Another effect on taxpayers is cost.
Even if an individual taxpayer prepares his or her own Form 1040 (which the IRS estimated to take 21.4 hours), the cost of compliance is not trivial. Put simply, the cost to a taxpayer earning $25/hour to prepare his own tax return is $535. He can "save" almost $400 by having a tax preparer complete his return at an average cost of $166.
Indeed, the tax preparation industry's growth may be attributed to the growing complexity of our tax laws. Tax professionals serve a legitimate need by helping millions of honest taxpayers who can no longer prepare their own tax returns, but at a great cost. The GAO estimated that in 2008, 85 percent of all individual income tax returns were prepared by a paid preparer or tax preparation software. Estimates for the total cost of tax preparation do not include expenditures made by the industry for training and the continuing education required by tax preparers to keep up with the hundreds of tax law changes that occur every year.
This presents a challenge for tax policy makers.
Our tax system has always been a force in shaping desirable social behavior - encouraging home ownership, supporting families, obtaining an education, saving for retirement, etc. However, rather than a single set of common-sense laws that are comprehensible to those who must follow them, complexity is the rule, not the exception.
For example, encouraging taxpayers with tax benefits to become educated and contribute to our economic growth is sound tax policy. However, the tax code's complicated menu of education tax benefits is overwhelming, with its credits (Hope, American Opportunity, Lifelong Learning), deductions (tuition and fees, student loan interest), and exclusions (qualified bond interest) - not to mention qualified tuition plans.
Taxpayers hoping to ease the burden of high education costs through tax benefits face a complex set of rules for eligibility, qualified education expenses, distributions, and penalties for violations.
A similar situation exists with retirement savings.
Tax law that encourage taxpayers to save for retirement is good policy. However, complexity can obstruct those goals, and sometimes the goals overlap. Is it better to save for retirement, or to pay for an education? Consider the unfortunate taxpayer who takes an early distribution from his qualified plan to pay for his daughter's tuition. Not only must he pay tax on the distribution, but imagine the shock on his face when he learns that he is also subject to a penalty. Had he instead taken the distribution from his IRA, he would not have been penalized.
The myriad of retirement savings vehicles (traditional and Roth IRAs, 401(k)s, 403(b)s, SEP, SIMPLE plans, etc.) and their different rules for eligibility, contributions, phaseouts, distributions, and penalties - make it easy for taxpayers to ignore altogether - contrary to the policy lawmakers envisions when they forged such laws.
In her 2008 Annual Report to Congress, Nina Olson, the National Taxpayer Advocate, wrote that the "confounding complexity of the Internal Revenue Code is one of the most serious problems facing taxpayers."
Indeed, this has been a recurring theme in previous reports, but while the call for tax simplification continues, Congress is making great strides - but possibly in the opposite direction.
Amy McAnarney, CPA, Executive Director, The Tax Institute at H&R Block