The Government Accounting Office has issued a report in which, relying on data from the IRS National Research Program, it discloses that 68 percent of S corporation returns filed for 2003 and 2004, the last years for which information is available, contained errors. It also noted that, citing an earlier report, 70 percent of sole proprietorship Schedules C have errors. This news may be shocking to some, but it’s not shocking to those who live in the tax practice world and to those living outside of that world who pay attention to what has been happening to federal tax law during the past several decades. It’s a wonder that 32 percent of S corporation returns and 30 percent of sole proprietor filings were error-free (or at least were not found to have errors, which isn’t the same as being error-free). Of all the business entity returns, these two are far from the most complex. If the error rate on S corporation returns is at 68 percent, the error rate on partnership returns must be close to 100 percent. Or more. S corporation taxation isn’t rocket science compared to partnership taxation. There’s no section 704(b) special allocation complexity, no section 704(c) contributed property allocation challenges, no section 743(b) or 734(b) optional basis adjustments, no section 732(d) special basis adjustments, no section 736 maze, no section 751 ordinary income asset analysis, to identify but some of the far more challenging provisions of subchapter K.

A few days before the GAO released its latest report, the Commissioner of the Internal Revenue Service disclosed in a C-SPAN interview, according to, among other sources, The Capitolist, that he does not do his own tax return. Why? He “finds the tax code ‘complex.’” Instead, the Commissioner hires a tax return preparer to do his return. Goodness. The Commissioner of the Internal Revenue Service does not even try to do his own return using software such as Turbotax. What I want to know is whether he CAN do his own return. He says he has been using a preparer “for years.” If he lacks confidence about his ability to do his own tax return, why not prepare the return and then have someone review what he has done? That is a learning experience, not only in terms of the substantive law that is involved, but also in terms of acquiring some empathy for what millions of taxpayers must endure, or pay someone else to endure, every year. How complicated could the Commissioner’s tax return be? It surely isn’t anywhere near as complicated as a partnership return.

The GAO report makes the following suggestions to deal with the horrific noncompliance rate in the S corporation area:
Identify and evaluate options for improving the performance of paid preparers who prepare S corporation returns, such as licensing preparers and ensuring that appropriate penalties are available and used.

Send additional guidance on S corporation rules and record-keeping requirements to new S corporations to distribute to their shareholders, including providing guidance on calculating basis and directing them to the specific IRS Web site related to S corporation tax rules.

Require examiners to document their analysis such as using comparable salary data when determining adequate shareholder compensation or document why no analysis was needed.

Provide more specific guidance to shareholders and tax preparers, such as that provided to IRS examiners, on determining adequate shareholder compensation through means such as IRS’s Web site.
In other words, it’s pretty much a matter of trying to get more people to understand the rules. That’s fine, but it’s only part of the solution. Very few people understand quantum physics, and only a handful more understand the federal tax law. The GAO reports prove that the problem is deeper than tax education, though tax education, done properly, might wake up Americans to the need for sending more powerful messages to the Congress that its manner of doing business with respect to taxation is no longer tolerable.

The key element of any solution, of course, is to clean up the tax law. Duh. When asked how he would make the tax less complex, the IRS Commissioner said, “I don't write the tax laws. Congress writes the tax laws. It's a whole different discussion.” Was this an attempt to avoid offending Congress by pointing out what it could have done differently and should be doing now? Was it the consequence of not understanding the tax law well enough to be in a position to point out ideas for simplifying unjustifiably complicated provisions in the tax law? No matter, it’s just one more bit of evidence demonstrating the disarray into which federal income tax administration continues to sink.

When people do not understand a law, their ability to comply diminishes. When the percentage of people complying with the law diminishes, the risk of the law becoming ineffectual increases. At some point the law becomes something very hollow. When that happens to the law that is the lifeblood of the nation, the nation will go into need of critical care. Then what?

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