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Friday, August 9, 2019

Does TCJA Make C Corps Better?

Does TCJA Make C Corps Better? Generally no when you factor in double taxation of C corporations. I've got an article looking at this question but only looking at domestic tax rules. Certainly, lots of international activity might make the C corporation look better.  Here is the article, published this week in the Wealth Strategies Journal

What do you think?

Saturday, August 3, 2019

Two New Sales Tax Exemptions in California for Two Years

California SB 92 (Chapter 34, 6/27/19) adds two new sales tax exemptions starting 1/1/20 and ending 12/31/21:
  1. “diapers designed, manufactured, processed, fabricated, or packaged for use by infants, toddlers, and children” [R&T 6363.9]
  2. menstrual hygiene products” shall only include the following: (1) Tampons. (2) Sanitary napkins primarily designed and labeled for menstrual hygiene use. (3) Menstrual sponges. (4) Menstrual cups.” [R&T 6363.10]
For these new temporary sales tax exemptions, the legislature applies R&T §41 dealing with accountability. Thus, the legislature had to specify the purpose of the exemptions and require a report from the LAO on the effectiveness of these provisions including whether they should be modified, extended, or allowed to expire. For the diaper exemption, the LAO is also to assess “whether more targeted approaches to providing families in need with adequate access to diapers are available.” For the menstrual products, the LAO is also to assess “whether more targeted approaches to providing individuals in need with adequate access to menstrual hygiene products are available.” The specified goals of these exemptions:
·         Diapers: “to promote public health by increasing the affordability of, and expanding access to, diapers.”
·         Menstrual hygiene products: “to promote public health by increasing the affordability of, and expanding access to, menstrual hygiene products.”

Observation: Often, bills that provide a new credit or exemption state that R&T §41 does not apply. Then there is no need for accountability as to whether the provision meets its purpose or even that a purpose be articulated. Important to this assessment though is whether the LAO will have the information needed for a strong assessment. The legislation should have included a provision and funding to have the LAO identify information it will need the CDTFA to collect.

Other states provide similar exemptions with the sales tax on menstrual products sometimes referred to as the pink tax or the tampon tax. States with an exemption include Connecticut, Florida, Illinois, Minnesota, New Jersey and New York.

Do these exemptions reflect good tax policy? NO. The biggest issue is equity and fairness in that they give the largest break to higher income buyers because they are likely to spend more on diapers. I see that on Amazon, diapers range from 11 cents/diaper up to at least 49 cents/diaper. Someone already buying the more expensive diapers doesn't need a sales tax break to make diapers more affordable as they have already opted to not buy a less expensive diaper that would be more affordable. If the exemption were only given to individuals who need it and who may need even more assistance in paying the price without the sales tax, this exemption is poorly targeted.  A similar argument can be made for the menstrual products.

There are better ways to target relief to taxpayers needing relief rather than also giving relief to those who don't need it. This sales tax break results in reduced revenue for state and local governments. How will they make it up?

More targeted relief would be to provide diaper coupons to individuals already receiving state or local aid, or just giving them diapers which the state would buy in bulk at a reduced cost. Same with menstrual products.

Another concern with these products is that there are added environmental costs of these disposable items. Thus, removing the tax on them means that the costs of disposal and filling up landfills needs to come from elsewhere.

What about the argument that only females need menstrual products so taxing them is a gender disparity. That same argument can be made for other products such as razors, shaving cream, jock straps, football helmets, and I'm sure other items. Exempting these items makes the system more complex, less equitable, and requires that the rate be higher on other items.

The California Legislative Analysts Office issued a report (5/12/19) on these exemptions before enactment of S 92. It notes a few additional issues including the difficulty of defining a "necessity" and whether an income tax credit for the menstrual products would present greater tax relief.

What do you think?

Monday, July 29, 2019

Moving Backwards - New Form 1040-SR for 2019

Draft Form 1040-SR
You're online reading this blog post so you know that technology can do a lot, usually making our lives easier. For example, can you imagine filing a complex tax return without the aid of tax prep software? Well, IRS statistics show that for fiscal year 2018, about 12% of individual federal tax returns were filed on paper (but some of this could have been prepared using software). The balance were prepared by a paid preparer, or otherwise online or via the free file system. This is still a lot of paper filings given a total of almost 153 million individual returns files (about 18.6 million paper filed) (2018 IRS Data Book, p 2).  I think many of these paper filed ones are fairly simple returns, perhaps with just one or two Forms W-2.

When using tax prep software, you're asked questions and you need to enter information from your tax reporting forms, such as W-2 and 1099. Good tax prep software performs the required calculations and produces a return that you can print and file or much easier, e-file. It doesn't really matter much what the return looks like, just that your required information is on it.

Well, despite this reality today and that e-filing continues to grow, a proposal offered since at least 2009 (H.R. 728, Seniors' Tax Simplification Act of 2009), calls for the IRS to create a new individual income tax form for use by seniors - those age 65 or older. This form 1040-SR, finally made it into legislation that was enacted in 2018 - P.L. 115-123 (2/9/18), effective for the 2019 tax year.

The enacting legislation calls for this new form to:
"be as similar as practicable to Form 1040EZ, except that--
(1) the form shall be available only to individuals who have attained age 65 as of the close of the taxable year,
(2) the form may be used even if income for the taxable year includes--
  (A) social security benefits (as defined in section 86(d) of the Internal Revenue Code of 1986),
  (B) distributions from qualified retirement plans (as defined in section 4974(c) of such Code), annuities or other such deferred payment arrangements,
  (C) interest and dividends, or
  (D) capital gains and losses taken into account in determining adjusted net capital gain (as defined in section 1(h)(3) of such Code), and
(3) the form shall be available without regard to the amount of any item of taxable income or the total amount of taxable income for the taxable year."

Well, the IRS got rid of Form 1040EZ starting in 2018.

With this new form, which the IRS released on July 11 - draft Form 1040-SR, U.S. Tax Return for Seniors, taxpayers and their preparers will need to spend time figuring out if the taxpayer should file Form 1040-SR.  Seniors may still file the regular 1040, and I assume that is what will happen.  But, tax prep software will likely ask this question: "If the taxpayer and spouse are age 65 and older and qualify to use Form 1040-SR, do you want that form produced?"

What is the point of all of this? Well, if we were still filing tax returns on paper and without the aid of tax prep software, perhaps it would be helpful except that the senior still needs to be sure they have the right type of income and deductions to qualify to use the form rather than just using Form 1040.

I refer to this as a step backward because the form isn't needed. Form 1040 is just fine.

Also, any change in filing should be to make greater use of technology.  For example, have a system that regularly grabs your digital data, such as those automatic deposits of your paycheck into your bank account, and your Quickbooks data if self-employed, and bank and brokerage data, and calculates your tax liability on a daily or weekly basis. In fact, with so much digital data and the ease of making non-digital data digital, this would be a much more efficient system. But instead, there continues to be too much focus on paper as the basis of our 21st century tax system. We need to change that mindset to move forward to have a more efficient and simpler compliance system.

What do you think?

Thursday, July 4, 2019

Fixing the SALT $10,000 Cap

Source: JCX-35-19 (6/24/19) for the House Ways and Means Committee hearing on problems with the SALT cap.
On June 25, 2019, the House Ways and Means Committee held a hearing on the SALT cap with the majority's views on it clear from the title of this hearing: How Recent Limitations to the SALT Deduction Harm Communities, Schools, First Responders, and Housing Values. Testimony was provided by some state and local elected officials and the Tax Foundation.

I agree that this is a flawed provision that was addressing what was already a flawed provision. There were no hearings held for the Tax Cuts and Jobs Act so it was difficult to get broad input into the process.  The AICPA Tax Section did submit a few letters during this process including one that made a very important point. If individuals would have a cap on their state and local tax deduction when claimed as an itemized deduction, an additional change had to be made to treat all business entities the same. Since a C corporation continues to get to deduct all of the state and local income taxes it pays, so should a sole proprietor, partner and S corp shareholder. That could have been accomplished by making a change to a 1944 law to allow state and local income taxes on that business income to be deducted above the line (for AGI) rather than only as an itemized deduction. [See AICPA letter of 11/21/17 and letter of 9/25/18 submitted when the House was discussing Tax Reform 2.0]

My observations regarding the policy of deducting state and local taxes:
  1. There should be equity among different types of business types (see above paragraph).
  2. Prior to the TCJA, only 30% of individuals itemized deductions and many of these folks lost their SALT deduction due to owing AMT. Thus, this was not a widespread deduction.  Many elected officials including governors of New York and New Jersey have issued statements since the change was introduced in fall 2017 that make it sound as if all of their residents are losing a big deduction. But, again, prior to the TCJA, less than 30% of individuals deducted their personal SALT.
  3. Why allow a deduction for state and local taxes not related to a business? After all, there are lots of personal expenditures we can't deduct such as car insurance, 100% of child care, 100% of tuition, and lots more. Well, one argument is that you must pay state and local taxes so it does represent dollars not available for paying federal taxes. But, this is not completely true.  For example, if Jane decides to buy a large home for $1 million rather than a modest one representing the median home value in Jane's area of $300,000, she will owe more property tax. Should she be allowed to deduct property tax on the $1 million home which is far above the median home price in her area?

    Bear in mind that special tax rules (deductions, exclusions, credits and favorable lower tax rates) reduce someone's taxes with the "cost" borne by others.  Why should others bear the cost (tax deduction) of Jane's decision to buy a more expensive home than the median home price. A great example of an extreme on this is evidenced by Mitt Romney's return for 2011 showing he paid property taxes on his personal residences of $214,728.  I'm not singling him our to pick on him, it is just that his return is publicly available from when he ran for President and voluntarily disclosed it. Many high income/high wealth individuals own multiple homes of high value and thus pay a lot of property tax. Many of these high income individuals also used to get a full deduction for these taxes before the $10,000 SALT cap because their regular tax rate was high enough to not be subject to AMT. [Thanks to Tax Notes (and the candidates and elected officials) for making these returns available to the public.]

    Note: Limit or repeal of the SALT deduction is not new. It was addressed in Treasury's 1984 Blueprint for Tax Reform which led to the Tax Reform Act of 1986 and repeal of the sales tax deduction. For more, see my May 2008 article - here.
  4. Repeal of the SALT cap will provide a significant benefit to high income individuals. After all, it's a deduction and bigger deductions reduce taxes the most for individuals in high tax brackets. Per data from the Joint Committee on Taxation released for the June 25 hearing (JCX-35-19, Table 4), for 2019, repeal of the $10,000 SALT cap would reduce individuals' taxes by $77.4 billion with $40.4 billion of this savings going to individuals with income over $1 million (less than 0.5% of the public). All told, $73 billion or 94.3% of the benefit would go to individuals making over $200,000 of income.

It is puzzling why so much attention is being paid to repealing the $10,000 SALT cap (and mostly from Democrats who tend not to be fighting for additional tax cuts for high income taxpayers), rather than taking a policy perspective to reforming this flawed deduction and cap.  And better yet, why not look at other weaknesses in our tax system as well, and work to fix them, with the result that we'd have a more understandable (simpler) and equitable system, most likely with lower rates.

I suggest that for fairness and equity and better ability to keep rates low, as part of reform of the SALT cap that it be replaced with a cap on Schedule A property taxes to only allow a deduction for property taxes on a principal residence costing 110% of the median home price for the area. In addition, state and local income taxes attributable to business income should be deductible above the line (for AGI) just like a C corporation is allowed to do. Property taxes on business property (including rental property) would continue to be deducted above the line as they have been in the past (and still today). And the individual AMT should be repealed so there is just one set of rules rather than two with two tax calculations.

What do you think?

Sunday, June 16, 2019

Latest Guidance on SALT Cap and Donations + Notice 2019-12 Safe Harbor

Excerpt from 2018 Form 1040 Schedule A, Itemized Deductions
The $10,000 cap on itemized deductions of state and local taxes led a few states to add new "workarounds" such as offering a credit that would reduce state taxes (where the deduction is limited) and converting it to a federal charitable contribution (which is not limited (well it is, but only when donations exceeds about half of your income)). For example, since 2014, California's College Access Fund takes donations for which the donor gets a 50% credit against their California income tax. On the federal returns that means a charitable contribution for the full amount and a reduced state tax deduction since the credit reduced the donor's state taxes.

Prior to the Tax Cuts and Jobs Act, at least 18 states had these credit donation arrangements with credits up to 100%, mostly for donations for scholarships to private schools (see Sept. 2018 GAO report). The benefits are funding scholarships, shifting tax dollars to private schools rather than only public schools, and providing a tax break to donors who owe alternative minimum tax (AMT).

After the TCJA, Treasury said it would issue regs to limit the benefit of these credit schemes, taking a substance over form approach in the guidance (Notice 2018-63 (8/3/18)). Proposed regulations were issued in late August 2018 (REG-112176-18 (8/27/18)) & IR-2018-172 (8/23/18)) that basically require the donation to be reduced by the state tax credit claimed or available unless that credit was 15% or less of the amount transferred to the state or local government. This treatment applies to donations made after 8/27/18, regardless of when the state/local tax credit regime was created. Treasury Secretary Mnuchin also issued a press release on 8/23 about the regulations and intent.

IRS received over 7,500 comments on the proposed regs. Per the IRS, 70% of the comments favored the approach of the regulations (see IR-2019-109 (6/11/19)). The final regs (TD 9864 (6/13/19)) follow the proposed regs.

The IRS also issued a proposed safe harbor effective starting for 2018 that provides a benefit to a donor receiving a state or local tax credit but who has deductible state and local taxes below the $10,000 deduction cap. Individuals who can benefit and who have already filed can file an amended return. The IRS expects the proposed safe harbor to be added to proposed regulations it will issue on the new $10,000 SALT cap.

I didn't find the notice to be entirely clear, but piecing together how it is described in the preamble to the final regs (TD 9864 (6/13/19)) and the suggested rationale for the safe harbor, I offer the following interpretation and examples.
[assumes both Anne and Ben have itemized deductions greater than standard deduction]
Anne - Donates to state charity and receives 60% state tax credit
Ben - Donates to Red Cross for which regular deduction rules apply
Amount donated
Amount disallowed under §170
Total SALT before state credit
SALT after state credit
Charitable donation allowed
$ 400
Aggregate Schedule A deduction for SALT and donations
Schedule A with the safe harbor
($7,400 + $400 + $600)
(safe harbor n/a)

While it may seem that the Ben is better off than Anne in this example, Anne paid $600 less of state income tax than did Ben. Looking at cash flow, they are in the same situation.

If the individual were already above the SALT cap, treating the amount disallowed as a charitable contribution as a SALT deduction is of no benefit. Thus, the safe harbor is only helpful to an individual below the SALT cap who also donates to a charity that yields a state or local tax credit.
Meanwhile, a lawsuit (No. 18-CV-6427) filed by Connecticut, Maryland, New Jersey and New York in July 2018 has oral argument on June 18, 2019 in the Southern District Court of New York. I don't expect the states will win on their position that the SALT cap is illegal or that it was politically motivated. There are several deduction prohibitions and limitations in the law and political motivation is likely tough to prove.

What do you think?