Tax and insurance

The Wall Street Journal article indicated one proposal under consideration would exempt up to 40% of Americans from having to file a tax return. After contacting the article's authors, I learned that the plan was written by Austan Goolsbee and adopted by the Obama campaign.

A few of the key points in the plan:

I have just read this over in the last couple of days, so I'm far from qualified to render an expert opinion. Still, I'll go ahead an render my inexpert one:

This seems to be a valiant effort to make the existing system more manageable for the average taxpayer. But it treats the symptoms rather than the disease. The real problem is the complicated, convoluted, mind-numbing tax law.

Rather than trying to lessen the headache of working within a broken system, let's try to fix the system itself.

The plan spells out 2 overarching goals for the next 5 years:

A few specified objectives for meeting these goals are to:

Based on what I know (which, admittedly, may not be a lot), these are my suggestions to my fellow taxpayers:

I would be very happy to see the IRS be successful in meeting the goals outlined in its Strategic Plan, as that would help the average, honest taxpayer and tax professional. It would not help the average tax cheat, which sounds good to me, since tax cheaters make my tax bill higher.

We'll see how the next 5 years go. For now, I'll just keep working to help my clients navigate the existing system, painful as it is.

Of course, I've got opinions. And I'm usually too quick to share them. In the spirit of full disclosure, I figured I'd share my philosophy on taxes. And I hope that I'm not breaking any copyright laws by stealing the idea from Tax Attorney and CPAPeter Pappas.

So that's my philosophy in a nutshell.

Back to tracking tax developments...

He began his remarks with this statement: "Let's begin with a simple premise: Nobody likes paying taxes, particularly in times of economic stress. But most Americans meet their responsibilities because they understand that it's an obligation of citizenship, necessary to pay the costs of our common defense and our mutual well-being."

Agreed!

Here are a few key statements he made:

The White House released a Fact Sheet on its plan, which provides detail on the following goals:

(1) Replacing Tax Advantages for Creating Jobs Overseas With Incentives to Create Them at Home

(2) Getting Tough on Overseas Tax Havens

We'll see how this all plays out with Congress. Here are a few links for more on the story...

The Tax Lawyer's Blog: Obama Vows to Close Foreign Tax Loopholes

CNN Money: Obama plans corporate tax crackdown

Isn't the term "tax madness" redundant?

Anyhow, this is a fun exercise for us tax geeks. Pappas asks at the end of the post: "What code section do you think is the 'greatest?' "

Being obsessed with detail as I am, I immediately thought: "Well, what do you mean by greatest? Greatest in terms of saving taxpayers money, generating tax revenue, collecting tax revenue, or another definition altogether?"

I drove my professors crazy in college, as you can imagine. ("But what do you mean by this question?" "What if this exception applies?" "What if I read it this way instead?")

Pappas suggests the greatest code section is 3402, reasoning that: "Withholding is the chief administrative mechanism enabling the federal government to collect, without significant protest, sufficient private resources to fund an ever-expanding government."

So I agree that this is the greatest section in terms of tax collection.

I'm thinking "greatest" in terms of the impact on taxpayers, whether for good or ill. And though one could argue that the withholding section has the greatest impact, my inclination would be to crown the code section that imposes the tax in the first place. In general, that's code section 61 (which Pappas named as the runner-up to 3402).

Section 61 says: "Except as otherwise provided in this subtitle gross income means all income from whatever source derived."

Everything is taxable, unless we give you a special hall pass to exclude it. Casts a pretty wide net, eh?

"A Texas restaurant owner has been sentenced to two years in jail after he was convicted of trying to bribe an IRS agent by offering her free pizza and a job."

When the agent first figured the taxpayer was offering her a bribe, she reported it.

Subsequent conversations were recorded, during which the taxpayer "offered the agent $2,500 and delivered $2,000 in exchange for having his tax liability reduced from $49,000 to around $500. In addition to financial compensation, [he] repeatedly offered the agent pizza from his restaurant as part of the deal."

If she had taken the bribe, that could have led to one heck of an advertising campaign: "Our pizza is so good, people will destroy their careers and go to jail to get it!"

Unfortunately for the owner, I guess the pizza just wasn't good enough.

But hey, at least this guy didn't try to have the agent killed by a hit man named Reaper.

I hope to read more later. Thanks to all the bloggers tracking the news for me!

The connection I see is one of the unfortunate but very real facts of life: We cannot change people's motivation for behavior. 

We can regulate behavior, but not motivation. We can educate, discuss, persuade, encourage... but when all is said and done, people can only be changed by themselves.

Here's how this relates to the above blog posts...

I don't think bigger government and higher taxes are the answer, but I'm afraid I don't know what the answer is. Ideally, everyone could agree on some clear goals for American citizens, which might include acting ethically, being healthy, and living within our means. But it's impossible to get millions of people to sit around the table and figure it out, so until then we're stuck trying to regulate behavior.

I figured I'd still come the to party, even though it may mean receiving disdainful looks from those wondering why I'm so slow. So here's my take on the specific issue of tax preparer regulation:

One of my pet peeves (and goodness, there are many) is when a person repeatedly talks about problems but never suggests solutions. Granted, I am always pointing out problems (much to the challenge of co-workers), but all the while strive to find solutions.

Going back and reading my previous post, "Why Regulation Won't Work," I now kick myself for doing just that which I detest -- discussing the problem but not possible solutions. Doh! Let's see if I can get back in my own good graces.

So regulation won't solve our problems. That's simply a fact of life. In all aspects of life, we have a gap between the ideal and the reality. The issue, then, is how to minimize the size of the gap. We must have law and order if we are to avoid anarchy.

A couple of concepts from Economics 101 come into play here. First, we must deal with externalities, both benefits (such as public safety) and costs (such as pollution). And second, we have limited resources.

How do we deal with it? We must decide whether to use our scarce resources to affect an externality, be it public safety, education, law enforcement, whatever.

I'd argue that tax evasion itself is an externality. Most people would not comply with tax law if society did not dedicate resources to its enforecement. Few people argue that we do not need laws or regulations. Rather, the argument centers on the method and extent of regulation.

I think those involved in this debate agree on several things, such as:

If we all agree on those points, then the key issue is: Would the benefits of regulating unlicensed preparers justify the resources required to do it?

I'm inclined to say no. In my experience, government (and the IRS in particular) does not operate efficiently.

Maybe I'm wrong, and someone will present to us a beautiful, inexpensive, efficient system to regulate preparers. If that happens, I will gladly eat my words. But until them, I'd rather the IRS spend its scarce resources on other things.

First, I must say it's great to have experts talk openly about what will and will not get the attention of the IRS. I am much newer to the profession than the tax bloggers, so I value the information they share about "the real world." After all, the IRS isn't going to teach me about the realities of enforcement. During a recent radio show, an IRS representative told a caller that he should, in fact, amend his tax return because he received a 1099 that increase his tax by $40. Hmm... thanks IRS, but I think I'll read what the bloggers have to say.

So Peter Pappas began the debate (perhaps inadvertently) with his post titled 5 Slam Dunk IRS Audit Red Flags. Robert Flachposted a commentary, and the debate ensued.

As usual, I agree with both of them on several issues. And I think they too agree on several key points. The IRS is more likely to scrutinize returns with these five deductions, simply because returns with these deductions are more likely to have error or fraud. It's about probability, and don't we tax preparers love math?

I did not anticipate the change in the debate's focus, which became that of whether a return prepared by a CPA is less likely to have errors than a return prepared by a non-CPA.

Robert is correct that a CPA is not specifically licensed for tax preparation, rather "a CPA is a licensed accountant, authorized to certify audits of financial statements." Just a couple of months ago, I was pondering this exact issue. I was thinking about all the fancy credentials the AICPA offers for CPAs in other specialties - financial planning, fraud examination, business valuation - and wondering how to become a certified tax expert.

So I emailed the AICPA asking about it. Here's the exact wording of the response I received:

"We do not offer a credential in taxation. In general, our approach has been not to develop credential programs around areas for which the public already believes CPAs to 'own'. In addition, we do not endorse a particular tax credential."

And so we CPAs specializing in tax find ourselves in a bit of a quandary. Our CPA designation does not by itself qualify us as tax experts, but there is not another designation available that does. 

And now we arrive back at our original issue of debate, that of tax preparer regulation. Is anyone else getting dizzy?

Before responding, I should point out that both Mr. Flach and Mr. Pappas are more qualified to answer these questions, considering they have been in the professional far longer than I. (Mr. Flach has been preparing returns longer than I've been alive, which is impressive to say the least.)

So if anyone decides to stop here, that's really understandable.

On to the questions at hand...

(1) Yes, I do think that, by claiming one of these deductions, a taxpayer increases his/her chance of an audit. I hesitate to say whether the increase is "substantial," as I have limited knowledge of IRS enforcement statistics. (Learning more about them is on my to-do list.) These areas are more likely to have error or fraud, the IRS focuses its efforts on areas especially susceptible to error and fraud; ergo, returns with these items are statistically more likely to be examined.

(2) I am not likely to recommend that a client not claim a legitimate and documented deduction because it would increase his/her chances of an audit. Like Flach, "I do not believe that one should be scared off from claiming legitimate deductions for fear of being audited."

In a perfect world, honest taxpayers would not be subjected to the time, expense, and stress of an audit. They would claim just those expenses and credits to which they are legally entitled, avoid examination, and keep on being honest.

We all know the world isn't perfect, and that honest taxpayers will continue to be audited along with the cheats. And so taxpayers must address the question: If I claim this tax benefit, my risk of audit will increase -- Is the benefit work the risk?

I suppose we could create a risk/reward mathematical equation using IRS statistical audit data. (Hmmm... summer project? Anyone know where I could get good IRS stats?)

I suppose my risk/reward idea is similar to Mr. Pappas' suggested cost/benefit analysis: "What is the comparative value of the deduction? Taxpayers should weigh the benefit of the deduction against the costs (monetary and psychological) that would be involved should the deduction trigger an audit."

I'll wrap up this post with a feeble attempt at an analogy.

I'm going on road trip, and have identified the fastest, most efficient route. Partway into the journey, I hear on the radio that there is a roadblock checking for drugs on my route. I consider my options.

I can't see the future, so I just have to make the best decision I can with the information available. Several things would influence my decision, such as:

So do I take the safe option and avoid the roadblock, and lose the benefits of a quicker trip? 

Do I fail to claim legitimate Schedule C expenses, in the hope of decreasing the chance of IRS audit? 

In my practice, I generally encourage clients to claim all legitimate deductions and credits, and inform them of the audit risk. 

Nothing too exciting, but there you have my 2 cents.