With President Bush's big tax cuts of 2001 and 2003 all due to expire at year-end, and with the two parties locked in combat over whether to extend all or just some of them, federal taxpayers are left to wonder what they will owe the IRS next year and how to plan for it.
Taxpayer uncertainty, however, is nothing new to the taxpayers of North Carolina who want to pay their state taxes correctly. They've faced decades of confusion because the state's Department of Revenue has purposely hidden the ball when it comes to advising taxpayers -- even those who have asked the department for help -- on how to comply with state tax laws.
North Carolina is one of a small number of states that doesn't routinely publish its "private letter rulings" -- written communications from state tax officials to taxpayers about how North Carolina's tax law applies to a particular situation. The Revenue Department's refusal to publish these guidelines leaves other taxpayers with no way to navigate the state's tax laws with any confidence that they are complying with them -- or with any confidence that tax officials are treating them the same as they are treating other similarly situated taxpayers.
The state's move toward less transparency in its tax laws came on the heels of aggressive efforts in the 1990s among businesses and accounting firms to shift assets and income among affiliated corporate entities, generating a state budget shortfall. In response, the department launched an effort to force companies to file combined returns among separate business entities (rather than continuing to let those separate entities file separate returns).
The department made the policy change without notifying taxpayers beforehand. In fact, it worked to conceal the standards that it was using out of concern that taxpayers would use it as "a roadmap to tax avoidance."
A 2003 report from the American Institute of Certified Public Accountants outlines the harm that insufficient transparency in tax law can produce. It includes government's impaired ability to administer the tax system, taxpayer frustration, and higher costs for taxpayers, advisers, and government as they all face the inefficiencies and uncertainties of a less-than-transparent system.
While North Carolina's legislature has tried to address some disputed tax issues through rulemaking, concerns have arisen that, in the absence of published rules or guidance, it's left largely to state courts to decide tax issues after disputes move to litigation. Court decisions have increasingly become the operating guide by which taxpayers determine tax rulings, which consumes time and resources that the state, its courts, and its taxpayers could more productively spend elsewhere.
Delegating policy to litigators and auditors can cause other problems as well. For instance, lower-level employees may lack the perspective of more experienced executives with a broader understanding of how a policy can indirectly affect other stakeholders.
Transparency is essential for administering a fair and balanced tax system, one in which everyone plays by the same rules and the state treats everyone equitably in applying the tax law.
When states provide insufficient guidance on how they administer or interpret their tax laws, taxpayers have no ability to anticipate how a specific transaction or position will affect their tax liability. Moreover, by leaving policy decisions in the hands of litigators, courts are tied up with unnecessary cases that lead to backlogs and a drain on state resources.
Both states and taxpayers benefit from open dialogue and information exchange with regard to tax determinations. North Carolina lawmakers should permit open public access to all letter rulings and tax determinations -- a move that will enhance taxpayer compliance and lead to a fairer and more even playing field for all taxpayers.
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Christopher E. Bergin is president and publisher of Tax Analysts, the publisher of State Tax Notes and other tax-related publications and a non-profit organization that works for greater transparency and openness in the making and administration of state and federal tax law.