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Wednesday, May 25, 2016

Sharing economy - need for tax literacy

The House Small Business Committee held a hearing today (May 24) (part 1 of 2) on “The Sharing Economy: A Taxing Experience for New Entrepreneurs.” Part 2 is scheduled for May 26 with National Taxpayer Advocate Nina Olson speaking.  A focal point of the hearing per the posted testimony was difficulties freelancers face in the sharing economy because they don't fully understand their tax obligations.

The opening statement of committee chair Congressman Steve Chabot noted:

"these entrepreneurs are running smack-dab into the buzz-saw of an outmoded tax code that is not designed to accommodate them. The tax compliance challenges they face have gone largely unacknowledged so far. But as we are hearing from a growing chorus of entrepreneurs, they present new and unnecessary obstacles for our small businesses.

Some of these new entrepreneurs fail to file their taxes altogether, and, when they do, they often pay too much. They don’t know that can deduct certain expenses, or they don’t have the records to back up their deductions, putting them at risk for audit.

Unfortunately, the IRS has not been part of the solution for entrepreneurs in navigating this new sharing economy. Too often, it has been part of the problem.

Our current tax system isn’t working for these new small businesses. In many ways, it is working against them. We can do better, we must do better.

Today, we will explore some of these problems and discuss some potential solutions with this distinguished panel."

But, their challenges are mostly those that small businesses have had for years.  One of the signs that  you are a contractor/self-employed rather than an employee is that you look like you are a business. You keep records, you understand how to make a budget and generate a profit, grow your business, etc.

One simplification that freelancers have is that they don't have to deal with payroll taxes because they don't have employees. They do have to make quarterly estimated taxes for federal and state income taxes and self-employment taxes. They need to keep records of revenue and expenses and reconcile any 1099-MISC and 1099-K received.

So, why isn't the system working for freelancers?  I think the problem is that they entered business in non-traditional ways. That is, they didn't have to do a lot of research and may not have had to invest anything to get started. This is in contrast to starting a restaurant where one likely would take more time to gain some financial skills and knowledge.

Yes, the IRS should send them information once they know they are filing a Schedule C. The IRS can provide the basics of reporting revenue, tracking deductible expenses and reconciling 1099 forms.

A representative from TaskRabbit suggested offering some type of moratorium to allow taxpayers and the IRS to get simpler compliance tools available.

I have been suggesting for years that technology and economic changes would lead to more self-employed entrepreneurs.  I suggested a few times at my university that all students get some instruction, such as part of general education, on entrepreneurship including basic financial and tax literacy, how to start your own business (including that of a consultant or freelancer).  The sharing economy model shows the great likelihood that more individuals will be self-employed. That does bring more tax compliance considerations beyond what an employee faces. We need to provide instruction in high school and college to increase the financial and tax literacy of students. They will need it!

What do you think?

Monday, May 23, 2016

Guest Post - Four Factors That Can Help Business Tax Compliance

Here is a guest post from Jayson Mullin, a partner at the tax debt resolution company Top Tax Defenders, offering helpful tips for small businesses to reduce tax headaches and feel more comfortable dealing with complex taxes which likely won't get much easier for businesses even with tax reform.


Whew! Tax Day is more than a month behind us. For many small business owners, that's a huge weight lifted. For others, it means playing the procrastination game against a filed extension, or continued concern that taxes weren't filed correctly, sparking the dread of a potential audit.

There are four things small business owners can do for a more stress-free tax experience (no, that's not an oxymoron):

  •  Be financially prepared.
  • Be organized enough to file on time.
  •  Have a decent understanding of complicated tax laws, rules and the paperwork required.
  • Understanding differences between federal and state reporting.

According to Rep. Tim Huelskamp, R-Kan, chairman of the House Subcommittee on Economic Growth, Tax and Capital Access, small businesses that employ between 1-5 employees spend an average of $4,308 to $4,276 per employee in order to comply with the United States tax code. That's a notable financial burden.

4 Factors to Protect Your Business's Tax Compliance & Bottom Line
Filing incorrectly can mean sizable penalties. Even if you opt not to use a certified tax professional to file your taxes, it's a good idea to consult with one to make sure that you are filing taxes correctly. Let's take a look at each of the above factors in greater detail.

Get Tax Finances in Order
In almost all cases, small business owners should be filing quarterly taxes. While that may seem like just one more thing to do, there are several benefits to this method. First, it works as a budgeting tool for small business owners, allowing them to get money sent in to the IRS in the hopes that they will not owe anything more, or that the amount they owe will be significantly reduced when taxes are due.   Also, being faithful about paying quarterly taxes is a good way to "be prepared" as the old Boy Scout Motto goes. Accurate tax filing requires organization and preparation. Ideally, if you're doing your homework to get accurate quarterly tax figures, you will have less to contend with as tax day approaches.

Be Organized Enough to File on Time
Yes, certain small businesses (primarily partnerships) can file for a tax extension but we never recommend this route. The goal for tax compliance is to be on time. Filing an extension usually translates to "more time to procrastinate," and this isn't helpful when you're scrambling a few months down the road.   It's much better to consider tax compliance as a year-round event. Pay attention to small business tax updates provided by the IRS. Keep your paperwork in order. Work with a CPA to determine which things your business can deduct and which you can't. Then, keep individual files for deductions so they are easy to itemize later.   Make sure you:
  • Separate personal and business expenses.
  • Track mileage and relevant car expenses (check the IRS publication pertaining to Car Expenses).
  • Don't exaggerate deductions; the IRS has a good idea of which expenses make the most sense for specific industries.
  • Keep payroll records up-to-date (it's often worth the expense of hiring a payroll company to make sure this item is taken care of).
  • Reconcile, track and support expenses with a receipt.

The more organized you are, the easier it is to do your own taxes, or streamline the work you'll do with a professional.

Have an Understanding of Current Tax Laws and Relevant Paperwork
That's simple enough, right? It's no mystery that small businesses have it rough when it comes to tax compliance. The U.S. Tax Code contains more than 10 million words! It's impossible for a small business owner to keep up with each and every code included there. 

Should you choose to go it alone, there are helpful IRS tools you can access, like the Small Business & Self-Employed Tax Center or IRS-Hosted Webinars and Tax Workshops.   While there are some new breaks, such as Section 179, which allows small business owners to write off equipment purchases and leases (up to $500,000), the tax code is a very complicated web to navigate.

This is the most compelling reason to work a tax professional is so important, ideally a CPA or licensed tax professional with experience and an impeccable reputation. At the end of the day, you are ultimately responsible for any discrepancies in compliance.

Variances Between Federal, State & Local Compliance
That segues to the fourth factor: knowing the variances between the federal and state tax codes. Then there are the other local taxes you're responsible for. Many business owners get so caught up in the stress of federal tax compliance that they forget about their other tax obligations such as self-employment, property, payroll, local and excise taxes. 

Again, even a series of consultations with the right tax professional will help you remain organized and ahead of the curve with small business tax compliance.

Saturday, May 14, 2016

9th Anniversary of the 21st Century Taxation Blog

Today is the 9th anniversary of when I started this blog!  I try to post at least once per week and this is my 871th post!  I get about three to five thousand views per month.  That keeps me going.
I started this blog when I was a fellow with the New America Foundation, charged with getting new ideas out, such as through op eds and articles.  I thought the blog would be a good additional technique and was a new thing back in 2007.

My goal continues to be focused on tax policy matters.  More specifically, how to modernize our tax systems and ensure they meet principles of good tax policy.

For this 9th anniversary, I'll note one topic I plan to focus on more over the next year - increased transparency in our tax systems and better tax literacy for all individuals.  More on this later (although I did recently post on it - 4/16/16 post.


Wednesday, May 11, 2016

Deciphering Campaign Tax Proposals

Here is my 15 minute presentation to the San Jose Rotary Club delivered today (May 11) on deciphering campaign tax proposals and helping members increase their tax policy savviness.

Deciphering Campaign Tax Proposals
Presentation delivered to Rotary International San Jose Chapter (District 5170) on May 11, 2016.
Thank you for inviting me to talk about tax policy and reform. As noted in the publicity for today, my goal is to help you decipher the wide range of tax proposals mentioned in a presidential campaign and provide some pointers to help raise your tax policy savviness.
First, are changes even needed to our federal tax system?  YES.  Here are a few reasons:
  •       Taxes are too complex. We have multiple definitions for the same term, such as “small business.” We have duplicative rules such as for tax reductions related to children.  Over 150 special rules have been added to the federal income tax since the last major reform in 1986.
  •       Our corporate tax system fails at international competitiveness. We use a worldwide taxation system and double tax corporate earnings, when most of the rest of the world does not. Our statutory rate of 35% is higher than all other industrialized countries.
  •        Our income tax has inequities in that some things are deductible such as mortgage interest while others are not. Too much spending is buried in our tax system – about $1.1 trillion, which equals the amount of our discretionary spending.  For example, we basically spend about $80 billion each year to allow less than 1/3 of filers to deduct mortgage interest. The majority of this subsidy helps taxpayers with $100,000 or more of income.  This is inequitable. It’s also more than we spend on low-income housing.  We should be examining why all or part of this $80 billion isn’t used instead to increase the standard deduction or lower tax rates, or allow some type of first-time homebuyer subsidy.  Also, special tax rules encourage us to invest in one area over others. What is the overall impact to our economy of our tax system that encourages investment in housing over other types of investments?
  •       Our tax gap is growing. The tax gap means taxes owed but not collected. This is due to both intentional and unintentional errors.  The federal income tax gap is about $400 billion per year!  Each year about 147 million individual returns are filed.  Thus, each of these filer’s share of the tax gap is about $2,700!  Reducing the tax gap could allow for lower rates.  Lowering the tax gap will require simplifying the system and going after non-filers.

And these are just some of the federal income tax problems – we also have problems to address in our employment taxes, gasoline excise taxes and others.
So, yes, tax reform is needed - so we should be hearing candidates talk about tax reform.
Well, what are we hearing from candidates that we may need to decipher?  Let me offer two cautions to aid in deciphering.
Caution number one – be aware that campaign tax proposals almost always lack specificity, making it difficult to critique them.  A common reform promoted for the past few years is to lower the rate and broaden the base -  in a revenue neutral manner. To help understand this, let’s review the basic tax formula:   Tax Rate  x  Base = tax owed,  which is further reduced by tax credits.  Simple math tells us that if we make the base higher and/or eliminate credits, we can lower tax rates and bring in the same amount of tax revenue.   Broadening the base means cutting back or repealing deductions, exclusions, preferential rates and tax credits. BUT, details on which of these special tax rules will be repealed or cut back to allow for lower rates is usually not mentioned.   After all, who wants to campaign on reducing the mortgage interest deduction or repealing the lifetime learning credit?
But if we aren’t willing to talk about each of the more than 200 special tax rules that support high tax rates, we’ll never achieve relevant tax reform.  Each special tax rule needs to be examined in terms of its purpose, whether that purpose is still valid, who benefits, alternatives, and overall economic effects of each rule.
We really need to ask for specific details when we hear that someone wants to broaden the base and lower rates in a revenue neutral manner.
Caution number two – we need to decipher statements about data or ones calling for definite actions that must be taken.  For example, a common data statement in the last presidential election was that half of individuals don’t pay income tax.  That’s true. What we didn’t hear and we didn’t seem to ask, was why? Well, the 50% of individuals who do not pay federal income taxes does include a few thousand high income individuals with lots of deductions or loss carryovers. However, this group is mostly comprised of low income individuals.  For 2013, for example, 46% of individual filers had adjusted gross income below $30,000! They pay little or no federal income tax because their income is too low!  Yet, many in this group do pay payroll taxes of 15.3%, excise taxes and state taxes.     We also hear that high income individuals pay a higher portion of total income taxes than do other income groups. The top 1% based on income, pay about 1/3 of our federal income taxes. High income individuals pay a lot of income taxes because they have lots of income!  And the super high income folks pay a lot of taxes, but their average tax rate might be lower than that of lower income taxpayers – a situation that Warren Buffett called attention to in a 2011 op ed in the New York Times, noting that his average tax rate was lower than that of his secretary. Yes, he pays more taxes, but at a much lower average rate.  Also, while we often hear about making changes for the income group with more than $250,000 of income – which is less than 5% of filers, this group has a very wide range of income.   IRS data for 2008 showed that the average income for the top 400 individuals was $220 million! This is mostly capital gains and dividends taxed at lower tax rates than the rate that applies to wage income. But perhaps our tax system should not put people with $250K of income in the same group as those with over $100 million of income or even over $1 million of income.  To understand who pays and how much – we need to be looking at income levels and total taxes, marginal tax rates and average tax rates. We need to be asking what are appropriate tax brackets and how progressive we want the rate structure to be – considering the wide range of income levels among individuals today.  That’s a better topic than why individuals with less than $30,000 are not all paying federal income taxes.
   The IRS stats website has tons of data. The non-partisan Tax Policy Center has lots of data in user-friendly formats. We need to use this data more often.
   In addition to critically analyzing data statements, we also need to analyze any statement.  For example, what about “abolish the IRS.”  Of course, this statement is often fully expressed as “abolish the IRS (as we know it)”.  The IRS receives over 180 million tax returns each year and collects over $3 trillion of gross tax revenues. It also audits about 1% of filers and writes rules to explain the laws congress enacts.  We do need a government agency to do this.
   Another statement – we need a carbon tax.  Perhaps, but ask why? How would it work? If we are only going to tax fossil fuel emissions, why not just increase the gasoline excise taxes? What alternatives exist? 
     We all need to be more critical of tax data and statements from candidates.
     Ok, so my tips for deciphering campaign tax proposals are to ask for the details of the plans and to apply our critical thinking skills to tax data and blanket statements that are offered without reasons.
  I’ll spend my remaining time on my promise to increase our tax policy savviness beyond the points I just offered. 
1.      Some proposals call for replacing all or part of our income tax with a consumption tax. Consumption taxes come in many forms, such as a sales tax, a VAT, a flat tax or a formula that removes investment income from the tax base. Yes, when you hear “flat tax” think consumption tax, not income tax. Questions to ask – how to address the harshness of a consumption on low income taxpayers. Consumption taxes are regressive – they represent a larger chunk of a low income taxpayer’s income compared to higher income taxpayers.   Also, will a consumption tax produce enough revenue?  If it causes us to reduce consumption – how will that affect the economy?  What would the rate or rates be?  Proposals for a national sales tax use a tax-inclusive rate of 23% – that really means about a 28% rate – and on almost everything you buy – services, a new home.  Also, to raise the same amount of revenue that we raise today, because high income individuals don’t spend all of their income, we likely would also need an income tax for those with over, perhaps $150K of income.
2.      It is difficult to lower our 35% corporate tax rate in a revenue neutral manner. There just are not enough special corporate tax deductions and credits to allow, for say, a 25% rate. So, when someone says they will drop the corporate rate to 15% or 25%, ask how it will be paid for.  The answers you’ll hear, if any, need further discussion.  One answer might be that we’ll stretch out depreciation and R&D deductions and get rid of all credits including the research tax credit.  Well, does that make us more globally competitive?  Probably not. Also, stretching out depreciation deductions is just shifting deductions to later years – it doesn’t raise revenue in the long run, only in the 10-year budget period used for the revenue measure.
    Alternatives to the difficult task of lowering the corporate tax rate in a revenue neutral manner include getting rid of double taxation of corporate income. Moving from double taxation to single taxation of corporate income is called corporate integration. It can be done in a way that reduces taxes directly for corporations, such as by allowing a deduction for dividends paid.  Senator Hatch, chair of the Senate Finance Committee, plans to issue a corporate integration proposal in June.  Corporate integration –a single layer of tax on corporate income, is a not new idea – you can read proposals on the roughly 8 ways to do this, dating back to at least the 1970s.
   Another alternative to lowering the corporate rate is to move to some form of a consumption tax along with an income tax for higher income individuals.
   Despite its challenges, don’t plan to see the topic of a lower corporate tax rate drop off of the agenda.  A lower corporate tax rate has bi-partisan support.  President Obama has been calling for it for a few years.  Also, today, a good portion of the corporate tax is borne by labor, not by investors - making a lower corporate rate of wider interest.  The challenges will be lowering the corporate rate in a revenue neutral manner and agreeing on the details of how to do it.
3.      A plan that repeals the Earned Income Tax Credit is a tax increase on low-income workers.
4.      A plan that says it simplifies by reducing the number of tax rates is misleading. Complexity is not due to the number of rates. It is due to the 250 special rules in our tax system that don’t all need to be there.  Special tax rules support our high rates, inequities, complexity, inefficiencies, a high tax gap, and a non-transparent system.  The challenge of tax reform is changing the tax base – what is taxed, not how many tax rates we have.
5.      Federal tax reform can have significant impact to state and local governments. For example, states are indirect beneficiaries of some federal tax credits such as for low-income housing or for hiring long-term unemployed individuals. A flat tax requires governments to pay tax on fringe benefits paid to employees.  A consumption tax will make all interest income tax-exempt requiring state and local governments to pay higher rates on the bonds they issue.
What should you ask candidates about their tax reform plans? Here are a few suggestions:
  •       What is the goal of your plan? Simplification? Greater equity and fairness in the system? International competitiveness?  We really can’t evaluate any paln without knowing its purpose and goals.
  •       Is your proposal revenue neutral? If not, how will reduced or increased revenues be addressed
  •       Is the plan distributionally neutral? If not, which income groups will pay more or less than today? How much more or less? How does this affect vertical and horizontal equity?

There are some good sources of information available to help understand our current tax system and proposals for reform …
-          Data from the IRS stats website and the non-partisan Tax Policy Center (and their Briefing Book).
-          The Tax Policy Center and The Tax Foundation have detailed analysis of the plans of presidential candidates and their cost.
-          You can visit my 21st century taxation website and blog.
Taxes are a complex topic and public understanding of them is low. Thus, candidates can oversimplify, be vague, and even make incorrect statements. We need to apply critical thinking and ask for details.
Tax reform is difficult, but not impossible.  It is also necessary.

Thank you. I’d be glad to take your questions on federal tax reform or even state and local tax reform.
What do you think?

Monday, May 9, 2016

New Rules Can Produce New Problems - AOTC and 1098-T

In writing a summary of a recent Tax Court summary opinion, I realized that a 2015 law change may cause problems for some students trying to claim the American Opportunity Tax Credit (Section 25A), Lifetime Learning Credit (Sec. 25A) or Section 222 above the line tuition deduction starting in 2016.  A 2015 law changes requires an individual to have received a From 1098-T from the university in order to claim the tax benefit.

In McCarville, TC Summary Opinion 2016-14 (4/4/16), M was a student at Arizona State University from August 2008 to graduation in May 2012. M paid his spring 2012 tuition of $4,895 on 12/18/11 although it was not due until January 25, 2012. He had already paid his fall 2011 tuition of the same amount on 8/6/11. In spring 2012, his only expense was textbook rental of $247. M claimed a $2,500 American Opportunity Tax Credit (AOTC) on his 2012 Form 1040A which also included wages from his part-time job. Form 8863, Education Credits (American Opportunity and Lifetime Learning Credits), was attached to the return.

ASU did not issue M a Form 1098-T for 2012 (likely because the tuition was paid in 2011). The IRS disallowed the AOTC claimed on the 2012 return. (It was easy for the IRS to spot because there was no Form 1098-T.)

At trial, the IRS acknowledged that M was entitled to an AOTC for 2012 of $247. The court agreed.

Observation: M’s problem was that he paid his 2012 tuition in 2011 when he had already paid $4,895 of tuition earlier that year, which caused him to reach his maximum AOTC of $2,500. While paying spring 2012 tuition two weeks early (in 2011) easily seems like a 2012 item to a layperson, the tax law is strict.

What guidance is available to students and their parents to avoid problems and maximize the AOTC? The 7 pages of instructions to Form 8863, Education Credits (American Opportunity and Lifetime Learning Credits), note that the payment must be in the year the credit is claimed. Many universities also include basic information and IRS links on their website about education credits.

Query: If instead of 2012, the year was 2016, is M unable to claim a $247 AOTC? Remember, he won't have a 1098-T (because he paid nothing to the university in that year)? If this is the case, hopefully the IRS can correct this problem such as by requiring the university to note on the Form 1098-T $0 paid to the institution, but that the person was a student there for the spring semester.  Or perhaps Congress needs to modify the law to allow claiming of the textbooks and other related expenses that are not paid directly to the university. That could be noted on Form 8863. However, it seems contrary to congressional intent in requiring a Form 1098-T, which serves to show that the student actually attends a college.

What do you think?