The Tax Man Cometh

by B. Lana Guggenheim


‘Tis the season - tax season, that is. Yours are due April 18th, unless you’ve filed a timely extension.

There is much muttering and moaning about the dreaded tax man, though when pressed, most of us would admit that some level of taxation in return for government services is both fair and necessary. However, today’s tax code is a dizzying labyrinth of laws that seem invented to torture rather than merely tax. It is such exhausting work to navigate that there are entire professions centered around helping people properly file their taxes. Tax laws are so filled with loopholes, it’s as though the system lacks integrity altogether. Unlike individuals, large businesses have the power to gain industry specific tax breaks, and corporate taxes have reduced over time as a result. And the IRS seems to make little effort in tracking down corporate tax law-breakers, resulting in nationwide distrust of this organization.

Why is our tax code such a monstrous mess? Part of the answer is that our tax laws weren’t formulated in a particularly organized matter. Rather, the laws we have evolved and changed in bits and pieces over time, resulting in many layers, some of which are very confusing. In order to collect taxes and administer the Internal Revenue Code, the domestic portion of federal statutory tax, the IRS or Internal Revenue Service was created. Though this name was only made official in 1953, though it was used as early as 1913, the government body collecting taxes has been in place since 1862, when income tax was first levied by President Abraham Lincoln to raise funds to fight the Civil War. By war’s end, the Union had raised 21% of its funds via this tax. At the time, income tax was meant to be a temporary measure, but it continued on to fund the Reconstruction, and was only allowed to expire 7 years after the war’s end. In 1894, the Supreme Court declared income tax unconstitutional (and there was probably much rejoicing, unless you were in the government). In the start of the 20th Century, there was a populist movement for tax reform, ultimately culminating in the ratification of the 16th Amendment in 1913, which essentially stated that the government had the right to tax its citizens without regards to apportionment among the states by population. Since then, income tax has been part of the landscape of the American economy, though less so than it is today. However, even the imposition of a modest income tax caused the IRS a ten-fold jump in their workload, and they fell behind in their duties almost immediately; they were still processing 1917 returns as late as 1919.

The twin pressures of Prohibition and the Great Depression were the next influences on the evolution of American taxes. Prohibition eliminated the income the government received from taxes on the sale of alcohol, and drove an entire economy underground into the hands of a professional class of criminals - gangsters. The financial strain, exacerbated by the onset of the Great Depression, meant that the government sorely needed the income both from taxing alcohol sales as well as from an increased income tax. In 1927, the Supreme Court ruled that illegally obtained income was subject to taxes (and that remains true today, though we would recommend leaving out the specifics of your occupation in such cases), giving the Feds access to money they sorely needed, as well as the legal means to seize some of the gains the gangsters earned from bootlegging. It is this law that ultimately put Al Capone behind bars, when he was nailed and jailed for tax evasion. However, the demise of Prohibition in 1933 did not mean the demise of the income tax, as some had hoped. The New Deal did cut taxes for those earning less than $3,000 a year, but was pretty harsh on the wealthy, who saw their taxes rise. Payroll and quarterly tax withholdings were introduced during WWII, and the marginal tax rates on income at different income levels have fluctuated wildly since then, reaching a height of 92% in 1952 on top individual earners, and down to 28% in 1987. Currently, the top tax bracket hovers at around 35%.

Today, the IRS processes taxes as well as institutes investigations. Some of these investigations are civil tax cases and audits, which are about money owed. If you are subject to an audit, you might end up owing a lot of money, but it is unlikely you will face criminal charges. Most Americans are unlikely to be audited - the odds are somewhere around 1%. If you earn over $200,000, your likelihood of being audited goes up to just under 3%, and if you earn above ten million, or alternatively, if you report no earnings, your chances of being audited go up (approximately 16% and 5%, respectively). So too if you report income from abroad, especially from a place like the Cayman Islands. As the IRS has fewer employees now than it used to (a low in 2012 of  89,000 versus a peak in 1996 of over 116,000), their ability to audit has been impaired, even as the work they have to do has increased. This sounds like good news, but in many cases, audits find that people are owed larger returns than they initially had received, so the inability of the IRS to do its job is more likely to harm than help. This is soon after the IRS had its reputation blackened by the reveal that more than half of its employees willfully violating tax law were not let go, and some were in fact promoted. In such a situation, things don’t look good for either the IRS or the average American.

In addition to audits, some IRS investigations are criminal investigations that center around the violation of specific tax laws. In such cases, even if all the money owed is paid, the case is not likely to be dropped. While the most common crime is tax evasion, other prosecutable ills include money laundering, identity theft, and fraud. The IRS website shows an entertaining list of the top ten biggest such cases in the past fiscal year. But tax-related crimes are a regular occurrence, for the famous, infamous, and average citizen alike. The 1989 case of Leona Helmsley, nicknamed “the queen of greed” by the press, evaded taxes by charging millions she spent in redecorating to her business. She was fined over $7 million and sentenced to four years in prison. Wesley Snipes is estimated to owe the government millions in tax debt, and was eventually convicted in 2008 to three years in prison. The IRS likes to make a big deal of celebrities they catch in tax fraud, hoping to scare the rest of us into being honest on our tax forms, provided we can successfully navigate them, that is.

Where does this money go? Primarily to the military and healthcare, it turns out. Of all the Federal tax revenue, a little under half of the total comes from income taxes, making it the single largest source of federal funds. From there, the budget is divided into discretionary and mandatory spending -- 30% and 64% respectively, the remaining being interest on federal debt. Discretionary spending is decided by Congress through the annual appropriations process, and mandatory spending refers to spending on programs required by law. More than half of discretionary spending is bestowed on the military, about 15% of the total budget, and the majority of mandatory spending is split between healthcare and social security, about 60% of the total budget. Tax breaks, which function as a type of federal spending, outstrip discretionary spending, by about $0.1 trillion - or ten billion dollars. That’s a huge amount of money, but the relative difference isn’t that large - tax breaks account for $1.22 trillion, and discretionary spending for about $1.11 trillion.

All told, untangling the federal budget, the tax law, and our own taxes is a taxing affair.

Works Cited

Brandeisky, Kara. "These Are the People Who Are Most Likely to Get Audited." Time. Time, 14 Apr. 2015. Web. 14 Apr. 2016.

Coleman, James William. "Fraud and Deception: Tax Evasion." The Criminal Elite: Understanding White-collar Crime. New York: Worth, 2002. 31-32. Print.

"Federal Spending: Where Does the Money Go." National Priorities Project. National Priorities Project, 2016. Web. 14 Apr. 2016.

Fishman, Stephen. "What Are the Odds of Being Audited by the IRS? | Nolo.com." Nolo.com. Nolo, 2012. Web. 14 Apr. 2016.

Henchman, Joseph. "How Taxes Enabled Alcohol Prohibition and Also Led to Its Repeal." Tax Foundation. Tax Foundation, 5 Oct. 2011. Web. 14 Apr. 2016.

Henderson, Audrey. "Tax Tips: The IRS Criminal Investigation Process." Optima Tax Relief. Optima Tax Relief, 14 Aug. 2014. Web. 14 Apr. 2016.

"Historical Documents Relating to Alphonse (Al) Capone, Chicago." Internal Revenue Service. Internal Revenue Service, 18 Aug. 2012. Web. 14 Apr. 2016.

"Internal Revenue Service (IRS) 2012 Data Book." The Concise Dictionary of Crime and Justice (n.d.): n. pag. The Internal Revenue Service, 30 Sept. 2012. Web.

"IRS Statistics." Infoplease. Infoplease, 2007. Web. 14 Apr. 2016.

"IRS's Top Ten Identity Theft Prosecutions; Part of Ongoing Efforts to Protect Taxpayers, Prevent Refund Fraud." IRS's Top Ten Identity Theft Prosecutions; Part of Ongoing Efforts to Protect Taxpayers, Prevent Refund Fraud. IRS, 3 Mar. 2015. Web. 14 Apr. 2016.

Okrent, Daniel. "No Closing Time for Income Taxes." The New York Times. The New York Times, 12 June 2010. Web. 14 Apr. 2016.

Prohibition. Dir. Ken Burns and Lynn Novick. Perf. Peter Coyote. PBS, 2011. Documentary Mini-series.

Thomas, Kenneth. "A Big IRS Job and Fewer People to Do It." US News. US News, 30 May 2013. Web. 14 Apr. 2016.

Wood, Robert W. "61% Of IRS Employees Caught Willfully Violating Tax Law Aren't Fired, May Get Promoted." Forbes. Forbes Magazine, 07 May 2015. Web. 14 Apr. 2016.

Republican Tax Plans: How will they Impact CPAs & Tax Preparers?

I'm sure many of you watched the admittedly entertaining spectacle that was the second Republican Presidential Debate of 2015 last night. During that 3 hour long information & misinformation packed program, many of the candidates touched on their plans for the outdated, ineffective, & altogether noncompetitive tax code America has been saddled with since it was largely enacted in 1986. Some of the prospective Presidents proposed adjustments to the current system of Progressive Taxation that has been in place since the Revenue Act of 1913 officially established the income tax we Americans know today. Different candidates proposed a Flat Tax on income, while others scrapped income taxation altogether for a Fair Tax. What do all of these mean & what affect will they have on the professionals that spend their entire careers working to help average Americans legally deal with the taxation system?

Before delving into the affect these changes may have on CPAs & tax preparers across the country, we need to discuss exactly what these candidates are proposing. Changes to our current Progressive Taxation system of income tax include taxing carried interest, which is basically a performance fee often paid to large fund managers, at normal rates. This change will largely affect the wealthier taxpayers who are currently able to pay taxes on these performance fees at a lower rate than they would had the carried interest been normal wage income. Candidates who advocate a Flat Tax on income are for a single rate for all taxpayers no matter what their income, but this rate varies depending on the candidate (Rand Paul is for 14.5%, while Ben Carson is for somewhere between 10 & 15%). Some of these candidates, including Ted Cruz, also advocate for significant government spending reductions to go along with this Flat Tax, one of which is the closure of the IRS. Finally, the Fair Tax advocated by candidate Mike Huckabee replaces a tax on income with a 23% tax on all purchases.

Now that we know what tax plans have been supported by the Republican candidates who have publicly discussed reforming taxes, how would these plans affect those who administer the tax code & work with Americans everyday to help them navigate through financial & tax decisions? First of all, many of the more radical changes to the tax code advocated last night would abolish the "evil" Internal Revenue Service, or IRS. This crucial federal department is responsible for the collection of the bulk of federal government revenue, which is the source of funds that keep the government functional & working. Abolishing this organization would not only seriously hamper the government's ability to collect tax revenue & monitor the taxpaying (or avoiding) activities of citizens & corporations, it would, as of 2014, put over 84,000 men & women out of work (see page 76 for statistics). The gutting of the tax code would also destroy the currently thriving tax preparation industry, which employed over 65,000 people in 2012 & has large seasonal hiring surges that temporarily increase that figure. The tax preparation companies often give on-the-job training that allows temporary workers to learn important skills that can help them land permanent jobs in the industry. Not least of all, accounting firms that employ CPAs would take a large hit from a massive tax code change, especially in the corporate tax code. Many CPAs at large & small firms alike specialize in taxation & would immediately either have to relearn a new specialty within the profession or switch professions entirely.

As much as candidates from both sides of the aisle, Republican & Democrat alike, love to boast about how they would reform America's broken tax code, most of them have completely ignored the impacts those changes would have on a large subset of professionals that many Americans rely on at least once a year to help them through important financial & tax decisions. Please share this with any accountant, tax preparer, or CPA friends or family you may have, as all should understand what these potential changes could mean for their professional lives. As a CPA myself, I know what kind of impact these changes can & will have. Thanks for reading & please subscribe to the Enky blog for more professional content!


Yours truly,

Mike Coté
CPA & CEO/Co-Founder, Enky Inc.