"If the true instances of taxpayer abuse were ever known, the public would be appalled. … If the public also ever knew the number of abuses covered up by the IRS, there would be a tax revolt."
Senate testimony by an IRS collection agent. September 1997
As the Senate Hearings televised to the world, the IRS is completely out-of-control. When it deals with the taxpaying public, it is arrogant, abusive and often a law-breaker. There is two-fold problem: (1) A tax code that is incomprehensible, thanks to Congress who is responsible for writing the law; and (2) a dysfunctional IRS bureaucracy charged with applying the tax code, then collecting taxes due.
Unfortunately, for most people, the IRS is judge, jury, prosecutor and executioner. If the IRS says you owe taxes, whether it is true or not, your life may become a living hell. It will, without providing any warning, seize bank accounts, levy wages, go after ex-spouses and current spouses of the taxpayer, even though they do not owe taxes.
The President and Congress talk about fixing the IRS, but their discussions involve tinkering with the bureaucratic structure. There is little talk about changing the tax code and the collection system to make the process smoother, fairer and more rational.
There is one major problem with the current tax code -- Congress. It has usurped the tax code’s traditional function of raising taxes and has used it as a mechanism to extract and extort campaign funds from special interests. Congress routinely sells tax breaks for campaign dollars. By doing so, it creates hundreds of unnecessary tax provisions designed to either reward or punish some special interest group. Often, to "pay" for a tax break given to special interests, Congress will enact complex accounting changes and penalties that burden millions of taxpayers.
Note: To date, only the Republican party has pressed for a flat tax. The most widely-know proposal is the Forbes flat tax. The Republicans introduced a bill in Congress for a flat tax and it is that proposal (generally, 20% tax for the first 3 years and 17% thereafter, with no taxes on capital gains, dividends, interest, and no estate or gift taxes) which is hereafter referred to as the "Republican flat tax proposal."
If the tax code were governed by broad economic principles, rather than politicians’ insatiable appetite for money, then we’d have a saner, more rational tax code that treated taxpayers more fairly and equitably. Also, the tax code is complex because it taxes a $5 trillion-a-year economy with millions of businesses and individual taxpayers. The tax code is necessarily complicated because our economic system is intricate and sophisticated. A simple approach, such as the Republican flat tax proposal, cannot work without causing massive disruption in the current economic system and unduly benefiting wealthy taxpayers at the expense of everyone else. [See the following articles regarding the flat tax and other radical tax proposals and why they won’t work: Hot Topics - March 1996 - Wealthy Slackers Relief Act ; Hot Topics - September 1995 - Flat Tax Reconsidered ; Hot Topics - April 1995 - How About a Flat Tax? ; and Publications - Radical Tax Reform Proposals ]
Although the tax code is a mess, it should be noted that most people never directly deal with its complicated provisions. Many taxpayers file a simple Form 1040 EZ, listing their wages and interest income. Even those with complicated tax situations can purchase computer software for under $75 that will calculate their taxes. These taxpayers can engage in endless "what-if" scenarios to lower their tax bite. If those with complex taxes can’t be bothered, there is an army of tax preparers, accountants and tax attorneys willing to assist them for an appropriate fee.
The following proposal, while not perfect, simplifies the current tax system without significantly raising or lowering the current tax burden on any one group of taxpayers as a whole. It retains the current progressive tax system, but combines the best elements of the flat tax. Just as important and unlike the Republican flat tax proposal, it would not cause massive disruptions in the economy.
Step One: All income that is taxable under the current system remains taxable. Unlike the Republican’s flat tax proposals, capital gains, interest and dividend income remain taxable. Municipal bond interest continues its tax-free status. Capital gains and capital losses would be netted, but the net gain would be taxed as ordinary income. Capital losses would be carried forward as under current law.
Comment: This approach does not favor one type of income over another. It eliminates all the current income limitations, phase-outs of benefits, passive activities, investment activities and other distinctions between income, targeted tax benefits, and alternative minimum tax and capital gains tax complications. Either everyone gets the same tax break or no one does.
The Republican’s flat tax proposal is an absolute gift to the rich. [See: Hot Topics - March 1996 - Wealthy Slackers Relief Act ]. It is not necessary to give the rich a free pass with respect to investment income and gains to increase national savings and investment. Savings and investment can be easily increased by making IRA and Roth IRA type investment incentives available to all taxpayers, without income restrictions.
Step Two: The deductions for mortgage interest, charitable gifts, alimony payments, state income taxes and medical expenses remain.
Comment: These deductions are necessary to avoid economic disorder and chaos by changing the rules in the middle of the game. Also, retaining tax-free treatment for municipal bond interest prevents a potential cataclysmic disruption in this market.
Step Three: Determine the percentage of tax paid by taxpayers under the current system. In 1995, individual income taxes amounted to $590 billion. It is generally reported that 5% of the returns produce 50% of the income tax, and the top 1% produce 30% of the income tax. These ratios should be maintained.
Use three tax rates to raise the same amount of revenue without significantly raising or lowering the tax burden for any segment of taxpayers. For instance: exclude tax for families with incomes of less than $20,000; use a 20% tax bracket for taxable incomes under $70,000; 25% on taxable income between $70,000-$250,000; and 30% on taxable income over $250,000.
Comment: For example, an individual with taxable income of $350,000 would be taxed as follows:
| 20% on first $70,000 | $14,000 |
| 25% on next 180,000 | $45,000 |
| 30% on next 100,000 | $30,000 |
| Total tax: | $89,000 |
Make appropriate adjustments for tax status (married filing jointly, single, head of household, married filing separately) and dependency exemptions, then adjust the tax rates and brackets to produce $590 billion. Adjust the tax brackets (or the tax rates) to generate the same equivalent revenue in each subsequent year.
Comment: These tax rates are significantly higher than the 17% - 20% tax rate proposed by the Republican flat tax proposal advocates for several reasons: (1) Deductions reduce the total revenue subject to tax, so rates must be increased; (2) Unlike the Republican flat tax proposal, there is no gift to the rich. They must pay the same share now as before; (3) The Republican flat tax proposal is loaded with hidden tax increases, such as taxation of employee benefits and loss of deductions; and (4) The 17% - 20% Republican flat tax proposal is bogus, since it causes a tremendous shortfall in the tax revenues raised, thereby creating large annual deficits. To raise the same amount of tax under the Republican flat tax proposal, the tax rate would be between 22-24%. The arbitrary rate of 20% might as well be 15%, since it is not related to raising the same amount of tax dollars.
Finally, because the modified flat tax is a true and honest mechanism for raising taxes, and for simplifying the lives of ordinary citizens, the politicians have no incentive to adopt it. There is nothing in it for them or their special interest constituencies.
The advantage of the modified flat tax is that is eliminates most of the complexity under the current system, while retaining the current progressive tax structure and those deductions which are vital to the economy. The amount of taxes raised each year can be adjusted by raising or lowering the tax rates or tax brackets. This approach is simple, straight-forward and easily explained. It honestly reflects the true tax burden being paid by taxpayers.
Fairness loses when the tax code is simplified. There will be some individuals who would have been entitled to deductions, credits or benefits under the old system who lose out under this system. The biggest disadvantage, however, is that politicians will loose their cherished source of campaign financing since they can no longer sell tax loopholes to special interests.
Also, the modified tax rates are higher than they would be under the Republican flat tax proposal and politicians might have a hard time convincing taxpayers that these higher rates do not translate into higher taxes. Their opponents will claim that so-and-so raised your taxes (a falsehood) and refer to the tax rates. In other words, the biggest downside is that the modified flat tax is too simple, honest and straight-forward for Washington politicians to grasp or embrace.
On the back-side of the IRS Monster resides their collection division. The horror stories told in the Senate hearings speak volumes about this department. The collection process, however, is a necessary evil and there are several concrete steps to minimize the current abuses.
Step One: The IRS collection department should be bound by state law, just like any other creditor. State law protections regarding homestead exemption for residences, limitations on wage garnishments and state exemptions as to property should apply to the IRS. The IRS should not be allowed to levy bank accounts with less than $2,500 since, invariably, that amount will be needed for necessary living expenses.
Also, with any garnishment or levy, there should be notice that the taxpayer may contact the Taxpayer Representative ("TA" discussed below). Once the TA has been contacted, it must, within 24 hours, affirm that the levy or garnishment will not cause hardship to the taxpayer, or the garnishment or levy must be released. A hardship would be presumed if the taxpayer’s necessary living expenses for 30 days would be significantly diminished by the garnishment or levy. Taxpayers would have to cooperate and provide necessary financial data to the TA for the determination of a hardship.
Step Two: The maximum garnishment or levy percentage under state law should apply to all federal and state taxing authorities. For instance, if the law permits a maximum of 25% on garnishments of wages, then the IRS and state taxing authorities should be limited to that amount. Also, federal and state tax authorities should share in the proceeds on a pro-rata basis. For instance, if a wage earner who owes $4,000 to the IRS and $1,000 to the state receives $400, $100 of which is subject to garnishment, then the total amount going to taxes would be $100, allocated as follows: $80 to the IRS (4,000/5,000 X100) and $20 to the state. The state and IRS should be forced to cooperate in joint tax liability situations.
Step Three: The tax liability on joint returns is an outrage. By signing a joint return, a couple might save $1,000 in taxes, but each spouse automatically becomes liable for an unlimited tax increase, even if the increase was caused by misreporting income or deductions by the other spouse! An innocent spouse (the spouse who did not misreport income or expenses) should be liable only for her share of any increase in taxes.
In addition, a spouse who finds out that income was misreported after filing a joint return, is not allowed to amend his or her return and file as married filing single. So the act of filing a joint return causes an innocent spouse unlimited tax liability. Although there are rules designed to protect an innocent spouse, those rules are complex and in many instances, are strictly applied against the innocent spouse to deny relief.
Finally, in community property states, if a wife signs a joint return and becomes liable for taxes caused by her husband’s misreporting, then obtains a divorce and remarries, the new husband may end up paying the tax liability caused by the ex-husband, and vice-versa!
Solution: Calculate the innocent spouse’s share as if he or she filed as married filing separately and compare it to the tax break received by filing jointly. The innocent spouse’s tax liability should not exceed twice the savings obtained by filing a joint return.
Also, the earnings of one spouse should never be subject to claims by the IRS for tax debts of the other spouse that arose prior to marriage. California has such a law in place, but the IRS ignores state laws that impede its collection options. Therefore, the IRS will levy 50% of the new spouse’s earnings and claim those earnings belong to the other spouse under community property laws.
Step Four: If a divorce decree allocates the tax burden to one spouse and that spouse is solvent and able to pay the taxes at the time, the IRS should be bound by the divorce decree. The IRS should be given notice of the divorce hearing and an opportunity to be heard. As a condition to making one spouse liable, the IRS could be given a tax lien on that person’s property, but under the current system, allocations of tax burdens between spouses upon divorce have no effect on the IRS.
Step Five: With every collection matter, a publication describing the TA’s function, contact number and necessary forms, should be provided so taxpayers are properly informed that they have an independent advocate on their side who can stop the collection action. Whenever this is a collection dispute, the TA should be required to hold hearings in which the IRS and taxpayer present their sides of the story. The TA needs to be separate and independent from the IRS. Decisions of the TA should be published and reprimands given to the IRS should be made public.
Each IRS district should be required to publish statistics on the number of audits, appeals and court cases, the issues involved and the income level of the taxpayer and the results. Each district office should maintain a website with downloadable forms, telephone numbers and discussion groups in which taxpayers may question the IRS regarding pertinent, non-confidential issues affecting the district. The district director should be available to respond to questions raised by the public, both in the discussion groups and in public forums. The TA should also attend both forums and provide input.
Step Six: Once the taxpayer appoints a representative under a Power of Attorney ("PA"), the PA must be respected by the IRS. Currently, the IRS often ignores the taxpayer’s representative and continues to deal directly with the taxpayer, thereby undermining the representative’s ability to effectively represent the taxpayer.
All dealings must be with the PA and any notice or action taken in violation of this procedure would be null and void. The IRS cannot contact the taxpayer, except to provide copies of correspondence sent to the PA.
Step Seven: Taxpayers should not be liable for negligence penalties when the IRS is also negligent in the performance of its duties. With too many audits, the IRS is wrong on 9 out of 10 issues, but is right on 1 issue and then charges the taxpayer with a negligence penalty. Failure of the IRS to properly follow its procedures, consider the taxpayer’s evidence or legal arguments or to disregard IRS published rulings and court precedence should be considered negligence, and should negate any negligence penalties asserted against the taxpayer.
Fixing the tax code and collection procedures should be a top priority in Congress. But those people benefit from the current system and there is little incentive for them to change it. This 10-step proposal, however, would go a long way to improving the system, without unduly benefiting or burdening any particular segment of the taxpaying public.
| Home Page | Search |
E-mail Form | Firm
Profile |
**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**