Individuals Archives

Does the EITC discourage work?

As a followup to my February 17th post, entitled NC EITC is not the answer, I thought I would expand on my reasoning on why I do not favor the earned income tax credit (EITC). Beyond the improper or fraudulent payments amounting to almost one-quarter of credits paid, the EITC discourages many workers from working more or pursuing a higher paying job.

EITC summary

Briefly, the EITC is a credit to encourage the poor to work. If someone has no earned income (generally wages or self-employment income), they get no EITC. As they earn more and have more children, the credit gradually increases to a maximum of $6,242 in 2015 for a married couple filing a joint return with three or more qualifying children. For each dollar earned over $23,649, the married couple loses some EITC until it is all gone once they have income above $53,266. The amounts are different for single taxpayers and those without fewer then three children.

I think we can all agree that at some point people make enough they do not need a tax credit to encourage them to work. Where is the magic number where they no longer need the government’s encouragement? It varies based on living costs and on each persons view of what is enough to live on. I would hope we can all agree someone making $1 million does not need the EITC to encourage them to work.

Encourages work

A married couple with at least three qualifying children making zero gets no EITC credit. If one or both spouses goes to work and earns at least $13,850 but less than $23,649, they get an EITC of $6,242. Earning the minimum means the federal government gives them $6,242 or almost 46% of their wages. A pretty good incentive for one of them to find a job. Adding an NC credit at 10% like Progressive Pulse recommended results in an additional $624 in EITC for a total of $6,866 or almost a 50% tax-free raise beyond the $13,850 in wages.

An aside

Lets be realistic, who can support themselves, their spouse and three or more children on income of $20,280 after taxes? (Gross wages of $13,850 + federal EITC $6,242 + proposed NC EITC $624 – Social Security & Medicare tax of $1,060). Rent and some food take care of all of that, rent might take care of all of it and more. That seems to be the reason Congress left the maximum at $6,242 until the family makes more than $23,649. Even at $23,649 the net after income and payroll tax is only about $28,706. Still extremely difficult to take care of a family of five. Note I am ignoring the child credits and any other credits since this post is about the EITC.

Discourages work

So what does Congress do to help the family of five try to cover their expenses beyond $28,706 net of taxes? Congress punishes them for earning more. Yes, punishes them by taking away some of the EITC credit. Lets say our example family of five starts making $33,850. A raise of about $20,000 versus $13,850. That is good, right? Our family now owes $126 of federal income tax and $1,084 of NC income tax. They also owe $1,530 more in Social Security and Medicare taxes.

Look at this chart:

Chart of EITC marginal tax rates — Marginal income tax rates for every $1,000 of income from $1,000 to $75,000. No other credits considered, for example the child credit is omitted. Excludes state taxes and payroll taxes.

See the peak? An effective marginal income tax rate of over 36% for the next $1,000 earned above $52,000. In 2015, the 35% bracket starts at $411,500 for a married couple filing a joint return. The next $1,000 the couple makes above $411,500 causes an extra $350 of income tax. But a couple making the next $1,000 above $52,000 will pay $361 of tax on that next $1,000. That is not right! Oh, but yes it is right. The EITC causes the marginal income tax rate the EITC middle class to pay a higher marginal rate than a couple making as much as $464,850 (the top of the 35% bracket).

So if a married couple with three or more qualifying children qualifies for the EITC, they are strongly encouraged to work from zero to about $25,000. Then the way the EITC phases out as income increase, they are being discouraged from earning more as their marginal tax rate goes to 21%. It only gets worse until about $54,000 when their marginal tax rate finally falls back to 15%. Interestingly, for 2015 the federal poverty income for a family of five is $28,410. So the EITC is designed to raise taxes on some people making less than the federal poverty level income.

Conclusion

There has to be a better way than wasting at least $14.5 billion (in 2013) on improper EITC payments and then adding insult to injury by charging high marginal income tax rates on people trying to lift themselves out of poverty. I will leave it to others to come up with a better plan. My feeling is the tax law is the wrong place to try to provide incentives and assistance to the working poor.

NC tricking taxpayers?

Tax

Frustrated man — Frustrated by Zach Klein, CC-BY, on Flickr

This year NC taxpayers filed for the first time under the tax changes made by the Legislature in 2013 but mostly effective in 2014. Many lower-income people, those making less than about $80,000, paid the same, a little less or a little more income tax as under the 2013 rules. But because the withholding tables resulted in much lower withholding in 2014 than in 2013, many taxpayers owed for the first time. Others received much lower refunds than they did the prior year.

Complaints abound

Complaints were loud and intense for a while. Politicians being politicians, they figured they needed to fix this problem and help most people receive a refund in the future. After all, 2016 is an election year. Instead of cutting tax rates or allowing more deductions the Legislature decided it could fool most of the people most of the time.

The “fix” or tricking taxpayers

Maybe I am a cynic but this is sure what it looks like. The Legislature passed House Bill 117, also known as Session Law 2015-259 (PDF). Starting in 2016, the law requires employers to withhold at a higher rate than the actual NC tax rate. This should cause more people to get a refund or get a larger refund. Voila, problem fixed.

Of course one could argue the Legislature is helping taxpayers who were confused by the more complex new NC-4 (PDF of withholding allowance form) and had less tax withheld than was proper. The fix to that would seem to be to make the law simpler and not cause smaller take home pay for almost everyone, even those who got the NC-4 right.

Example of the “fix”

Lets look at a simple example. Taxpayer Tom owed $2,000 for 2014 and had $1,900 withheld. Poor Tom has to pay another $100 with his 2014 tax return. For 2016 he owes $2,000 but he has $2,100 withheld. Now Tom is happy because he is getting $100 back. What really happened? He still owes $2,000 in total income tax before any payments. Because of the $100 refund, the NC Legislature hopes Taxpayer Tom is tricked into thinking 2016 was a good tax year while 2014 was a bad tax year.

Conclusion

So taking more money up front and then returning it later is a tax cut? Sadly, the NC Legislature will fool quite a few people with this ploy. So is tricking taxpayers part of the Legislature’s job?

IRS relief for SC flood victims

Tax

Sometimes the IRS does something right. Hope nobody fainted. On October 7, 2015 the IRS provided people living in Bamberg, Berkeley, Calhoun, Charleston, Clarendon, Colleton, Darlington, Dorchester, Florence, Georgetown, Greenwood, Horry, Kershaw, Lee, Lexington, Orangeburg, Richland, Sumter and Williamsburg Counties in SC with more time to meet their filing requirements. More counties may be added once FEMA continues their damage assessments.

Taxpayers with income tax extensions who live in the affected counties will get until February 16, 2016 to file returns they extended to October 15, 2015. Other tax filings with payments or deadlines starting October 1 will also get the extension to February 16, 2016.

The IRS release is available here.

IRS taxpayer service declines

Tax

The Taxpayer Advocate released their mid-year report on how the tax season went. “Likening the 2015 filing season to ‘A Tale of Two Cities,’ however, the report says: ‘For the majority of taxpayers who filed their returns and did not require IRS assistance, the filing season was generally successful. For the segment of taxpayers who required help from the IRS, the filing season was by far the worst in memory.’” This is even worse than last year’s report detailed in this post – IRS doing more with less?

Highlights

IRS processed 126.1 million individual returns versus 125.6 million the prior year.
The average refund was up slightly to $2,711 from $2,686 the prior year but about 3 million taxpayers received a refund this year.
Hold times for taxpayers were 23 minutes versus 14 minutes the prior year.
Sadly, only 37% of taxpayer calls were answered versus 71% the prior year. Answered means the taxpayer talked to a human and does not mean the taxpayer was actually helped.
Supposedly the IRS Taxpayer Advocate is a taxpayer’s last hope at IRS. With hold times of 19 minutes and only 39% of calls answered taxpayers seem to have little hope.
Tax practitioners have their own hotline to speed up service to them. Apparently 45 minutes on hold is faster than the 23 minutes non-tax practitioners received. Must be the newer “new math.” The IRS did answer 45% of tax practitioners calls which is better than for individuals but that may be because they held longer.
IRS is trying to introduce a new term to the average American – “courtesy disconnect.” It means the IRS hung up on us. What a polite way to say “we do not care.” About 8.8 million of use were shown this “courtesy” this year versus only 544,000 last year. If you get hung up on by the IRS you can no longer even consider yourself special.

Incentivizing taxpayers to cheat?

The news release says:

Olson wrote that the decline in taxpayer service imposes increased compliance burdens on taxpayers and may lead to erosion in taxpayer trust. “For a tax system that relies on voluntary self-assessment by its taxpayers, none of this bodes well,” she wrote. “In fact, there is a real risk that the inability of taxpayers to obtain assistance from the government, and their consequent frustration, will lead to less voluntary compliance and more enforced compliance.

I read that to mean the Taxpayer Advocate would not be surprised if people throw up their hands and do what they think is best for them instead of trying to figure out the law and the forms.

Long-term plan concerns

According to the report, IRS’ long-term plan is too heavy on enforcement and too light on customer service. Additionally, the IRS’ is pushing too much online taxpayer service and cutting back on human assistance. For a hint on a better way to search the IRS website see the Website section of this post – Get IRS help by appointment.

Identity theft protection

OK your identity has been stolen and someone is using your information to get a tax refund. From my experience, this is an extremely stressful situation for most people. So how does IRS help?

If someone else uses your Social Security Number before you file, expect to wait an average of six months for a refund. If you owe, do not worry they will promptly take your payment. If an IRS’ fraud filter incorrectly flags your return, IRS makes you wait an average of 28 minutes to speak to someone and “courtesy disconnects” 83% of callers. The good news is IRS is catching more fraudulent returns before sending refunds. The bad news is IRS’ fraud filters are flagging more legitimate returns – over 600,000 this year.

Obamacare problems

Not surprisingly, there were quite a few problems caused by the new Affordable Care Act (ACA) provisions. Interestingly, the Taxpayer Advocate attributes many of them to other parties. For example, the Center for Medicare and Medicaid Services sent out about 800,000 erroneous Forms 1095-A regarding health care acquired through the ACA exchange.

Conclusion

Considering the 17% inflation adjusted budget cut IRS has experienced since 2010, the problems with answering the phone are not surprising. I discussed the IRS budget earlier in this post. Of course, if IRS would stop shooting themselves in the foot they could do a better job with their existing budget. A bit more money to customer service and less to enforcement might actually be profitable.

Get IRS help by appointment

Tax

In the past, IRS Taxpayer Assistance Centers were open on a first come first served basis to provide in person assistance with tax issues. Now the IRS is testing letting taxpayers get IRS help by appointment in-person. IRS encourages taxpayers to use the face-to-face meeting to only handle issues that cannot be taken care of over the phone or online.

You can find an IRS Taxpayer Assistance Office offering appointments here. Scroll to the bottom and click on your state or the international link. Look for a link to “By Appointment” in the Days/Hours of Service column for those offices scheduling appointments. As of this writing, the only NC IRS site taking appointments is in Wilmington. All other locations are drop-in with first come first served service. So how good are IRS’ suggested alternatives?

Website help

Is the IRS’ website a realistic option? Depends on how complex your problem is and whether it is specific to your account or not. Downloading forms and publications is pretty straight forward, assuming you know the form or publication you need. The IRS search tool is not ideal (being polite here). If I do not know where the information is on the IRS site, I usually use Google to search just the IRS website. You can do this in at least two ways – 1) use the Google Advanced Search screen and complete at least one search field and put “irs.gov” in the site or domain field or 2) type your search normally and at the end add “site:irs.gov.” Leave out the quotation (“) marks. Here is an example search for information on the child tax credit that will provide results only from the IRS site:

So the IRS website will only help you can find and understand the information on their site. It is no help if you need specific help with your actual account (e.g. respond to an IRS notice).

Phone help

Good luck calling IRS! You are better off searching IRS’ website than calling. The Treasury Inspector General for Tax Administration (TIGTA) has several reports on IRS phone efficiency. Need help because you have a collection notice? TIGTA reports IRS collections answers 25% fewer calls than they did in 2011 and taxpayers who do get through wait 97% longer (about 8 more minutes) than in 2011.

What about taxpayers seeking answers to help them complete their returns? TIGTA wishes them good luck (OK, not really but that is the gist of the report). TIGTA reports the level of service in 2015 through March 7th has dropped to 38.5% from 74.7% in 2014. The level of service is a measure of a taxpayers success in getting assistance (i.e. talking to an IRS employee, not necessarily getting the right answer). The average wait time more than doubled from 11.7 minutes to 24.6 minutes in the mid-season report.

On July 15, 2015 the Taxpayer Advocate gave updated numbers – IRS answered 39% of calls and hold times averaged 23 minutes compared to 71% answered the prior year with an average hold time of 19 minutes. So by the end of the tax season things got a little better or less bad.

Only the IRS could come up with a term like “courtesy disconnects” to replace “we hung up on you while you were on hold.” IRS hung up on 8.8 million callers before they got to speak to anyone. Wonder how many were hung up after starting to talk to an IRS employee but before receiving help? At least the hang ups only increased 544,000 from 2014.

In conclusion

It will be interesting to hear from people actually using the appointment system. Please add a comment letting us know if they were available at the scheduled time, were able to resolve your issue, and how difficult it was scheduling the appointment. If you prefer, you can send your comment directly to me.

Meal and entertainment tax rules

Tax

Cunard QM2. Britannia Restaurant, under Creative Commons license, on Flickr

Special rules for Meals and Entertainment

Congress decided there was a higher chance for fraud or errors in deducting meals and entertainment. Consequently, Congress enacted Section 274 of the Internal Revenue Code in 1962 creating special meal and entertainment tax rules. There have been quite a few changes to Section 274 but this post will only cover the current rules. Beyond the normal documentation to claim any business deduction Congress added these additional documentation requirements:

The amount of each separate expense
The date of the event
The name, address or location, and designation of the type of activity. For example, dinner or theater, if that information is not apparent from the other information.
The business reason for the expense or the nature of the expected business benefit. Include the nature of any business discussion or activity before during and immediately after.
The occupation or other information relating to the person(s) attending. Include their name(s), title(s), or other designations, sufficient to establish business relationship to the taxpayer.

Leave something out, IRS will deny the deduction and the courts will uphold the IRS. Congress allowed no leeway for IRS or the courts. A perfect example where Congress needs to allow IRS and the courts some discretion. If you agree, please contact your Representative and Senator.

Per Diem rules

Per Diem expenses must be documented the same as all other meal expenses. If the Per Diem exceeds the federal amount then the employee has to return the excess, or the entire amount, not just the excess, must be included in the employee’s wages.

Conclusion

To sum this post up, want a deduction for meals and entertainment then keep the proper documentation. This is a brief summary of the rules so please contact us for more details or post a question or other comment in reply to this post.

Does the EITC discourage work?

EITC summary