In our “Money Mic” series, we hand over the podium to someone with a strong opinion on a financial topic. These are their views, not ours, but we welcome your responses.
Today, Gary Craig, CPA, explains why he believes the tax code should be changed, and how.
As a CPA with my own boutique tax firm, I know the ins and outs of the tax code and the features that make it confusing, expensive and time-consuming.
For a wide group of taxpayers, tax reporting is already inordinately complicated. If you have a full-time job, a little bit of investment interest and dividends, and own your home, I don’t think you should have to buy specialized tax software every year or hire someone to do your taxes. Yet most people with that kind of relatively simple tax situation find themselves shelling out $300-400 each year for an accountant, lest they mess up or face a penalty.
And let’s not even mention more complex tax situations.
Last month, the national taxpayer advocate Nina E. Olson reported to Congress that individuals and businesses spend about 6.1 billion hours a year complying with tax-filing requirements. That’s the workload of more than three million full-time workers, which is more than the number of workers on the federal government payroll.
Just before Olson's report, Congress passed new tax laws that will make the tax code even more complicated.
Get started with a free financial assessment.
Get started with a free financial assessment.
Although I don't present a comprehensive solution in this article, I do believe my proposals, based on experience with clients, could go a long way toward making taxes easier and less costly for many Americans.
To Give You a Sense of How Complex Our Tax Code Is ...
The biggest example of the tax code’s complexity is the Alternative Minimum Tax, which was implemented in 1969 to ensure that the wealthy, who have access to fancy tax shelters, pay their fair share of taxes. But it doesn’t always accomplish that goal: In 2011, 42% of millionaires paid it, while 52% of those making between $200,000 and $500,000 did.
The AMT is very complex. In a nutshell, it's an alternative way of calculating income that removes some of the deductions that normally lower your taxes. If your AMT taxable income is higher than your regular taxable income, you have to pay the AMT. Complicated, right?
Need Help With Taxes?
We have straightforward tax advice in our Ace Your Taxes bootcamp. Sign Up For Free
Taxes aren't just complicated for the wealthy, either: At the end of 2012, the government created two more tax rates for capital gains, two more tax brackets, and started limiting deductions you can take in interest and property taxes as you make more money.
Long story, short? There are a ton of variables that make paying taxes way harder than simply calculating a percent of your income.
How the Tax Code Impacts Real Lives
I have a client who is approaching 90 and receiving a pension distribution. Depending on when she retired, she could have owed no taxes on this income, partial taxes or full taxes. It's very important that she and other older folks living on a fixed income see a CPA.
After reading a rather vaguely reported tax form, this client’s daughter misunderstood and told her mother she didn’t owe taxes for three years. Well, the government labeled my 85-year-old client a tax evader and fined her $5,000. She only makes $10,000 a year.
Here are some suggestions to make the tax code clearer and fairer:
1. Eliminate the AMT
There are other ways to make sure the wealthy pay their fair share of taxes. The AMT isn't really necessary, and it's unnecessarily confusing. Not to mention that it increasingly hurts the middle class. The original legislation that created the AMT didn't account for inflation, so it has gradually ensnared more of the middle class. In 1970, only about 20,000 people paid the AMT; 4 million paid it in 2011.
Last month, Congress passed a law indexing the AMT to inflation, but I believe it will still envelop more taxpayers over time. Just look at history: Congress has repeatedly "patched" the AMT to try to prevent this "creep" that keeps enveloping middle class taxpayers, and yet look at the ever-growing numbers!
I think it's better to get rid of the AMT entirely and simply make tax brackets that are transparent.
2. Cut Deductions and Phaseouts
Another easy way to simplify the tax code would be to cut a number of deductions and phase-outs (rules limiting how much you can deduct after you reach certain income thresholds). Getting rid of deductions would reduce tax perks we enjoy, so to make up for it, we could just decrease the income tax rate.
Many of these deductions make people’s tax returns more complicated without necessarily adding value. Cutting down on deductions would also ask the wealthy to pay more in taxes directly. Right now, a lot of people don’t actually know their tax rate. I’ve heard clients who are in the 39% tax bracket rant and rave about paying 39% of their income to taxes. But I know their tax returns inside out, and they're really paying more like 28% after deductions.
It would be good for all of us to have a better understanding of what we really pay.
For instance, I would cut out, or at least simplify, deductions for:
- Medical care you pay for
- DMV fees
- Gambling losses
- Investment margins, which allows day traders who trade on margin to write off the margin interest on their brokerage accounts
- Tax fees to CPAs
- Mortgage interest (though I know this proposal isn’t going to be popular, one can argue that this deduction artificially inflates home prices and mortgage rates—sellers can inflate their price tags somewhat, knowing that buyers are mentally calculating their savings come tax time)
- Property taxes
3. Make It Easier to File
This has nothing to do with the tax code itself, but the process of filing. Since I run a boutique tax company, I have tax software (UltraTax or Prosystem fx) that allows me to scan a W-2, mortgage interest form (1098) and a property tax statement. In some cases, with almost no manipulation, the software will spit out an accurate return.
[lv_share_bricks]Since this technology exists, why can’t we have kiosks at libraries and malls that allow people to input this information so they don’t have to pay anyone to do their taxes at all? It would be an easy way to get people to file for free.
The IRS has a free file program that works with the major consumer tax software producers like TurboTax and H&R Block to file your taxes for free if you make $57,000 or less. But free tax services shouldn't be based on how much money you make. They should be based on how simple or complicated your individual situation is.
A Step in the Right Direction
The government did take one step toward simplifying the tax code this year with the home office deduction. Previously, you had to complete a 43-line form, calculating allocated expenses and depreciation, among other things. Now, if you qualify, it’s $5 per square foot for up to 300 square feet. That's much easier, and most importantly, it will make things simpler for the more than 14 million small businesses based in the home.
For my clients, I will always advocate every legal and accurate mechanism I can find in the tax code to reduce their tax burden. This is my passion. But for most Americans who aren’t accountants, it should be easy to pay one’s fair share. Plain and simple.
Gary Craig is a certified public accountant and the owner of Craig & Associates, LLP, a tax firm in Orange, CA.