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Tax Complexity. Complexity is added to the tax laws in a number of ways, including (but certainly not limited) to:
The Sheer Volume of the Rules. CCH reported in 2012 that there are 73,608 pages of federal tax rules. According to the IRS Taxpayer Advocate Service (“TAS”) in its 2012 report (issued on January 9, 2013): “The tax code has grown so long that it has become challenging even to figure out how long it is. A search of the code conducted using the “word count” feature in Microsoft Word turned up nearly 4.0 million words.” That's a rather significant departure from the 1913 federal income tax code which only contained 14 pages.
The growth of the federal tax laws was shown in a report by the Tax Foundation on the number of words in the tax rules (reported in the thousands):
1955 1965 1975 1985 1995 2005 Increase in 50 years

Entire Tax Code 409 548 758 1332 1791 2139 523%

Regulations 987 2960 3148 4407 5861 6958 705%

Total 1396 3507 3906 5739 7652 9097 652%

Sun-setting Tax Laws. According to the 2012 TAS report: “The tax code contains more than 100 provisions that expired at the end of 2011 or were set to expire at end of the 2012, up from about 21 in 1992.” Sun-setting tax provisions are often designed to disguise the true long term budgetary impact of tax provisions (e.g., the annual AMT "patch"). Sun-setting tax laws also add uncertainty to the planning process as advisors wonder what happens if the sunset occurs. For example, The Economic Growth and Tax Relief Reconciliation Act of 2001 provided that: "[t]he Internal Revenue Code … shall be applied and administered… as if the [2001 Act] had never been enacted.” For the next 12 years, tax practitioners scratched their heads about the scope and impact of a retroactive revocation of the massive 2001 Tax Act - while hoping Congress would have the good sense not to let it happen
Constant Changes. While Congress may have made the Bush tax cuts permanent in January, the tax community is already anticipating the next round of tax changes. For example, President Obama's recent budget proposal provides that the estate tax exemption is reduced to $3.5 million in 2018. According the 2012 TAS report: “There have been approximately 4,680 changes to the tax code since 2001, an average of more than one a day.” These changes do not include the 154 pages of the American Taxpayer Relief Act of 2012 (“ATRA”) that was enacted on January 2, 2013. CCH has indicated that between 2000 and 2010, Congress made 4,428 changes to the Tax Code, including 579 in 2010. In 2006 the IRS Commissioner testified to Congress that since the tax reform in 1986, "Congress has passed 14,400 amendments to the tax code. That's an average of 2.9 changes for every single working day ... for the last 19 years." Congress’s continuing propensity to modify the Tax Code requires a constant updating of tax and investment plans.
The failure of the IRS to promptly update the Treasury Regulations after the enactment of new tax legislation adds another layer of uncertainty. As a consequence, advisors lack precise guidance on the IRS positions and have to work with out of date regulations.
Incomprehensible Tax Law. Congress has enacted a number of incomprehensible Code sections - cynically, perhaps so the perceived benefit of the Code section evaporates. For example, in 1997 Congress adopted Code §2033A which provided family business estate tax exclusion. The exclusion was later revised (as Code §2057) to be a tax deduction. Both Code sections were so imprecise and had so many conditional variables that they were virtually useless, because taxpayers had no certainty that they could rely upon the Code provision to escape an estate tax liability - and if they were wrong, penalties and interest could add to the tax pain. I started working on an article on §2033A in 1998 and after 50 hours of work, threw the article away because it seemed impossible to properly analyze the new rules.
Elusive Tax Benefits. While not incomprehensible, some purported tax benefits are subject to conditions that effectively render them unusable - making many tax practitioners wonder if the tax provision was just a political gimmick. For example, in 1993 Congress offered a special tax break in Code §1202, designed to help small business owners raise capital by reducing the capital gain rate on investors by 50% (temporarily increased to 100% in the Small Business Jobs Act of 2010) if certain conditions were meet. According to the Senate Finance Committee, the stated purpose of the bill was: "The Committee believes it is important to maintain a larger exclusion for stock in small, start-up enterprises. Such enterprises are inherently risky and may not have easy access to the capital necessary to launch a new venture. The Committee believes that it is important to foster such entrepreneurial activities and believes targeted reduction in capital gains taxation will help provide access to needed capital." However, the §1202 restrictions effectively eliminated the benefit to most small businesses:

  • The tax break only applied to investments in C corporations. Most new startup businesses are created as LLCs, Partnerships or S corporations.

  • As a C corporation, neither the business owner nor the investor could personally write off any business losses created in the early years of the business.

  • Redemptions of stock were significantly restricted.

  • The exclusion was treated as an AMT preference, reducing the true tax benefit.

  • The stock must be held for at least five years.

Ambiguity. You might hope that the underlying mathematics of the Tax Code would create precision in the wording of the tax rules. Unfortunately, that is often not the case. For example:

  • Charitable Deduction Appraisals. Treasury Regulation §1.170A-17(a)(9) addresses the issue of how long you need to retain an appraisal used for a charitable deduction by providing: "The donor must retain the qualified appraisal for so long as it may be relevant in the administration of any internal revenue law." In other words, figure it out for yourself, we're not going to tell you.

  • Business Deduction. The Code §2057 family business ownership deduction (eliminated for 2004) provided in §2057(e)(2)(D) that the deduction excluded: "that portion of an interest in a trade or business that is attributable to cash or marketable securities, or both, in excess of the reasonably expected day-to-day working capital needs of such trade or business." No objective standard was provided in the statute or regulations to define the reasonable day to day working capital needs of the business. The committee report indicated that use of a Bardahl formula might be appropriate.

  • Resident Aliens. The United States taxes the world wide income and assets of its resident aliens, so defining a "resident alien" is a critical definition. For income tax purposes, a "resident alien" is defined in Code §7701(b)(1)(A) in fairly objective terms. However, for transfer tax purposes, Treasury Regulation §20.0-1(b)(1) and 25.2501-1(b) provide: "A person acquires a domicile in a place by living there, for even a brief period of time, with no definite present intention of later removing therefrom. Residence without the requisite intention to remain indefinitely will not suffice to constitute domicile, nor will intention to change domicile effect such a change unless accompanied by actual removal." (emphasis added). How exactly do you prove your "present intent" of not planning to leave the US?

Form over Substance. One of the particular oddities of the Tax Code is how two transactions that create the same economic result can be taxed differently. For example, assume there are two owners of a C corporation. One of them dies and his estate sells his 50% interest to the other shareholder for $500,000. In that transaction the purchaser's tax basis in the corporation increases by $500,000. But assume, the transaction was a corporate redemption for $500,000. Although both transactions result in the surviving shareholder owning 100% of the corporation, in the redemption, the surviving shareholder's tax basis is $500,000 less than it is in a cross purchase. At a federal capital gain rate of 20%, the difference in form could cost the client $100,000 when the business is sold.
Phased Out Tax Provisions. Tax benefit phase-outs are an effective means of raising the effective tax rates without touching §1 of the Tax Code. Both political parties use the tax illusion. There are 19 separate Tax Code provisions which deny benefits to taxpayers once they reach certain levels of income. According to the 2012 TAS report: “Roughly half of all individual income tax returns filed each year are affected by the phase-out of certain tax benefits as a taxpayer’s income increases. There are, in fact, legitimate policy reasons for using phase-outs in certain circumstances. Like tax sunsets, however, phase-outs are largely used to reduce the cost of tax provisions for budget-scoring purposes.” The complexity is magnified because the income levels at which the phase-outs occur are not remotely uniform. See a summary of the phased out tax benefits at the Tax Policy Center website:
Exceptions and Limitations. Deductions, credits, exclusions, exemptions, exceptions, limitations to exceptions and exceptions to the limitations - it can drive you crazy. For example:

  • Corporate Losses. Code §1244 provides the perfect example of the complicated insanity of the Tax Code. In 1958 Congress adopted Code §1244 which provides an ordinary loss to individual investors in certain small businesses corporations. Current law provides for numerous limitations and exceptions, including the following partial list:

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