Is It Time to Change the Name of Form 1040?

Updating a 100-Year-Old Precedent

The past year has seen one milestone pass largely unnoticed-2013 represents the 100th anniversary of Form 1040, U.S. Individual Income Tax Return. Now that CPAs and taxpayers are readying themselves for the next busy season, it is fitting to pause and reflect on the document that, more so than any other (except perhaps the ballot), periodically reconnects U.S. citizens with the federal government. Moreover, it is appropriate to consider which changes to the form might allow it to better serve its purposes, one of which is to remind taxpayers why they are filling out the form.

As a starting point, I propose a seemingly insignificant change: an update to the name of the form-the actual words, not the digits. Although the number was selected only because 1040 follows 1039, it has accumulated too much cultural importance to be dropped without good cause. Indeed, it has spawned legends, songs, and punch lines. The problem is with the rest of the title-in particular, it is time to drop the word "income." Whereas the words "individual" and "tax return" remain just as informative in 2013 as they were a century ago, the importance of income is on the wane.

Credits and Deductions

The original Form 1040 was an income tax return. It took six lines to get to "taxable income," and, except for the taxpayer's exemption, every item related to economic well-being. Every dollar-whether a plus or a minus-received equal weight, just like the income statement of any individual or business; however, the concept of "all dollars treated equally" ended in 1924, with the introduction of tax credits.

Credits differ from deductions in the following two ways:

* A $1 deduction lowers taxable income by $1, but its impact on the tax owed depends upon the individual's tax bracket. With today's maximum tax rate at 39.6%, a $1 tax deduction reduces one's tax bill by less than 400 (approximately 250 for most taxpayers). In contrast, a $1 tax credit, which is unaffected by the applicable tax rate, directly lowers one's tax bill by $1. In other words, relative to a deduction, a credit gives taxpayers a lot more bang for their buck.

* A tax deduction is virtually irrelevant to taxpayers without taxable income, because the applicable tax bracket is 0%. In contrast, many credits-those deemed "refundable"-apply to individuals even if they have no taxable income. In 2010, the most recent year for which complete 1RS data are available, more than 40% of Form 1040 filers reported no income tax liability. Many of these persons filed just to get tax credits. Out of roughly 84 million returns with no tax liability, more than 25 million claimed refundable earned income credits, and more than 20 million included claims for refundable child tax credits. Altogether, tax credits claimed amounted to almost $113 billion.

Credits further muddy the "tax is a function of income" equation when they arise from spending choices unrelated to a taxpayer's ability to pay. Examples include expenditures for education, retirement savings, home buying, adoptions, and energy conservation. The last comprehensive tax package passed by Congress (the American Recovery and Reinvestment Act of 2009) contains 20 income-irrelevant provisions that arise from expenditures (mostly credits), and 16 income-focused provisions. More importantly, between 2001 and 2010, the dollar amount of tax credits increased by roughly 150%, whereas adjusted gross income (AGI) grew by just over 30%.

A Global Comparison

The shift away from income is not necessarily bad. Growing numbers of tax professionals question the efficiency and fairness of our nation's overreliance on income as the nexus for federal tax liability. Compared to other nations, the United States is an extreme outlier, with a ratio of federal income taxes to expenditure taxes of approximately 20 to 1.

Japan and Canada, the two countries with tax regimes closest to that of the United States, have ratios of less than 4 to 1. China, home to the world's secondlargest and fastest-growing economy, has an income tax to expenditure tax ratio of less than 1 to 1. If this country aims to be in sync with the economies of other leading nations, the relationship between income and tax liability will probably continue to decline.

A Subtle, But Important, Change

It appears that the connection between income and Form 1040 is somewhat specious. At the same time, income is too often relied upon as a determinant of tax liability. Overlaying this conundrum is the Patient Protection and Affordable Care Act of 2010, which will require individuals to pay a tax if they don't buy something (i.e., health insurance). If this is indeed a tax, as the Supreme Court has mied, it surely isn't an income tax.

What better anniversary present for Form 1040 than to bring its name in line with the realities of the 21st century? I propose it be renamed the "U.S. Individual Tax Return." Congressional paralysis doesn't stand in the way because such a change would not raise or lower taxes. It makes federal tax policy a touch more transparent, and, keeping in mind the need for austerity, it saves a bit of printer's ink.

What better anniversary present for Form 1040 than to bring its name in line with the realities of the 21st century?

George Jackson, CPA, is an attorney who also teaches tax courses at Longwood University, Farmville, Va.