Are some Americans paying income tax they don't owe?
Headline got your attention? No, it isn鈥檛 a come-on for a new tax avoidance scheme. Rather, it reflects an interesting but little known problem with the federal income tax system: People who have聽tax withheld from their paychecks but, for some reason, don鈥檛 file returns. For many, ignoring their 1040 means they are paying tax they don鈥檛 owe.
According to one estimate, in 2003 more than 8 million people had almost $16 billion in taxes withheld but did not file 1040s. Not only did many pay tax they didn鈥檛 owe but some likely missed out on refundable credits that could have improved their well-being. 聽
To some degree, this is the flip side of another set of numbers that get far more attention鈥攖hose American who pay no federal income tax. 聽The other day, the Tax Policy Center that about 43 percent of Americans will be off the federal income tax rolls in 2013, down from 47 percent in 2009.
Nearly three in four non-payers file 1040s. Nearly all pay some tax鈥攕ales taxes, payroll taxes, excise taxes and the like. And most have income taxes withheld from their paychecks but get these payments returned from the government in the form of refunds or credits.
There are also people who make money, have no tax withheld, and owe no tax. Think low-income retirees who are living on Social Security or younger adults who work but make very little. 听听听听
But a surprisingly large number of people do work, do have taxes withheld, but never file 1040s. Because we don鈥檛 know much about them, TPC treats them as non-payers of income tax even though some do pay through withholding. As a result, our estimate that 43 percent of Americans don鈥檛 pay federal income tax is probably high.
A 2005for the National Tax Association Proceedings by Jacob Mortenson of the University of Nebraska-Lincoln, James Cilke of the congressional Joint Committee on Taxation, Michael Udell of Ernst & Young, and Jonathon Zytnick of Yale explores the phenomenon.
Unfortunately, their paper uses what are now fairly old data (from 2003) but there is no reason to believe matters have changed very much in the past decade. 聽
It isn鈥檛 easy to learn about these non-filing taxpayers, mostly because the IRS only publishes data about those who do file tax returns. But the authors used information returns such as W-2s and 1099s to build a broad profile.
Not surprisingly, non-filers who had tax withheld earned a limited amount of income. The NTA paper figures聽an average of only about $20,500 in 2003. And the vast majority of their income was from wages. Keep in mind, though, that this estimate is based on what was reported on those information returns. Some non-filers surely had unreported income as well.
A more recent for the IRS publication Statistics of Income also found a signficant number of non-filers who had tax withheld.聽That paper, by Udell and Joshua Lawrence of Ernst & Young and Tiffany Young at Yale, used 2005 information return data. It estimated that non-filers missed out on $3.8 billion in potential refunds of withheld income tax and another $5 billion in refundable credits.
Of course, while many non-filers are owed money by the federal government there are also many聽who owe taxes, including some who had tax withheld.
It is easy to understand the motivations of those who owe Uncle Sam and don鈥檛 file (such a course of action isn鈥檛 very smart but it is explainable). It is much harder to figure out why someone who has tax withheld and聽is likely eligible for refunds or refundable tax credits doesn鈥檛 bother. We can all speculate about what is happening here, but it would sure be nice to learn more about these taxpaying non-filers.
