National Taxpayer Advocate Urges Tax Simplification and Compassionate Treatment of Taxpayers Hit by Recession

WASHINGTON — National Taxpayer Advocate Nina E. Olson today released her annual report, urging Congress to greatly simplify the tax code and recommending measures to reduce the burden on taxpayers who are struggling to pay their tax bills.

The report takes note of the serious financial difficulties facing many Americans in light of the ongoing economic downturn. “It is imperative for the IRS to consider the circumstances of taxpayers facing economic hardship before initiating enforcement actions,” Olson wrote.

When the IRS contemplates taking an enforced collection action such as a levy, a lien or an asset seizure, both the tax code and IRS procedures require that IRS personnel consider whether the collection action will impose an economic hardship on the taxpayer. Despite these requirements, “current IRS guidance provides little direction to help IRS employees identify taxpayers who are experiencing economic hardship and prevent undue economic burden,” Olson wrote.

Call for Tax Simplification

The report designates the complexity of the tax code as the most serious problem facing taxpayers. According to data compiled by Olson’s office, U.S. taxpayers and businesses spend about 7.6 billion hours a year complying with tax-filing requirements. “If tax compliance were an industry, it would be one of the largest in the United States,” the report says. “To consume 7.6 billion hours, the ‘tax industry’ requires the equivalent of 3.8 million full-time workers.”

The report estimates that U.S. taxpayers spend $193 billion a year complying with income tax requirements, an amount that equals 14 percent of the total amount of income taxes collected. One count shows the number of words in the tax code has reached 3.7 million, and over the past eight years, changes to the tax code have been made at a rate of more than one a day – including more than 500 changes in 2008 alone. Individual taxpayers now find the tax rules so overwhelming that more than 80 percent pay transaction fees to help them file their returns – about 60 percent pay a preparer to do the job and another 22 percent purchase tax software.

Two examples of tax law complexity:

The Alternative Minimum Tax (AMT) effectively requires taxpayers to compute their taxes twice — once under the regular rules and again under the AMT regime — and then to pay the higher of the two amounts. Absent repeal or continuing AMT patches, the AMT will affect 33 million taxpayers in 2010. Although the AMT was originally conceived to prevent wealthy taxpayers from escaping tax liability through the use of tax-avoidance transactions, 77 percent of the additional income subject to tax under the AMT today is attributable to the disallowance of deductions otherwise allowed for state and local taxes and personal and dependency exemptions. “Few people think of having children or living in a high-tax state as a tax-avoidance maneuver, but under the unique logic of the AMT, that is essentially how those actions are treated,” the report notes.

The tax code provides tax breaks to encourage taxpayers to save for education and retirement. However, the number of such tax incentives has grown to at least 27 and the eligibility requirements, definitions of common terms, income-level thresholds, phase-out ranges and inflation adjustments vary among the provisions. This complexity undermines the intent of the incentives, as taxpayers can only respond to incentives if they know they exist and understand them.