Practitioners and industry observers concur with the call by Taxpayer Advocate Nina E. Olson for tax simplification.Although legislation calls for the Taxpayer Advocate to list at least 20 of the most serious problems facing taxpayers, Olson went a step further and included a major section on tax simplification.
"More than anything else, this year's report is a call for tax reform," Olson said.
The complexity of the tax code is a major stumbling block in the attempt by the Internal Revenue Service to provide quality tax service, she told Congress in the first of this year's two required reports. She said that the code has grown so complex that it creates opportunities for taxpayers to make inadvertent mistakes, as well as to game the system, and leads to ever increasing complexity.
"As taxpayers become confused and make mistakes, or deliberately 'push the envelope,' the IRS understandably responds with increased enforcement actions," she said. "The exploitation of loopholes leads to calls for new legislation to crack down on abuses, which in turn makes the tax law more complex. Thus begins an endless cycle - complexity drives inadvertent error and fraud, which drive increased enforcement or new legislation, which drives additional complexity."
"In short," she said, "complexity begets more complexity. This cycle can only be broken by tax simplification, followed by ongoing legislative and administrative discipline to avoid subsequent 'complexity creep.'"
In what she described as a taxpayer-centric approach to tax reform, Olson listed six core principles to guide tax code revision:
* It should not entrap taxpayers.
* It should be simple enough so that taxpayers can prepare their own returns without professional help, simple enough so that taxpayers can compute their tax liabilities on a single form, and simple enough so that IRS telephone assistors can fully and accurately answer taxpayers' questions.
* It should be written in a way that anticipates the largest areas of noncompliance and minimizes the opportunities for such noncompliance.
* It should provide some choices, but not too many.
* It should not necessarily avoid refundable credits but, if it includes them, it should design them in a way that is administrable.
* It should require a periodic review of its provisions - in short, a sanity check.
Tax pros agree
"The tax code is extremely complex," agreed Paul Cinquemani, director of government relations with the Appleton, Wis.-based National Association of Tax Professionals.
"Taxpayers should approach tax returns with care," Cinquemani said. "A great many who use software to do their own returns believe that is the answer. But in so many cases, the questions the software program asks require knowledge of the code to answer."
"The most common errors result from not understanding the questions asked by the software program, from entering amounts in the wrong places, or not entering some amounts at all, and from not knowing if the software is calculating correctly or capturing all of the information to give the taxpayer the correct outcome," he added.
"Calculations are based on the answers taxpayers give to the online questions," said Pulaski, Tenn., tax preparer Thomas Raines. "This doesn't make the tax return accurate - only the calculations."
"She's right on target with her core principles," said E. Martin Davidoff, tax liaison chair with the American Association of Attorney-CPAs. "Taxpayers should have some, but not too many, choices. The pension arena is a good example. There are too many choices of plans. The same is true of education. Here there are two different credits, as well as various deductions for the same purpose."
"In the ideal world, the return should be simple enough for the taxpayer to compute without help. We're never going to get there, but we can move toward it," said Davidoff.
"Common sense should be the key," he added. "When Congress looks to change the revenue, it should have the courage to change the rates and not how the tax law operates. If they need more money they eliminate a deduction or find something else to tax or change the timing - wouldn't it be simpler to just change the rate? If they want simplicity, they have to decide to raise revenue not with smoke and mirrors, but with a change in the rates."
To be sure, acceptance of Olson's core principles is not universal among tax reform advocates. "All of her principles have to do with the way the code interfaces with the taxpayer," said Tom Giovanetti, chief executive of the Lewisville, Tex.-based Institute for Policy Innovation.
"I would argue that it's the wrong approach," he said. "The core principles ought to address the tax base itself. You could fulfill all of her six core principles and still have a horrible tax code. The goal should be to stimulate economic growth."
"While most reformers talk about simplicity, they come at it from the economic standpoint. They have an economic angle, rather than taxpayer convenience in mind," he said. "The biggest concern is, do we want a tax code that encourages growth and does not harm the economy? The current code harms the economy. By taxing the correct tax base, you eliminate noncompliance."
Meanwhile, Olson listed 21 new areas that she considered the most serious problems, including the cash economy tax gap, an apparent reversal in the trend toward increased taxpayer service, and the freeze on hundreds of thousands of refund claims each year by the Criminal Investigation function.
The cash economy is probably the largest single component of the tax gap, according to Olson. "It may exceed $100 billion per year," she said. "Because income from the cash economy is not subject to information reporting, many of the IRS's traditional means of enforcement are unlikely to be effective in addressing it."
"No single function coordinates research, outreach and compliance initiatives aimed at improving reporting compliance among cash economy participants," she said. "Nor does the IRS give these initiatives the same level of attention as other initiatives, such as those addressing tax shelters or the Earned Income Tax Credit. The IRS must develop a comprehensive strategy for addressing the cash economy if it is to significantly reduce the tax gap."
"The IRS audits address tax shelters," said Davidoff. "They're not giving the same level of attention to the cash economy."
"They're doing a more comprehensive job at the state level. Look at liquor stores in New Jersey," he said. "All purchases are reported to the state, and the state audits them. Eighty percent of liquor stores have been audited over the last 10 years in New Jersey."
"It comes back to Congress - if Congress gave the IRS the money to do these things, we'd all be paying less taxes," he said.
Olson noted that the IRS has eliminated TeleFile, reduced the number of returns that personnel prepare for taxpayers who seek assistance, reduced the percentage of taxpayer calls that telephone assisters answer, and substantially reduced its taxpayer education function for small businesses.
"Significantly, these actions are taking place without any empirical evidence that the reductions will not harm taxpayers and not result in decreased compliance," Olson wrote. "Too much is at stake not to conduct the appropriate research and develop cutting-edge strategies that will provide world-class taxpayer service."
Olson placed Criminal Investigation refund freezes near the top of the list of most serious problems facing taxpayers. She said that CI places freezes on hundreds of thousands of refunds each year due to suspicion of fraud, and then makes a determination whether the returns are, in fact, fraudulent without notifying taxpayers that their refunds are under review or giving them an opportunity to present evidence supporting their positions.
"When TAS assisted the taxpayers, CI ultimately agreed to issue the full refund claimed (or more) in 66 percent of the decided cases and to issue a partial refund in an additional 14 percent or the decided cases," she said. "Thus, taxpayers received a full or partial refund in 80 percent of frozen-refund cases brought to TAS."
She recommended that the IRS develop procedures to notify taxpayers that their refunds have been frozen, provide them with an opportunity to submit documentation, and bring cases to a quicker resolution.
Olson also critiqued the accessibility of e-Services for tax practitioners. She charged that the IRS uses e-Services as a reward and incentive for e-filing, rather than addressing it from a customer-service perspective. The Web-based e-Services suite is currently available only to practitioners who are active participants in the e-file program and electronically file five or more accepted individual income tax returns in a season.
"This policy of limiting access to e-Services deprives many highly trained and experienced tax practitioners of an extremely useful and efficient tool," Olson said.
"This makes a lot of sense," agreed Davidoff. "Our group [the American Association of Attorney-CPAs] needs greater access to e-Services, but many members don't file returns and can't get into it. We suggest that whenever the IRS sends a notice, they also send a transcript - don't wait for a request, just send it along with the notice."
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