Tax Complexity

As Congress deals with various tax measures, the usual calls for tax simplication are made. So how complex is the federal tax system?

Complexity is a difficult concept to measure. One objective indicator is how words there are in the applicable tax laws. John Walker, of the site www.fourmilab.ch, has indexed the Internal Revenue Code and sets the number of words at 3.4 million. If Treasury Regulations are added in, add another 6 million words to the total, with the combined total approaching 10 million words. If you want to add in Treasury Department pronouncements, such as publications, revenue rulings, revenue procedures, private letter rulings, and other explanations of the law, the number becomes incalculable.

To put these numbers in context, there are 602,585 words in the Old Testament. In the New Testament, there are 180,552 words. So who has the more difficult job - bible scholars or tax attorneys? Even without the word differential, the Bible is static - the Internal Revenue Code and its interpretation is a moving target with the constant tinkering and revision of Congress and the Treasury Department.

As the Wall Street Journal noted in a November 1 article on the subject ("Taxing Words"), Ronald Reagan's 1986 tax reform cut the Internal Revenue Code in half, but it has since grown back like jungle brush, thicker than ever. Will this year's tax acts add or take away from the size of the Code? I think we can all predict the answer to that.

That $3 Checkbox

When you file your income tax return, there is a box that taxpayers can “check off” to send $3 of their taxes to the Presidential Election Campaign Fund. This Fund provides funds to candidates to help finance presidential campaigns. When initiated in 1981, 28.6% of taxpayers made the designation. In recent years, this has dropped to 9.1%.

There are various theories discussed for why the participation has dropped. One theory is that the computer/electronic tax preparation software discourages taxpayers from participating, based on default assumptions of “no participation” and inadequate descriptions. According to this theory, the explosion of use of this software has accelerated the decline.

Working with Commisioners of the Federal Election Commission, the Campaign Finance Institute has been able to bring the purported problem to the attention of the tax preparation software producers and tax preparers. In response, two of the major software producers have now agreed to modify their software.

H &R Block has agreed -- in all of its TaxCut boxed software and online products -- to:

--Change “I want to contribute $3” to “I want to designate $3” to the Presidential Fund (This is followed by the caution “Checking the box will not change your tax or reduce your refund,” a key Form 1040 phrase that the company added last year at CFI’s request); and

--Add to its explanation of the Fund the following Form 1040 language: “The fund reduces candidates’ dependence on large contributions from individuals and groups and places candidates on an equal footing in the general election.”

Intuit agreed -- for all versions of consumer TurboTax -- to:

--Eliminate the pre-filled in “No” check box;

--Change “Do you want $3 to be contributed” to substitute “designated” for the last word (The caution remains, “Note: Selecting Yes will not increase your tax due or reduce your refund”) ; and

--Amplify its current explanation of the Fund to include the missing 1040 phrase, “and places candidates on an equal footing in the general election.”

All of the changes will go into effect in consumer product and web updates for Tax Year 2005.

It will be interesting to see if this reverses the slide in taxpayer participation, or whether the decline arises for other reasons (including the reduction in the number of tax filers that actually owe tax and intentional decisions not to participate in public finance of elections).

Private Trust Companies

At times, families often seek to establish their own trust company to serve as fiduciaries of estates and trusts of family members. Such a trust company can reduce the costs involved with using third party trust companies, allows for continuity, management and control of the fiduciary function by a family, and avoids some of the drawbacks to both third party trust companies and individual fiduciaries. Indeed, several well-known trust companies got their start as private trust companies for a family.

Since the trust company is generally established and controlled by senior family members, tax issues arise regarding whether this “related” relationship gives rise to retained control by family members such that the grantor trust rules may be inadvertently brought into play, and that also may result in unintended estate tax inclusion in family members of the trust assets.

In a favorable ruling, the IRS has confirmed that when properly structured (including provisions that exclude family members from participating in discretionary decisions and having adequate trust company “firewall” provisions), the private trust company is not a “related or subordinate” party for purposes of these tax provisions and does not otherwise give rise to undesired grantor trust consequences. Private Letter Ruling 200546052, 11/18/2005.