Extension of form 1040a return to taxpayers with incomes above $3,000
January 25, 1944
To: Mr. Paul
We have given considerable study to the suggestion that Supplement T be extended to taxpayers with gross income up to $5,000. There are some reasons in favor of this suggestion. Many of the taxpayers that in 1941 and perhaps also in 1942 had incomes under $3,000 will, with up-grading of incomes as the national income increases, reach into higher income levels, perhaps as high as $5,000. If then, the individuals who have accustomed to the use of the simplified form 1040A are to be permitted to continue to use such form, it is necessary to extend the privilege to taxpayers with higher incomes. The taxpayer compliance is simpler under the Form 1040A and the Bureau's costs of administration are lower.
There are, however, some considerations against the suggestion to extend the privilege to file 1040A returns to taxpayers with incomes in excess of $3,000. Millions of taxpayers that are now eligible to use 1040A actually do not do so because their deductions exceed the 6 percent allowed in the computations of tax liability in the 1040A table. Millions more that have income under $3,000 are not eligible to use the simple form because they have incomes from ineligible sources, such as business and partnership income, fiduciary income, capital gains, rents, etc. There are many millions with incomes under $3,000 which for one reason or the other do not now use the simplified form. It is important to explore the possibilities of broadening the use of the simplified form for taxpayers with incomes less than $3,000 before moving into the area from $3,000 to $5,000. The higher the income level, the more serious are the main obstacles to the wider use of form 1040A. The deductions are likely to be higher and the streams of other ineligible sources of income are likely to be more important.
An examination of the most recent and available data would seem to point to the conclusion that perhaps not more than two million additional taxpayers would become eligible for the use of Form 1040A if the income range were extended to $5,000 and that of these perhaps not more than a million taxpayers would actually use 1040A because it would not be in their interest to do so, the deductions being higher than the allowed 6 percent.
From the above, it is clear that the importance of extending Supplement T to incomes up to $5,000 can easily be exaggerated as an element in the whole simplification program.
The proposal which is attached has some special defects or disadvantages.
First, the proposal suggests that Supplement T be made mandatory for taxpayers with incomes that do not exceed $5,000. That is in first instance, all taxpayers with gross incomes from the sources now eligible would have to file a 1040A return. Then the proposal would permit the taxpayers that had deductions in excess of 6 percent of gross income to file a claim for refund on the basis of computations made on the long Form 1040. Many taxpayers now compute the tax both ways. This is regarded as one of the chief shortcomings of the present procedure. The proposal would compel everybody with deductions in excess of 6 percent to compute the tax both ways. The so-called mandatory use of the simplified 1040A return thus turns out to be mandatory only for the taxpayers that deductions of less than 6 percent. These will gain from the use of the simplified return. Those that have deductions of more than 6 percent ultimately file two returns and with the 1040 return claim a refund. But this is not all. The refund which could have been avoided in first instance by the use of the proper return after a little trial and error arithmetic or consultation with Bureau aides would under the proposal bear interest, that is, if it amounted to $100 or more. If the interest were kept very low, there would be no special harm from this type of compulsory loan, but there is also no strong case for it.
Altogether the plan seems to add up to a substantial amount of useless compliance and administrative trouble without really furthering Simplification.
Treasury Department, Division of Tax Research
LS:ned - 1/25/44
Considerations respecting extension of Supplement T (the simplified form) up to incomes of $5,000, $6,000, and $10,000.
A. EXTENSIONS UP TO $5,000
1. More than 5 million /1/ taxpayers, it is estimated, will have income between $3,000 and $5,000 for 1943. This large number should not be excluded from the advantages of the simplified form.
2. Raising the income limit is necessary if simplification is to be afforded the same groups that have had it heretofore. With the upward shift of incomes, many taxpayers who have heretofore used the simplified form, and some who have not before had to file a return, will be in the $3,000-$5,000 class. They ought not be obligated to use the complicated Form 1040.
3. The table for estimated tax accompanying Form 1040ES for 1943 covered incomes in this range and allowed deductions of 8 percent. If a precise computation is required next March, large numbers of taxpayers with deductions of less than 8 percent -- probably more than half of those in the income range $3,000-$5,000 -- will find themselves underpaid as a result of having used the table. The underpayment can be substantial, reaching a possible maximum (assuming no deductions) of $94 for a single person /2/ and of $85 for a married person with no dependents. Option to use Supplement T, even though the deductions thereunder should remain at 6 percent, would remove this source of discrepancy between estimated tax and final tax for an appreciable number of individuals.
4. Renters should be given the benefit of the uniform percent deductions used on form 1040A. On the precise computation they get no deduction for property taxes and interest which are included in their rent, although home owners are allowed these deductions. The simplified form gives more equal treatment on this score, since it allows the same percent deductions to all, whether renters, home owners without mortgage, or home owners with mortgage.
5. Administrative costs would be reduced. In 1942 the estimated cost of handling, per return, was less than half as great as great for Form 1040A as for Form 1040.
1. Individuals with incomes as high as $3,000-$5,000 are almost certain to compute the tax both ways if there is any doubt as to their tax advantage. For such individuals the simplified form is no real simplification but merely a means of reducing the tax.
2. Net revenue loss would be involved, since loss in tax far outweighs saving in administrative costs.
3. The facts as to the present use of the simplified form do not justify its extension to higher income classes. Even whit the $3,000 limit, in 1942 only 50 percent (roughly) and in 1943 not more than 60 percent of those eligible used the simplified form. The rest presumably found precise computation more to their advantage. If more general use of the form is desired, attention should be centered on the 10 million or 12 million who could have filed Form 1040A in 1943 but filed Form 1040, rather than on making additional smaller groups eligible to file.
4. If the simplified form is to be largely a tax-benefit rather than a tax-simplification device, it may be desirable to consider discontinuing the separate form rather than extending coverage. If certain statutory simplifications (such as use of one tax base and elimination of the earned income credit) were adopted, the computation on Form 1040 could itself be made relatively simple.
5. A large proportion, possibly a third, of the individuals with incomes of $3,000-$5,000 receive some income from sources not specified under Supplement T. Hence at those income levels the option to use the Supplement would be a smaller part of the group and would be more discriminatory than at lower income levels. /1/
6. Use of a table for estimated tax in 1943 ought not be viewed as committing the Treasury to a modification of the precise computation after the year has closed. In September (and even in December) income and deduction uncertainties warrant some crudity in the tax calculation.
7. Discovery of underpayment next March is a more widespread problem than can be met by extension of the simplified form. Probably the largest group finding themselves underpaid will be those not required to a declaration of estimated tax in 1943, because not above the $2,700 and $3,500 income limits, but with larger incomes in 1943 than in 1942. Though these individuals doubtless think themselves current, they may in fact be substantially underpaid, depending on how much their income rose in 1943 and how it was spread over the year. Another source of underpayment will be the use by single persons, as directed on the computation for Form 1040ES, of a 3 percent rather than a 3.75 percent rate for not Victory tax. The possibility that taxpayers will find themselves underpaid next March, in part though Treasury or Congressional action, is therefore not confined to the group using the table of estimated tax.
8. While benefiting Renters to some extent, the simplified form does not eliminate iniquities between different classes of home owners and between home owners and renters, and should not be relied upon to do so. At the same time it does confer unwarranted benefits on many single persons living at home, with small actual deductions and with little or no rental expense.
B. EXTENSION UP TO $6,000
REASONS FOR: 1. Extension of the limit up to $5,000 would involve the third surtax bracket in the case of some single persons (those with gross incomes between approximately $4,800 and $5,000 if deductions of 6 percent are assumed). Extension to $6,000 would not involve any higher bracket. All persons in this bracket may as well be given the advantages of the simplified form.
2. Probably 40 percent or more of the individuals in the group with income of $5,000to $10,000 have incomes under $6,000. By use of the $6,000 limit, therefore, the benefit of the simplified form could be extended to a large number of individuals in the wider $5,000- $10,000 group without being extended to incomes as high as $10,000.
1. Extension to $6,000 would primarily benefit single persons with substantial incomes. Most married persons with incomes between $5,000 and $6,000 are not subject to third bracket rates. Approximate breaking points above which third-bracket rates apply are for a married person with two dependents, $6,300; for a married person with no dependents, $5,500; and for a single person with no dependents, $4,800.
2. Since the marginal rate in the third bracket is 26 percent, significant tax savings will be realized by individuals with actual deductions of less than 6 percent. Here again single persons may be unduly favored, since the proportion of single individuals with deductions below the 6 percent level seems likely to be greater than the proportion of married persons.
C. EXTENSION UP TO $10,000
1. The table of estimated tax accompanying Form 1040ES covered incomes up to $10,000, and allowed deductions of 8 percent. For an individual with a $10,000 income and with no deductions this could mean an underpayment of tax amounting to $216, if single, an to $229 if married with no dependents. /1/ Actual underpayment will range down from these amounts. Under the simplified form individuals would be allowed deductions of at least 6 percent. Underpayments would therefore be considerably less, and much dissatisfaction would be avoided.
2. Individuals who have used the table of estimated tax in September may legitimately expect continuance of a simplified form.
3. As in the case of lower incomes, renters would be afforded a remedy against the present disallowance of interest and taxes as a deduction.
1. Only about 1 million taxpayers are in the income range $5,000-$10,000. It is not important that the advantages of the simplified form be extended to this relatively small group.
2. Of the million or so taxpayers with incomes of $5,000- $10,000, apparently less than 40 percent have income restricted to the sources specified by Supplement T. If discrimination were to be avoided, therefore, the Supplement would simultaneously need to be broadened to cover all sources of income, including business and capital transactions. Yet details from taxpayers respecting such sources of income are presumably important for audit purposes, since substantial amounts of tax are involved.
3. Further, unless the 6 percent deductions allowance now made in computing the tax under Supplement T is raised to 8 percent, the simplified form will not generally be beneficial to this income group, since average deductions clearly exceed 6 percent. The expediency of fixing a blanket deduction of this size so high up the income scale is questionable.
4. Extension would not be productive of simplicity, since it is virtually certain that the larger taxpayers would figure the tax both ways if there were any doubt as to their tax advantage. Form 1040 is not too complicated for individuals with incomes in this range, or for their tax advisors.
5. Underpayments as a result of using the table of estimated tax, though they can range higher for incomes of this size than for smaller incomes, are likely to be less frequent, since the 8 percent allowance is at or below the average for this group. (See tables 1 and 2).
6. What merit there is in the argument that the simplified form by its uniform percent deduction helps remedy inequities between renters and home owners applies much less forcefully to incomes as high as $5,000-$10,000 than it does to lower incomes. In this high income group more do or could own their own homes; and those that rent are more able financially, than are persons of low means, to bear the tax discrimination involved.
7. while a majority of taxpayers in the group would not secure a tax saving from extension of the simplified form the tax saving to persons with high incomes but with small deductions would be substantial because of the high marginal rates that apply. The fourth and fifth surtax brackets are involved. In the fifth surtax bracket the combined normal and surtax rate is 34 percent, so that on a $10,000 income even a one percent error in the deduction allowed would reduce tax by $34. It is undesirable that tax savings of this sort be extended to large incomes.
8. The additional revenue loss from extending a blanket deduction of 6 or 8 percent to individuals with incomes from $3,000 to $10,000 would have to be recouped. For this purpose, rates in low income brackets would probably have to be raised. Any further increase of marginal rates in low income brackets beyond the levels now contemplated should be avoided.