People's Tax Problems and Possible Solutions

Yesterday, a blogger sent me a post on "The Ten Most Famous Tax Evaders of All Times." It lists some very famous people with tax problems such as not paying their taxes timely or failing to report all of their income. The list includes Judy Garland and Abbott and Costello with problems in the early 1950s which I assume was partly due to the high tax rates at that time - 92% (!) which didn't leave much money for "ability to pay" even for high income earners (see IRS table with income tax rates over time). If you do a Google search, you'll find a few websites with information on famous people with tax problems.

So - what is the relevance of this to improving tax systems? Well, this is April 1st and we'll likely read a few stories in the papers in the next few weeks about taxpayers being sent to prison and/or paying large fines for not paying their taxes or omitting income or taking improper deductions. These stories at this time of the year help promote voluntary compliance. You can find press releases from the Tax Division of the US Department of Justice with stories about tax preparers shut down for illegal activity and serious troubles of some taxpayers.

My search for more stories of tax problems led me to an assortment of problems posted at numerous tax and finance related websites, including the following. I think all stem from the complexity of federal and state tax systems and the general public not understanding tax basics (a subject not taught in K-12 or tested on standardized tests).

• Questions about whether people owe taxes on eBay sales (you can find several websites with this question and some of the answers)
• A CPA noting that one tax problem observed with some new businesses and young people is not filing a return (!). (See Generation X Finance post and comment on "Don't Let Your Taxes Make You A Criminal" 3/23/10)
• Some states post lists of the names of those with the largest outstanding tax bills - an interesting and low-cost collection technique - public shame (for example, see the California FTB list here)

And, there is a great post from the Tax Policy Center - "The Other Individual Mandate: Tax Prep" by Howard Gleckman (3/30/10). (Also see the links in that post to recent posts by Lawrence Lokken.) They note that growing complexity of the tax law (made worse with recent health care legislation that includes numerous tax changes and mandates), causes more people to seek professional tax compliance assistance or buy tax prep software. And, as I've noted in a few articles reporting on GAO findings in various tax gap studies, error rates are not much different on returns completed by paid preparers versus those that are self-prepared. ("S Corps and the Tax Gap" (2/1/10), and "Complexity and the Tax Gap - We Just Can't Blame Cheaters" (1/16/09), and an article on California finding that self-prepared returns were more likely to report use tax than those by paid preparer)

Relevance to a 21st century tax system:

• Federal and state tax systems need to be simplified. A high error rate (or even a low one) on returns prepared by paid preparers indicates a system that is too complex. Yes, some of the errors by paid preparers are unscrupulous preparers ripping off taxpayers and the system, but there are also numerous errors by attorneys, CPAs and Enrolled Agents. A key simplification is eliminating deductions and credits in exchange for lowering the rate. Also, Congress needs to stop adding more special rules.
• Taxpayer education is needed. Something the IRS and others found in uncovering work of unscrupulous preparers is that some did not sign the return, claimed bogus deductions and omitted income. BUT - why didn't the taxpayers raise questions? Most likely, few taxpayers know that a paid preparer must sign the return and don't know how to verify when they hear things that sound too good to be true. High school civics classes should include lessons on our tax system, citizen's role, how to get tax information and the basics of how different types of taxes work.
• Tax agencies need to do even better in providing guidance by thinking of tax questions from the taxpayers' perspectives. Why does anyone have questions about whether eBay sales are taxable? This is not an obscure question and hundreds of thousands of people are likely to have it. So why not just lay out the answers simply in a flowchart on tax agency websites? Why not post ads with the flowcharts on popular websites?

Tax problems and the number of people with them - famous or not, will grow with increased complexity of the tax laws and new types of transactions for which clear and timely guidance is not provided by tax agencies. What is preventing this all from happening? Probably that not enough people are demanding it.

What do you think?