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Saturday, January 2, 2021

Tax Policy Observations of COVID-19 Legislation


The FFCRA and CARES Act enacted in March 2020 and CAA-21 enacted Dec. 27, 2020 provide a variety of financial relief to individuals and small businesses. The recovery rebates (called "economic impact payments" by the IRS) in the CARES act ($1,200 per adult and $500 for child under age 17) helped over 160 million people. The $600 payments in CAA-21 should help a similar number.

Is that the best way to help? There was also increased and longer payments of unemployment compensation to clearly help those who lost their jobs. There were changes to allow those with sufficient retirements accounts to pull out up to $100,000 without penalty and even to pick it up into income over three years as well as to pay it back.

The changes also included odd ones or odd features. I call them odd because the purpose was to help people in financial need. Yet rebates went to retired individuals who likely continue to have their same income despite the pandemic. While they may have extra costs of obtaining food and household items, perhaps a greater benefit would have been for state and local governments to get funds to help people unable to get to the store safely to get items delivered or to help them make online orders.

The recovery rebates phase-out at specified income levels shown below without any child credit:


The way the phaseout works, is that individuals continue to get them the larger their original credit is. So the more children, the more income someone can have and still get a credit. For example, a married couple with four children under age 17 can still get a very small credit at just under $238,000 of adjusted gross income (AGI).  The full credit would be $4,400 [($1,200 x 2) + ($500 x 4)]. Here is that formula:

   ($AGI - $150,000) x .05 = $4,400

   AGI of $238,000 brings the credit to $0

Is that the right policy? Does anyone with over $150,000 of AGI need assistance? Certainly some might, but most likely do not. Per the U.S. Census Bureau, for 2019, median household income was $65,712.

It will really depend on many factors as to need. For example, some people continue to earn the same amount of income before and during the pandemic. Again, there might be increased costs, but also likely some decreased costs (such as travel, gasoline, etc.).

Some people needed more than what they got while some got money they did not need. And some of these folks found ways to get the money to those in need.

The cost of the CARES Act recovery rebates was $292 billion. Some of this went to people who didn't need it and some needed more. What is an alternative to better target these needed funds?

A bigger policy issue with CARES and CAA-21 is that limited funds were used for.  Here is an example from both acts.

CARES - The IRC Section 461(l) loss limitation of the Tax Cuts and Jobs Act was delayed three years. The estimated cost was $170 billion. That is 58% of the cost of the recovery rebates. The policy issue is that the roughly 130,000 individuals who got the benefit of the $170 billion are generally very high income individuals who most likely don't need assistance. How does a bill get enacted that provides $292 billion to over 160 million individuals and 58% of that amount to benefit 130,000 individuals? Or stated another way: how is relief designed to help less than 1% of individuals who don't need it by giving them 58% of what is given to help 160 million individuals?  Without the section 461(l) change, the 160 million could each have received about $1,060 more!

CAA-21 - Included extending 33 items that expired at 12/31/20. While some are likely worth extending, there was no policy discussion on this and it wasn't an immediate need. The cost of the CAA-21 recovery rebates was $164 billion. The cost of the extenders was $104 billion or 63% of the cost of the rebates. So, the rebates could have been $650 higher and we could have delayed or ended a special 7 year life for motor sports complexes and 3 year life for racehorses, among many other extended tax rules.

How did the above happen? It is puzzling. The House passed the HEROES Act in May 2020 with  various COVID change including putting back the effective date of section 461(l) on losses. But why didn't they notice the effect or realize that only a few thousand individuals had losses subject to that TCJA provision? 

Possible solutions:

1. Require a distributional analysis of all provisions before a vote.

2. Show the tax benefit (or cost) per person affected.

3. Make the above available not only to lawmakers, but also the public.

What do you think?

Sunday, December 13, 2020

Common Sense and Tax Policy - Any Connection?

clip art of car and $100 bills

I think that often, there is some common sense consideration of tax policy before enacting or changing tax rules. One example was the 1954 decision to enact IRC section 174 to allow for expensing of R&D expenditures. That simplified the law to avoid uncertainties and taxpayer/IRS disputes on the life for amortization purposes of these expenses. It also incentivized these expenditures that also benefit the economy through new technologies to improve our lives. I'm sure we can find more recent examples too.

Of course, before leaving my example, I should note that the 2017 Tax Cuts and Jobs Act modified the R&D expensing rule starting after 2021 to require R&D expenditures to be capitalized each year and amortized over 5 years (15 years for foreign R&D).  That's an odd provision for a piece of legislation intended to improve international competitiveness of our tax system when most other countries have research incentives in their tax law, but oh well. (I think we'll see this rule forever postponed and hopefully repealed at some point to go back to expensing.)

I want to draw attention to the numerous places in our tax laws where tax breaks are provided for people who don't need them. By tax breaks, I mean provisions that are not part of the "normal" structure of a particular type of tax (such as a mortgage interest deduction in a personal income tax or an exemption for digital books in a sales tax). For example, the American Opportunity Tax Credit worth $2,500 of tax savings per college student per year for each of the first four years of college is available to taxpayers with up to $180,000 of income if married ($90,000 single). This is beyond the income level that would qualify for a needs based scholarship. So why provide a government subsidy to people who don't need it? (and that likely leads some colleges to increase student fees!) How might that money better help society and our economy by using the funds such as to increase the standard deduction and/or Pell grants?

There are many of these provisions in the law including the lower capital gains rate (20% maximum versus 37% maximum for non-capital gain income). One that I was reminded of recently in looking at updates for 2021 cars that qualify for perhaps up to a $7,500 credit for purchase of a new qualified plug-in electric drive motor vehicle (Code section 30D) is that the buyer of a MSRP $156,900 Bentley Motors Bentayga Hybrid SUV gets a $7,500 tax subsidy from the government - that is, all other taxpayers chip in a bit to help this buyer get the luxury car.

The credit exists to encourage car manufacturers to build electric and hybrid vehicles which they argue cost more so people don't want to buy them; hence, the tax credit. But what happened to common sense? If someone is able and willing to spend over $150K on a car, will their decision be based on whether the federal government will give them $7,500? I don't think so. The federal government with $27 trillion of debt is giving money to people who don't need it.  According to information on the donation website of one of my favorite charities - Sacred Heart in San Jose, $7,500 could instead provide 3,000 families with food including fresh fruit and vegetables for three days.  (Per the Bentley website, $7,500 would also help cover the cost of the $8,500 rear seat entertainment center for one's hybrid Bentley.)

How does this happen? How did this law get enacted years ago and remain unchanged without having a cap on the cost of the car?

What questions should we ask to help get government funds where they can provide the most benefit for our society and economy? 

A requirement that before voting on a bill, the "cost" of all new and modified tax breaks be published for at least two days could help. The "cost" information should also include how the new or modified rule will be used by taxpayers in each quintile of income plus the top 1% and top 0.1%. This statement should also include why the provision is needed and why it needs to be in the tax law. For example, the AOTC funding could instead be used for existing programs such as the longstanding Pell grant program. 

What do you think?


Saturday, November 28, 2020

Does a Work From Home Tax Make Sense?


On November 10, 2020, Deutsche Bank (DB) released a report, Konzept #19: What we must do to rebuild. Per DB, the report presents "ideas for how economies, businesses, and societies should rebuild from the pandemic. From changing the way we stimulate labour markets, to implementing digital currencies, and even taxing those who work from home, this Konzept is designed to spark the most important of debates. Some of our ideas may seem radical, but we hope they will inspire decision makers as we rebuild from this bracing and tragic period." Topics include climate change, connectivity, fate of shopping malls, and more.
DB also suggests the need and appropriateness for a tax on employees who work from home after the pandemic, to be paid by the employer. Per DB, the pandemic has resulted in about 5 to 7 times more people working from home and many will continue to (and about 50% will want to) continue to do this.
Why a tax? DB suggests what can be described as some negative externalities of working from home. Per DB (pages 32 to 34): 
"The sudden shift to WFH means that, for the first time in history, a big chunk of people have disconnected themselves from the face-to-face world yet are still leading a full economic life. That means remote workers are contributing less to the infrastructure of the economy whilst still receiving its benefits." 
DB also notes the savings WFH employees gain such as commuting costs and costs to acquire and maintain clothing. They also save the time for commuting. 
But what about counterarguments including the provision of positive externalities, such as:
  • WFH employees might still go out to lunch and support the local economy.
  • WFH employees may still need to use child care services in their community.
  • Traffic in many cities, such as Los Angeles and San Jose, partly exists because there is insufficient infrastructure. So, aren't WFH employees savings dollars by reducing the need for more highways and maintenance of roads?
  • WFH employees are driving less so contributing less to greenhouse gas emissions that create climate change.
  • WFH employees might find it easier to contribute time to local community needs such as helping at the public school and cleaning parks.
The concept though of measuring income by economic considerations includes the benefits of growing your own food and living in a home you own. Recent OMB tax expenditure reports list the fact that our federal income tax does not tax the net imputed rental income of owner-occupied housing as the second largest tax expenditure (#60 in the report). There is no specified exclusion in the Internal Revenue Code for this item, such as there is for the largest tax expenditure - the exclusion for employer-provided health care. To help understand the new imputed rental income item, the OMB provides:

"Under the baseline tax system, the taxable income of a taxpayer who is an owner-occupant would include the implicit value of gross rental income on housing services earned on the investment in owner-occupied housing and would allow a deduction for expenses, such as interest, depreciation, property taxes, and other costs, associated with earning such rental income. In contrast, the Tax Code allows an exclusion from taxable income for the implicit gross rental income on housing services, while in certain circumstances allows a deduction for some costs associated with such income, such as for mortgage interest and property taxes."

The Joint Committee on Taxation doesn't include this in their list of tax expenditures. Per the JCT, the "measurement of imputed income for income tax purposes presents administrative problems and its exclusion from taxable income may be regarded as an administrative necessity." JCT also notes (page 5) that if this imputed income were allowed, then all mortgage interest and taxes on the home, as well as repairs would be deductible. Of course, providing lots of tax breaks for owner-occupied housing including the gain exclusion, without any offset for not including the imputed value in income is not accurate, but as the JCT notes, administratively sound as measuring the value of the income would be challenging.

DB suggests a WFH tax of 5% of the employee's salary with the revenue used to help displaced workers. Another perspective on the tax is not only displaced workers but smaller business footprints by employers when more of their employees work from home. I suspect we'll see a lot of office vacancies after the pandemic with cities facing issues of abandoned buildings, less need for public transit and in some areas, less economic activity for local service businesses. Cities will need to find ways to adjust to this and of course are already facing these issues during the pandemic.

So, an interesting idea for a WFH tax and I think it also highlights, along with other topics in the DB report, the need to continually examine our tax systems to be sure they reflect the ways we live and do business today and to ensure they meet principles of good tax policy.

What do you think?



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 - https://web.archive.org/web/20191114021648/https://www.irs.gov/pub/irs-pdf/p535.pdf.

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?