Definitions for the same or similar terms such as “income,” “small business” and “disabled” can differ across various tax provisions and policy objectives, according to a new government report.
The report, from the Government Accountability Office, examined some of the differences in definitions and rules in the Tax Code.
“The federal tax system contains complex rules and multiple definitions for the same or similar terms,” said the GAO. “These rules and definitions may be necessary to target benefits to specific groups of taxpayers, among other reasons. However, different rules and definitions can also impose a wide range of recordkeeping, planning, computational, and filing requirements upon individual taxpayers. Complying with these requirements costs taxpayers time and money.”
Administering the complex tax rules can also strain the Internal Revenue Service's ability to serve taxpayers because of the resources needed to develop guidance, clarify instructions, or address misreporting.
The report addressed several ways in which the Tax Code provided varying definitions and rules. At least a dozen different Tax Code sections modify adjusted gross income (AGI) as part of determining the tax consequences of a particular provision. Depending on the section of the Tax Code, modified adjusted gross income (MAGI) is determined by incorporating as few as one and as many as nine modifications.
For example, for purposes of the adoption tax credit, among others, MAGI is computed by adding back the following income excluded from AGI: foreign earned income; income from American Samoa, Guam, and the Commonwealth of the Northern Mariana Islands; and income from Puerto Rico.
The definition of “small business” can differ based on the number of employees, amount of gross receipts, and other characteristics, the GAO pointed out. For example, under the Patient Protection and Affordable Care Act, a small business must have 25 or fewer full-time equivalent employees, among other requirements, to claim a certain tax credit, but to be eligible for a Savings Incentive Match Plan for Employees Individual Retirement Arrangement, a business must have 100 or fewer employees, among other requirements.
“Small business” is also defined differently depending on whether a taxpayer is claiming a gain or a loss for a small business stock. If the taxpayer is claiming a gain, the qualified small business is defined by gross assets. If a taxpayer is claiming a loss, the small business is defined by amount of equity capital.
The definition of “disabled” also varies across the Tax Code, the GAO noted. All the definitions include the inability to engage in some activity, but definitions differ by duration of impairment, whether proof of disability is required, what type of activity is limited, and whether income replacement benefits are received.
Rules and definitions for the same or similar terms can also vary among tax provisions with similar policy objectives, such as child-related tax benefits, education tax benefits and retirement savings benefits.
“Navigating the number of child-related tax benefits can make it challenging and time-consuming for taxpayers to determine how to claim each benefit, especially since families can receive multiple benefits in one year,” said the GAO. “This is burdensome because each benefit is governed by slightly different eligibility definitions, rules, and calculations.”
For example, each benefit is phased out in a different range and at a different rate, the GAO pointed out. Many of the benefits require multiple calculations, and each defines an eligible child using a different combination of age, residency and relationship requirements.
The Tax Code also includes at least 11 different provisions benefiting taxpayers with educational expenses. All of these provisions encourage educational investment, and most help offset expenses for tuition and fees. However, the rules determining eligibility for these benefits differ by income qualifications, eligible expenses, educational institution and education level, according to the GAO.
In addition, the Tax Code offers at least half a dozen tax-favored retirement savings incentives. All these incentives encourage taxpayers to save money for retirement and have age distribution requirements. However, they also have different rules for contribution limits, contribution method, timing of distributions, taxation of withdrawals, and loan allowance.
The GAO made no recommendations in the report, but pointed out that while simplification of definitions and rules can have benefits, some differences will always be required to appropriately target tax policy goals.