Taxes: Your Annual Ethics Test

Many ethical dilemmas land on our doorstep when we least expect them, but there’s one that arrives with dogged regularity—the annual income tax return.

While there are thousands of strict regulations and rules, and many checks and balances, a lot depends on our own integrity. With the Internal Revenue Service able to audit so few returns, the tax code becomes dependent to a surprising degree on the honor system, and that can lead to strong temptations to cheat.

It doesn’t help that the tax code is often impenetrable. The more frustrated you get trying to figure out the right thing to do, the more likely you are to throw up your hands and take a money-saving guess at the right answer. That’s particularly true if you think the tax code is unfair. And there are lots of areas that force you to guess: Is the fair market value of that couch you donated to charity $25 or $50? Is it okay to deduct medical miles for that trip to Target when you shopped for clothes and household goods and then stopped at the pharmacy to pick up your prescription?

A recently released poll suggests most Americans are honest when it comes to their tax obligation. A survey taken last September found that 87 percent of Americans believe it is morally wrong to cheat on your tax return even a little. “The overwhelming majority of American taxpayers play by the rules and expect everyone else to do the same,” said Paul Cherecwich, Jr., the chairman of the IRS Oversight Board, which sponsored the poll taken by GfK Roper Public Affairs and Corporate Communications.

My own experience supports the poll’s finding. Over the last three years, I’ve seen firsthand how honest people tend to be. As a volunteer preparer for elderly and low-income taxpayers, I’m struck by how meticulous people are about keeping receipts and reporting accurately. When there’s a need to estimate, people invariably pick a figure on the low side and often refuse deductions they’re entitled to, such as taking those medical miles for the Target trip mentioned above.

Some of this is undoubtedly out of fear. I lot of people quickly admit they don’t want to risk getting into trouble, but more say they’re quite willing to pay their fare share, that they’re glad they have enough income to pay taxes, that they want to do the right thing. Sure, there have been cases when I had my doubts about what someone was telling me, but those instances have been few and far between.

But a case can be made that I’m looking at the bright side. Most of the people I deal with have little opportunity to cheat. They tend to be people whose income is reported directly to the IRS anyway, and most don’t itemize so the government already has all their information. The taxpayers who are bound by the honor system are mostly the people with income and expenses that can’t be easily checked by the IRS, such as small business owners and the self-employed.

And IRS data confirm that this is where most of the cheating occurs. In a study of 2006 returns, the IRS found a super-high compliance rate—99%—for those whose income is directly reported to the IRS, but only 56 percent of taxes were paid on income not reported independently to the IRS. And those that do cheat, cheat in a big way. According to most estimates, the government manages overall to collect only about 80% of what is owed, a loss of over $450 billion a year, enough to put a serious dent in the deficit.

So how honest are we? Do we toe the line only when we know we’ll get caught if we stray? Or is it personal integrity that compels us. I like to think the latter plays the larger role with most people, and my experience with my tax clients, many of whom have little income to spare on taxes, gives me some confidence in that.

But tell me if I’m wrong.

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