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Saturday, August 1, 2020

Recovery Rebate Fix Needed by Congress to Not Encourage MFS Filing Status

The CARES Act enacted March 27, 2020 included the 2020 recovery rebate for individuals that provided over 160 million adults with $1,200 to help them with financial challenges during the pandemic (see GAO data). The IRS refers to this payment as the Economic Impact Payment (EIP) and as of today (8/1/20) has provided 70 FAQs to help explain it! The provision added Section 6428 to the Internal Revenue Code.

I was surprised by FAQ 26 and its answer because I would think that if for a married couple one spouse has an SSN and the other has an ITIN which disqualifies that spouse for an EIP, the spouse with the SSN would still have been given $1,200. But that will only happen if they file as Married Filing Separately rather than as Married Filing Jointly.

A26. No, when spouses file jointly, both spouses must have valid SSNs to receive a Payment with one exception. If either spouse is a member of the U.S. Armed Forces at any time during the taxable year, only one spouse needs to have a valid SSN.
If spouses file separately, the spouse who has an SSN may qualify for a Payment; the other spouse without a valid SSN will not qualify.
In reviewing Section 6428, the rationale for this answer seems to be at Section 6428(g)(1)(B) which in explaining the identification number requirement states that a person filing a joint return only gets an EIP if the spouse has an EIN. So, the answer from the IRS appears to be correct.

So, the problem is with the text of the law. I say this because the tax law doesn't encourage using the MFS status over the MFJ status. The tax law provides that when a married couple file separately, there are several favorable rules they will no longer qualify for. These include the Earned Income Tax Credit, the dependent care credit, most education tax breaks, and a few others (see page 7 of Pub 501).

I think the rationale for the harsh treatment for MFS that has existed in the law for a long time is that it is extra work for the IRS to be sure both spouses are not claiming benefits where only one may be allowed to claim them. Generally, MFS is only used where a spouse wants to avoid joint liability for the taxes owed or their combined taxes will be lower with that status (which occurs in rare situations).

I believe Section 6428(g) is incorrect because the tax law should not be encouraging MFS over MFJ. For example, a couple with children where one spouse has an SSN and the other has an ITIN, will need to determine if skipping the $1,200 EIP is better than losing an EITC and other tax breaks. This awful decision should not have to be made - a fix is needed from Congress.

I hope that the next round of COVID legislative relief will correct this by removing Section 6428(g)(1)(B). The IRS can easily tell from a MFJ return that one spouse has an SSN and the other has an ITIN so only issue the EIP to the spouse with the SSN. Thus, (B) at (g)(1)is not needed. This change would also enable the IRS to issue these EIPs based on the 2018 or 2019 returns already filed.

What do you think?

Friday, July 10, 2020

Some Tax Terms Create Confusion, Such as "Automatic"

July 15 - the due date for most 2019 filings as well as the first and second quarters of 2020 income tax payments, being just  few days away, we see reminders from the IRS and state tax agencies.

The other day I saw a statement that you can get an "automatic" extension from the IRS, I thought I had missed something because I thought you still needed to file a Form 4868. I double-checked and you do still need to file the Form 4868 by July 15 to get an extension to file until October 15. So, here, "automatic" meant you don't have to offer a reason to get the extension, you just file the form.

In contrast, in California, an automatic extension means you don't have to do anything other than not file by the "normal" due date. So, here, automatic means it all happens without any action by the individuals. See here and here. You do need to file something if you owe on the due date.

The California usage of "automatic" is similar to the FBAR filing extension. An FBAR is normally due by April 15 for individuals but can be extended to October 15. That extension request is automatic and you don't need to do anything.

So, why not do any of the following to make this clearer and eliminate the likelihood of error (such as not filing Form 4868 by July 15 (normally it is due April 15 but was extended for 2020 due to COVID))?
  • Don't use "automatic" but instead state that you must file Form 4868 to obtain more time to file (but not pay). And state that you do not need to state a reason for needing the additional time.
  • Use two dates: Payments are due by April 15 (July 15 for 2019 returns) and returns are due by October 15.  (The reality is that if you don't need to do anything to get the extra time to file, then isn't the filing date really that later date?)
What do you think?

What other words should be changed to reduce some of the complexity in tax systems and reduce mistakes? btw, I'm all for getting rid of Form 4868 and going with the second option above.

Saturday, June 27, 2020

Are travel tax subsidies a good idea?

On May 18, 2020, President Trump met with some restaurant execs and suggested a few tax law changes to help the industry. This included "restore the restaurant deduction to help jobless restaurant workers" He also suggested: "Create an “Explore America” — that’s “Explore,” right?  Explore America tax credit that Americans can use for domestic travel, including visits to restaurants."

On June 22, 2020, Senator McSally (R-AZ) introduced S. 4031American Tax Rebate and Incentive Program Act (the American TRIP Act). This bill would add new IRC §25E, Travel, Hospitality, and Entertainment Expenses. This bill does the following:

  • Provide a 100% nonrefundable credit on up to $4,000 of expenses for travel and restaurant usage ($8,000 MFJ) + $500 x # qualifying children (under age 17).
  • The credit is for qualifying travel in the U.S. and its territories that is over 49 miles from the taxpayer's home for food, lodging, transportation, live entertainment (including sporting events), expenses related to attending conference or business meeting).
  • For use of a personal vehicle, the amount considered spent is measured using the standard mileage rate in effect under §162(a), with is 57.5 cents/mile for 2020 (this is the rate that includes depreciation so too high for personal travel).
  • The credit is based on travel after 12/31/19 and before 1/1/22 per the text of S. 4031 (so 2020 and 2021). However the sponsor's press release says the credit applies for 2020, 2021 and 2022.
  • Travel to the taxpayer's vacation home is okay if 50 miles or more away, but expenses of the home don't qualify.
  • S. 4031 also allocates $50 million of grant funds to promote tourism and travel in the U.S.
Is this a good idea? Let's consider the likely purpose and how it stacks up against a few principles of good tax policy.

Purpose: Encourage people to travel and spend money at hotels and restaurants and buy airline, bus or train tickets or gasoline, and to support theaters, amusement parks and sporting events. Will it be enough for people to risk exposure to COVID-19? Might it be enough for these facilities to put more protection in place for customers? Might it send a message that travel and interaction with others is safer than it might really be? What about helping other industries such as local restaurants, theaters, fitness centers and stores?

Why is this effective starting on January 1, 2020? This means the credit subsidizes behavior that already took place - a retroactive incentive. That is a waste of funds.  Personally, I was in DC for two extra days as part of a business trip before the pandemic. That would qualify for the credit, meaning that with a 100% credit, all of my fellow taxpayers would subsidize my expenses on those two days. Why? There is no purpose for this subsidy or gift.

Certainly, the effective date should be after enactment, not before.

Equity: Generally a credit is more fair than a deduction because the credit is worth the same amount to all taxpayers. However, this credit is not refundable so it it not available to many taxpayers or won't cover all of their travel even if below the specified credit amounts, but the full credit is easily available to higher income taxpayers, so they get a significant subsidy.

For example, assume a married couple with no children has taxable income of $70,500 in 2020. Their tax liability is $8,065. They should think ahead and take a vacation and spend that much money. Basically, instead of paying that total to the U.S. Treasury, they can spend $8,000 on a vacation and just owe $65 to the government. In contrast, if this couple's taxable income in 2020 is instead $19,000, they owe only $1,900 (less or zero if they are eligible for the EITC, particularly is they have a child). So if they managed to spend $3,000 on their vacation, they get a subsidy of only $1,900.

Simplicity: The terminology seems clear. But, what documentation will need to be maintained and forms completed? 

Minimum tax gap: Might some taxpayers just say they took a trip to get the tax break? Hopefully not but if there is no reporting form, it could happen. Also, the credit is better than a business deduction so self-employed individuals who need to travel for business may be better off making sure the trip doesn't qualify as a business deduction so they can claim the 100% credit instead.

So, while the purpose to help out restaurants and the travel industry may sound good, this large non-refundable credit means that the government (that is, all taxpayers) will in essence, subsidize vacations for individuals with tax liabilities up to $8,000 (more if the married couple has children under age 17). Fairness and the cost to government revenues is a significant issue.

What do you think?

Thursday, June 4, 2020

Employee Retention Credit Issue - What is likely policy resolution?

Having been in the taxation and tax policy field for over 30 years, I've spent a lot of time studying, researching, speaking, testifying and writing about tax reform.  Since early March 2020 with the COVID administrative and legislative changes and proposals, I can't recall a busier and more complex time so far as tax changes go.  There have been a lot of changes enacted quickly.  Drafters are doing a great job. Issues easily arise as to interpretation though due to lack of time for adequate review and discussion prior to enactment and due to the volume of changes. Hopefully areas of confusion can be resolved soon so individuals and businesses in need of the legislated assistance can take advantage of the benefits without worry that they may have to give them back later.

I have spend a lot of time over the past many weeks on the following multi-faceted (complex) provisions:

1st - The required paid sick and medical/family leave for employers with under 500 employees in the Family First Coronavirus Response Act (FFCRA) (PL 116-127; 3/18/20). The required salary payments produce refundable payroll tax credits for the employer. And, equivalent credit is provided for self-employed individuals. Between the Dept. of Labor and IRS, there are about 200 FAQs to help explain these provisions!

2nd - The Employee Retention Credit and OASDI deferral of the CARES Act (PL 116-136; 3/27/20). The ERC helps employers who continue to carry on business and pay wages despite facing one of these two tests/reasons:

  1) Government Order Test: Business operations were fully or partially suspended due to government orders limiting commerce, travel, or any group meetings due to COVID-19 [see FAQ 28 to 38]; OR

  2) Reduced Gross Receipts Test: Employer’s gross receipts (per §448(c) definition) are less than 50% of gross receipts for the same calendar quarter of 2019, AND ending with the quarter following the first quarter where gross receipts exceed 80% of gross receipts for the corresponding 2019 quarter [see FAQ 39 – 46]

The key point I want to make for this post (beyond the complexity* of the provisions) is that there is an interpretative issue with the ERC that is significant for many employers. The ERC works differently for employers based on the number of full-time employees they had in 2019. Full-time means working on average at least 30 hours per week. If an employer had 100 or fewer full-time employees in 2019, then if reason 1 or 2 is met for wages paid from March 13 to December 31, 2020, all of the wages count towards the ERC (but limited to $10,000 per employee or a credit of $5,000 per employee). If an employer had over 100 full-time employees in 2019, then the qualified wages are only those paid to employees for NOT working.

Well, how do you count full-time employees? Here is the challenge. The Joint Committee on Taxation states that full-time equivalent (FTE) employees are included (see footnote 145 in the JCT CARES Act report) while the IRS states that only full-time employees are counted (FAQ 49).

Now for many employers, they will reach the same result under either calculation. For example, an employer with ten employees working at least 30 hours per week in 2019 and another ten working twenty hours per week, is a small employer under both definitions.

But let's consider an extreme example to highlight a point that makes the JCT interpretation more equitable (although that doesn't mean it is what Congress intended). Suppose Employer X had 120 full-time employees in 2019 and each worked 30 hours per week and there were no other employees. Clearly, X is a large employer under both the JCT and IRS definitions. In contrast, Employer Y had 240 employees all of whom worked 15 hours per week in 2019, and no full-time employees. Under the JCT definition, Y is a large employer, but under the IRS definition, it is not (no full-time employees in 2019). The ERC calculation is significantly different for Y under the JCT interpretation (only generated for wages paid for hours not worked) while under the IRS definition the credit is based on all wages paid (assuming Y meets reason 1 or 2 above).

Query: Aren't X and Y the same size in terms of hours worked by all employees in 2019?  Seems so. This is likely why the JCT footnote 145 says include FTE employees.  Also, the law refers to IRC section 4980H to define full-time employees which is not clear as to whether that reference is solely for the definition of at least 30 hours per week to be full-time or to also include FTE employees used for section 4980H to determine if an employer is an "applicable large employer" subject to the employer mandate to offer health insurance to its full-time employees and their dependents up to age 26. The text at section 2301 of the CARES Act is brief and doesn't specifically mention FTE employees. But then, why does it even refer to section 4980H rather than just say full-time means at least 30 hours per week?

Hopefully this issue can be resolved soon so affected employers can correctly calculate and claim their refundable ERC to help them in these challenging times.

What do you think?

*I'll share a personal example on the complexity of these employment tax provisions, I have well over 30 hours devoted to figuring out just the three employment tax provisions to present webinars on them of one to two hours in length!

Monday, May 18, 2020

Shifting tax base to consumption tax is bad idea

In January 2020, a Nebraska legislator introduced LR300CA, to amend the state constitution to prohibit all forms of taxation other than a consumption tax. The proposal states that the tax is to be at a single-digit rate. Presumably, both the state and local governments could have a single-rate tax. It would apply to all new goods and services, but does not define this term. It sounds like it means tangible personal property and services, possibly also travel and entertainment, but not clear.

It is unlikely that such as tax can raise as much revenue as an income tax, even with no exemptions to the sales tax. High income taxpayers don't spend all of their income, they save it and invest it. So that drops the tax base compared to an income tax.  Consider these two formulas and you'll see the base for an income tax is broader.

   Income = consumption + savings

   Consumption = Income less savings

And, with an income tax it is easier to have a progressive rate structure to increase vertical equity in the system.

One new category that would become taxable and affect higher income individuals more than lower-income is to tax food. Currently, Nebraska doesn't impose sales tax on food.  According to data from the Bureau of Labor Statistics, the top 20% of income earners buy 1/3 of total food purchases. They also buy 41% of all entertainment spending. Hopefully the Nebraska proposal  intends to apply sales tax to entertainment.

The proposal is likely to be a tax increase for low-income individuals as there is no exemption for low-income as there easily can be for an income tax.  With removal of income and property taxes and only a single-digit sales tax, it is likely that government would have to cut services which would also disadvantage lower income individuals.

What about alternatives?  Here are a few ideas:
  • Repeal income tax preferences such as the mortgage interest deduction.
  • Impose sales tax on food but provide an income tax credit to low-income individuals to reduce the impact to them of the tax.
  • Expand the sales tax base to include high-end consumption such as entertainment, travel, and household help.
Also in 2020, a California legislator introduced AB 2712. This calls for a universal basic income amount of $1000 per month to be paid to individuals age 18 or older with income below 200% of the median per capita income for the person's county of residence (measured by the BLS). This amount would not be subject to tax in California or affect income based tax and other benefits. AB 2712 defines "universal basic income to mean unconditional cash payments of equal amounts issued monthly to individual residents of California with the intention of ensuring the economic security of recipients." The payments would be handled by the FTB.

To pay for this, the bill calls for that "on or before July 1, 2024, the California Department of Tax and Fee Administration shall submit a report to the Legislature on the feasibility of establishing a new state tax to finance the California Universal Basic Income (CalUBI) Program. The report shall consider the feasibility of establishing a value-added tax on goods and services in the state, an analysis of the feasibility of taxing the sale of services offered in the state, and an analysis of the feasibility of raising the corporate tax. The report shall also include projections of expected tax revenue."

Adding a VAT on goods and services to fund the UBI would impose a burden on those receiving the UBI. Aside from rent, much of what is left over each month is spend on goods and services with most of the goods (other than food) subject to sales tax. Adding a VAT on top of the sales tax would also add complexity. Consideration should instead go to replacing the sales/use tax with a VAT with a broad base and low rate.

A higher corporate rate will be borne by employees, owners and customers and so can also hurt low-income individuals.

Why not remove tax breaks that primarily benefit high income individuals such as the mortgage interest deduction, sales tax exemptions for household utilities, personal service, entertainment and food? And consider if the EITC should be increased in place of a UBI although the EITC is only for workers.

Two of my colleagues and I wrote a paper in 2017 on a proposal for a different type of consumption tax that could be paid along with one's state income tax, but exempt low-income individuals. And businesses would not be subject to it (similar to how a VAT work and how a consumption tax should work to avoid pyramiding). Please check it out. I think it would be groundbreaking for the first state to adopt it in terms of removing regressivity of this consumption tax and making the state very attractive for businesses.

A UBI should be discussed as a way to help low-income individuals to know if it will help more than other programs such as greater education opportunities and medical care for all. 

And we have lessons learned from the pandemic and federal and state programs aimed at helping those with health and financial needs. This included funds for businesses of all sizes, unemployment benefits extended to self-employed individuals, economic impact payments and other provisions. Were these benefits equitably distributed? Did they help those most in need? How will the increased deficits and debt (and its interest expense) be paid?

How will these topics get attention in the public arena?

What do you think about such proposals?