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Tuesday, May 14, 2019

12th Anniversary of This Blog

I started this blog on May 14, 2007 as a way to share ideas and generate discussion on ways to improve our tax systems. My focus is to discuss and propose ideas to enable our tax laws to reflect the way we live and do business today and to reflect principles of good tax policy.

Upcoming over the next several months leading to the election, I plan to start a presidential series to discuss tax proposals of candidates, questions we should be asking of candidates regarding taxes, and suggesting ideas for improving our tax systems. I expect a lot of this will also include a look at the $1.4 trillion of spending that is buried in our tax system via tax expenditures - that is, special deductions, exclusions, rate and credits that are not crucial to the particular tax and mostly just result in higher tax rates and usually, subsidies for taxpayers who don't need them.

For example, California Senate Kamala Harris has once again proposed the LIFT Act (S. 4, Livable Incomes for Families Today) the Middle Class Act). It offers a tax credit of up to $3,000 per year ($250/month) ($6,000 if married filing jointly), based on earned income.

I think many people first react saying - why? That's a lot of money.

But, consider what the tax break is for a high income individual today with a $1 million grandfathered mortgage on their first (and/or second home) generating an interest expense deduction of about $40,000. Let's say this person also has health insurance paid by his/her employer of $15,000 (tax free), and $3,000 of tax-exempt interest income.  Let's say this person is in the top rate of 37%. The value of these deductions is $21,460 or almost $1,800 per month.  Even if this person had a marginal rate of 35% or 32% the subsidy received just for these tax breaks is more than what LIFT offers.

Of course, there are more people who would qualify for the S. 4 credit than there are folks in the top tax brackets.

But, I hope this illustrates questions we should be asking (such as why are we providing large subsidies to those who don't need them, and how much could rates be lowered if we cut back on tax breaks). Also, is the monthly credit the best way to go? What are the costs to administer? How can technology make this all a more efficient process.

If you have suggestions or questions, please post them here.

Thank you for reading this blog!

Monday, May 6, 2019

Taxpayer First Act and IRS Free File Program

H.R. 1957, the Taxpayer First Act, passed in the House on April 9, 2019, includes several provisions intended to improve IRS operations and taxpayer services. One that has received a good amount of media attention is a prohibition that the IRS can't create its own tax prep and filing software.  When I first heard that I was puzzled as I did not see that prohibition in the bill.

But, in looking more carefully, I was reminded of something I always remind my students of - don't overlook what might appear to be unnecessary language and information in parentheses. Sec. 1102 of the House passed bill states that the Treasury Department shall continue to operate the "IRS Free File Program as established by the Internal Revenue Service and published in the Federal Register on November 4, 2002 (67 Fed. Reg. 67247), including any subsequent agreements and governing rules established pursuant thereto."

Well, when you look at that page in the Federal Register, you'll see on page 67249 in the middle column in the bottom half of the page, the following:

"During the term of this Agreement, the IRS will not compete with the Consortium in providing free, on-line tax return preparation and filing services to taxpayers."

I don't know if the IRS has any plans to compete with the many software companies providing tax preparation services, but how broadly might that prohibition be interpreted?  And why tie the IRS hands at all?  A few years ago, the IRS started working on what it calls the IRS Future State. This provides taxpayer with online accounts where they can see their returns and documents and perform many functions, likely also paying their taxes. Might any of this software be prohibited?

Some people think the IRS isn't capable of creating anything too advanced technology-wise as it is a government agency. I disagree. Certainly, it needs funding for any technology modernization. Let's remember that the Internet started from the government's ARPANET project launched in 1958 and this July 20 is the 50th anniversary of men landing on the moon and returning!  That's a lot of government technology.

On 5/6/19, Senators Grassley and Wyden sent a letter to IRS Commissioner Rettig noting concerns with the recent news reports that allege "deceptive advertising practices and practices involving search-engine manipulation by some of the private-sector participants" in the Free File program. They want to receive updates from the IRS as they review the program and how to improve it.

What do you think?

Monday, April 29, 2019

Tax, Tokens and the Blockchain - H.R. 2144 of 116th Congress

Introduced on April 9 2019, the Token Taxonomy Act of 2019 (H.R. 2144) would “amend the Securities Act of 1933 and the Securities Exchange Act of 1934 to exclude digital tokens from the definition of a security, to direct the Securities and Exchange Commission to enact certain regulatory changes regarding digital units secured through public key cryptography, to adjust taxation of virtual currencies held in individual retirement accounts, to create a tax exemption for exchanges of one virtual currency for another, to create a de minimis exemption from taxation for gains realized from the sale or exchange of virtual currency for other than cash, and for other purposes.”
The proposed di minimis exemption is worded as follows:
“(a) In General.—Gross income shall not include gain from the sale or exchange of virtual currency (as defined under section 408(m)) for other than cash or cash equivalents.
“(b) Limitation.—
“(1) IN GENERAL.—The amount of gain excluded from gross income under subsection (a) with respect to a sale or exchange of virtual currency shall not exceed $600.
“(2) AGGREGATION RULE.—For purposes of this subsection, all sales or exchanges which are part of the same transaction (or a series of related transactions) shall be treated as one sale or exchange.
“(c) Inflation Adjustment.—In the case of any taxable year beginning in a calendar year after 2018, the dollar amount in subsection (b) shall be increased by an amount equal to—
“(1) such dollar amount, multiplied by
“(2) the cost-of-living adjustment determined under section 1(f)(3) for the calendar year in which the taxable year begins, determined by substituting ‘calendar year 2017’ for ‘calendar year 2016’ in subparagraph (a)(ii) thereof.
Any increase determined under the preceding sentence shall be rounded to the nearest multiple of $50.”
Sec. 10(c) of H.R. 2144 provides:
“Reporting Of Gains Or Losses.—The Secretary of the Treasury shall issue regulations providing for information returns on transactions in virtual currency (as defined under section 408(m)) for which gain or loss is recognized.”
Proposed new §408(m) defines virtual currency as: “For purposes of this subsection, the term ‘virtual currency’ means a digital representation of value that is used as a medium of exchange and is not currency (within the meaning of section 988).”
Also see sponsor Rep. Davidson’s press release of 4/9/19 on the proposal.  It addresses the token and blockchain aspects of the proposal but not its tax proposals.
Observations/Queries: How broad are the reporting regulations intended to be? More should be specified in the bill.  For example, are the sponsors aiming to be sure exchanges that exchange virtual currency for other virtual currency or U.S. dollars issue a reporting form?  Or is this broader and any merchant would be issuing a report that it received virtual currency and the value it assigned to it (generally, the selling price of the goods or services exchanged)? Also, how broad should a $600 exclusion for gain from transactions be applied?  After all, $100 of bitcoin in 2010, was worth about $4.3 million in fall 2017.  And it is still worth a lot today.  The exclusion would incentivize these holders to only purchase goods and services from merchants who take bitcoin and to never spend more than $600 at a time. This would enable them to exclude the gain although it might take a long time to fully exclude the gain on that $100 cost basis of bitcoin. A policy goal of an exclusion is to simplify tax reporting by not having to figure out the gain or loss when virtual currency is used to buy low-value items.  The foreign currency exclusion at Section 988(e) is $200. Why not use that same amount for virtual currency? Also, consideration should be given to not allowing the exclusion for bitcoin acquired before a specified date due to the tremendous inherent gain that exists in it that arguably defeats the policy reason for a de minimis reporting rule. Also, I suspect including all of this highly appreciated virtual currency will make this bill cost too much and possibly not get enacted, when it can provide a helpful benefit to avoid tracking small gains and losses that might many times be less than $5.
For more on virtual currency and blockchaing, please visit my website on these topics.

What do you think? 

Tuesday, April 16, 2019

How about making April 30th Celebrating Taxpayers Day?

How about making April 30th Celebrating Taxpayers Day

A few things lead me to suggest this. The reasons mostly tie to my recent research and writing on improving transparency of our tax systems.*  I like all principles of good tax policy (I hope we all do). I think that two on the AICPA set of principles of good tax policy need more attention because doing so will help tax systems to better meet the other ten principles the AICPA promotes. These two principles:
  • Transparency and visibility - Taxpayers should know that a tax exists and how and when it is imposed upon them and others.
  • Accountability to taxpayers - Accessibility and visibility of information on tax laws and their development, modification and purpose are necessary for taxpayers.
If people better understand our tax rules and policies, they are more likely to question why, for example, a special rule exists or was introduced or enacted, why permanent or temporary, how a deduction benefits those in higher brackets more than those in lower brackets (unless there is a phase-out), marginal tax rates and relevance, and that the amount of one's refund has little to do with their total tax liability. They would ask better questions of elected officials and those running for office. They would be better aware of the taxes they and others owe. And, hopefully, compliance would improve and be something we are proud of and celebrate.

Here are three recent events that lead me to suggest starting a Celebrating Taxpayers Day.

1. IRS Commissioner Rettig issued a message on April 12 thanking taxpayers. The first two paragraphs follow:
"As the tax filing deadline approaches on April 15, I’d like to thank taxpayers for taking the time to file and pay their taxes. Our nation’s tax system is built around the concept of voluntary tax compliance, meaning citizens comply with their civic duty each year by preparing and filing their taxes – without direct government intervention.
  This principle has helped make our tax system a model for the entire world. Thanks to taxpayers, this system helps fund our great nation. Each year, 95% of the gross receipts of our country flows through the IRS – about $3.5 trillion last year – funding critical aspects of the U.S., ranging from roads and schools to the nation’s military."
Why not make this "thank you" an annual event on a specified date with an explanation of why taxpayers should be thanked, the importance of voluntary compliance, and seize an opportunity to build and support positive tax morale.

2. In my research I came across a 2015 OECD report, Building Tax Culture, Compliance and citizenship: A Global Source Book on Taxpayer Education. It lists activities of 28 developing countries for promoting tax compliance. A few of them have celebration days. For example, Rwanda has an annual Taxpayers Day celebrating compliance and helping citizens understand and appreciate how taxes and the country's development are connected. The president officiates at the event and a report on tax revenue data and tax agency challenges is released. Bangladesh holds a National Income Tax Day 15 days before the tax due date. There are street processions, workshops, conferences and tax clinics. They also show documentaries and dramas on taxation. 

   Celebrating Taxpayers Day in the U.S. could be educational and a reminder of the importance of taxes to our economy and society. It could also be a day where state and local governments help explain their taxes and budgets to their citizens, an opportunity for debates on current tax issues, and release of important government reports about our tax and budget systems. All levels of government release many tax and budget reports throughout the year, why not highlight some key ones on April 30 to draw greater attention to them?

3. Our tax gaps are growing - The IRS estimates the federal tax gap at $458 billion per year. This is more than we collect from the corporate income tax even before the corporate rate was lowered by the Tax Cuts and Jobs Act. A report from the Treasury Inspector General for Tax Administration (TIGTA), Expansion of the Gig Economy Warrants Focus on Improving Self-Employment Tax Compliance (2/14/19) reports some alarming data that indicates we need greater taxpayer education and to better support positive taxpayer morale. Among many findings was that 25% of individuals in a sample of 3.8 milion gig workers filed a 1040, but didn't report their gig income on either the other income line or Schedule C. And, 13% with self-employment tax income who received Form 1099-K did not include Schedule SE or pay their SE tax with their 1040. The IRS also found a 237% increase from 2012 to 2015 in discrepancies between Forms 1099-K filed and what was reported on Forms 1040. 

    A 2018 report from the California Franchise Tax Board found that about 70% of gig economy service providers receive no tax reporting form, which increases non-compliance. With understanding of tax rules and recordkeeping low, compliance without reporting forms become a bigger challenge and frustration. A 2018 QuickBooks survey found that 32% of self-employed individuals admit they don't report all of their income.

The above threee items indicate to me that a Celebrating Taxpayers Day would be a positive step in building respect for our tax systems, building a culture of filing and paying and being proud of that fact, and improving understanding of our tax systems. And, hopefully have some fun with it!

Why April 30?  Well, people are still busy on April 15 filing and sometimes due to weekends and Emancipation Day, filing day falls on April 16 or 17 or 18.  April 16 is Emancipation Day (the day in 1862 when President Lincoln signed an emancipation decree for the District of Columbia). April 30 gives preparers time to recover, and individuals getting refunds to hopefully have them in time for the celebration. In history, April 30 is the day George Washington was inaugurated (1789), the U.S. Navy was formed (1798), San Jose State University formed** (1857), the ice cream cone was unveiled in the U.S. at the World's Fair in St. Louis (1904), and the World Wide Web emerged in the public domain by Tim Berners-Lee (1989) and its source code was released to the public in 1993.

On April 30, we still have income tax filings on our mind and have time to reflect on such things as, "well, next year, I'll keep better records," or "perhaps I should adjust my withholding." So April 30 would be a good day to help taxpayer get their tax compliance needs in order (January 1 would be better, but we all have too many other things we're focused on then). Also, bills are making their way through Congress, and June and November elections are coming up, and K-12 is still in session.

Yes, there is something called Tax Freedom Day® by the well-respected Tax Foundation. They describe this day as the one marking "how long Americans as a whole have to work in order to pay the nation’s tax burden." For 2019, it is April 16. It isn't a national celebration day though. Also, this information is useful, but I find it is easily misunderstood. Most people do not work until April 16 to pay their taxes but think they do when they hear this information, which harms understanding of our tax system. But it would be a good topic for discussion for April 30 Celebrate Taxpayers Day, to help improve tax literacy and transparency.

So, Celebrating Taxpayers Day on April 30. What do you think?

*See for example, Nellen, "'Oh, I See': Suggestions for Greater Tax Transparency," State Tax Notes, 11/20/17. Also, Nellen, Suggestions for Improved Transparency and Accountability of California Taxes and Related Information, 10/12/18.

**I'm not suggesting April 30 for the SJSU connection. In fact, I wasn't focused on the exact date of the founding of Minns' Evening Normal School (how SJSU started in San Francisco); on campus, we all just say SJSU was founded in 1857 (btw, I'm one of SJSU's historians).

Friday, April 12, 2019

Tax Reform Ideas to Reflect How Small Businesses Operate in the Modern World

The Tax Cuts and Jobs Act brought several improvements for small businesses, most notably, favorable accounting methods such as use of the cash method and not having to deal with the Unicap rules. The AICPA Tax Section recently posted a position paper noting 13 more changes that would further help modernize the Code to reflect how small businesses operate. Some of these would more completely simplify what Congress started with the TCJA.

For example, the TCJA increased the Section 179 expensing amount to $1 million, adjusted for inflation annually. But, despite the fact that intangibles are important to all sizes of businesses today (and for the past two decades), it only applies to tangible assets (and off-the-shelf software), not intangible assets, such as acquisition of a patent or domain name.

The TCJA also allows for use of the cash method by businesses with average annual gross receipts in the prior 3-year period of $25 million or less ($26 million starting in 2019). Yet, despite the higher Section 179 amount and the use of the cash method, a small business might still be amortizing such items as acquired intangibles, start-up expenditures and organizational expenditures.

Here is the list of the 13 items from the AICPA Tax Section:
  1. Expand section 179 to also include intangible assets
  2. Further simplify accounting method rules for small businesses (such as allowing completed contract accounting).
  3. Increase the deduction thresholds under sections 195, 248 and 709 and adjust them for inflation.
  4. Simplify retirement plan options and rules for self-employed individuals.
  5. Modernize the definition of tax shelter (the one used in the TCJA is from 1986 before we had the passive activity loss limitation rules and before LLCs were used in all states as a common business vehicle).
  6. Repeal the individual and estate and trust AMT - the corporate AMT was repealed; this should have also have at least been done with respect to business preferences for all taxpayers.
  7. Relax the exclusive use requirement for a home office deduction (anyone taking their smartphone into their home office likely has violated the exclusive use requirement).
  8. Allow a deduction for health insurance of self-employed individuals in computing self-employment tax.
  9. Increase the current, longstanding $400 self-employment earnings threshold.
  10. Provide similar treatment for all businesses with respect to deducting state and local income taxes - corporations can deduct all of their taxes, all businesses should be allowed the same treatment. Today, the $10,000 SALT cap also applies to income taxes attributable to an individual's sole proprietor, partnership or S corp income.
  11. Limit section 461(l) and the 80% limitation on NOLs of section 172 for start-up businesses.
  12. Repeal section 465.
  13. Require all estimated tax payments to be due on the 15th day after quarter end.
For details, see the complete position paper here.

I think it's a great list of ideas (truth in writing - I proudly chair the AICPA Tax Executive Committee who assembled this list with help from other tax section volunteers and staff). Blog posts are my own.

What do you think?