."

Some who underreport rationalize their actions as the right thing to do. For example, Bryan believes that since poker is not his primary source of income, he doesn't need to declare the money. "The high-up tournament players get audited sometimes and need to get receipts and recordings of their winnings, but I don't get nervous about the IRS or anything," he says.

(For the record, the IRS considers gambling winnings to be income as it does any other form of cash remuneration, which it says must be reported.)

Not reporting her income has made Stephanie P., who works "off the books" for $10 an hour at a real estate office in New York, feel guilty. "I feel a little hypocritical," says the college student, "because I favor a bigger government in terms of more spending on social programs and healthcare, but here I am not paying an income tax."

Large movements of cash often do attract the IRS. But IRS scrutiny does not always result in a check to the Treasury.

For example, last June, a jury acquitted a south Florida couple accused of evading taxes on $10.1 million in income on their apartment painting business. The case started when the IRS was investigating a check-cashing business in Miami. The IRS observed a couple cashing millions of dollar in checks and began to look into their dealings. It decided they were cheating. But the jury determined that the couple were using the check cashing store legitimately to pay workers in New York City who were painting low-income apartment buildings.

• Courtney Allison and David T. Cook contributed to this story.