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Bankrate's 2010 Tax Guide
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Cash-strapped states turn to tax amnesties

State benefits, problems

Amnesties also are sweet deals for states, especially in tough economic times when tax revenues shrink.

"We definitely see them in times of budget shortfalls," says Thies. "The cost of having to initiate and conduct an audit and find nonfilers is very expensive for the state. So when they are already up against a budget crunch, by waiving at least a portion of interest and penalties, they can jump-start their own coffers by getting people who would otherwise be difficult to find."

But Mark Robyn, an analyst with the Washington, D.C.-based Tax Foundation, says amnesties actually could end up costing states.

"The biggest downside in our view is that an amnesty is unfair treatment of different taxpayers," says Robyn. "It creates a situation where law-abiding taxpayers who are paying taxes on time are paying for those who aren't."

And fully or partially waiving the penalties that are usually associated with noncompliance could cause some people to use amnesties as an unconventional tax strategy.

"Knowing that the state will hold a tax amnesty every three or four years, taxpayers could decide to hold onto their money to invest it or spend it and then take advantage of the next time the state offers amnesty," says Robyn.

Undermining tax confidence

Amnesties also can undercut the purpose of the tax system.

"It undermines people's perception of taxes and their willingness to pay taxes on time when it appears that those who don't pay taxes don't pay a price for their noncompliance," says Robyn. "Confidence in the tax system erodes."

Such damage to tax collection methods might not be a problem if states were more like Alabama than Massachusetts when it comes to amnesties. The Bay State held three tax amnesties in just seven years, whereas in 2009, Alabama conducted its first tax free-pass period in 26 years.

Federal fallout

Tax amnesties also could present problems for filers who, in addition to not paying state tax bills, have neglected their federal obligations.

The IRS Fed/State Program is a partnership between the IRS and most states to enhance voluntary compliance with all tax laws.

When some of the shared information is on previously unreported state income, you can expect the IRS to make sure it got a return from you about the money on the federal level. If not, it's going to want its cut now.

Despite the downsides, for taxpayers and states, amnesties are likely to continue.

"We will probably see states turn to amnesties more as the economy goes bad and they have trouble raising revenue. It is a quick way to bring in money that may have gone uncollected to a large extent," says Robyn. "But that doesn't make it sound tax policy."

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