Sweeping tax legislation enacted in 2017 implemented many changes affecting the average taxpayer, including a lowering of rates, increasing the standard deduction and limiting the deductibility of mortgages and state and local taxes. Each taxpayer’s situation is different, but for the millions of additional taxpayers who will no longer need to itemize, tax returns should be simpler. Nevertheless, for millions of households, tax compliance remains complicated, especially for taxpayers living in non-traditional family arrangements, who may be eligible for refundable credits like the Earned Income Tax Credit and the Child Care credits. This is true not only because of the underlying complexity of the tax code, and the complexity of documenting eligibility, but, increasingly, because of the changing nature of work and make-up of the American family for many households.
Simply put, a great deal of the tax code was designed and written for traditional, two-parent married households with clearly defined dependents, deductions, and credits, that were common many decades ago. Yet, in a 2016 study titled “Increasing Family and Complexity Volatility: The Difficulty in Determining Child Tax Benefits,” researchers Elaine Maag, H. Elizabeth Peters and Sara Edelstein of the Tax Policy Center document how changing family dynamics have significant consequences at tax time. Their research remains a must-read for anyone who cares about tax policy and believes we need to further simplify and reform the tax code.
Among their findings, Maag, Peters, and Edelstein reported that about 40 percent of all births in the United States now occur outside of marriage, including many households where there are two unwed parents living together. They also found that modern divorces have resulted in millions more children living in complex custody arrangements that often change during or between tax years. In addition to parental custody arrangements, they reported that many children are also living, either temporarily or permanently, with caretakers other than their birth parents, or with multiple generations of family members, including grandparents who raise grandchildren.
“In some cases, tax filing may be complicated because rules that simplify who can legally claim a child do not clarify who should optimally claim the child,” Maag, Peters and Edelstein found. “For example, if cohabiting biological parents of two children live together, it may be beneficial for one parent to claim both children or for each parent to claim one child (depending on each parent’s income). So long as the parents agree, they are legally allowed to divide the children as they wish. However, calculating which division of children produces the lowest total tax liability for the couple may be difficult, or cohabiting parents may simply choose not to file in a manner that produces the lowest tax liability.”
For taxpayers who find themselves in these situations, the challenge is two-fold. On the one hand, it can be a struggle to produce an accurate tax return each year and, on the other hand, their ability to take full advantage of vitally important tax credits can be jeopardized.
The Earned Income Tax Credit, or EITC, is a good example.
For more than 40 years, the EITC has provided federal tax relief and assistance to more than 25 million families each year who earn a paycheck but still struggle to make ends meet, including many of the enlisted men and women serving in our military. For most recipients, their EITC tax refund is the single largest check they receive each year, providing them with money they count on to help meet essential household expenses, pay down debt, fund education, forestall eviction or repossession, or, in some cases, establish a small savings account and rainy day fund.
Taxpayers claiming the EITC must demonstrate they worked, earned a certain amount of money, and, if claiming qualifying children, meet specific tests around where they lived, with whom and for how long. Providing adequate factual records to enable accurate answers to those questions can be a challenge. For the millions who held several different jobs, and who shared custody or responsibility for their dependents during the course of the year, the government has no reliable method to electronically verify their circumstances.
As Maag, Peters, and Edelstein conclude: “Complex tax rules likely stem from a desire to limit program costs while ensuring that limited resources are directed at the most needy or most deserving beneficiaries…” From a policy perspective, that makes perfect sense. At the same time, however, these same findings should raise a cautionary note about the common misperception that lower-income taxpayers have simple returns, for which Government already has all the information necessary to accurately determine their tax liability or tax benefit. In fact, the converse is true, that only the individual tax filer can accurately make claims for these types of refundable tax benefits, and focus of future tax reform ought to be on further simplifying the tax compliance regulatory requirements for the average taxpayer.
As noted above, recent tax reforms reduced the number of taxpayers who have to itemize deductions on their tax returns. But many other opportunities still remain for tax simplification reform. That work should start by recognizing that both tax compliance and tax benefits are often the most complicated for the millions of lower and middle-income Americans who find themselves in non-traditional family arrangements and work in non-traditional employment structures in the 21st century economy.
Continued modernization of the tax code, and implementing tax regulatory requirements, must recognize the real-world societal and economic evolution that has taken place over the last half of the 20th century, and is continuing and accelerating now in the 21st century.