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Saturday, November 14, 2020

Challenges of Finding Tax Information

stick figure sitting inside a question mark
In theory, it should be fairly straightforward to find the tax law. At the federal level, we have the Internal Revenue Code (Title 26 of the U.S. Code) available at a congressional website, Cornell Law School site and from commercial tax publishers. Regulations can also be found at the Cornell Law School website, perhaps a few others (including this blogger'sites for regs published in the Federal Register for 2011 through the present), and commercial research publishers. And the U.S. Tax Court and many other federal courts publish their opinions on their websites (but not all). The best way to find everything and have the ability to confirm currency of the information is via a commercial tax publisher.

But, there are challenges of finding the law even with complete access to it for a fee, in how it sometimes is assembled. I'll demonstrate this using temporary regulations issued in July 1987 (TD 8145), an IRS notice issued in 1989 that modified parts of the 1987 regulations, a 2020 effort to replace the 1989 notice, and an oddity of a incorrect explanation of part of the 1989 notice in the 2019 IRS Pub 535 on business expenses (it was correct in prior versions of this pub). I'll also attempt to explain why this all happened, AND how it can all be avoided.  After all, the tax law is complex enough and should not be made even more complex by challenges of finding that law!

The Tax Reform Act of 1986 made personal interest expense non-deductible. It created passive activity loss limitations which also created a category of interest expense on passive activities. To enable an individual borrower to classify their interest expense between personal, business, investment and passive activity, the IRS issued TD 8145 giving us Reg. 1.163-8T referred to as the interest tracing rules.

P..L. 100-647 (TAMRA, 11/10/88) included a modification to IRC section 7805 that temporary regulations expire three years after issuance and also have to be issued as proposed regulations. This was effective November 20, 1988. TD 8145 issued in July 1987, as well as a few other TRA'86 regs, were excepted from the 3-year expiration date so because issued earlier, seemed to have become unimportant in relation to all of the guidance the IRS had to issue for the numerous TRA'86 changes.

The IRS issued a new notices in 1988 and 1989 that modified the TD 8145 regulations at 1.163-8T. I think this was done as it was easier given the immense workload of the IRS, than reissuing these regs as proposed and/or temporary regs that would then be subject to the 3-year expiration date. One of these notices was Notice 89-35

Notice 89-35 modified Reg. 1.163-8T(c)(4)(iii)(B) to change the special 15-day allocation account for debt proceeds deposited into an account to a 30 day before or after, any account rule, with a similar change to the rule for debt proceeds received in cash at Reg. 1.163-8T(c)(5)(i). These rules were summarized in some IRS documents such as in Publication 535, Business Expenses. See for example, the text on page 14 of the 2018 Pub 535, first column, available here -

However, there was a change to this text in Pub 535 for 2019 (note, this link goes to the current pub which in 2020 is the 2019 version). The new text refers to a 15-day before or after, any account rule. Thus, it is not properly summarizing Reg. 1.163-8T(c)(4)(iii)(B) or Reg. 1.163-8T(c)(5)(i) or its modification by Notice 89-35. How did that happen and where did this strange 15-day, any account rule come from? The summary of Notice 89-35 continues to be correct in Publication 550, Investment Income and Expenses (page 31, middle column) 

Due to the age of Notice 89-35 and that it modifies a regulation, it is not easy for taxpayers and practitioners to find Notice 89-35 (one reason I know about it was I was using it with clients back in 1989!). Thus, for many, finding the rule in Pubs 535 and 550 is helpful but needs to summarize the law correctly which would be use of the explanation that was in the 2018 and earlier versions of Pub 535.

And, there is more! The Tax Cuts and Jobs Act (TCJA) added new section 163(j) a limitation on business interest. The extensive regulations on this included proposed regs issued 9/14/20 (REG-107911-18). While the focus is section 163(j), they also include Prop. Reg. 1.163-14 and 1.163-15. The -14 and -15 rules basically cause Notices 88-20, 88-37 and 89-35 that modified Reg. 1.163-8T to finally get on a path to being part of final regs - after 32 years! The rules at Prop. Reg. 1.163-14 basically add rules on interest categorization when individuals and their passhtough entites are involved while Prop Reg. 1.163-15 is the 30-day rule in Notice 89-35.

BUT, there is still a "finding" problem. How will someone reading Reg. 1.163-8T(c) and its 15-day rule know that there is a more generous 30 day before/after, any account rule at what will eventually be Reg. 1.163-15? I always remind my students that they need to look at the headings of all of the regs for a particular Code section, but I'm guesing not everyone does this. And then when we see an incorrect summary of the law in an IRS publication, it reduces the chances of getting what are already complex rules applied correctly.

Solution? First, all temporary regulations issued before November 20, 1988 need to be finalized. This is likely the best solution and would eliminate the need for reg-modifying notices to be outstanding (and often not known by practitioners) for decades. It would make the law easier to find.  If the IRS continues with issuance of Reg. 1.163-14 and -15, it should still make a modification to Reg. 1.163-8T(c) to tell readers to go to Reg. 1.163-15. I know that would require reissuance of the temp reg, but that wuld be a good thing and it could all be updated.

What do you think?

Thursday, October 22, 2020

34th Anniversary of TRA86 Enactment - What's Changed and Still Needed?

On October 22, 1986, President Reagan signed the Tax Reform Act of 1986 (PL 99-514). Take a look at this picture at the Social Security Administration website to see a group of men from the tax committees cheerily watching the president sign the bill outside of the White House. At the time, we had a Republican president and controlled Senate and a Democrat controlled House, all working together and holding numerous hearings about the reforms).

The TRA86 lowered rates and broadened the base. Prior to TRA86, the top corporate rate was 46% and the top individual rate was 50%. Today, the top corporate rate is 21% (flat, no longer graduated) and the top individual rate is 37% (goes back to 39.6% after 2025). 

The new rates:

  • Corporations: 15%, 25% and 34%
  • Individuals: 15% and 28% with capital gains taxed at the same rates

Why was there a TRA86? President Reagan wanted to lower the rates and there was bi-partisan support for a fairer, simpler tax law that would be more supportive of economic growth. There was also a desire to shut down some problem areas such as tax shelters that middle and high income individuals were investing in and get most corporations to use the accrual method of accounting and the percentage of completion method for their long-term contracts (as they would for their GAAP financial statements).

There were several extensive reports by the Treasury Department about issues with the existing system and analysis of possible reforms. See Tax Reform for Fairness, Simplicity, and Economic Growth: The Treasury Department Report to the President in 3 volumes with the third volume on a VAT.

The transmittal letter in the report included: "we believe we have followed your mandate of May 1984 to design a sweeping and comprehensive reform of the entire tax code. The Treasury Department study focused on four options: a pure flat tax, a modified flat tax, a tax on income that is consumed, and a general sales tax, including a value-added tax and retail sales taxes.”

Further: “These proposals are bold, and they will be controversial. Those who benefit from the current tax preferences that distort the use of our nation's resources, that complicate paying taxes for all of us, and that create inequities and undermine taxpayer morale will complain loudly and seek support from every quarter. But a far greater number of Americans will benefit from the suggested rate reduction and simplification. The achievement of fundamental tax reform and the manifest benefits it would entail -- will require extraordinary leadership.”

Several provisions of the TRA86 remain such as no deduction for personal interest expense and uniform capitalization rules and required use of the accrual method for large businesses. Some notable changes since TRA86:

  • Max individual rate of 28% ended with addition of 31% bracket by OBRA’90 (P.L. 101-508), effective for 1991.
  • Maximum capital gain rate remained at 28%.
  • Corporate rate raised to 35%
  • AMT preference for contributions of appreciated property was repealed by RA’93 (P.L. 103-66).
  • Base broadening slowly eroded with addition of new preferences, particularly with Taxpayer Relief Act of 1997 (P.L.  105-34).
  • Added child tax credit, Hope Scholarship credit, expanded §121 gain exclusion for residence, and repealed AMT for small corporations.
  • Numerous credits and special deductions added (§199, energy credits, and more)

After the TRA86, other countries lowered their tax rate on corporate income until the US rate became one of the higest rates until loweredto 21% by the TCJA in December 2017.

Did the TCJA of 2017 address all tax issues? No.  Here is a partial list of once still in need of addressing that have been longstanding issues.

  • Recognition of technology in tax compliance
    • Compliance system still rooted in paper, and not as technologically modern as online banking or online shopping.
    • Return-free system
      • Called for in Treasury’s 1984 report
      • GAO report Alternative Filing Systems (10/96)
      • Many countries have gov’t or employer prepare return
      • Camp’s HR 1 (2014) prohibits it - “SEC. 6103. PRE-POPULATED RETURNS PROHIBITED.”
  • Clarification of worker classification system
    • Revenue Act of 1978, Section 530 – Congress to study; added temp rules
      • 1982 – made permanent
      • Today – issues continue
  • Debt reduction and other budget issues, such as Social Security and Medicare reforms

What do you think? 

Monday, September 28, 2020

Missing from Tax Plans - A "Normal" Personal Income Tax

 We can gather some general ideas about tax changes in looking at various websites and documents of presidential candidates. This includes the Democratic Party platform for 2020, Republican Party platform for 2016 (it was not updated for 2020, so actually includes pre-TCJA tax ideas), and candidate websites. I recently reviewed these plans for an upcoming webinar. One observation I'll make about both plans (best I can tell since most details are missing):

Why not fix an outstanding problem with the individual income tax that has worsened with recent law changes and ways people generate additional income and cash flow today? This problem is that expenses of producing taxable income are not allowed unless the activity is a business (other than the business of being an employee). This started with the Tax Reform Act of 1986 and worsened with the TCJA.

The TRA86 added section 67 to treat some miscellaneous itemized deductions as only deductible to the extent they, in aggregate, exceed 2% of one's AGI. The TCJA disallows this deduction entirely for 2018 through 2025. Thus, no deduction for unreimbursed employee business expenses or expenses of producing income from an activity not engaged in for profit, or expenses of producing investment income. These expenses generally are all limited to the income produced, but not deductible today.

There is a growth in individuals engaged in activities that likely are not a business but that generate income and cash flow. For example, today, technology in the form of apps run by platform companies make it easy to rent out your car or extra space you have, perhaps even a closet (yes, see for example). While in some cases, this might be a trade or business, it is more often someone trying to monetize extra space or assets they have and not run as a business. The income is taxable, but no expenses are allowed. The main expense incurred is the fee paid for using the platform and likely some insurance. I think this type of income and cash flow generation will continue to become more common.

In its annual tax expenditure report, the Joint Committee on Taxation explains what a tax expenditure is. It is a special tax rule that is not part of the normal tax. They are deductions, special rates and tax credits that are not part of the normal design of the particular tax. For example, a basic or normal personal income tax would not include a mortgage interest deduction or an American Opportunity Tax Credit, among numerous other special provisions. Per the JCT (page 3) though, the normal individual income tax would include "the following major components:

  • one personal exemption for each taxpayer and one for each dependent,
  • the standard deduction,
  • the existing tax rate schedule, and
  • deductions for investment and employee business expenses.
Most other tax benefits for individual taxpayers are classified as exceptions to the normal income tax law."

And the expenses of producing the non-business income should be limited to the income produced and deductible for AGI (not as itemized deductions).

And individuals would need reminders about what is a personal expenditure and not deductible versus is truly an unreimbursed employee business expenses or other expense incurred to produce taxable income.

And more changes would be needed to get closer to the "normal" income tax. Per the presidential plans, we are likely to see more items proposed that continue to move us from that normal tax although some might be variations on the personal exemption and standard deduction noted above.

What do you think?

Saturday, September 5, 2020

Problems with Payroll Deferral for Employees

There has already been a lot written about the employee payroll deferral President Trump announced on August 8. This allows employers to not withhold the employee's 6.2% OASDI tax for pay periods from 9/1/20 to 12/31/20, but to instead withhold it later.

Late on 8/28/20 (and right before the start of the weekend), IRS released Notice 2020-65 on how this works. Basically, the employers who opt to defer will instead withhold the tax from the employee pay for January 1, 2021 through April 30, 2021, doing so ratable.

It all means that eligible employees will see slightly higher paychecks for the rest of 2020, but smaller ones for January 2021 through April 2021. The 6.2% deferral for four months is just over one week's worth of pay.

What is the point?  Good question!

President Trump wants to get some cash into hands of eligible employees (those with pay under $4,000 for a two-week pay period or equivalent for a different pay period). Yet, not all of these employees need an extra week of cash only to have to pay it back in the first four months of 2021.

And Notice 2020-65 makes it clear this is the employer's liability. If an employee leaves, I assume most employers will take the deferred tax out of the employee's final paycheck. But if they don't or the final check is not enough, the employer has to pay. And once employees who stay know that, they might as well ask their employer to pay their tax too.

A few observations:

  • If your employer pays your 6.2% tax for you, it is wage income.
  • Reprogramming pay systems usually takes more than the few days between August 29 and when the first paycheck are issued after the 9/1 effective date, so how many employers could even start this for pay on 9/1?
  • Notice 2020-65 says that employers "may make arrangements to otherwise collect the total Applicable Taxes from the employee." What does that mean?
  • If an employer opts in, can an employee opt out? Apparently that is up to the employer.
  • Are there other laws that will prevent employers from withholding the deferred tax in 2021? What about minimum wage workers? Is it a violation of the FLSA for an employer to reduce 2021 pay for a 2020 tax that the employer opted to defer until to 2021? Any state law issues?
  • Politics or help? I aim to stay out of politics with this blog, but it seems too problematic here. I hope journalists and voters are on the watch for campaign statements that the president increased the pay of those making under $104,000 without also saying he decreased it for the first four months of 2021 and increased costs for employers due to the processing and the reality that many employers are going to end up paying some portion of the deferred tax.
  • State and local governments need to opt out! The cost of handling this temporary change and being on the hook for the delayed payroll taxes is more than any state or local government should be misspending limited funds on.
  • Federal employees: As reported by Federal News Network, federal employees including those in the military will have to have this liability shift without any option to elect out.
  • Will this deferred tax eventually be forgiven? While the president says he wants to do that, it will take an act of Congress for this to happen. Given the cost and that most employers and employees are not going to opt into this oddity, it is unlikely we'll see forgiveness.
  • Watch for FAQs from IRS to help explain more items not obvious in Notice 2020-65.
What should employees do if their employer, such as the federal government, requires the deferral and they don't want it and cant' opt out?  Seems to be no reason why the employee can't provide a new Form W-4 to the employer asking for additional federal income tax withholding equal to what the deferred 6.2%  OASDI will be (line 4c). So, take home pay for the rest of 2020 will be the same as before 9/1/20.  Then file as early as possible in 2021 to get your refund of the extra tax paid (assuming you were not already under-withheld) and set it aside to help cover reduced paychecks you'll have through the end of April 30. This will be extra work for the employer, but one their system should already be able to handle, unlike this new temporary OASDI deferral.

Here is a nice summary of the memo and Notice 2020-65 from VP Ed Karl of the AICPA.

What do you think?

Sunday, August 23, 2020

Virtual Currency Question Gains Prominence on 2020 Return - Why?

Draft 1040 for 2020 dated 8/18/20

The 2019 Schedule 1 (Form 1040), Additional Income and Adjustments to Income, included a new question at the start of the form:

 "At anytime during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency."

On August 18, 2020, the IRS released the draft 1040 for 2020 and it shows this question has moved to page 1 of Form 1040 right below where you put your name and address.

For 2019, this seemed like an odd question since few individuals out of 150 million have any virtual currency (11% per a 2019 article by CoinTelegraph), and there are better questions to ask that affect far more people and potential income. For example, why not ask:"Did you receive any funds from any web-based or Internet-based activity?"

And either question should have follow up questions, such as:

If yes, is the income reported on the return?

If yes, where?  If no, explain why not, with space provided to do so.

My question would cover virtual currency, renting out property via a web-based platform but not receiving any Form 1099, earning ad revenue from your website, selling goods on eBay or Etsy or similar site.

The form instructions are not yet out but hopefully the IRS will explain the question better for 2020. Some questions and issues:

  • What is “virtual currency” given IRS lack of clarify on this?
  • Why doesn’t IRS use “convertible virtual currency”? Per Notice 2014-21 and other statements, it seems that this is what the IRS is focused on.
  • What if you only moved your VC from one wallet to another, should you check yes?
  • What if you receive VC by gift or something else with no tax consequence? Or receive it as wages and reported it on the wage line?
  • Is IRS expecting a “yes” answer to mean that VC shows up on Schedule D or Form 8949
  • Should you attach an explanation if you check yes but have no reporting obligation?
  • What if a passthrough entity owns it? You need to ask the entity apparently?
  • What if your VC had a fork or airdrop and you didn’t know that?

In February 2020, the IRS modified its answer to a website question "What is Virtual Currency?" Between October 2019 and February 11, 2020, it stated "Bitcoin, Ether, Roblox, and V-bucks are a few examples of a convertible virtual currency." [See IRS website at 1/14/20 from The Wayback Machine.] Afterward, the gaming currency was removed. The IRS explanation was posted on a different website (2/14/20) to note that the change, which they don't describe on this website, was done to "lessen any confusion."  But Roblox and V-Bucks and likely other game currency seems to be convertible virtual currency as you need it to play the game and you get it and can redeem it using USD. So confusion, arguably, is increased with the change.

For more on virtual currency - click here.

What do you think?