Why your taxes are so complicated
Finding the patterns
At 4 million words long, the US tax code is one of the most complex in the world, the result of issues of fairness and, yes, your desire for deductions.
Washington — Aaron Pludwinski was on the phone with the Internal Revenue Service. Actually, he was waiting on the phone hoping to talk with the IRS.
He began reading to pass the time. And he mused on Twitter: “on hold with IRS, what will happen first: IRS picks up or I [finish] reading the last 80 pages of my book?”
He finished his book. When someone did finally come on the line, the IRS employee couldn’t help Mr. Pludwinski resolve his problem about why it was proving difficult to set up a tax ID number for a partner in his business.
Despite making multiple calls in his quest to navigate a tax code as complicated as quantum physics, Pludwinski says he is not angry with the IRS employees. The people who answer, he says, have been friendly and have tried to help. They’ve simply been unable to tell him why the Form W-7 he filed is mysteriously in limbo. Besides, he was able to catch up on his reading – a book by business guru Peter Thiel.
But the experience of this Miami entrepreneur was one of frustration. It’s also far from unusual. Yes, software programs and e-filing have eased the burden of submitting tax forms, but to millions of Americans the annual ritual remains a source of anxiety, perplexity, and unwelcome accounting fees.
And that’s just for normal filers. If you’re a pastor of a church, congratulations: Your calling to the ministry comes with the worldly demand of extra tax complexity. If you broaden your horizons by teaching at a school overseas, the job comes with the need for added tax-accounting services. Even many Americans who owe no taxes scramble for help to get their forms filed.
Things as common as saving for retirement or a child’s college education can lead to primal scream moments. One example: Withdrawing money early from a retirement account, and using it for college bills, carries a tax penalty if the money was in a 401(k), but not if it was in an individual retirement account. Really?
To state what may be obvious, the US tax code is a mess. Or at least, few argue otherwise. And, although tax complexity is hardly an only-in-America problem, many finance experts see the United States as an exemplar of tax backwardness relative to other advanced nations. The good news is that the problem can be addressed. Tax-code simplification is attainable, albeit with a caveat* or two about the politics to be navigated. (*This point is not covered in IRS Publication 17, but we’ll get that in "Fixing the tax code.")
“I’ve often said, the tax code is 10 times the size of the Bible, with none of the good news,” says former US Rep. Dave Camp, who during his time as chairman of the House Ways and Means Committee pushed for a sweeping overhaul of the tax code.
Mr. Camp’s 2014 effort failed, yet many finance experts say his proposal – cutting tax rates and drastically reducing complexity, while also maintaining a progressive system that imposes the heaviest burdens on the rich – showed the potential for pragmatic and bipartisan reforms. A telling sign: An Obama administration panel of tax experts has embraced similar principles. It’s not clear when reform will happen, but there’s little doubt that it will.
“Everyone agrees our tax code is broken,” says Camp, now a consultant at PricewaterhouseCoopers in Washington. Across the political spectrum and from Pennsylvania Avenue to countless Main Streets, he says, “there’s a lot of interest and desire – really seeing an urgency to finding a solution.”
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Complexity isn’t the only challenge. But the issue is intertwined with other problems in the US tax system: the influence of lobbyists, public perceptions of unfairness, multinational companies using artful ways to dodge billions in potential tax liabilities. Many finance experts say the benefits of simplifying the tax code can go far beyond saving taxpayers time, money, and emotional distress. A simpler code, potentially, could also help the economy grow faster, deliver better on the elusive goal of fairness in fiscal policy, and do a more efficient job of bringing in the revenue government needs in order to function.
IRS staffers might even be able to pick up the roughly one-fourth of incoming phone calls from taxpayers that now go unanswered. (By the way, there’s actually a new private service, called enQ, that is already on hold with the IRS, and will, for a small fee, allow you to take its place in the queue, eliminating a wait time that can be as long as an hour. It’s unclear whether the fee is deductible.)
It would all be funny if it weren’t so serious. Actually it is funny, even though it’s also serious. The Old Farmer’s Almanac once noted that if “Patrick Henry thought that taxation without representation was bad, he should see how bad it is with representation.”
Writer Russell Baker developed a “taxpayer’s prayer,” perhaps to be offered around the current season: “O Mighty Internal Revenue, who turneth the labor of man to ashes, we thank thee for the multitude of thy forms which thou hast set before us and for the infinite confusion of thy commandments, which multiplieth the fortunes of lawyer and accountant alike.”And tax lawyer Joseph Darby calls attention to a sentence in the code (helpfully banished a decade ago) that was longer than Lincoln’s Gettysburg Address. The sentence had 342 words, with 25 parentheticals, 17 commas, 2 dashes, and, finally, a period at the end. Or so we think. It’s not clear if anyone other than Mr. Darby ever got to the end of it.
The tax jokes aren’t likely to subside. Even reform can’t do away with taxes, and simplification isn’t an elixir for all that ails the modern economy. But, despite the political obstacles that seem to lie in its path, tax reform is a compelling proposition.
• Complying with the code takes Americans almost 6 billion hours per year, according to one estimate cited by the IRS. Camp puts it another way: If one person had to do all of America’s taxes for this year, it would take that individual about 700,000 years of nonstop work. File for an extension, perhaps?
• The tax code now contains almost 4 million words, and new provisions are being added at the rate of about one per day, Nina Olson, the National Taxpayer Advocate, said in 2012. Appointed to be a watchdog for customer interests within the IRS, she called tax complexity the top problem facing taxpayers.
• Even with the rise of software and online help, some 6 in 10 taxpayers hire paid preparers. “To inspire confidence and trust, the tax laws should be comprehensible,” Ms. Olson wrote in her 2012 report. She also says that America spends 15 cents doing tax paperwork for every dollar collected in taxes (and some say the figure is even higher).
Geoff Parker is a minister in Brunswick, Maine, who utters his own heartfelt prayer to the government regarding his tax status: “Could we have a nice trade where I could just be an employee and have my taxes withheld like a normal person?”
He’s referring to the way clergy are typically treated by the tax system: partly like employees of their churches, and partly as self-employed. They calculate their own payroll taxes to participate in Social Security. They file a Schedule C like many small-business owners, and deduct various work-related expenses. And they are often granted housing allowances as part of their pay. That’s a nice perk, but since the tax law allows that to be treated as tax-free income, it means extra record keeping.
“That [housing allowance] is federal income tax exempt but ... not Social Security and self-employment tax exempt,” says Mr. Parker of First Parish Church, part of the United Church of Christ. “I keep an entirely separate bank account just to handle housing.”
One year, when he chose to do taxes on his own rather than with an accountant, Parker was shocked to see his tax bill soaring unexpectedly. “It took me like a week or two of constantly going back and saying, ‘now what happened here?’ ” The answer that emerged: His tax software had prompted him to answer questions about the housing allowance on two different occasions, and he had unwittingly caused that income to be counted twice.
It’s probably a good thing that Parker is so meticulous about his record keeping. The IRS has a special document called the “Minister Audit Technique Guide.” It’s not that the IRS has a diabolical obsession with people who fear God more than they fear the taxman. Audit technique guides are an entire genre within the agency’s vast catalog of publications.
Truth be told, though, few Americans face anything approaching a grand inquisition from auditors. Millions of people have a relatively easy time with taxes, as the computing power of software code has been harnessed to tackle the twists and tabulations of the IRS code.
But just because many people are coping doesn’t mean Americans want – or should want – the tax status quo to continue. A 59 percent majority of Americans say the code needs a sweeping overhaul, according to a Pew Research Center poll last year. Complexity was an even bigger concern than the amount people have to pay. Higher still on the concern list, though, was whether corporations and the rich pay their fair share of taxes.
Small businesses list tax complexity among their top challenges, too, according to the National Federation of Independent Business. The US Chamber of Commerce, the Obama administration, and many tax experts say the US corporate tax code needs an overhaul to draw more investment to the US.
The US has one of the highest nominal rates of corporate taxation in the world – bad for America’s reputation as a place to locate a business headquarters. Yet large companies deploy complex tax strategies that allow them to pay at much lower effective rates – bad for revenue collection. The high corporate tax rate was a main reason the Tax Foundation, a conservative-leaning think tank in Washington, ranked the US as having the third worst tax code out of 34 countries in the developed world in 2014.
Some good news: Things in the US could be worse. In Brazil, it can take a midsize business 2,600 hours (or 325 days of employees working eight-hour shifts) to do tax paperwork – about 10 times the world average and 15 times what it takes in the US. That’s according to the World Bank and PricewaterhouseCoopers, surveying the tax burden in 180-plus nations using a hypothetical company – a ceramic flowerpot manufacturer with 60 employees. The US, incidentally, came in 66th in the ranking.
For taxpayers, the challenges arise not just in tallying income but also in knowing whether and how to take advantage of the various deductions and credits Congress has created. Yes, there really is a deduction available to captains of whaling ships, useful for members of certain Alaskan tribes. The US tax court has let some unusual deductions slide by (clarinet lessons for a child as a way to help correct an overbite) but has nixed plenty of others (boarding your dog as a business expense while away on a work trip). Rules on work-related clothing allow a welder to deduct the cost of his work boots but not the blue suit that his foreman asks him to wear.
Other tax provisions are less unusual, but still aren’t very easy to navigate – from green tax credits to deducting job-search costs.
How the tax code has come to be as scary as a Stephen King novel is attributable to a variety of factors – and you, taxpayers, are one of them.
For starters, America has evolved a vast industry supportive of all the complexity. Accountants earn their livelihoods by it. Members of Congress reap lobbyist donations every year they consider possible changes to the code.
Taxpayers can be a powerful constituency behind all the variation and verbosity in tax rules since one person’s extraneous “loophole” is another’s righteous relief. Do you want an IRA in Roth or traditional flavor? In the land of the free, this choice is an opportunity to have a say in how your retirement savings will be taxed – just like being able to choose among cereals at a supermarket.
Beyond all this is something more basic, though: A modern government needs lots of revenue, and people want that revenue to be collected in a way that distributes the burden fairly. Those twin goals don’t lend themselves to simplicity.
Most advanced nations opt to have an income tax, and once that choice is made, things get inherently complicated. “What constitutes income and how do we account for it? That actually is where much of the complexity comes from,” says Joseph Thorndike, who oversees a “tax history project” at Tax Analysts, a publisher of tax-related news. “[And] that means that the issue doesn’t ever go away.”
Back in 1776, of course, the US didn’t have an income tax at all. It didn’t impose one until the Civil War – and then it was just a temporary tax used to fund Union forces. After that it was dropped until 1913, when Washington imposed a light income tax on the very rich.
Its scope was soon extended to the broader population because of two world wars and the Depression-era expansion of federal programs. By 1947, a respected judge, Learned Hand, would lament in exasperation that the income-tax rules “merely dance before my eyes in a meaningless procession, cross-reference to cross-reference, exception upon exception....”
The code kept growing. After concern arose in 1969 about rich people who found clever ways of avoiding taxes altogether, Congress enacted the Alternative Minimum Tax. This amounted to a new tax system layered atop the existing one. It mitigated the fairness challenge, but after a while legions of less-wealthy Americans were engulfed in dreaded AMT calculations.
By 1986, Ronald Reagan chose to mount a simplification effort. During a radio address, he recited this sentence about certain charitable organizations as a poster child of tax-law incomprehensibility: “For purposes of Paragraph (3), an organization described in Paragraph (2) shall be deemed to include an organization described in Section 501(c) (4), (5), or (6) which would be described in Paragraph (2) if it were an organization described in Section 509(a)(3).”
The goading helped, apparently. That year saw a landmark tax-reform law pass with bipartisan support. The income tax didn’t become simple (the AMT is still with us, for one thing), but it got simpler. Such major reforms haven’t happened since.
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Raj Agarwal doesn’t need to be told that the last overhaul happened 30 years ago, back when “Crocodile Dundee” was playing in movie theaters. As director of tax accounting for the firm Sempra Energy in San Diego, he’s pretty savvy when it comes to understanding all the desultory clauses of the IRS code. But even he struggles doing his own taxes.
With a house, investments, and income from a rental property, he says completing taxes for his family usually takes an entire day. And it doesn’t end there. “When it’s done I sit on it for a couple of days to verify and recheck everything” using tax software, Mr. Agarwal says.
For people who aren’t accountants, tax season is often a time to seek advice. Pludwinski, the Floridian who’s launching a website for creative collaboration called Kanvasroom, gets tax help but had to file for an extension because of his lingering question.
In Cumberland, Md., Heather Harman is a working single mother who worried that “I wasn’t going to enter the tax numbers correctly.” And she doesn’t have lots of extra money. So this year and last, she availed herself of free help available to people with incomes that qualify (through an IRS-supported program called Volunteer Income Tax Assistance).
Now Ms. Harman feels confident that she will get the child and earned-income credits she qualifies for – and not get an audit or a surprise bill from the IRS. With the volunteer’s help, she says the whole process was done in about 20 minutes.
Harman’s experience may be the exception. For many people, the process can be onerous, which means the pressure will remain on Congress to simplify the code. In the meantime, these words from an anonymous sage will continue to resonate: “For every tax problem, there is a solution which is straightforward, uncomplicated – and wrong.”
ρ Eilene Zimmerman contributed to this report from San Diego.