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Combating the tax gap

Experts define the tax gap as the difference between what taxpayers owe, and what they voluntarily pay. The tax gap consists primarily of three groups:

  • Non-filers.
  • Filers that underreport income or overstate deductions, exemptions, or credits.
  • Non-paying filers.

We understand that there will always be a tax gap, and that it consists of many components. We also believe there are several initiatives that can be used to counteract it. For example, FTB formed the Tax Gap Action Committee (TGAC), which has these goals:

  • Increase public awareness to improve self-compliant behavior.
  • Deter those who consider noncompliance.
  • Improve taxpayer confidence in the tax system.
  • Level the playing field for all taxpayers.
  • Support high standards in the tax professions.
  • Become more innovative in attacking the tax gap.

Along the same lines as the TGAC initiatives listed above, FTB is emphasizing efforts to increase transparency, educate the public, and facilitate taxpayer self-compliance, by:

  • Participating in symposiums and Town Hall meetings to involve industry and interested public parties.
  • Updating internal procedure manuals available on the FTB Website.
  • Updating forms with easier instructions.
  • Translating forms to other languages.
  • Writing more audit-related Tax News articles.

We are working hard to address compliance concerns, including abusive tax shelter transactions. We are pursuing multiple avenues in this effort, including:

  • Education and outreach.
  • Joint efforts with IRS and other states.
  • Looking at preparer and promoter activities and applicable penalties.
  • Tax shelter reporting requirements.

To improve efficiencies, we are also partnering with the IRS and other states to:

  • Exchange information and training material with the IRS to improve audits, and avoid duplication of resources.
  • Actively exchange information, audit results, and audit leads with other states to improve audits, and avoid duplication of resources. We are also meeting with other states to discuss trends, tax gap areas, and tax avoidance schemes discovered.
Within FTB, we conduct joint audits involving FTB Pass-Thru Entity and Multistate Audit staff to improve quality and efficiency of audits.

Recent court cases demonstrate that the IRS' and states' endeavors are having successful results. The courts have sustained the IRS position that certain abusive tax avoidance strategies lacked business purpose or economic substance. These cases include a variety of abusive transactions used by corporations:

  • The Dow Chemical1 case is a Corporate Owned Life Insurance (COLI) tax shelter.
  • The Coltec2 and Black & Decker3 cases are both Contingent Liability tax shelters.
  • Castle Harbour4, involves a Lease Stripping shelter.
  • Tribune (Times Mirror)5 uses a gain avoidance shelter.
  • BB&T 6 uses a Lease-In, Lease-Out (LILO) transaction.
  • The Santa Monica Pictures7 case involves high tax basis, low fair market value assets that produced artificial tax losses.

Part of FTB's mission is to encourage self-compliance by administering the income tax audit program responsibly, fairly and timely. We encourage all taxpayers and tax representatives to avoid tax avoidance strategies. For more information on the tax gap, abusive tax shelters, and other compliance initiatives, visit our Website at

1 Dow Chem. Co. v. United States, 435 F.3d 594, 599 (6th Cir. 2006.)
2 Coltec Industries v. United States, 454 F.3d 1340, (2006.)
3Black & Decker Corp. v. United States, 436 F.3d 431, 437 (4th Cir. 2006.)
4TIFD III-E, Inc. v. United States, 459 F.3d 220, (2nd Cir. 2006), also known as Castle Harbour.
5Tribune Co. v. Commissioner, 125 T.C. 110, 2005 U.S. Tax Ct. LEXIS 28 (2005)
and Tribune Co. v. Commissioner, T.C. Memo 2006-12, 2006 Tax Ct. Memo LEXIS 13 (2006.)
6BB&T Corporation v. United States, DC NC, 99 AFTR 2d 2007-320, 2007 U.S. Dist. LEXIS 321 (2007.)
7Santa Monica Pictures, LLC, et al. v. Comm, T.C. Memo 2005-104, (2005.)