The golden goose of financial data
This is my first year of filing tax returns as a married man. We still have not done it and the main reason is it is a daunting task. The only thing that rivals combining your life together and having a child together in a 12-month span are filing your taxes together. Every bit of income, significant expense, investment, and retirement account comes together on our 1040. If you want to see what we earn as a household, what assets we own and do not own (home), or whether we work from home or the office you will know by our tax return.
This is the case for a married couple as well as an individual. Taxes are the most comprehensive view of American financial life if they make over the required amount to file taxes in the US.
The most exciting thing about taxes is it is a requirement for any individual or couple with an income of $12,550 or more and for any business that makes $400 or more. The coverage of individuals and companies that submitted tax returns in 2021 equaled 240.1 million. This means nearly double the amount of filed tax returns as there were open bank accounts in 2021.
These facts lead to taxes serving as the golden goose of financial data and serving as a forcing function for financial data in the US. This leads to the question how did taxes become the golden goose of financial data in the US?
How we got here — filing taxes in the US a historical
Income reporting
Tax information is among the most zealously guarded secrets in the federal government. It shows income and taxes, investments, stock trades, gambling winnings, and even the results of audits. Taxes are a kind of collective sacrifice. We do not willingly and freely want to give our information to the US government, but that is likely why we have to.
The financial requirements of the Civil War prompted the first American income tax in 1861. The 16th amendment was finally ratified in 1913 and made an income reporting law. This triggered what we have now as the largest revenue-generating entity on the face of the earth the IRS. In 2021, $4.1 trillion was generated by income taxes.
Expense reporting
While income accounts for the largest transactions expenses for both individuals and businesses are reported on tax returns. Indirectly expenses such as mortgage interest get reported on tax returns for individuals. This gives insight into who is a homeowner and who is not. For businesses, expense records are required to be held in the case of an audit.
Investments
Investments show up on tax returns in the form of tax forms there are an absorbant amount of 1099 forms that report things like capital gains and losses, dividends income, distributions, interest income, and retirement account distributions to name a few.
Additionally, business owners typically receive K1s for businesses they have ownership in. With this information taxes give further insight into who owns what and how much income and revenue they may be generating on these assets.
Data science
An underutilized benefit of tax return information is the data. You can build models, tax engines, optimization tools, and predictive tools on top of various tax forms, but the limiting factor is many times the data is inaccessible. Taxes live in a black box. With the proper technology we can unlock tax data and utilize it to build better systems, and a better tax code.
Nearly every tax return is different as 62% of taxpayers have a unique tax return which makes tax data an interesting source of financial data because it provides such a robust data set. For instance, if I am accessing someone’s bank data I am only seeing one bank feed most likely. By accessing someone's tax return I am seeing various sources of income, potential debts related to mortgage interest, household size, and other assets that may be bearing interest.
The other conceptually good thing about tax returns is standardization. Generally, all IRS reports are in a standard format. Everyone’s tax return comes in the same format through the various IRS sources like getting Transcript, Transcript Delivery, and IVES. With access, you can port data into various payloads, pull out specific information and run reports and models to make calculations and predict future results, audits, and payments.
Closing thoughts
In closing, tax return and tax information is the last form of financial data aggregation yet to be unlocked for use cases across financial services. With the direct use cases around verification, planning, and filing there is a unique opportunity to improve taxpayer experiences, and transparency across the board.
If you own a piece of tax data you can offer services related to consumer finance beyond the tax use case. You can offer financial services, asset management, and more. There is needed assistance for many taxpayers as only 42% of tax return filings can be fully automated. The long tail of consumers and businesses need help planning and optimizing their financial decisions.
