INTERNSHIP REPOR

BUPA-A 590: Independent Study

Indiana State Individual Taxation: Mistakes in Submission of

Tax Return and Scope of Improvement

Submitted To: Professor Nolan J. Taylor

Clinical Assistant Professor of Information Systems Kelley School of Business Indianapolis

Submitted By:

Md. Moniruzzaman Master of Science in Accounting

Class of 2014 Kelley School of Business Indianapolis

Date of Submission: December 18, 2014

"Someone's sitting in the shade today because someone planted a tree a long time ago."

-Warren Buffet (1951–present),

American business magnate, investor, and philanthropist

Executive Summary:

Being a tax analyst at the state tax department, I noticed that after the filing season is

over, we have to deal with the return that has some sorts of mistakes throughout the year.

These consist of more than 50% of the workload after the filing season for the Indiana

Department of Revenue. Thus, these bear a huge cost and time for the state and in turn,

are burden on the taxpayers. These mistakes could be avoided easily. In this paper, I tried

to find out what are the most common mistakes the taxpayers make and how these can be

avoided. Besides the as usual mistakes from the taxpayers side, one of the reasons they

make mistakes is the complicated tax law. I tried to find out how state taxation could be

made simpler in this paper as well.

Introduction:

The state income tax environment has become increasingly complex and contentious over

the last several years. Forty-three states and the District of Columbia presently have an

individual income tax. Only Alaska, Florida, Nevada, South Dakota, Texas, Washington,

and Wyoming do not tax an individual's income. New Hampshire and Tennessee tax only

interest and dividend income. In addition, over two dozen major cities, e.g., Baltimore,

Cincinnati, Cleveland, Detroit, New York, and Philadelphia, impose an income tax on

individuals.1 Through the extensive use of computers and information sharing with other

states and the Federal government, state tax authorities are aggressively assessing

deficiencies against non-complying individual taxpayers, particularly nonresidents.

The definition of taxable income varies by state, but most states generally follow the

federal definition, except that taxpayers may not deduct state income taxes paid. In

addition, states often apply different rules than the Internal Revenue Service for other

types of income and have differing tax rates. Nine states apply a single tax rate to all

incomes, while the rest have multiple tax brackets and rates. Income tax is generally

imposed by the state in which the income is earned. However, various states have entered

into reciprocity agreements with one or more other states that allow income earned in

another state to be taxed in the state of residence.

The Sixteenth Amendment (passed in 1913) to the U.S. Constitution empowered

Congress to tax incomes from whatever source derived.2 This is applicable for both

federal and state taxation.

Tax rules are considered as one of most complicated rules throughout the world. Though

elaborated largely, there are conflicting rules and misunderstanding amount the taxpayers

that give rise to mistakes in filing tax returns and paying taxes. It is found that more than

50% of the working hours of the Indiana department of revenue are spent on correcting

the wrongly filled return. This eventually costs the half of the total expenditure for

Indiana department of Revenue. If proper awareness could be raised or if the tax rules

could be made simpler, these mistakes could be avoided. That would reduce the expenses

of the department substantially and make the taxpayers more comfortable in submitting

tax return and paying tax.

1 THE TAX POLICY BRIEFING BOOK, A Citizens' Guide for the 2012 Election and Beyond, Tax policy

center Urban Institute and Brookings Institute 2 U.S. Code § 61

This paper focuses on two aspects:

1. Areas taxpayers make the most mistakes and ways to avoid those mistakes by filing

Indiana state tax return correctly

2. Simplification of Indiana State Taxation

1) Areas taxpayers make the most mistakes and ways to avoid those mistakes by

filing Indiana state tax return correctly:

Working as a tax analyst at the Indiana Department of Revenue and interviewing other

tax analysts and tax supervisors, I found that taxpayers make mistakes in the following

areas in terms of state taxation most of the times:

1.1. Living in another state but working in Indiana: Taxpayers who have

Indiana income must have to file return in Indiana. The department of the

revenue gets numerous unreported income in Indiana from IRS. When notified

about the income, taxpayers say they were not aware that they have to file

Indiana return as they live outside Indiana. The taxpayers make the mistake

because they think as the state and county tax have already been withheld and

their obligation to Indiana is clear, they are not supposed to file return in Indiana.

However, per Indiana law, anybody who has Indiana Income is required to file

return to Indiana Department of revenue.

1.2. Working in another state but living in Indiana: In this case, the

taxpayers think that as they do not earn the income from Indiana, they do not

have to file tax return in Indiana. However, individual who live in Indiana or has

valid Indiana driver’s license has to file Indiana tax return.

1.3. Neither living nor working in Indiana, but have Indiana Income per

federal return: Sometimes per federal tax return, the taxpayers who do not live

or work in Indiana have Indiana unreported Income. This happens in many cases

for example when the taxpayers have gambling income from Indiana. In this

case, they have to file state return. Taxpayers are not aware of that. Sometimes

there might be mistakes from the IRS or IDOR as well. The burden of proof is

always on Taxpayers that they are not supposed to file a return. In these cases,

taxpayers are supposed to submit the copies of their driver’s license, voter’s

registration and vehicle registration to IDOR. Most of the cases, they do not do

that, but just send the copy of their federal return or return from another state that

proves nothing.

60%

5%

13%

22%

Percentage

Missing withholdingstatements

Different working andliving place

Missing estimatedpayment

Others

Figure: Based on 100 Sample returns of Indiana Department of Revenue

1.4. Missing withholding documents: Many of the returns that have

problems are because of missing withholding statements. While filling return,

taxpayers forget to include W-2, 1099-R, 1099-Div forms and thus loose tax

credits. After inquiry, when they send these documents are costly from both

taxpayer’s and IDOR’s end.

1.5. IN-529 education savings plan contribution: Either the taxpayer or the

College choice does not deposit the IN-529 contribution money in the correct

time. Though taxpayers think that they contributed in the right time, it may not be

the case. This creates differences between the IDOR and taxpayers’ balances.

They need to be ensured that they have account number, payment amount, and

cancelled copy of checks of the contribution. They also need to make sure that

the amount is deposited before December 31 of that particular year when they

want to take the credit.

1.6. Wrong county number: Taxpayers mistakenly report wrong county

number code in the return. This creates mismatch with their and state’s county

tax amount.

1.7. Extension to file, not to pay: This is one of the common mistakes.

Taxpayers file for extension and think they are allowed to pay at the time of

filing return. When the extension to file is approved, this means the taxpayers

are allowed to file later, not pay the tax later. If the estimated tax payment on due

dates are not 90% of the total tax, then the taxpayers will be imposed Schedule

2210 penalty.

1.8. Filing the wrong form: There are separate tax filing for each class of

taxpayers i.e. resident, non-resident etc. Taxpayers sometimes file the wrong

form.

Taxpayers are supposed to use Form IT-40EZ if s/he was a full-year Indiana

resident and all of the following are true:

• Filed a federal Form 1040EZ,

•Claiming only the renter’s deduction and/or unemployment compensation

deduction,

• Have only Indiana state and county tax withholding credits, and

• Do not have any interest income from a direct obligation (acquired after Jan. 1,

2012) of a state or political subdivision other than Indiana.

If taxpayer (and his/her spouse, if filing jointly) were a full-year Indiana resident

and does not qualify to file Form IT-40EZ, then s/he will have to use Form IT-

40.

If a full-year resident of Kentucky, Michigan, Ohio, Pennsylvania or Wisconsin

has only type of income from Indiana is from wage, tip, salary or other

compensation, then s/he will have to file IT-40RNR.

If taxpayers (and/or the spouse, if filing jointly) were an Indiana resident for less

than a full year (or not at all) and do not qualify to file Form IT-40RNR, then

they have to Use Form IT-40PNR.3

I have found taxpayers required to file one type of form was filing other type.

1.9. Filing Wrong County: Taxpayers sometimes mention the wrong county

code in the tax return that give rise to mismatch between their calculation and

department’s calculation. For example, the county code of Marion County is 49,

but the taxpayers write 41 instead. The county tax rate for different counties vary.

1.10. Offset credit (Schedule 6/ schedule F): If the taxpayer had to pay a

local/state income tax outside Indiana, s/he may be able to take a credit. This

credit applies only if the tax paid outside Indiana was to another state, city,

county, town, or other local governmental entity, and they did not refund the tax.

3 Indiana department of revenue Booklet IT-40 for 2013

The credit amount is calculate per department’s county specific conversion rate.

Many cases it was found that taxpayers do not convert the credit amount per state

rules or do not claim this offset credit at all.

1.11. Penalty for underpayment of estimated tax: Taxpayers might owe a

penalty for the underpayment of estimated tax if they did not have taxes withheld

from their income and/or did not pay enough estimated tax throughout the year. 4

In fact, not properly paying estimated tax is one of the most common errors made

in filing Indiana tax returns. Generally, if taxpayers owe $1,000 or more in state

and county tax for the year that’s not covered by withholding taxes, s/he need to

be making estimated tax payments.

There might be this penalty if:

The total of the credits, including timely estimated tax payments, is less than 90

percent of this year’s tax due or 100 percent of last year’s tax due or

Taxpayers underpaid the minimum amount due for one or more of the installment

periods.

If either of these cases apply, taxpayer must complete Schedule IT- 2210 or IT-

2210A. 5

1.12. Tax software does not withdraw money for state tax like federal tax

automatically:

Tax softwares like HR Block does not withdraw tax payment on behalf of taxpayers for

the state tax. Thus taxpayers will have to send money to the department via online or

check. Taxpayers have misconception about this issue and make mistakes.

1.13. Signatures and signing dates: Taxpayers frequently forget to sign the

tax return. Unsigned tax returns are not considered as valid tax return.

1.14. Sending Federal tax return to the department: Many taxpayers do not

know that the department has different tax return. Thus, they send the federal tax

return to the department instead of Indiana Individual Tax Return.

These are the most common mistakes I have found so far working at the Indiana

department of Revenue. To avoid these mistakes, raising awareness among taxpayers and

launching tax assistance program actively during filing season could be taken.

4 IC 6-3-4-4.1 (b) 5 Indiana department of revenue Booklet IT-40 for 2013

2. Simplification of Indiana State Taxation:

When taking an interview with one of the supervisors of the IDOR, an interesting

proposal came out. He suggested that if the IDOR assesses a flat tax rate on all the

taxpayers’ income eliminating the process of deductions and exemptions, taxation would

be much easier. This would eliminate most of the mistakes discussed in this paper. IDOR

policy makers can think about this.

In general, a competitive tax structure rests upon sound principles. Simplicity allows

taxpayers to easily understand and comply with the rules. Transparency enables taxpayers

to forecast their total tax liability and comprehend the state’s tax structure without hidden

costs.

Indiana’s tax system enjoys many positive features. For instance, Indiana has a flat

individual income tax rate. However, by updating and simplifying its tax system once

again, Indiana could improve its competitiveness in the national and global economies.

This paper recommends that Indiana reshape its tax system in ways that remain revenue

neutral.

Today, residents must pay both state and local income taxes if they live, work, or own a

business in Indiana. At the state level, individuals must pay the adjusted gross income

tax, which is currently a flat 3.4%. In calculating their adjusted gross income, individuals

start with their federal adjusted gross income and then adjust that figure based on up to 32

state modifications.6

6 Francina A. Dlouhy, Partner, Faegre Baker Daniels, Thoughts on Tax Simplicity, Indiana’s Tax

Competitiveness and Simplification Conference whitepaper (June 24, 2014),

http://www.in.gov/dor/files/dlouhywhitepaper.pdf