Tax Forms, Complexity, and Tim Geithner

People often measure our tax system’s complexity by counting tax forms as if the documents, not the law, are the culprit. But my former IRS colleagues used to remind me that forms actually help taxpayers. Imagine if people were required to read the Internal Revenue Code to figure out how much they owe.

This truism leapt to mind when I read about Treasury Secretary-designate Tim Geithner’s tax problems. While employed at the IMF, Geithner failed to report liability for about $34,000 in payroll taxes. After the IRS audited his 2003 and 2004 returns, he paid the back taxes with interest. Recently, he also remitted payroll taxes for 2001 and 2002, even though by then the statute of limitations had expired.

For most workers, paying payroll taxes is simple because employers withhold both the employee and employer portions. Self-employed people and those with income from partnerships or farms must report their incomes on Schedules C, E, or F. Those forms have a line for payroll tax (called self-employment tax) and refer taxpayers to a Schedule SE to compute this tax. Tax software performs these calculations, completes Schedule SE, and reports the tax owed automatically.

But employees of international organizations (and some others, including clergy) live in a tax never-never land. Their employers aren’t required to pay U.S. payroll tax, but they are. U.S. employees of international organizations owe payroll tax only on the portion of their earnings from work within the U.S. The employer sends the employee a Form W-2, which shows wages that must be reported on Form 1040 and reports payroll taxes withheld. (For IMF employees the latter line is zero.)

Here’s where the fun begins. There is no place to remit this payroll tax on Form 1040, where employees report their wages. Instead, the employee must complete Schedule SE even if he has no self-employment income or any other reason to complete a schedule (C, E, or F) that would direct him to Schedule SE.

Ready for some more fun? Line 2 of Schedule SE lists the types of income that must be reported for SE tax and also specifies: Ministers and members of religious orders, see instructions for amounts to report on this line. Who would guess that these instructions also apply to U.S. employees of international organizations? (Note: the instructions to Schedule SE do specify this, but who reads instructions?)

As the Senate Finance Committee report on the Geithner matter states, the IMF prepares a booklet for its employees detailing their tax responsibilities and sends its U.S. employees quarterly wage statements that show how their earnings are grossed up to cover the cost of state and federal income taxes and payroll taxes they must pay. So Mr. Geithner had a lot more to go on than just the IRS tax forms. Still, the chances of an error would have been lower if the tax forms had clearly pointed to the right result. And I and some of my colleagues who have consulted for the IMF have ourselves been confused about whether to report our IMF income as wages or self-employment income for tax purposes, with some of us “tax experts” paying too much self-employment tax in past years.

No tax form can clarify every possible wrinkle in the tax code, and the number of taxpayers involved probably doesn’t warrant a special form for income from international organizations or another line on the 1040. But it is not hard to see why we need so many tax forms.

Maybe, however, there is some benefit to this embarrassing episode. Having stumbled in the overly complex maze that is the Internal Revenue Code, maybe Treasury Secretary Geithner will have some sympathy for those who want to simplify it.