Wednesday, April 28, 2010

YES to calls for a simpler tax system but ...

I heartily endorse Professor Nellen's call for a simpler tax system, but I have some issues to raise with the third of the three steps she advocates in her op ed.

The solution? Become an advocate for simplification -- demand it. Three steps are needed.

First, tell Congress you don't want any new deductions or credits. Be willing to tell lawmakers you'd prefer to have a lower tax rate or higher standard deduction instead.

Second, be willing to live without some of the deductions and credits you currently claim. If you currently do not receive full benefit of some deductions and credits due to phase-outs or the alternative minimum tax, be willing to be taxed at a higher rate so these complex rules can be eliminated. After all, phase-outs and the alternative minimum tax just disguise your true tax rate.

Third, trust the Internal Revenue Service to do more of the compliance work for you. The IRS has much of the information that you enter on your 1040. It receives the same forms on wages and interest income that you do. The IRS knows your marital status and number of dependents from the form you give your employer.

Amen to #1 and #2, but not so much on #3.

Here's where I disagree:

Professor Nellen says "The IRS has much of the information that you enter on your 1040." What is actually true is that the IRS will someday have much of the information that you enter on your 1040, but it's certainly not the case right now that the IRS has that information at the time you enter it on your 1040.

Consider this: employers are required to send W-2 information to their workers by January 31, and many employers actually do this in early January. Many taxpayers file their returns as soon as they get their W-2s, because, understandably, they need their refunds as soon as possible.

However, employers do not need to send that W-2 information to the government until February 28 if they are paper-filing that payroll information, and they don't need to send it to the government until March 31 if they are efiling the payroll information.

And guess what, even then, they are not sending the information to the IRS, they are sending it to the Social Security Administration (SSA). Many employers send W-2 information with serious flaws in it, due to the widespread misuse of incorrect Social Security numbers, and the SSA has the huge task of trying to reconcile as many of those errors as they can before forwarding the W-2 information to the IRS.

So, bottom line: the IRS may well not get your W-2 information until many months after most Americans file their tax returns.

Professor Nellen also says: "The IRS knows your marital status and number of dependents from the form you give your employer."

Well, no, not really. The form you give to your employer simply lists "the number of withholding allowances" you claimed at the time you filled it out. Years ago, the main item that factored into figuring out how many withholding allowances to claim was the number of dependents, but now it includes a long laundry list of other items including estimates of deductions, credits, and so on. Moreover, most Americans prefer not to claim all the withholding allowances they are entitled to claim on their W-4's in order to minimize the chance of an unpleasant surprise on their tax returns and/or to increase the size of their refunds.

Furthermore, the most difficult issues we deal with at our VITA site have to do with determining exactly how many dependents a particular taxpayer is entitled to claim. It is a surprisingly difficult issue and many taxpayers are simply not in a position to know how many dependents they will have on their tax return at the time they file a W-4 with their employers. Will their child move in with the other parent or a relative later in the year? Will their child stop attending college full-time or start it again? Will their mother-in-law move in with them and exactly how much of her support will they provide? Taxpayers typically don't know the answers to these questions at the time they fill out their W-4's and few taxpayers take the time to update their W-4's every time their situation changes. There are similar questions about the rules for marital status which can be difficult for a taxpayers to resolve at the time they fill out their W-4.

So, bottom line: yes, I heartily endorse Professor Nellen's call for a simpler tax system--let's get rid of as many unnecessary bed buffaloes as we can, but it is premature to say that the IRS currently has much of the information that taxpayers enter on their 1040s.


  1. I have always felt that the best way to change our system NOW is to simply close many of the corporate loopholes....which is in essence a tax increase b/c they won't be able to take some of the HUGE deductions.

    I also would like to see charitable contributions changed b/c too many groups are getting the benefits w/o actually giving nearly as much

    I say we close the issues and keep making foreign tax laws as we still have so much gray area there

  2. Thanks for the great comments. I think that these points can be addressed, such as moving up the filing date for W-2s (today's technology can easily allow that for most employers). Additional questions can be provided on W-4s and that information can even be submitted online by the employees (with the employer's help perhaps).

    It will be interesting to see if Senators Gregg and Wyden who include a return-free filing option in their current reform proposal (S. 3018), will pursue it.

    Great blog - love the title!

    Annette Nellen

  3. The thought that we would rely on the IRS to file accurate and timely individual tax returns makes me cringe. I am a practicing CPA who deals alot with IRS audits and most of the auditors that I come across don't know the tax code much better than the person they are auditing.