Tax Freedom

April 11th was Tax Freedom Day—the day when taxpayers stop working for the government and start working for themselves—but April 14th was Tax Freedom for me because I got our return done ON TIME. That’s a major accomplishment, because over the past twenty years it was rare when we didn’t go on extension until August 15th or even October 15th.

During the eighties we couldn’t file by April 15th regardless of how much the spirit was willing. The accountant for a limited partnership investment would not send us the K-1 until July. (Form 1065 K-1 lists each partner’s share of income and expense.) Usually we must fill out at a minimum Schedules A-Itemized Deductions, B-Interest and Dividend Income, C-Self-employment Income (twice), D – Capital Gains and Losses, E – Supplemental Income and Loss, and SE – Self-Employment Tax. Depending on our circumstances, we sometimes have had to include Forms 4797 – Sales of Business Property, 6251 – Alternative Minimum Tax, 2210 – Underpayment of Estimated Taxes, and 8283 – Noncash Charitable Contributions. Including attachments, Form 1040 normally exceeds 40 pages.

Among our friends and acquaintances, these conditions are fairly normal. We are not wealthy (we don’t have nannies, maids, or household employees, else we would have to file Form H – Household Employment Taxes), but we’re not poor either. Completing our income tax forms is maddening and complex, and, if our experience is replicated hundreds of thousands of times by people in like circumstances, the waste of societal resources is staggering.

Because I trust their results from the days when I used to prepare tax returns for a living, I subscribe to a non-retail tax software package used by CPA firms. Nevertheless, both as a check and as an estimating tool, I use Intuit’s Turbotax, which is adequate to handle most situations. But the bulk of the effort—and frustration—is due to the painstaking accumulation of the data inputs, not the actual operation of the programs themselves.

Example of a typical frustration: we sold a mutual fund in which we had invested in 1995. Total 2003 proceeds were less than $10,000, so there wasn’t much of a tax impact, but the basis on which gain or loss was calculated involved sifting through dividend and capital gain distributions for eight years (we didn’t take any cash out, so distributions were invested each year at different share prices). At least we didn’t take a partial distribution in a previous year: with a mutual fund I’m either all in or all out because of the complexity of the per-share basis calculation.

Second Example: Form 1116 calculates the Foreign Tax Credit. Annually we collect over $340 in dividends from a large publicly held British company, which paid $34 in British withholding taxes on these dividends. The simple—too simple—approach would be to report the $340 of dividends and take a $34 tax credit off the U.S. taxes due. But we can’t allow beleaguered taxpayers to use foreign tax credits to offset income from U.S. sources, so Form 1116 requires us to total not only our foreign income and U.S. income but also assign a percentage of our itemized and other deductions to foreign income in order to calculate the “overall limitation” on Foreign Tax Credits. Because my tax service charges me $50 to prepare Form 1116, I don’t bother claiming the $34 credit.

Our tax system mirrors the countervailing forces at work in our schizoid society. We want people to buy a home (mortgage interest deduction), but not too much of a home ($1 million loan limitation); we want people to contribute to charity (charitable deduction) but not too much (50% adjusted gross income limitation); we want people to invest in municipal bonds (interest is tax-exempt), but if they have too much of this type of income more of their social security benefits are taxed. The list goes on and on.

But it’s a beautiful day outside. I am free. © 2004 Stephen Yuen

Foster City Lagoon--view from Ryan Park