Analysis of the US Tax Code - Research Paper Example

?Assignment 3: Tax Credits The Original Purpose of Tax Credit in the U.S Tax and Its Present Relevance to the Taxpayer “Tax credit is a direct reduction in the tax liability of the taxpayer receiving the credit” (Murphy & Higgins, 2011 pg. 23). Since 1940s, the U.S tax code has undergone many modifications to ensure justice to taxpayers as well as to generate revenue for the federal government. Tax credits, along with other instruments such as tax deductions and tax exemptions, was used to protecting various income groups and business enterprises during economic downturn (economic instability). Tax credits are neutral and enable the Congress in making certain that specific taxpayers get tax credit as concerns marginal tax rates (Cordes, Ebel, & Gravelle, 2005). This purpose is still relevant for today’s taxpayer because the economy of the country has continued to deteriorate over the years. As such, individual and businesses still need protection from harsh economic times. Fairness of Tax Credits and Their Impacts on Taxpayers According to (Murphy & Higgins, 2011), tax credits provide incentives to taxpayers hence motivating them to actively engage in certain economic activities. Tax credits also ensure the cannon of equity among taxpayers and avail tax-relief for low-income earners. The Congress favors the use of tax credits to deductions since the amount of tax relief is similar for all taxpayers falling in various marginal tax brackets. Tax credits are in most cases nonrefundable and if the total of the credit is more than the tax owed, the taxpayer has no prerogative over the extra credit paid. However, the earned income tax credit and in particular occasions, the child credit are refundable. Many people have criticized tax credits for being unjust. Refundable tax credit is arguably the most unfair form of tax credit. Refundable tax credits are those that a person can get back irrespective of the amount of tax he or she paid. According to Murphy and Higgins, tax credit is refundable when the taxpayer receives tax credit when his or her total tax liability is zero (Murphy & Higgins, 2011). Refundable tax credit is an unconstructive income tax, where the taxpayer does not bear tax liability but collects compensation from the federal government on the basis of his or her income. This scenario perpetuates fraud in the handling of refundable tax credits. Tax credit payable to the taxpayer phases out when his or her income supersedes the pre-set income limit. The utilization of the phase out principle ensures that lower-income taxpayers receive higher tax credit than and reduces or get rid of credits available for high-income taxpayers. Tax credits are only beneficial to individuals who pay taxes. If the poor fail to pay taxes, they are locked out from using tax credits without resorting to sophisticated and expensive leasing deals, which basically benefit the leasing company and not the individual leasing the a property. Despite the fact that tax credits are embraced by many people for availing relief for taxpayers, they have been criticized by a section of the population for unfairness and inconsistency. Tax credits makes the situation even worse for poor individuals who do not qualify for the tax credits as they try to get into deals, which they perceive would be beneficial to them in terms of receiving credits. Unfortunately, they end up getting caught in large debts that they never had before. Tax Credits Susceptible To Abuse by Taxpayers and Possible Professional Accountant Advice In the United States, there have been many claims of billions of dollars paid to illegal immigrants in tax credits. The Internal Revenue Service (IRS) demands that everyone in the united states must file tax return irrespective of whether they are Americans or not. The payment of “illegal tax credits” to illegal immigrants happens at the expense of the legitimate taxpayer. As such, the tax credits that are susceptible to abuse are refundable tax credits such as child tax credit, earned income credit, adoption credit, American opportunity credit and credit for excess Social Security withholding. Child Tax Credit Child tax credit permits a refund of up to $ 1,000 in tax credit for every child who qualifies under the age of 17 years. the qualifying child is similar as the requirements for child qualification for dependency reason with the only variation being that in tax credit, the child must be 17 years and below at the close of a given tax period and has to be a united states citizen or resident (Murphy & Higgins 2011). Tax fraud schemes, which are a menace to the United States consist of refund received for children, who in most cases do not reside in the United States or even exist. Citizens of United States use Social Security numbers to process tax returns. Legal immigrants on work visas in the country as well as illegal immigrants, utilize an Individual Taxpayer Identification Number (ITIN). ITINs provide the greatest avenue for tax credit fraudsters (Walker (2004). ITINs make it possible for illegal immigrants in the country to obtain unimaginable sum of money all in the name of tax credits for “ghost” children. Earned Income Credit This tax credit extends tax relief to taxpayers with low incomes. Distinct from other personal tax credits, the earned income credit (EIC) is refundable to the taxpayer. A taxpayer with zero tax liability can receive an amount equal to the one stated in tax credit. The extent of credit relies on the amount of earned income, which phase out after hitting the pre-set limits. For married couples, they are required to file their tax returns together so as to claim earned income credit. However, in some cases, couples who want to obtain maximum earned income credit may illegally file separate tax returns in order to collect more credit than would be under joint filing of returns. Also, in given occasions, the combined income for a couple may exceed the highest tolerable earned income to be eligible for credit. Consequently, such couples may decide to file separate returns so that they can qualify for earned income credit, which would be impossible under joint filing of their returns. According to Walker (2004), Federal agencies make erroneous payments per year. With continuous development of sophisticated computer enabled accounting programs, payments made in errors have increased. “The Earned Income Tax Credit (EITC) is particularly vulnerable” (Walker 2004 p. 66). Professional accountants are likely to advise individuals who make false claims for tax credit that they can be disallowed from receiving tax credit for two years. The Internal Revenue Service, upon discovering that an individual taxpayer has claimed earned income tax credit for which he or she does not qualify, can disallow the individual from receiving tax benefit for two years. Incase payment of tax credit was because of recklessness or intentional violation of the rule of Internal Revenue Service concerning earned income tax credit, the taxpayer also faces elimination from benefiting from the credit. For couples, they may be disallowed for a maximum of ten years for making fraudulent claims on earned income tax credit. The penalties are however not applicable if the payment was made in clerical error by tax agencies. For proper planning for taxes, individual taxpayers must comprehend the legal consequences of violating the existing rules on tax credits (Johnson, 2009). Possible Remedies That the IRS Can Adopt To Prevent or End Tax Credits Abuse and Probable Response by the Taxpayer The first remedy available to the Internal Revenue Service (IRS) is to scrap off Child tax credit or ensuring an effective means of verifying qualifying children. Scraping of the credit would eliminate the possibility of illegal occupants obtaining hefty payments in the form of tax credits. Immigrants have been reportedly complying with the IRS requirement that everyone should file his or her tax return whether or not they are in the United States legally or illegally. As such they have taken the opportunity to file their tax returns and in turn claim child tax credit for children who are not even in the United States. Scrapping off the tax credit would eliminate such occurrences and save the nation the unnecessary expense. Child tax credit is always an accepted tax relief for many taxpayers. However, in a system where qualifying children for the benefit cannot be effectively verified, there will always be a big loophole that sways people to lie in order to obtain maximum credit. Therefore, this remedy would infuriate many beneficiaries of the tax credit because it would no longer be available to them. However, the idea of immigrant not siphoning money from the United States through child tax credit would be a welcomed idea in the country. The second possible remedy that is available to the Internal Revenue Service (IRS) is to ensure that all workers are registered. This would ensure that only registered workers who qualify for child tax credit receive the payment. It would make it easy to trace individual taxpayers for IRS audit to determine the reliability of information given by taxpayers on their taxable incomes and relief thereof. It is through unregistered worker claim that increases fraud in child tax credit. Because many fraudsters exist in this area, it is likely that many people will oppose the move to have everyone who claims for tax credit registered. The third option for the Internal Revenue Service (IRS) to prevent, control or eliminate the abuse connected with tax credits is to encourage whistle blowing among the public. The IRS can motivate people to watch over those who may be claiming child tax credit illegally and report any incidence that is perceived to be unwarranted. The IRS can appeal to American citizens to be their own guards in protecting the country’s resources from alien swindlers. Also, the Internal Revenue Service can reduce or eliminate the abused to tax credits by instituting strong internal checks and establishing tax credit that impose defaulters and fraudsters to very stringent measures. Strict regulations on tax credits would discourage individuals from making false claims in a bid to obtain tax credits for which they do not qualify to get. An alternative to tax credits that would be fair to all individual taxpayers A possible alternative to tax credits if Feed-in-Tariffs (FITs). FITs are fairer than tax credits. Feed-in tariffs do not adversely affect poor taxpayers. FITs tend to be more egalitarian as compared to other renewable energy policies. They are democratic when compared with other renewable energy standards that only restrict renewable energy to giant firms. When put against tax-metering and tax credits, FITs are much fairer. Tax credits are only advantageous to individuals who pay taxes. Poor individuals who cannot afford to pay taxes are locked out and cannot enjoy the benefits of tax credit. In some instances, tax credit compel poor people to resort to lease deals so that they can also enjoy tax credit but the move only plunge them into further state of penury while benefiting the owner of the assets leased (Gipe, 2012). Properly designed Feed-in tariffs allow every individual to own property (renewable energy). A case for FITs can be seen in Germany where FITs are more democratic than a pack of tax credits used in America. Majority of solar PV in Germany belong to farmers and individual citizens. A considerable proportion, about 54 percent of wind of wind power generation is held by the same ordinary citizens and farmers. Comparing this with the United States scenario, overridden with tax credits, not more than 2 percent of wind power generation is possessed by American people (Gipe, 2012). Some parts of the nation have realized the potential benefits of FITs and are pushing for them so that they can get actively involved in renewable energy revolution (Gipe, 2012). Further, FITS permits the sustainability of green projects, which are not supported by tax credits and net-metering. As opposed to net-metering, Feed-in tariffs do not require the projects to be tethered to any particular property. Last but not least, status quo is quite unjust to poor Americans. It burdens the poor and negatively impact on them through emissions and exposes them to the perils from nuclear power and more so pushes the price of obtaining energy to extremely high points for the poor Americans (Gipe, 2012). Conclusion Tax credits in the U.S tax code are basically meant to provide relief to particular groups of taxpayers. They are not components of tax bases and reduce the amount of tax payable by individual taxpayers, which consequently make them neutral as regards marginal tax rates paid by taxable individuals. Tax credits can either be refundable or nonrefundable. Most federal tax credits are nonrefundable. Refundable tax credits are payable back to the tax payers if their net tax liability totals to zero. However, refundable tax credits are criticized for perpetuating fraud, especially with not so effective tax system. To eliminate or reduce the abuse of certain tax credits by individual taxpayers, the IRS should register workers and improve the tax assessment system which amending existing laws and creating new ones to check against possible abuse of tax credits. The IRS can also resort to alternatives to tax credits such as feed-in tariffs, which have proven to be more liberal than tax credits in some countries. References Cordes, J.J., Ebel, R.D. & Gravelle, J.G. (2005).The encyclopedia of taxation & tax policy. Washington, D.C.: Urban Institute Press. Gipe, P. (2012). Why FITs are Fairer than Tax-Credits and Net-Metering. Retrieved on December 15, 2012 from http://www.wind-works.org/FeedLaws/WhyFITsareFairerthanTax-CreditsandNet-Metering.html Johnson, L.M. (2009).Federal Tax Course 2009.Chicago, IL: CCH. Murphy, K. E. & Higgins, M. (2011). Concepts in Federal Taxation 2012, Professional Version. New York: engage Learning. Walker, D.M. (2004). Financial audit: IRS's fiscal years 2003 and 2002 financial statements. Washington, D.C.DIANE Publishing. Read More