Among senior employees, the predominant portion of self-employment income absent from taxation records arises from earnings not reported to the Internal Revenue Service rather than discrepancies in how income is categorized, a new study from the University of Michigan reveals.
The examination indicates that the self-employment income figures reported in the Health and Retirement Study, yet missing from tax information, align with IRS assessments of undisclosed earnings. The HRS is a prolonged research initiative at U-M that surveys individuals over the age of 50.
The IRS has established through random audits that the net tax gap—the difference between taxes owed and taxes collected by the government—for the 2022 tax year (the latest year for which data is available) is approximately $606 billion, for instance.
For the U-M examination, researchers evaluated the 2004-2016 Health and Retirement Study linked to administrative records and discovered significantly greater self-employment income consistent with IRS compliance assessments.
“While the IRS figures are derived from random audits, this study employs a different source, the HRS survey,” noted Joelle Abramowitz, an associate research scientist at U-M’s Institute for Social Research. “This research offers further understanding of the profiles of individuals who underreport self-employment income to tax authorities, in comparison to the survey, including the amounts they underreport and the nature of the work they undertake.
“The outcomes were quite unexpected for me since previous comparisons of other surveys with tax data indicate that individuals are less inclined to declare self-employment earnings in those surveys than in tax records,” Abramowitz stated. “This survey may have a superior capability to capture this information compared to others, and we can investigate how to apply this survey’s methodology to enhance other surveys to identify this information more effectively.”
Prior studies indicate that self-employment earnings are frequently underreported in administrative records and household surveys, which impacts the analysis of tax policies.
“I ascertain that the majority of missing self-employment income reports do not reflect misreporting of income but rather signify income that is not reported to the IRS,” Abramowitz mentioned. “I also observe evidence that, compared to individuals engaging in more formal self-employment, those participating in informal self-employment are less likely to report any self-employment income to tax authorities yet do report it in the survey.”
Abramowitz highlights that the unreported self-employment income is particularly prevalent among those declaring minimal income to tax authorities and among higher earners.
“For instance, overall, individuals reporting earnings to the IRS within the 5th to 75th percentiles underreported self-employment income averaging $4,000,” she explained. “In contrast, those below the 5th percentile underscored self-employment income averaging $21,000 while those above the 95th percentile underreported self-employment income averaging $27,000; this is a conservative estimate as earnings exceeding $250,000 are obscured in the data.”
The lost revenue hampers the government’s capacity to reduce its budget deficit or finance initiatives aimed at enhancing individuals’ lives, she asserts.
“These insights could guide more effective targeting of audits,” said Abramowitz. “They are also critical because policies and regulations hinge on survey and administrative data. This study uncovers that tax data and other surveys do not reliably capture self-employment income.
“Overlooking this income component distorts estimates of poverty and inequality, which are essential for assessing well-being, as well as understanding the implications of policies on these outcomes, subsequently influencing policy formation and program development.”
In ongoing research, scholars are investigating how discrepancies in reporting differ by race and gender, assessing how varying income metrics based on these reports impact poverty rate estimations. They also analyze how engaging in various forms of self-employment affects overall well-being.
The research is published in the National Tax Journal.