Last Updated: February 2, 2023
Once a year, around the 15th of April, the question echoes around America: Why are taxes so complicated? It is widely known that the US tax system is very tricky, with laws and regulations changing every upcoming year. But why is that? We’ll break down the tax law complexity, and explain how to gain tax efficiency.
Advice for Filing Taxes
Is filing taxes hard? In theory, it shouldn’t be, but in case you’re set on filing your own taxes, you might want to read up a tad more on how to do taxes on your own. We’ve also gathered the best tips on filing requirements and options you should take into consideration before you hand in your tax return.
Individuals and business owners with little or no tax expertise can use tax software programs to correctly file their returns, get the full refund due, and escape IRS audits. Tax preparation software simplifies your filing requirements by guiding users through each phase of the process while also searching for errors and deductions. Some of the best programs for this are TurboTax and H&R Block.
The rate of the income tax is determined by the filing status. The status you choose can affect your tax burdens for the year, so you need to understand what each status stands for. Each carries its own tax benefits. In the US tax law, the five filing statuses are:
- married filing jointly
- married filing separately
- head of household
- qualifying widow(er) with a minor child
Adjusted Gross Income (AGI)
Adjusted gross income (AGI) is your gross income such as wages, dividends, alimony, capital gains, business income, retirement distributions, and other income. This does not include certain payments you’ve made during the year.
Your AGI is often the starting point for calculating your tax bill, from which you make certain adjustments. AGI is also the basis on which you might qualify for many deductions and credits, so make sure to calculate correctly.
Tax exemption means the right to exclude all or some income from taxation. When organizations serve the public benefit, such as religious or charitable organizations, the government generally exempts them completely from paying income taxes.
However, in an individual’s case, a person may assert one personal tax exemption if he or she is not listed as a dependent on another taxpayer’s return. This tax process should be carefully analyzed.
A tax credit is a monetary sum that taxpayers can deduct directly from the amount of taxes they owe the government. Tax credits, unlike deductions, minimize the amount of tax owed rather than the amount of taxable income. There are three types of tax credits:
- nonrefundable tax credits
- refundable tax credits
- partially refundable tax credits
In the US tax law, a tax deduction is a deduction that lowers a person or organization’s tax liability by lowering their taxable income. This is just one of the many ways you can minimize taxes. Tax deductions have two categories: standard deductions and itemized deductions.
This is the portion of income not subject to tax that can be used to reduce a taxpayer’s tax bill. The standard deduction sum is determined by the filing status, age, and other factors.
A list of costs a taxpayer can subtract from his/her federal tax return to lower their taxable income. Medical bills, taxes, home mortgage interest, and charitable contributions are all part of this list.
A tax audit is where the IRS examines your tax return to ensure that your taxes and deductions are right. When something you’ve entered on your tax return is out of the ordinary, it’s usually selected for audit. The IRS performs three forms of audits:
- mail audits
- office audits
- field audits
An extension in time to file your return does not entitle you to a tax payment extension. This might ensure some problems with taxation later on. To escape fines, you can estimate and pay any overdue taxes by the regular deadline. A taxpayer’s request for an extension must be submitted by the usual due date of the return.
Know When to Hire an Accountant
In general, the more difficult your return is, the more demanding the situation is of a professional. If you’re self-employed, you’ve undergone a big life event, you own rental property or have foreign accounts and you’re a stockholder, then you should definitely consider hiring an expert to handle your income tax issues.
When You Should Let Professionals Do Your Taxes
The easiest way to do your own taxes is to just let the professionals take care of it. Here are some reasons as to why you should consider investing in experts:
It’s not always easy to find and enter tax information. Experts say that the process of filling out taxes requires critical thinking skills and comprehension of information that is even further complicated by specialized vocabulary. This means that problems with taxes are simply bound to happen.
Divorcing and Single Parents
Let’s imagine a situation where you might be dealing with a divorce, and your ex-spouse decides to hire a professional to go over your tax returns and finds a few mishaps. So, you’re left with two options: either stand by your taxes with the chance of being cornered into refiling all your tax burdens, or you hire your own professional accountant and let them deal with that mess.
And what if you’re a single parent? You may be asked to choose between filing as a “single” or a “head of household” while using tax software. Both are right, but if you choose “single,” you can miss out on important deductions and tax benefits.
For example, a client who hasn’t filed as “head of household” in the past has lost out on considerable savings, which can cost up to $1,500 per year. These problems with taxation can be easily avoided by a professional.
Paying nannies by the books has its complexities when it comes to filing taxes. Some families even unintentionally give Form 1099 to unsuspecting nannies. One such individual turned up at Louise F. Cochrane’s accounting office in Alameda, Calif., with a possible tax bill of $15,000 in her hands. If you’re one such employer, try to avoid doing that. Just save yourself and your nanny time and stress by hiring an expert.
If you’re a landlord, you understand the problem with depreciation in the US tax law. Namely, the tax code declares that your property depreciates even when it’s rising in value (either on paper or according to Zillow), as long as you are the landlord and owner. But not everything is that black and white when it comes to these complex provisions.
A single-family home depreciates at a different pace than commercial land. Besides nailing the tax rate, you need to take into consideration the “recapture” laws that refer to the amount of capital gain or loss you can declare. You can find out what property taxes are and how they work in order to understand a bit more about this. To summarise, these types of taxes can get quite messy.
If you’ve found yourself in a situation where you can sell a stock, pause ahead before the IRS repayment plan catches up with you and end up with problems with taxation. Might we suggest attending some employer education seminars, and mapping out all tax consequences together with an expert?
Not Filing Often
It totally happens, we’ve all been there. Even the thought of filing taxes can be overwhelming, let alone sitting down and actually doing it. But with that comes confusion over what and how much the taxpayer ends up owing amongst all those filing requirements. This can lead to penalties and additional charges. An expert knows their way around this and will save you time and money.
Causes of Tax Complexity
From The Tax Cuts and Jobs Act of 2017 to the CARES Act, there have been more tax law changes than we can count. So, why are taxes so complicated? Basically, it all comes down to the way we tax income.
These are the three categories of tax income:
Passive investors who purchase securities, bonds, business interests, and other investments have different tax burdens. In their case, their earnings may be entitled to preferential rates. They may be exempt from paying payroll taxes entirely, and some investments are so tax-favored that they aren’t even taxed.
According to the US tax law, wages are taxed at different levels, including federal, state, and local. Wage-earners are subject to federal income tax, social security tax, and Medicare tax to name a few. In addition, the wage earner’s employer would be responsible for matching social security contributions, as well as federal and state unemployment taxes.
Depending on how business owners run their business the tax process varies. If the company is run by a passthrough agency, the owner would pay taxes in the same way that wage earners do, with some exceptions. On the other hand, if they manage their business as a C-Corporation, they would be subject to various laws and rates, as well as taxes on any income distributed to the owners.
The main reason behind tax law complexity is the need to create tax incentives. The federal government offers deductions, credits, and exclusions from gross income to eligible taxpayers in an effort to incentivize good economic conduct. These tax incentives include having children, buying solar panels, saving for retirement, etc. For all these tax incentives the government needs particular rules and regulations so there is no room for fraud or ineligible claims. The more tax incentives introduced – the more complex the income tax code.
Why Are Taxes So High?
All working citizens of the US have to pay several types of taxes, which come out of their monthly personal income, such as:
- Social Security
- Federal income tax
- State income tax
In addition, there are other types of taxes depending on where you live, such as:
- State and local income tax
- Property tax
- Registration and licensing fees
- Other types of miscellaneous taxes
So, how does the American tax system work in this instance? In comparison to other countries, the US pays a relatively lower income tax percentage. For example, the US’s highest taxable state is California with a 12.3% rate (13.3% if income is more than 1 million USD), while Sweden has a personal income tax rate of 52.9%.
However, this is where the main difference lies: Sweden gets a myriad of benefits that balance out the very high tax rates, such as quality health care as well as child care, little to no tuition fees, paid sick leave and parental leave, affordable housing, etc., while the US redirects the biggest portion of tax income into government mandatory spending i.e. Social Security, Medicare, and Medicaid.
The biggest income tax issues at hand are the poor redistribution and redirection of the tax income itself. American households have private spending to consider in addition to paying taxes to get the benefits that come with their taxes, which in turn ends up costing a lot more than initially planned. The areas where the average US citizen has the most out-of-pocket expenses are healthcare (especially for Americans who don’t have healthcare insurance, estimated at 27.5 million in 2018), college education, child care, and retirement (since Social Security does not provide enough for retirement).
To sum everything up, you could choose to do your own taxes. Still, it is most advisable to hire a professional in order to avoid making errors, or if you’re in a tricky financial position such as paying a nanny, being divorced or a single parent, selling stocks, or renting property.
But why are US taxes so complicated? It all comes down to the way we tax income and the need to create tax incentives. In order to avoid fraud and ensure fairness, the government protects itself by creating a complex tax code that in turn makes filing out taxes a tricky task with little room for error.
The most common problems faced by taxpayers are penalties, unpaid taxes, not filing the required tax return, underreported income, incorrect tax calculation (the IRS adjusts return automatically by notice), and audits.
The federal income tax is progressive, meaning that tax rates grow as income increases. However, recently, high-income taxpayers (e.g. multimillionaires) pay lower taxes than the average American family through loopholes. The top 1% of the population pays a federal income tax rate of 24.7%. That’s a little higher than the 19.3% rate charged by those earning $75,000 on average.
If you can answer the question of why are taxes so complicated you’ll know it’s important to do them correctly. You can find that out by calling the IRS directly, getting your IRS transcripts, or researching your IRS online account, which might require the help of an expert.