LET ME SAY IT AGAIN - THE TAX CODE MUST BE DESTROYED!

The new GOP Tax Act drastically changes the US Tax Code, and will affect every single tax return filed from 2018 to 2025.  It includes some simplification, but it also adds more complexity to the Code.  It is not true “tax reform”. 

I have been preparing 1040s (and 1040As) for compensation since February of 1972.  As a veteran tax professional I am well aware that the Internal Revenue Code has grown into a complicated and convoluted “mucking fess”.  The major source of tax return errors, by both paid tax preparers and taxpayers who self-prepare, and tax fraud is the excessive complexity of the Tax Code.

Like Frankenstein in the Hammer film, the Tax Code must be destroyed!  It must be totally shredded and rewritten from scratch. The new Internal Revenue Code must acknowledge and confirm the fact that the one and only purpose of the federal income tax system is to raise the money necessary to fund the government. 

The new Tax Code must –

(1) Be simple – easy for everyone to understand.  Simplicity for simplicity’s sake. 

(2) Be fair and equitable - treat all taxpayers equally.

(3) Be consistent – treat specific conditions, situations, and activities, and maintain specific definitions and descriptions, the same in all instances.

(4) Encourage savings, investment, and growth.

(5) Index for inflation all allowable deductions and credits.

The Tax Code must not –

(1) Be used for social engineering, to redistribute income or wealth, or to deliver social welfare and other government benefits.

(2) Encourage or discourage certain economic decisions (other than savings, investment, and growth), or provide exclusive benefits for specific industries, business activities, or classes of taxpayers.

(3) Contain any refundable credits, or any phase-outs, exclusions or adjustments based on Adjusted Gross Income or Modified Adjusted Gross Income.

(4) Contain any “alternative” tax calculation systems (such as the “Alternative Minimum Tax”).

(5) Contain any temporary deductions, credits, benefits, or provisions.

One of the biggest problems with the current system, a large source of its complexity, and the major source of tax fraud, is the erroneous use of the tax return to deliver government benefits.  The Internal Revenue Service, and tax professionals, should not be required to act as Social Workers and administer government program benefit payments.   

I am not saying the government shouldn’t provide financial assistance to the working poor and college students, provide encouragements for purchasing health insurance, making energy-saving purchases and improvements and other ‘worthy’ actions.  What I am saying is that such assistance and encouragements should not be distributed via the Form 1040.

The benefits provided by the Earned Income Tax Credit and the refundable Child Tax Credit would be distributed via existing federal welfare programs for Aid to Families with Dependent Children. The benefits provided by the education tax credits and deduction for tuition and fees would be distributed via existing federal programs for providing direct student financial aid. The benefits provided by the Premium Tax Credit, the energy credits, and other such personal and business credits would be distributed via direct discount payments to the appropriate vendors or direct rebate programs, similar to the successful Cash for Clunkers program of a few years ago, funded by the budget of the appropriate Cabinet departments.

Distributing the benefits in this manner is much better than the current method for many reasons:

1. It would be easier for the government to verify that the recipient of the subsidy, discount or rebate actually qualified for the money, greatly reducing fraud. And tax preparers, and the IRS, would no longer need to take on the added responsibility of having to verify that a person qualifies for government benefits.

2. The qualifying individuals would get the money at the “point of purchase,” when it is really needed, and not have to go “out of pocket” up front and wait to be reimbursed when they file their tax return.

3. We would be able to calculate the true income tax burden of individuals. Many of the now infamous “47 percent” would still be receiving government benefits, but it would not be done through the income tax system, so they would actually be paying federal income tax.

4. We could measure the true cost of education, housing, health, energy and welfare programs in the federal budget because benefit payments would be properly allocated to the appropriate departments. 

Every taxpayer should be taxed exactly the same – regardless of marital status – under one tax rate schedule.  There should be neither a marriage tax penalty nor a marriage tax benefit.  And, if not a single flat tax rate, there should be no more than 2 or 3 rates and not 7.

On the business side, the new Tax Code should do away with all industry-specific loopholes, deductions and credits for all business activities, whether a sole proprietor, partnership or corporation.  A business should be taxed on the net book income for the year’s activity. 

Corporations should be allowed to claim a “dividends paid” tax deduction to do away with the current double-taxation of income.  Let corporations deduct from taxable income all dividends paid to shareholders out of accumulated “earnings and profits”, and pay federal corporate income tax on this net amount.  The dividends paid would be taxed to the recipient shareholders at normal “ordinary income” rates.  This would do away with the current “double-taxation” of corporate income.

And we should no longer allow a deduction for depreciation of real property, or capital improvements thereto, for any business activity – not on Form 1065, Form 1120, Form 1120S, Form 1041, or Form 1040 Schedules C, E, or F.  Real estate does not “depreciate”.  You do not replace a building every few years because it no longer provides the same service or function.  And, generally, the value of real estate as a component of the value of a business does not drop as it ages.  Depreciation of real property is a “phantom expense”, and distorts the economic reality of the business activity.   

Real estate is an investment, just like stocks, bonds, mutual funds, etc.  You invest in rental real estate because you expect the building to increase in value over time, often more so than stocks and mutual funds, and because it generates “dividends” in the form of net rental income or the elimination of rent expense.  Allowing a deduction for depreciation of real estate is like letting those who purchase stock depreciate the purchase price of the stock as a deduction against the dividends paid out.  If the value of a property drops due to market conditions then a loss can be claimed if sold, just like with any other investment.

For a more detailed discussion of the depreciation deduction see my post “Let’s Talk About Depreciation”.

Unfortunately, my dream of substantive tax reform will probably remain just that - a dream.  Tax law is written by Congress the members of Congress have absolutely no knowledge of or experience with the practicality of tax return preparation.  And, of course, there are the personal agendas of Congresspersons, who rely on the political contributions of lobbyists working to maintain specific tax breaks, and who more often than not avoid independent thought and merely do what they are told by their Party.

TTFN