Wednesday, July 31, 2013

While The Tax Code Is Complicated, The Chances Are High You'll Never See It

I originally posted this back in April, but given the renewed focus on taxes it seems appropriate to re-post it here
One of the most common refrains used about the tax code is that it's so complicated that no one can use it.  People who rail against it complain about it's length (there are over 2000 pages to it, after all), the odd way in which it's written and the fact you sometimes have to read multiple sections in multiple subsections to understand what's going on.

First, all of the above is true.  However, let's ask a follow-up question: how many people actually have to see this complexity as part of their daily economic life?  The answer is not many -- easily less than 5% of the total population.  Let me spend the rest of this article explaining the last paragraph.

First, the tax code is organized as a hierarchy: it's largest "section" is title, followed by sub-title, then chapter, followed by sub-chapter, then part and sub-parts and finally sections and sub-sections.  Here is how it looks conceptually.

                                   Sub- Section

For the purposes of most taxpayers, the most important divisions are the "sub-chapters," the vast majority of which no one will ever see.  For example, do you own a bank or insurance company?  How about a non-profit corporation or for-profit corporation?  Any exposure to natural resources?  Any international income, trusts, real-estate investment trusts or corporations used to eliminate taxes on shareholders?  If you answered no to all of the above questions, then you don't need to know anything about the vast majority of the tax code.

In fact, for most people, the only major sub-chapter they'll ever see is sub-chapter B, computation of taxable income. And here's the best part: if you use any of the major accounting packages to do you taxes (turbo tax etc...), you're already way ahead of the game as these packages are really good and work for the vast majority of people.

Now, when we look in detail at some of the other sub-chapters (estate and gifts, partnership tax, corporate tax, estates and trusts, and international tax) there are some complex issues.  However, most of this complexity is the result of anti-avoidance provisions built into the law.  These are rules that are put into place to plug previously exploited loopholes, a situation that fills the corporate tax code (sections 301-395), international tax code (sections 861-1000) and estate tax code (Subtitle B).  And, if you're involved in these areas of the code in any way, you're already working with accountants and lawyers who specialize in this area of the law.

And finally, consider this: the reason why we spend time preparing taxes etc... is because the US has a self-reporting tax system -- that is, we tell the government what we make and the fear of audit keeps us in check.  Do you really want the other system where the government is that much more aggressive?

So here's the real tax deal.  Yes the tax code is over 2000 pages (and that doesn't include the accompanying Treasury Regulations which easily add over 20,000 more.  I know because I've read the vast majority of them).  However, over 95% of the US population will never see this complexity because it doesn't apply to them.  Additionally, a primary reason for the complexity is that people have tried to get around the law with cute legal maneuvers (the vast majority of which wouldn't survive a substance over form challenge) requiring Congress to plug loopholes.  This means these sections need to be in the code to prevent abusive practices.