Question

Two taxpayers each have had $6,000 of income taxes withheld from their wages during the year. After preparing draft versions of their tax returns, the first taxpayer tentatively has a tax liability of $5,900, and the second taxpayer tentatively has a tax liability of $6,100. Taxpayers receive a refund, or must make an additional tax payment, equal to the difference between their tax liability and the tax amounts previously withheld.

Each of these taxpayers is subject to a marginal tax rate of 25%. Also, each of these taxpayers donated clothing worth about $400 to charity during the year, but failed to get detailed receipts that satisfy the Tax Code’s substantiation requirements. Therefore, although the taxpayers actually did donate $400 of goods to charity, it is inappropriate for them to claim a charitable contribution deduction. Which of these taxpayers is most likely to cheat by nonetheless claiming a charitable deduction?

Answer 1

Ans- The second taxpayer is more likely to act unethically because of loss aversion. This charitable contribution is worth 25% x $400, or $100, in tax savings to each taxpayer. For the first taxpayer, this added $100 will be perceived as a “gain” because it will increase his tax refund from $100 to $200. In contrast, for the second taxpayer, this tax saving willbe viewed as avoiding a “loss” because this dubious deduction will spare the second taxpayer from paying additional money to the IRS.

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