Three-card monte and the family making $400,000 per year

Three-card monte is a confidence game in which victims are tricked into betting on the assumption that they can find the money card (often the Queen of Hearts) among three face-down playing cards. After the victim places their bet, the con artist shows that the money card is one of those three, turns all the cards over, and shuffles them around. The victim tries to focus their attention on the money card, not realizing that through a sleight of hand, the con artist moved the money card, and the victim cannot win.

Once again, Democrats and Republicans are arguing about taxes. The current argument is whether the Inflation Reduction Act’s apportionment for the IRS to add 87,000 agents will result in higher audit rates for “working-class families.” The GOP wants to characterize families making up to $400,000 as working class.

 Let’s leave the issue of what constitutes a working-class family to the side and look at the games the GOP plays with this definition. Idaho’s senior Senator, Mike Crapo (R), offered an amendment to the Democrat’s Inflation Reduction Act. In his press release, he says the amendment “would prevent the IRS from using its massive, $80 billion cash infusion on enforcement actions designed to squeeze more revenue out of American taxpayers who earn less than $400,000 per year.” The amendment failed, and now the GOP is saying that this proves that Democrats are lying when they say they don’t want to raise your taxes.

 Sen Crapo’s amendment is less than 40 words. It reads –

 “At the end of section 10301, add the following: (c) LIMITATIONS RELATED TO THE INTERNAL REVENUE SERVICE. – None of the funds appropriated under subsection (a)(1) may be used to audit the taxpayers with taxable incomes below $400,000.”

It seems pretty straightforward. If Democrats really don’t want the IRS auditing working-class families, why aren’t they willing to put it in writing? But like all things involving the law, words matter. In this case, one word matters. That word is “taxable” in the phrase “taxable incomes below $400,000.”

Anyone who’s ever filed a tax return knows you don’t pay taxes on what you earn. Rather, you adjust your gross income by deductions and credits to obtain your taxable income. It’s common for very high net worth individuals to have zero taxable income, even though they’ve earned a lot of money in a given year.  

Take Donald Trump, for example. In 2020, copies of his 2017 tax returns were published by The NY Times. They show that in 2017, Trump earned $373,629 in wages, $6,758,494 in taxable interest, $21,984 in ordinary dividends, $7,562,038 in capital gains, and $84,351 in pension payments for a total of $14,800,496 in gross income.

 Against this amount, Trump claimed $15,313,785 in business losses and $12,306,111 in loss carry forwards from prior years for a total of $27,619,896 in losses. This made his 2017 taxable income a negative $12,819,400. Even if we assume that Donald Trump filed a completely honest and proper tax return, under Sen Crapo’s $400,000 taxable income threshold, Donald would be a working-class family man protected from an audit.

In 1987, the IRS first required taxpayers to provide the social security number of any dependents they claimed. Before that, a taxpayer simply wrote a dependent's name on the form. Starting in 1987, the SSN would be matched against the social security database to ensure that fictitious social security numbers weren’t used and/or that the same number wasn’t used twice. The number of dependents fell by 7 million between 1986 and 1987. Did 7 million people suddenly disappear? Of course not. Taxpayers were cheating on their taxes.

Having started my career at Arthur Andersen’s International Tax Consulting Group, I know a little bit about taxes and how to minimize taxable income. An entire industry exists solely to reduce someone’s taxable income. Read the Wikipedia entries for BLIPS, SOS shelters, or Son of BOSS. All those are names for just one group of structures widely marketed by tax professionals to reduce taxable income. All these structures were eventually ruled illegal by the IRS. But the only way the IRS discovers that someone is using these structures is to audit them.

So when Mike Crapo and his colleagues tell you they want to protect working families, don’t fall for the con. Through his amendment, the GOP wanted to ensure that the richest of the rich, those individuals that can afford $1,000/hour plus attorneys and accountants to save them money by stretching what was permissible under the Internal Revenue Code, never get audited.

The GOP is using the $400,000 figure like the Queen of Hearts and wants you to focus all your attention on that. Then maybe you won’t realize that you’re the mark and you’ve been swindled because you’ll be paying taxes while the richest of the rich don’t.

If the GOP really wanted to help “regular” taxpayers, they would have changed “taxable” to “gross” income. That way, real working families wouldn’t be subject to increased audits, but the rich like Sen. Mitt Romney and Donald Trump would.  Mike Crapo is a Harvard-educated lawyer. He understands the significance of the change. He’s not stupid; he just assumes you are