1.24.2005

Why do investors, entrepreneurs and landlords hate America?

Overstating of Assets Is Seen to Cost U.S. Billions in Taxes
The New York Times (01.24 - registration required)

Investors, entrepreneurs and landlords annually avoid paying at least $29 billion in taxes by overstating the price of stocks, businesses and real estate, two professors say in an article being published today in Tax Notes, an influential tax policy journal.

Claiming to have paid more than the actual price for a stock, business, apartment building or piece of art results in a smaller profit being reported when the asset is sold, and a lower tax on that profit.

"An unpublicized problem of crisis proportions is plaguing" the tax system, one that will cost the government at least $250 billion in the coming decade, the professors wrote.
"Investors, entrepreneurs and landlords, oh my!"

What will we tell the children?

The potential for abusive reporting in this area, particularly for stocks, "is virtually unlimited," according to the authors, who outline five ways that the law encourages cheating. They added that opportunities to cheat also abound in investment real estate, "where tax–free, like–kind exchanges are increasingly common."

Congress could easily reduce this cheating to a minor problem through changes in tax laws that, the professors wrote, would apply the same rules to those harvesting capital gains that now apply to workers, home owners and parents.

[snip]

The article, which appears in today's edition of Tax Notes, a nonprofit tax policy journal, is available online at www.taxanalysts.com.

Professor Soled said that conservative estimates were used in the article. He said he thought such cheating in the coming decade would top $300 billion.

The problem, the professors wrote, is that the Internal Revenue Service has no effective means to determine the price, known as the basis, paid for an asset that has been sold.

Capital gains and losses are reported on an honor system, unlike the rigorous verification regimes that Congress has imposed for wages, home mortgage interest deductions and tax breaks for parents.

Workers have their wages reported to the I.R.S. by their employer. Banks tell the I.R.S. how much people paid in tax–deductible mortgage interest. Congress requires parents to give a Social Security number for each child claimed as a dependent. The working poor are sometimes required to do much more, like producing report cards from schools and affidavits from landlords, to qualify for the Earned Income Tax credit.

Congress has cut overall financing for audits except for the Earned Income Tax credit for the working poor, which critics have said is rife with fraud. But the estimated $29 billion that is lost because of cheating on capital gains is more than four times the highest estimate cited by Congressional lawmakers for losses in the Earned Income Tax credit, most of which the National Taxpayer Advocate has shown is not related to cheating. Math errors and disputes between estranged parents over who may claim a child for the credit account for most of the disputes, and most of those who challenge denials eventually receive the credit.

Since 1997, Congress has given the I.R.S. additional funds to audit the working poor even as it has cut money for other audits. As a result, according to I.R.S. data, the working poor are about eight times more likely to be audited than investment partnerships.

A verification regime for capital gains would end most cheating, the authors say.
Our favorite part? "Congress has cut overall financing for audits except for the Earned Income Tax credit for the working poor, which critics have said is rife with fraud" as opposed to cheating on the capital gains tax with is 4 times higher as the article notes... but that's the "investor class" and they get to use the honor system.

Who is looking out for you? Nobody it seems. Good luck, 'cuz it seems like we all need it.

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