With the April 18 tax filing deadline just hours away, you might assume that the very wealthy and those with diverse investment portfolios are likely to have the most complicated tax returns. And that those with smaller incomes and a more straightforward financial situation have a pretty simple time of it. But in many cases, you’d be wrong. In fact, millions of low- and moderate-income taxpayers struggle mightily with the complexities of compliance with the tax code at tax time.
The problem facing many of these hard-working wage earners is simple: The makeup of the American family and household are evolving, and our tax code has failed to keep pace with society’s new dynamics. Those are among the findings of a recent study by Elaine Maag, H. Elizabeth Peters and Sara Edelstein of the Tax Policy Center. Their paper is a must-read for anyone who cares about tax policy and believes we need to simplify and reform our tax codes (http://tpc.io/205osO4).
Our tax code was designed and written for traditional, two-parent married households with clearly defined dependents, deductions and credits. Yet as Maag, Peters and Edelstein found, about 40 percent of all births in the United States now occur outside of marriage. Some children are born to parents who live together, while many are born to single mothers.
Divorce is another factor, with millions more children living in complex custody arrangements that often change during or between tax years. Finally, in a smaller but still significant number of households, many children also live – either temporarily or permanently – with relatives other than their birth parents, or with multiple generations of family members. Grandparents are increasingly raising their grandchildren.
The profound complexity of the tax code only adds to the complexity of the American family.
“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.”
The resultant problems for taxpayers in these situations are two-fold: They struggle to produce an accurate tax return each year, and their ability to take full advantage of vitally important tax credits is jeopardized.
The Earned Income Tax Credit, or EITC, is a good example.
For 40 years, the EITC has provided federal tax relief and assistance to millions of working American families who earn a paycheck but still struggle to make ends meet, including many men and women serving in the military. For most recipients, their 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, if very fortunate, establish a small savings account or rainy day fund.
Taxpayers claiming the EITC must demonstrate they worked, earned a certain amount of money, and lived with one or more dependents. While that may sound simple, providing accurate answers to those questions can prove daunting. For the millions who held several different jobs and shared custody or responsibility for their dependents during the course of the year, there are no reliable, third-party method methods to electronically verify their claim.
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…”
Their research validates the challenges facing many low- to moderate-income families. It also supports Intuit’s longstanding conclusion, based on experience with millions of taxpayers, that the current tax code is both overly complicated and out-of-date with the changes that have taken place in our society as well as our economy. For the same reasons, policymakers should recognize that these families do not have simple tax returns and, in fact, live in circumstances that complicate their tax returns, often significantly.
Fortunately, taxpayers do not have to navigate these complexities alone. The Volunteer Income Tax Assistance program and the Internal Revenue Service’s Free File program are available to help them comply with their tax compliance obligations. But more than free tax services is necessary. Meaningful tax simplification reform would go a long way to helping these hard-working families.
The tax code was written with every good intention of limiting costs and strengthening the tax system by reducing the likelihood of errors and fraud. But the research from Maag, Peters and Edelstein leads to an inevitable conclusion: Making it even more difficult to claim certain tax credits would not help the millions of low- and moderate-income families already challenged by a complex and often unintelligible tax code. For the American family and household, real improvement in our tax system must include tax simplification reform. It is an essential part of empowering the average American taxpayer to take charge of understanding and managing their financial lives.
To promote an informed dialogue on tax policy and tax reform, the Intuit Financial Freedom Foundation provides general financial support to the work of the Tax Policy Center and other leading tax policy experts.