Automatically Completing US Citizens' Tax Returns: What Extra Information Does the IRS Need?

For many US citizens, completing their tax returns can feel like an overwhelming task. However, there is a growing discussion about the potential to automate the process. The IRS, the tax collection agency for the United States, could theoretically complete these returns if it had the necessary information. But what information would the IRS need, and why might it face challenges in obtaining it? Let's explore this topic in detail.

Understanding the Tax Gap

The concept of the 'tax gap' plays a crucial role in understanding why the IRS needs additional information to complete tax returns automatically. The tax gap is an estimate published every five years by the IRS, which calculates the difference between the taxes that are legally required and those that are actually paid by US taxpayers. According to these estimates, around 85% of tax obligations are met, which is relatively good compared to other countries.

The Challenges and Opportunities

Despite the good overall compliance rate, there is still a significant portion of the tax gap that remains unaddressed, with businesses—particularly independent contractors—being the main contributors. A significant portion, about 15%, is attributed to these entities failing to report taxable income or over-reporting tax deductions.

One classic example is the scenario where a homeowner pays a contractor in cash. Since there is no paper trail, the contractor is less likely to report the income to the IRS. Therefore, for the IRS to complete the contractor's tax return accurately, it would need the homeowner to report the payment to the IRS. This is known as information reporting, and the US currently implements this via forms such as W-2 for wage income, 1099s for certain types of incomes, and K-1s for partnership/LLC income.

Information Reporting: Current Practices and Gaps

The IRS already collects information through various forms like W-2 and 1099s, which cover wage and certain types of income. However, the challenge arises when it comes to payments made by individuals to independent contractors. Requiring private individuals to report these payments to the IRS would significantly increase the administrative burden for taxpayers.

A question often raised is whether individuals would be willing to submit reports of their payments to contractors, such as plumbers, electricians, or roofers, in addition to their regular tax filings. While this might seem like a straightforward solution, the high cost and complexity of ensuring compliance could deter many taxpayers.

Best Practice from Other Countries

One interesting comparison can be drawn from New Zealand, where they have implemented a system of complete and accurate information reporting. According to their Inland Revenue site, taxpayers are required to review and affirm the accuracy of the information provided by the tax agency. This approach ensures that the data is both comprehensive and reliable, as it must be reviewed and validated by the taxpayers themselves.

Conclusion

The IRS's goal of automating tax return completion is a commendable one, but significant challenges remain. By understanding the role of information reporting and the current gaps in its implementation, taxpayers and policymakers can work together to improve compliance and ease the tax filing process. While much can be learned from successful models in other countries, it's clear that additional measures are needed to bridge the remaining tax gap and facilitate a more efficient tax system in the United States.