Friday, June 24, 2016

IRS Tax Compliance - A Costly Business

For millions of American individuals and businesses, the IRS tax code is becoming increasingly complex, largely because of its massive size.  Federal tax law has grown from 400 pages in 1913 to a staggering 73,954 pages in 2013 as shown on this diagram from Wolters Kluwer, CCH:


As you can see, over the past two decades alone, the tax code has risen from 40,500 pages in 1995 to its current level of 73,954 pages, an increase of 82.6 percent.  Interestingly as well, the federal tax code stood at 409,000 words in 1955 and has expanded to its current 2.4 million words, almost six times as long as it was sixty years ago.  That said, the Congressionally-passed tax statutes are only part of the tax paperwork mountain; if one includes the words that clarify how the U.S. tax code actually works, the number of words increases to 7.7 million.  When tax-related case law is included, it adds an additional 60,000 pages.

A recent analysis by the Tax Foundation shows us the high cost of the massive U.S. tax code to the American economy.  Obviously, the complexity of the tax code has real costs for both American households and businesses.  The Office of Information and Regulatory Affairs estimates that Americans will spend more than 8.9 billion hours complying with IRS tax filing requirements in the 2016 tax year.  This is equivalent to 4.3 million workers doing nothing but tax return paperwork with 2.6 billion hours being affiliated with individual income tax returns and 2.8 billion hours being affiliated with business income tax returns.

Here is a table showing the estimated hourly and compliance costs of IRS paperwork in 2016:



The authors of the study used two different hourly compensation costs:

1.) for large business forms and complex forms including estates, an hourly compensation cost of $52.05 was used for professional and related workers.

2.) for all other forms, an hourly compensation cost of $37.28 was used since it is the average compensation for all full-time private sector workers.

In total, the 8.906 billion hours spent to ensure tax compliance are estimated to cost $409,241,340,626.  This is greater than the gross economic product of 36 states.

There is a high cost for businesses who want to stay on the right side of the IRS.  The cost of business compliance stands at $147 billion or 36 percent of the total.  Businesses that become S corporations to avoid the additional taxation that is applied to C corporations have total compliance costs of $46 billion annually.  It costs individuals who wish to keep the IRS happy $99 billion annually.  When you think clearly about this, particularly in the case of businesses, spending on tax code compliance means that spending on other items like capital goods and hiring more employees is reduced.  As the tax code has become more complex, businesses have had to set aside more and more of their profits to ensure that the multitude of tax forms that must be filled out annually are filled out correctly, particularly given the rapid evolution of the tax code.

A 2008 study by the Taxpayer Advocate Service for the 2006 tax year showed that if tax compliance were an industry, it would be one of the largest in the United States.  That study showed that it took an average of 26.4 hours for an individual to complete their tax return and other reporting documents.  Corporations required 193.77 hours for the corporation income tax return (Form 1120) and other types of returns and information reporting documents required a widely varying number of hours as shown here:



Obviously, the complexity of the IRS tax code has passed the point of reason.  When it takes highly paid tax professionals to ensure that taxpayers are compliant with every aspect of the tax code, there is something wrong with the tax system.  Oddly enough, even though politicians often campaign on simplifying the tax code, reality shows that this is one promise that has never been kept.