As far as most people are concerned, the only thing to know about tax season is the filing deadline: April 15. Beyond that, few of us are all that curious. Almost everything else (particularly how much you paid) is blissfully forgotten. But believe it or not, there are some not-so-obvious facts about tax season that are worth knowing. Unbeknown to most citizens, tax season is home to strange behaviors, lesser-known laws and important requirements that can have a substantial impact on all taxpayers. Below are 12 things that you probably didn’t know about tax season.
Scams are more widespread
Identity thieves and hackers use tax season as an opportunity to unleash new and creative scams on the taxpaying public. Typically, such scams operate by attempting to trick people into believing they are on an IRS website. According to a March 29, 2010 report by Internet security giant McAfee, “phishing attacks, forum postings, and black-hat search-engine optimizations” are all used by online scam artists to con people into handing over their sensitive financial information. As McAfee’s research chart shows, the number of fake irs.gov domain names used to host phishing attacks spiked during April of 2009, and figure to do so again during April 2010. Be advised that the real IRS generally does not contact taxpayers through e-mail or insist that you click on links.
There is a substantial “tax gap”
It’s no secret that the IRS doesn’t collect all the taxes it is owed. Few, however, are aware of how large the federal income “tax gap” actually is. In a previous article, TurboTax revealed that the IRS fails to collect about $345 billion in taxes annually. Even when back taxes obtained by prosecution are deducted, some $290 billion in taxes goes uncollected every single year. Roughly 80% of the tax gap, in turn, is due to under-reported income which includes improperly taken deductions and individuals claiming to have earned less income than they truthfully earned.
There are lots of late filers
Another widespread behavior during tax season in the United States is filing returns late. CNN, for example, published an article on April 9, 2009 aimed at “the 10 million people expected to miss the April 15 tax deadline.” To put that number in perspective, keep in mind that (according to TaxProfBlog), 142 million tax returns were filed in 2008, and 51.6 million of those returns were for “people whose exemptions, deductions and credits wiped out any federal income tax due.” If we assume the 10 million non-filers are among the 91 million taxpayers who owe money, that means nearly 11% of paying taxpayers file late.
There are no immediate consequences for not filing
One of the most counter-intuitive facts about tax season is the lack of immediate consequences for not filing (or for filing late.) For as much as the IRS is feared and loathed, they do not punish delinquent filers as soon as April 15 comes and goes. Indeed, it is common, ordinary and expected that the IRS will take years to catch on when you do not file. What happens instead is that the names of non-filers or late filers are flagged for review later on by the IRS database, at which point you are investigated and/or punished.
Not filing is worse than not paying
Relatively few taxpayers realize that not filing a return is, in many cases, worse from a legal standpoint than not paying your taxes. The reason is that failing to file a return is perceived as attempting to conceal your tax obligations from the IRS. Catherine Clifford of CNN concurs, stating that “the absolute worst thing you can do is not file a tax return” because not doing so by April 15 “starts the clock running and they could end up owing more in penalties and interest than they would have in taxes.” Non-filers will also discover (eventually) that not filing a return is its own separately punishable offense, wholly separate from not paying whatever taxes should have been reflected in the return. While you cannot be imprisoned for inability to pay taxes, you can be imprisoned for not filing.
How to calculate your effective income tax rate
Many are familiar with the marginal income tax rates used by the IRS to calculate who owes how much. There are six such brackets (ranging from 10% of income to 35%) and Bargaineering lists a freshly updated table of them for 2010. That being said, it is easy to forget that marginal rates do not apply retroactively to all income earned before that bracket kicked in. As we clarified (with the help of reader Clark A. Wise) in our article on the tax burden:
“If you earn $50,000 in a year, the first $8,375 of it would be taxed at 10%, while the next $25,625 gets taxed at 15% and the remaining $16,000 gets taxed at 25%. Therefore, you owe $837.5 in tax on the $8,375, while you owe $3,843.75 on the $25,625 and owe $4,000 on the remaining $16,000.”
From this, you can calculate your effective tax rate “by dividing your total income tax by your total taxable income, which in this case equals .1736 (or about 17%.)”
America has the highest “tax morale” in the world
For as much as Americans disdain paying taxes, they voluntarily pay more frequently than other nations. James Alm and Benno Torgler published a scholarly paper in the Journal of Economic Psychology called “Culture differences and tax morale in the United States and in Europe.” In it, Alm and Torgler conclude that “individuals in the United States have the highest tax morale across all countries, followed by Austria and Switzerland.” All told, the IRS estimated an 84% voluntary tax compliance rate as recently as 2008. Such a high compliance rate has no doubt contributed to the continued overall prosperity of the country.
Dividends are taxed twice
Although many are not aware of it, investors who own dividend-paying stocks are effectively taxed twice. As Motley Fool points out in their article on surprising tax facts, “companies have already paid tax on the earnings that they use to pay their dividends”, which you are then taxed on individually upon receipt. As Milton Friedman and other economists have observed, this is one of several ways in which the corporate income tax functions as a hidden sales tax on the products, services, and/or dividends of a company. But because the tax bite is taken before consumers and investors get their money, it typically goes unnoticed by those parties.
Many large corporations pay no corporate income tax
Motley Fool goes on to reveal several examples of large corporations (including GE and ExonnMobil) that have not paid a dime in corporate income taxes in the last several years. Generally, such corporations can avoid paying U.S. corporate income taxes by instead paying foreign corporate income taxes – which can be substantially lower. It’s worth noting, though, that Motley Fool is not entirely correct to say such companies receive a “free ride” tax-wise. The corporate income tax is not, as many people believe, a substitute for personal income taxes. Rather, a C corporation’s income is taxed once at the corporate level, and what’s left is then taxed again on the personal income tax returns of the company’s owners. While one tax is called corporate and the other is not, both taxes are paid by the same human beings.
The top marginal income tax bracket was once 91%
As discussed earlier, the IRS taxes people at different marginal income tax rates (or “brackets) depending on the amount of their income. The more you earn, generally speaking, the more tax you pay. As of 2010, the highest marginal tax bracket in the U.S. is 35%. However, our older readers will remember that they were once far higher. As recently as 1980, the top tax bracket was 50% – which was itself a vast reduction from its 91% peak during the Carter administration. (Something to keep in mind before complaining too loudly about your tax burden today!)
Illegal income is still taxable
Uncle Sam exempts no one from taxation – not even drug dealers or human traffickers As far as the IRS is concerned, illegal income is still income and therefore subject to taxation. Consumerist.com clarifies, recalling that “Congress deleted the word “lawful” before the word “income”, making illegal income taxable” way back in 1916. Legendary Chicago gangster Al Capone (pictured above) is a case in point. It was not smuggling, bootlegging or racketeering that landed Capone behind bars after years of hot pursuit, but tax evasion. Several states (including Tennessee) also have laws on the books requiring that illegal drug sales be reported to the IRS.