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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
$1,000
$1,000
Amount disallowed under §170
$600
$0
Total SALT before state credit
$8,000
$8,000
SALT after state credit
$7,400
$8,000
Charitable donation allowed
$ 400
$1,000
Aggregate Schedule A deduction for SALT and donations
$7,800
$9,000
Schedule A with the safe harbor
$8,400
($7,400 + $400 + $600)
$9,000
(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?

Friday, May 31, 2019

Growing U.S. Gig Workforce Exposes Outdated Tax System

For the past several years I've spent a lot of time on tax issues - federal, state and local, for the gig economy. While at the ABA Tax Section meeting in DC this month, I co-presented on this topic and participated in a podcast on the topic for Bloomberg Tax.  Here is the link.

A few reform suggestions I have:
  • Remove the de minimis filing threshold for From 1099-K for third-party settlement organizations such as Uber, Lyft, Airbnb and Paypal. This ensures everyone receiving a payment from someone else through these platforms gets a reporting form. That makes it easier for tax compliance for the gig workers because the document can feed into their tax prep software. Yes, they need to make adjustments to the gross receipts shown on the 1099-K but the platforms can help by making those adjustments (such as for the platform's fees, returns, etc) easy to find on the taxpayer's platform account. Yes, this causes a hassle for non-business folks selling household junk on eBay at a loss, but the IRS should create a schedule for reconciling reporting forms. This will help all taxpayers and the IRS, well beyond the eBay example.
  • Congress needs to clarify worker classification rules and ideally, work with states to have just one classification system for all laws. It is crazy that within a state or a federal legal system or between federal and state laws, a worker might be a contractor for one law but an employee for another.
  • Laws need to change to make it easier for gig workers to save for retirement and other needs. Tax dollars benefiting employee fringe benefits (including the exclusion for employer-provided health insurance) and retirement benefits can be reduced to free up funds to benefit all workers whether they are employee or contractors.
I hope you enjoy the podcast.

For more, please also see a State Tax Notes article, Failure to Innovate: Tax Compliance and the Gig Economy Workforce, 5/6/19, by Caroline Bruckner and me.

What do you think?

Tuesday, May 21, 2019

TCJA Guidance Report from TIGTA


On May 14, TIGTA released a report, Status of the Office of Chief Counsel's Issuance of TCJA Guidance. It reviewed the process for issuing guidance on the 100+ provisions of the Tax Cuts and Jobs Act (P.L. 115-97; 12/22/17). It also lists the guidance issued through the end of March (83 items) and what is expected from that date (95 items). A good amount of this includes Treasury Decisions, meaning final regs of the numerous proposed regs issued so far. Here is the detail of what they still plan to issue:

44 Treasury Decisions
35 NPRMs
 4 Revenue Rulings
 6 Revenue Procedures
 4 Notice
 1 Announcement
 1 Undetermined

Appendices to the report list the specific topics of the guidance.

This is a lot of guidance. Practitioners and taxpayers are likely to raise issues on some of the items, as they have with earlier guidance. That could lead to further changes.

Will it all be done by time 2019 tax returns are due?  Probably not and new issues will arise. It's a difficult process as many of the TCJA items are complex such as the international provisions, the business interest expense limitation and the changes for tax-exempt entities. Some of the regulations issued are over 100 pages long! There are many new definitions, limitations, safe harbors, special rules and more.

To get a sense of how long guidance can take, consider that we still have some temporary regulations from the Tax Reform Act of 1986, such as Reg. 1.163-8T and 1.469-5T (issued before 11/20/88 so not subject to the 3-year expiration date of section 7805). Also, on March 26, 2019, proposed regulations were issued under sections 301, 356, 368 and 902. The explanation of these regulations states that they are needed to "update existing regulations under section 301 to reflect statutory changes made by the Technical and Miscellaneous Revenue Act of 1988"! [REG-121694-16 (3/26/19)]

Is there an easier way so we don't have to wait so long and have uncertainty as to how some provisions work or have taxpayers taking differing positions, unfortunately with little risk given the low audit rates? I think much of the complexity could have been avoided. For example, for the qualified business income deduction of section 199A, don't include the limitation for "specified service trades or businesses" as it isn't needed and only affects high income individuals. Don't have so many loss and deduction limitations. Instead, see if just one can work. 

What do you think?




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!