Claiming Tax Breaks Can Entail Headaches
Vince Dorn, a 46-year-old technical writer for Silicon Valley biotech companies, has filed his own tax returns for as long as he can remember.
This year, he handed his Form 1040 to a professional.
“We wanted to make sure we were getting all the tax breaks we could get,” said Dorn, who recently launched a technical writing business. “We had all these things going on: kids headed to college, a new business, a new home, issues with retirement plans. I knew there were tax issues, but I wasn’t confident that I knew what they all were.”
Nearly 62% of the nation’s taxpayers paid for tax preparation services last year -- up from 46% in 1986, when the nation’s tax code was drastically simplified in an effort to reduce loopholes and exemptions.
Critics of the system say the increase in paid preparations can be traced directly to the special deductions, credits and write-offs that have been steadily creeping back into the tax code. In the last five years, additions to the code have included new deductions for college tuition, new tax breaks for capital gains and dividends and lucrative write-offs for small-business owners, said Denise Sposato, a spokeswoman for the big tax preparation firm H&R; Block.
Last year alone, Congress passed two major tax bills that affected 416 existing rules and created 34 new ones.
“If you are eligible to file a 1040EZ form -- you just have wages and no kids -- that’s straightforward. You can do that yourself,” said Marc Minker, a certified public accountant with Mahoney Cohen & Co. in New York. “But once you get past that, life gets extremely complicated.”
There are four possible tax breaks for simply having children, two of which require wading through long and complicated worksheets. There are two more breaks for having children in day care, one a credit and one a deduction. There are 11 breaks related to financing higher education.
The so-called earned income tax credit, a break for the working poor, is so complex that it requires 12 pages of instructions. And the list goes on.
“It is rather mind-boggling when you get into it,” said Mark Luscombe, principal federal tax analyst with CCH Inc., which publishes tax preparation books for professional preparers and consumers.
The IRS estimates that the typical taxpayer will spend almost 21 hours filling out a 1040 with interest and itemized deductions. Add more than six hours if you bought or sold investments and 11 hours if you have a sideline business.
That’s about double the preparation time of a decade ago, according to experts. They maintain that Internal Revenue Service figures, which show only a 50% increase in preparation time, are off base because the IRS calculation doesn’t take into account the growing list of separate worksheets now required to complete the 1040.
“The code is so filled with loopholes, exceptions and lengthy explanations that individuals and businesses spend more than 6 billion hours every year on paperwork and other tax headaches,” Treasury Secretary John W. Snow said last week in testimony before President Bush’s Advisory Panel on Federal Tax Reform. It’s scheduled to make recommendations on ways to simplify the tax code by July 31.
Another person who testified was Stephen J. Entin, president of the Institute for Research on the Economics of Taxation, a conservative group that advocates lower taxes and smaller government.
“The system is very complicated, hard to comply with and hard to enforce,” Entin said in an interview. “Even when people are doing the right thing, they are wondering what the other guy is paying and whether that’s fair.”
Consider the bewildering array of breaks offered to families financing college -- all 11 of them.
First there are exemptions from income for withdrawals from 529 college savings plans (named for a section of the tax code) and Coverdell accounts, another tax-favored savings account dedicated to paying education expenses.
Employer-provided education assistance and interest earned on some savings bonds are also tax free if taxpayers meet a list of qualifications.
But to take advantage of tax-free income, parents may have to forgo other potentially lucrative credits and deductions, such as the Hope tax credit, which can reduce tax bills by as much as $1,500 for each eligible student; the Lifetime Learning Credit, which can reduce tax bills by as much as $2,000 per student; and the Tuition and Fees deduction, which can reduce taxable income by as much as $4,000.
There are also write-offs for student loan interest and special breaks for those receiving scholarships and loan forgiveness, but only in certain circumstances.
If that isn’t befuddling enough, most of the education-related tax breaks are income-tested, which means those earning more than set amounts lose their ability to claim them. The income thresholds vary from one tax break to the next, so even those who are unable to take the Hope tax credit, for example, may be able to get the Tuition and Fees deduction. Or they may be able to claim a partial credit or deduction.
Complexity -- once a gripe of corporate taxpayers -- is now something businesses and individuals alike can complain about, said Jeff Kupfer, executive director of the President’s Advisory Panel on Federal Tax Reform.
“The complexity is at all levels of the code, from the wealthy people to the working poor,” he said. “The president has recognized that the current code is a problem. All ideas for reform will be on the table, from incremental change to scrapping the entire code and starting fresh.”
A growing cadre of experts is pushing for the latter -- suggesting that legislators scrap the current code and replace it with a graduated consumption or sales tax.
The Bush panel is expected to consider those ideas, but experts say it’s likely the panel will simply try to streamline and improve the current system, as President Reagan and Congress did in 1986.
The vast majority of tax shelters, special deductions and credits that were in the code in the 1970s and early 1980s were eliminated that year in a sweeping measure that cut the number of tax rates to two: a 15% and a 28% rate. That tax law also got rid of deductions for personal interest and sales taxes and literally hundreds of specialized write-offs and credits in exchange for cutting tax rates for everyone.
But tax rates crept up -- a 31% rate was added in 1991 and a 39.6% rate in 1993 -- and taxpayers complained that middle-class voters were getting squeezed, struggling with the high costs of education, healthcare and raising children.
President Clinton responded by pushing through a series of “targeted” deductions and credits for the middle class, including four of the breaks benefiting college students, and the floodgates opened.
That’s partly because both political parties realized they could agree on targeted tax breaks, analyst Luscombe said. Republicans liked them because they fed the philosophical goal of lowering taxes. Democrats liked them because they provided funds for social aims.
The earned income tax credit, for example, has been cited by social workers as the most significant federal program to aid the poor since Aid to Families With Dependent Children, otherwise known as welfare.
“They gave something to everyone,” Luscombe said.
And they proliferated, with President Bush following Clinton’s lead by boosting or adding several deductions and credits for those financing college, saving for retirement, operating small businesses or investing. He brought back write-offs for sales taxes. And his budget for the upcoming fiscal year proposes a host of additional tax breaks for savers, investors and businesspeople.
All of the breaks serve valuable ends, said Kupfer, the head of the Bush panel, “but that doesn’t mean that when you look at it in the aggregate, it isn’t a problem that you have to deal with.”
*
More tax coverage and links are available at latimes.com/taxes.
