Friday, February 19, 2016

How Some Americans Hit the Maximum Tax-Refund Sweet Spot

FROM WSJ.COM

Aggressive tax planning isn’t just for the rich.
A new study shows how low-income households frequently report the exact right amount of income to get the maximum refundable tax credit from the Internal Revenue Service. And they follow the tax law from year to year, adjusting their income to fit changes that Congress makes.
Consider, for example, a married self-employed couple with two children. They pay payroll taxes, but make too little money to owe income taxes. Instead, they’re eligible to get tax credits designed to encourage work and help them raise children.
In 2012, to get the maximum refund of about $5,070, they had to report about $16,200, which happens to be the point where the entire $1,000-per-child tax credit becomes fully refundable. Any additional income wouldn’t yield a bigger tax credit. That led thousands to “bunch” their income around that point, according to the paper fromJacob Mortenson and Andrew Whitten, economics graduate students at Georgetown University who also work at the congressional Joint Committee on Taxation.
Then, in 2013, the expiration of a payroll tax cut changed the math, because it raised taxes that self-employed people report on their income-tax returns, reducing the incentive to report more income. That year, to get the maximum credit of about $4,890, the same couple had to report income of about $13,600, which just happened to be the income threshold for the maximum earned-income tax credit, or EITC. That’s what thousands did.
How do they do it? Even if you’re not a tax expert, software and shady tax preparers make it incredibly easy to fiddle with the numbers until you hit the sweet spot that shows the maximum refund. Indeed, previous studies had found such “bunching” around the EITC maximum.
What makes this study so interesting is the way it documents the year-to-year movement to different “kinks” in the tax code. The researchers used data from states without their own income taxes, which can create localized trends that obscure the overall movement.
Some of the maneuvers used by taxpayers can be borderline legitimate. A taxpayer could refuse to take real deductions to keep self-employment income artificially high.
Some are dubious. You can hit the threshold by reporting real income you might otherwise hide, like the $500 in cash you earned for odd jobs that the IRS would have no other way to know about. Or you can just completely fake it and make up numbers. That’s illegal.
Oh, there’s a catch.
All these data are taken from tax forms submitted by taxpayers. That is, they don’t reflect IRS audits, and the agency won’t discuss whether the computerized filters it uses to flag returns for auditing look for people seeking the maximum credit.
Because of a history of fraud and errors, returns with refundable credits do draw extra attention from the IRS, and the agency included inflated income claims on its list of theDirty Dozen tax scams last year.
“Scam artists don’t miss a trick and they can entice taxpayers to falsely inflate income on returns to claim tax credits they are not entitled to receive,” IRS Commissioner John Koskinen said last year. “Taxpayers are ultimately responsible for the information on their tax returns, and I urge everyone to file the most accurate return possible.”

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