Federal Tax Form Simplification

The Tax Form Status Quo

There are three main federal tax forms for individuals in the United States. They are: the 1040EZ, the 1040A, and the 1040. About 50 million out of 130 million people file on 1040EZ or 1040A, while the remainding 80 million must file on the regular form 1040.

Roughly speaking, you must file a 1040 if:
* You have $100,000 or more of income
* You itemizes your deductions (including most home owners)
* You have a health care savings account
* You pay a penalty for early withdrawal
* You have moving expenses
* You have certain business expenses of performing artists and certain government employees
* You have household employees
* You have tips upon which their employer didn't pay FICA taxes
* You have any foreign income
* You pay or receive alimony
* You have any income from self-employment, rental properties, a trust or estate, or a closely held business (other than a C corporation), or
* You have non-mutual fund capital gains.

You can file a 1040EZ if:
* You have no dependents
* Are under age 65 and not blind
* Have under $100,000 of income
* Have no adjustments to income.
* Don't itemize
* Have no tax credits other than the earned income tax credit, and have no advanced earned income tax credit receipts and
* Have income only from wages, salaries, W-2 tips, taxable scholarships and grants, unemployment compensation, Alaska Permanent Fund dividends, interest up to $1,500 a year, and non-taxable combat pay.

You can file a 1040A if you could file a 1040EZ except for the fact that you had:
* Ordinary dividends and capital gains distributions
* Pension, annuity or IRA distributions
* Taxable social security and railraod retirement benefits
* Dependents
* Age over 65 or blind
* Adjustments to income for educator expenses, IRAs, student loan interest, or tuition deduction, or
* The child tax credit, the education tax credits, the EIC (including advanced EIC payments), the child and dependent care expense tax credits, the elderly or disabled tax credit, the adoption tax credit, or the retirement savings tax credit.

The Problem

There is a great deal to be said for allowing people to fill out a tax form that is no more complex than necessary. But, the current system makes people with relatively simple tax situations fill out the dreaded 1040, rather than a 1040A or 1040EZ, or will out the 1040A when a slightly modified 1040EZ could have done the job. The problem is primarily that a number of tax benefits and types of income common to people who would otherwise complete a 1040A or 1040EZ aren't available on those forms.

The Solution.

A few slight tweaks in who can use each form, with accompanying modifications of the forms and instructions, could allow tens of millions of people to use simpler tax forms, greatly reducing the complexity they have to face each year at tax time. What are they?

The following items should be added to Form 1040EZ:

* Income from alimony received (since many otherwise 1040EZ qualified people receive it).
* The special standard deduction for people who are blind (since many blind people would otherwise qualify for the 1040EZ, while few over age 65 would qualify since most forms of retirement income aren't included on the form; this adds two check boxs, a paragraph of instructions and four numbers to choose from, instead of two on the standard deduction and exemption line).
* Adjustments to income for student loan interest (almost all childless college graduates pay student loans), alimony paid (many wage earners without dependents pay this), health care savings accounts (many employed people have these), moving expenses (many people without dependents have these expenses), and penalties for early withdrawal (which often accompany interest income and are shown on Form 1099-INT). Schedules for HSAs and moving expenses would be included with the instructions to the 1040EZ instead of as separate forms.
* Advanced earned income tax credit payments. (These can be copied off a W-2).

The following items should be added to Form 1040A:

* Itemized deductions (many people file form 1040 only for this, and it doesn't make the Form 1040A much more complicated, since non-itemizers can skip the schedule).
* Taxable tax refund income (goes hand in hand with itemized deductions).
* Alimony paid and received (so common these days).
* Tips not reported to the employer (why should waiters have to file a 1040?).
* Household employment taxes (many wage earners have regular baby sitters who receive substantial payments subject to employment taxes).
* Adjustments to income for health care savings accounts, moving expenses, penalties for early withdrawal, and certain business expenses of reservists, performing artists and fee based government officials, all of which are commonly taken by middle income wage earners.
* Schedules for itemized deductions, tips not reported to the employer, household employment taxes, HSAs, moving expenses and special business expenses would be included with the instructions to the 1040A.

Thus, in this regime, you would have to file on Form 1040 only if:
* You have $100,000 or more of income
* You have any foreign income
* You have any income from self-employment, rental properties, a trust or estate, or a closely held business (other than a C corporation), or
* You have non-mutual fund capital gains (including alternative minimum taxes on incentive stock option grants).

With these adjustments, something like 30-40 million people who now file Form 1040 could file on either 1040EZ or 1040A, and at least several million people who now file on 1040A could now file on 1040EZ. Perhaps one in three tax paying households could file on an simpler tax form, without any substantive change in the tax law at all.

It would add about nine lines to the 1040EZ, and it would add about eleven lines and one schedule to the 1040A. But, much of the apparent added complexity on the forms is only apparent, because taxpayers already had to consider many of the matters raised by the additional lines in the course of deciding which form they needed to use.