Tuesday, July 09, 2013

A Very Good Question

3HAHealthAssure asked the question: "Who is responsible for paying taxes under your plan...what is the mechanism to collect owed taxes and how is it enforced?"

The goal of the Object Tax is to create a new interface for the income tax. The income tax is a personal tax. Individual people are responsible for paying their taxes. This is true for the current income tax.

Currently, money is withheld by your employer and paid to the government. You receive a W2 Form and file an annual tax return.

If the HR department messes up their side of the process, employees can be in a world of hurt. Since the money flows from the employer, the IRS burdens employers with all sorts of compliance issues.

The goal of the Object Tax is to create an alternative interface for the income tax that is hosted by a third party financial institution (the financial institution could be an accountant).

The third parties would offer products which are registered, tested, certified and monitored by the Treasury Department (the IRS). If the third parties fail to execute the taxes correctly, they will lose their certification. Their contracts might include fines and even jail time for fraud.

I need to emphasize that people have the choice of sticking with the current payroll withholding system. If people opt to use a Tax Aware Account hosting by a third party the tax flow would work as follows:

Employers would send the employee's entire paycheck to a certified Tax Aware Account. When the employee withdraws money from the account, the account would charge a progressive tax. The tax money would flow into an account to be collected by the IRS. the employee receives the rest.

Let's say you withdrew $1000 and your tax rate was 20%. The Tax Aware Account would transfer $200 into an account in the Treasury Department's name and you would receive $800.

The financial firm that hosts the Tax Aware Account is responsible for seeing that the $200 actually goes to the IRS. If your accountant embezzles the money they claimed to pay the IRS, you would be in a world of hurt in the same way that you would be in a world of hurt if your employer embezzled the withholdings.

Essentially the Object Tax is transferring the compliance issues related to the income tax from employers to the financial firms that offer Tax Aware Accounts. The groups that host the accounts are offering to handle all of the compliance issues related to the income tax as a product.

This is already happening. A growing number of firms have taken to outsourcing their payroll. Many employers hire a third party provider to handle their payroll and all the compliance issues related to payroll.

The fundamental difference between the Object Tax and payroll services is that the payroll services work for the employer. With the Object Tax, the third parties work for the employees.

Please reread the above sentence. This is a truly fundamental change.

I will summarize the post. The income tax system is a personal tax. Individuals are responsible for their tax.

The withholding system creates a structure in which tax dollars flow from employers to the IRS. The IRS burdens employers with compliance issues to assure the money gets paid.

The goal of the Object Tax is to create an alternative to the withholding system.

Certified third party providers can host Tax Aware Accounts. These accounts will be tested, certified and monitored by the IRS.

People have the choice of continuing with current payroll withholding procedures. If people choose to use the new service, their employers would pay the workers' entire salary into a Tax Aware Account. The company hosting the account would handle all of the tax related compliance issues.

The fundamental change of this reform is that tax related compliance issues are handled by firms which are directly responsible to the individual taxpayer and not the taxpayer's employer.

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