Introduction
Every state has a systematic way of collecting taxes from its citizens. The tax system in the United States has undergone various transformations to respond to the needs of citizens in the evolving world (Rupert, Pope, & Anderson, 2014). Indeed, daily expenses are overburdening citizens in the contemporary world, and the citizens are in desperate need of a state that would relieve them from some tax burdens. Fortunately, the United States has a tax system that considers taxpayers who have encountered certain losses that have reduced their taxable income. Taxpayers who incur losses during sudden and unexpected events are entitled to tax deductions for all the losses incurred during the taxable year. It is noteworthy that losses that have insurance covers do not qualify for tax deductions. This paper will give an outlay of the manner in which tax-deductible losses came to be part of the U.S. tax code. It will also discuss a significant tax-deductible and non-deductible loss, and it will give an outline of the IRS audit activities.
Origin of tax-deductible losses
During colonial times, the United States obtained its tax revenues from excise taxes, customs duties, and tariffs. Since the government had a limited need for revenue, citizens did not have to pay taxes directly to the government. However, the post-revolutionary era acted as a revelation, and the federal government realized that there was a need to raise taxes to pay debts, develop the nation, and offer defense for the citizens. That revolutionary era marked the beginning of taxation, and within no time, taxation was imposed on all legal documents. The federal government began imposing direct taxes on the owners of land and property. The situation became worse when the federal government had to finance the civil war. The government obligated the employers to withhold the income taxes of their employees to enable timely collection of taxes. Fortunately, the income tax law of 1862 was reformed to cater to the taxpayers who lost their property in unexpected events.
After the end of the civil war, the need for federal revenue declined considerably, and the government officials thought that abolishing the income taxes would be a fair approach to relieve the citizens. However, later on, the first and second world Wars played a significant role in facilitating the hiking of income tax charges. The entire issues of wars, depressions, and economic booms affected the taxpayers considerably. Indeed, there was a need to find a permanent solution that would relieve the taxpayers from shocks and all unforeseen events. The policymakers felt that it was time to find a tool to stabilize the macroeconomic activities in the nation. After several deliberations, the income tax law was reviewed, and since the 1960s, the tax-deductable losses became part of the U.S. Tax Code.
Indeed, taxpayers who lose property during sudden or unpredictable events lose part of their taxable income. If the government continues charging them taxes on items that are no longer present, the taxes may be higher than the income on the taxpayer, and the tax burden would be overwhelming. Moreover, high marginal tax rates cause inflation, and the taxpayers may have a high regulatory burden. The scenario is devastating since the general economy would underperform. Therefore, although tax-deductible losses offer a small relief to individual taxpayers, the entire exercise has significant positive effects on the economy. In fact, the 2001 tax cut strengthened the economy, as the tax cut insured investors against economic downturns. The economy of the United States is undergoing a robust recovery, and this is attributed to the 2001 tax cut and the various tax-deductible losses.
Significant tax-deductible loss
Casualty losses are some of the most significant tax-deductible losses. Damage or destruction of property during sudden and unusual events like earthquakes, fires, floods, and terrorist attacks are deductable causality losses. As long as the property loss does not have an insurance cover, the owner of the property is entitled to a deduction of the taxable income. Moreover, if the insurance does not cover certain losses, the property owner can also claim a tax deduction of the losses incurred. In the case of partially destroyed property, the federal-state will calculate the deductable loss by subtracting the salvage value and the insurance proceeds from the net value of the property. The value of improvements is added to the original value of the property, whereas the depreciation value is subtracted to determine the net value of the property.
From the discussions, it is evident that casualty losses are inclined towards the property owners. Very little consideration is given to the multiple damages that occur in the case of casualty damages. Taxpayers who may happen to be tenants of the destroyed property may lose their valuables in the case of damage. Moreover, in case many disastrous incidences occur and the property owners claim for tax-deductible losses, the unaffected taxpayers will have to encounter a heavier tax burden than before. The tax rates may increase, inflation may occur, and the overall living expenses may increase. It would be worthwhile if the lawmakers considered the claims made by all the affected people in the case of a casualty loss. The tenants should have an opportunity to produce proof of their lost property, while the workers who lose their jobs should be compensated for their losses before they can secure other employment opportunities. Moreover, the government should use revenue reserves to run their errands during disastrous moments instead of raising tax levels.
Non-deductable loss
The sale or exchange of property between relatives is a nondeductible loss that affects the involved parties considerably. Two people who have a blood or ancestral relationship may decide to trade some property; however, in case they incur some loss in the course of the transactions, the federal-state cannot offer some tax-deductible losses. The state clearly indicates that people cannot have their losses deducted if prearrangements are made to sell an item to a relative through a broker. In case the relative resells the item at a profit, the recognized profit is the amount above the original price of the item. The entire rule applies to both direct and indirect transactions; therefore, the government discourages the trading of property or any tangible items between relatives, as it takes no responsibility in case of disputes or losses.
From a critical point of view, the state is somewhat unfair in dealing with the mentioned issue. This is because the state obligates the traders to figure the gains or losses separately, where, the gains are taxable, whereas the losses are non-deductible. Moreover, the gains from the trading activities cannot offset the losses incurred during the trading period. The government is acting in a selfish manner in handling trading activities between relatives. If it does not offer tax-deductible losses, then it should not tax the gains that are obtained during the trading activities between relatives. To make the entire procedure impartial, the federal government should allow tax-deductable losses for transactions between related family members.
Alternative to loss deductions
From the discussions, it is evident that some taxpayers are highly disadvantaged from the tax-deductable losses. The provisions for deductions are advantageous to the wealthy people who can afford to own large properties and large businesses. When such privileged people encounter losses, the poor taxpayers have to incur the expenses through increased taxes. The best alternative to loss deductions is adopting the Fair Tax Act. The act would replace all the practices of collecting revenue by the Internal Revenue Act with a retail sales tax. Essentially, the taxpayers will only have to pay tax when purchasing goods and services. The employers will not have to pay for medical taxes, capital gain taxes, estate taxes, or payroll taxes. Since the Fair Tax Act will not consider taxing people according to their income, the tax-deductible losses will be irrelevant (McCaffery, 2002). Investors will have to look for alternative ways to ensure their properties instead of burdening the taxpayers every time they incur losses. The federal government will be able to tax every citizen through the consumption tax. All citizens will contribute to the taxes needed regardless of their nationality. This approach will capture the immigrants and those citizens doing illegal activities within the nation. Everybody will pay taxes through the consumption tax to support the financial needs of the federal government. Indeed, the Fair Tax Act will achieve fairness to all taxpayers, as people will have to carry their own burdens. The property owners will not frustrate the United States Treasury, and neither will they impose tax burdens on the taxpayers. Citizens will be encouraged to save and invest, and there will be general economic growth.
IRS audit activities
The Internal Revenue Service (IRS) auditors double-check the reported figures of the taxpayers to ensure that they are free from discrepancies. From one time to another, people who claim tax-deductible losses cheat the system to avoid paying taxes. The IRS audit activities with regard to loss deductions scrutinize the tax gap. The main aim is to minimize the difference between what the IRS receives and what the taxpayers own the federal government (Keenan & Hoshall, 2014). Research indicates that the most recent IRS audit activities related to charitable donations and home office deductions. Since the IRS allowed deductions on charitable donations, taxpayers have abused the deduction. While charitable donations are a great show of selflessness, privileged people and big organizations have had a tendency of making false claims of offering charitable donations. Since the IRS can estimate the average charitable donation for a particular person or organization depending on the income bracket, exaggerated figures may raise eyebrows and trigger an IRS audit. Moreover, most people who work at home overstate their legitimate deductions, and the IRS is often triggered to audit the figures of people with home offices. Depending on the person’s profession and the prior tax filings, the auditors can identify fraud cases (Ungerman & Fowler Jr., 2011). The best strategy to defend a client facing an IRS challenge is providing all the supporting documents that indicate that indeed, the client underwent the losses that ought to be deductible.
Conclusion
From the discussions, it is evident that tax deductibles are social incentives that play a great role in relieving the taxpayers from tax burdens. However, some cunning people are taking advantage of the tax-deductible losses to trouble the federal government and the feeble taxpayers. It is upon the government to impose ways to establish alternatives to lose deductions that would be fair to all taxpayers. In this case, the Fair Tax Act would play a significant role in ensuring justice to all taxpayers who will collectively pay consumption taxes to support the financial needs of the federal government.
References
Keenan, J., & Hoshall, D. (2014). IRS watch. Journal of Tax Practice & Procedure, 16(1), 9-65.
McCaffery, E. J. (2002). Fair not flat: How to make the tax system better and simpler. Chicago, IL: University Of Chicago Press.
Rupert, T. J., Pope, T. R., & Anderson, K. E. (2014). Prentice Hall’s federal taxation 2014 comprehensive. Upper Saddle River, NJ: Pearson.
Ungerman, J. O., & Fowler Jr., C. E. (2011). The new gift tax audits A look at the recent IRS initiative to identify non-filers using state property records. Journal of Tax Practice & Procedure, 13(4), 29-47.