Dr. Bryan Menk, Assistant Professor of Accounting, has been investigating why people sometimes underreport tip income and casino winnings.

In the latest data sets released by the Internal Revenue Service in 2016, it was estimated that the total amount of underreported Federal Income taxes for the years 2008—2010 was $458 billion. Of this amount, about $329 billion was related to individual taxpayers who reported and paid taxes in a timely fashion. These taxpayers underreported their tax liability by one of many possible methods, some of which included negligence, tax evasion, or simple errors and mistakes.

One of the main factors that enables individuals to underreport income is the use of cash payments in a business. Such payments create opportunities for taxpayers to have income that is difficult or impossible to track. For example, when a server in a restaurant receives a cash tip, it is unlikely that anyone besides the server will know exactly how much was received. Similarly, when a person visits a casino and wins, no one tracks the individual gambler’s winnings (unless the winnings are above thresholds that are unique for each type of game in the casino). In these circumstances, it is possible for the person who received the cash to pocket the profits or winnings with no one’s knowledge of those monetary receipts and unreported income. In both of these circumstances, it is possible that the individual taxpayers did not know that a tax liability existed and did not intend to underreport and underpay their taxes.

Currently, a professor at the Palumbo-Donahue School of Business is examining some of the causes related to these types of underreporting and is trying to determine what can be done to better educate the general public about tax laws and increase compliance. Bryan Menk, Assistant Professor of Accounting, has been investigating the reporting behaviors of individuals in these situations: underreporting of tip income and underreporting of casino winnings. Bryan has collected extensive data from both servers and casino patrons located all across the country.

The results of recently published journal articles yield evidence that much of the non-compliance with the tax laws is a result of some consistent issues. First, tax compliance rules can be confusing, and the majority of restaurant servers and casino patrons involved had very little understanding of the rules. Those who did know the rules typically complied and reported taxable income at a much higher rate. Second, the perception of the fairness of taxes was found to be a highly significant indicator of taxpayer compliance. If a person felt that tax laws were unfair or that the government was using taxes inappropriately, they were much more likely to underreport their income and their taxes.  Interestingly, the ethical position of a person was not seen to impact the taxable income reporting behaviors.

Bryan stated, “Because the results were consistent across both studies, the perception of the fairness of taxes directly impacts whether a person would consider underreporting income as an ethical action. In a case where a person believes that taxes are immoral or used in an inappropriate manner, that person may see tax evasion or non-compliance with the law as the ethical behavior.” In order to increase tax law compliance and tax revenues, better education about the reporting requirements, more transparency about governmental spending, and efforts to improve the public’s perception of taxation is required.