Frustration with the federal tax system

Each week I receive a few emails from bloggers, people with tax reform proposals they'd like me to review as well as requests that are disguised advertising requests.  One I received recently from a blogger whose blog and website stems from the frustration with the tax system that so many people (perhaps everyone) feels. (more on this website and blog in a moment)

The tax law is too complex. In a recent presentation on tax policy and complexity, I asked the audience of tax practitioners if they could easily answer the following questions:

• College student with a job: Is he a dependent? Is he subject to the kiddie tax if he also has unearned income? If entitled to any higher education credit or deduction, does he claim it or do his parents? Could he be eligible for the EITC?
• How much first year depreciation is available on: (a) Computer purchased by a sole proprietor? (b) Self-constructed asset of a Fortune 500 company? (c) Off-the-shelf software? (d) Passenger automobile weighing < 6,000 pounds (e) Passenger automobile weighing > 6,000 pounds.
• How to source income from customer use of software in the cloud if the server is in Ireland and customers are in every state; company is headquartered in Nevada?

It is unfortunate that these questions cannot be readily answered. Of course, experienced tax practitioners can reason them out, identify the issues and research the answers, but these are not unusual fact patterns. The challenge in answering them without research is that there are so many rules including ones that work together and those that do not, as well as many that are temporary or expired but might be retroactively renewed.

The website and blog that I found intriguing is one by a scientist and lawyer (not a tax lawyer) whose frustration with the complexity of the tax law led him to highlight the causes of his frustration on a website. The website is http://sunsettheirs.org/.  I pointed out to the author that the complexity is not due to the IRS, but Congress. The website and blogger, Mr. Holland, agrees.

The website has some good links into examples of the complexity and problems. I applaud him in trying to get more people to understand the complexity and that it can be avoided. An income tax does not need to be complex. Fewer special rules would help. Removal of most special deductions, exemptions and credits would also allow for a lower rate which would also help.  Personally, I think we should aim for a return to the Tax Reform Act of 1986 with some modifications such as no unicap (Section 263A) for inventory, a territorial system, reduced mortgage interest deductions and no AMT. Under TRA 1986, capital gains and ordinary income were taxed at the same rates which allows for simplicity (the maximum rate for individuals was 28%).

Mr. Holland's website and blog also call for repeal the law, then reform. He is not alone on that. H.R. 462 (112th Congress) calls for the same thing. The sponsor, Congressman Goodlatte, has introduced such legislation before. I think he is also trying to call attention to the reality that an income tax does not have to be complex and that ours has become so complex that it might just be easier to write a new income tax than try to fix the current one (see sponsor press release of 2/1/11). Per H.R. 462, the "new Federal tax system should be a simple and fair system that--

(1) applies a low rate to all Americans;

(2) provides tax relief for working Americans;

(3) protects the rights of taxpayers and reduces tax collection abuses;

(4) eliminates the bias against savings and investment;

(5) promotes economic growth and job creation; and

(6) does not penalize marriage or families.

That is all vague and likely has too many interpretations to work. I'd like to see more specifics and more principles rather than "provides tax relief for working Americans" (is that a payroll tax cut, shoring up of Social Security so young people can expect they will receive it someday, or something else?).

We all need to exercise leadership in fixing our tax law. Mr. Holland is helping more people understand the weaknesses in our tax system. Good for him!  We can all help by asking elected officials promoting new tax breaks why they think they are needed, how they will be paid for and why they won't work to broaden the base and lower the rate (or keep the current low rates past 2012).

For good examples of the complexity, check out the links (mostly to Wall Street Journal articles and government reports) on http://sunsettheirs.org/. 

What do you think?

Excerpt from 2008 National Taxpayer Advocate Report to Congress - http://www.irs.gov/pub/irs-utl/08_tas_arc_intro_toc_msp.pdf