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| The Basics | Why the tax system drives me -- and you -- crazy
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Too many rules. Too much time. IRS 'help' thats frequently wrong. Its no wonder no one understands the federal income tax system.
By Jeff Schnepper
Who said, The hardest thing in the world to understand is the income tax?
Answer: Albert Einstein. He is also purported to have remarked, when confronted with a Form 1040 Personal Income Tax Return, Im a mathematician, not a philosopher.
Im with Uncle Albert. The tax code is driving me nuts! Ive got two law degrees and an MBA in finance. Im licensed by the New Jersey Board of CPAs. Ive taught taxation for over two decades, both on an undergraduate and a graduate level. And I still have no idea what theyre talking about half the time.
Since 1986, more than 84 new tax laws have been enacted. When the Corporation Trust Co., now known as CCH, first published its Standard Federal Tax Reporter in 1913, the tax law took up a mere 31 pages. As of 2004, it had grown into a whopping 60,044 pages, a 25-volume beast. And it keeps getting bigger and more convoluted each year.
A third of a year in taxes
According to the Tax Foundation, the typical middle-income taxpayer in 2005 had to work until April 17 to just cover his federal and state income taxes. Thats almost a third of the year, 109 days, or two hours and 23 minutes of each eight hours in earnings. In comparison, in 1930, it only took 30 seconds. In fairness, it was also 16 fewer days than in 2000 when the stock market bubble pushed tax burdens to a high and, the foundation said, Tax Freedom finally arrived on May 3.
(Your federal taxes represent about two-thirds of your total tax bill.)
With almost 600 different tax forms to deal with, we collectively spend some 5.4 billion hours a year filling out IRS paperwork. Economist Joel Slemrod of the University of Michigan estimates just managing our income taxes costs us all more than $125 billion a year. That number was roughly the equivalent of what the federal government spends to run the Departments of Education ($56 billion), Homeland Security ($34.2 billion) and State ($13.3 billion), Robert J. Samuelson noted in a recent column in the Washington Post.
Heres some more of the stuff making me crazy:
Taxes consume too much of our income. On average, Americans now spend more time working to pay their taxes than they spend working to provide food, clothing and shelter combined.
The instructions grow ever complex. The short form, Form 1040A, now has more than 80 pages of instructions and twice the number of lines that appeared in the standard full-blown Form 1040 back in 1945. So much for tax simplification.
The information the IRS offers taxpayers is often wrong. The Treasury Inspector General for Tax Administration last summer reported that taxpayers received incorrect or no answers to 43% of tax questions asked in a special study. The investigators concluded that about 500,000 taxpayers who visited Internal Revenue Service help centers got wrong or incomplete responses. The biggest problems cited dealt with education credits, the earned-income tax credit and questions involving dependents.
Sometimes good ideas become nightmares. Im all for lower rates on dividends and capital gains, but the 2003 changes in taxes on dividend and capital gains has resulted in a disaster. The IRS has estimated that it takes 7 hours 58 minutes for the average taxpayer to complete a Schedule D. The time is just for that schedule, not the whole return. You complete a Schedule D if you sold any capital assets such as stocks or mutual funds or received any dividends qualifying for the lower rate. Those are the IRS numbers, not mine. The new Schedule D now has 53 lines. Have a nice weekend.
Schedule D is not the only problem. Heres what it takes to fill out the five major schedules:
| Time required to complete IRS forms | | Form | Hours | | Schedule A Deductions | 5.5 | | Schedule B -- Interest and dividends | 1.5 | | Schedule D -- Capital gains and losses | 7.5 | | Schedule C -- Self-employed workers and sideline businesses | 10.5 | | Schedule E -- Rental property | 6 |
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And how long does it take to fill out the main form? If you fill out a Form 1040 and attach schedules A, B, D, D and E, youre looking at 44 hours of work if you do it yourself -- 14 hours for the 1040 alone. And the IRS says the Form 1040 EZ will take 3.5 hours.
The rules can trick even the smart people. Consider what happened when Sen. John Kerry, D-Mass., the Democratic presidential nominee, released his 2003 income tax return. Accountants combed through it and found that Kerry had incorrectly calculated the tax by nearly $12,000 on a painting he and his wife sold at a substantial profit. He thought his share of the gain should be taxed at the new 15% capital gains rate. But the profit on the sale of the art, as a collectible, should have been taxed at a 28% rate. (Kerry amended his return and paid up.) If a presidential nominee, with access to 57 varieties of tax lawyers and CPAs, got it wrong, what can the IRS expect from the rest of us?
Were not auditing the right people or enough of them. The IRS audit rate for fiscal 2005 was 0.92%, up from 0.77% in 2004. But who cares if theyre auditing the wrong people. The percentage of no-change audits has grown from 14% in fiscal 2001 to 17% in 2004, a significant increase, and a waste of time and resources. Why? Easy. Their formulas for selecting returns are way out of date. They havent been revised since the late 1980s. The IRS is updating its numbers. But, the data wont be reflected in IRS audit selection until 2006.
The formulas do things like compare your income and zip code with average deductions for that area/income class. A return claiming a big charitable deduction by someone who lives in a lower-income zip code might generate a computer flag. The more flags a return generates, the higher the chances the return will be kicked out for human review.
A few years ago, Sen. Max Baucus, D-Mont., said he worried that IRS audit priorities are misplaced. The IRS is trying to bolster its audit figures, not by going after those who are deliberately trying to cheat on their taxes, but by sending out more letters regarding mathematical errors or mismatching of taxpayer information, he said.
The Alternative Minimum Tax is catching ever more taxpayers. The Congressional Budget Office reported in 2004 that the AMT, as it exists today, will hit nearly every married taxpayer with income between $100,000 and $500,000 by 2010. The Urban-Brookings Tax Center said the AMT will affect 31 million taxpayers by 2010. The AMT is essentially a parallel tax code originally designed to ensure that all taxpayers pay at least some tax. It often forces taxpayers to do their taxes twice. Its so complex that Americans spent 29 million hours in 2000 just figuring it out.
Too much of a burden
Our tax code is just too complex. Even the IRS agrees. Commissioner Mark Everson has remarked that frequent changes to the tax code and rising complexity are perhaps the greatest obstacles to reducing paperwork burden.
And he worries that the growing complexity will encourage more people to cheat on their taxes. (And they may do just that. Recent surveys show growing percentages of taxpayers believe tax cheating is legitimate.)
Responding to a report of IRS employees incorrectly preparing 19 of 23 tax returns in a December 2003 survey, Everson replied, Whatever you can do to simplify the code would really help us.
Guess what, Commish? It would help the rest of us as well. If the code is too complex for the IRS and Jeff Schnepper, how about those who arent supposed to be tax experts?
But, lets not jump on the IRS. They dont write the code. Its those brain surgeons we send to Congress who have created this mess.
In 1986, I was invited to the White House to consult on the proposed Tax Reform Act. I suggested that it include a provision requiring all members of Congress to do their own tax returns. I also suggested that all elections be held on April 16th. Both my suggestions were rejected.
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