2-Year Anniversary of Tax Cuts and Jobs Act

On December 22, 2017, the Tax Cuts and Jobs Act (P.L. 115-97) was signed into law with most of it starting to be effective just ten days later. Give the roughly 115 changes in the law, that was a lot of work for the IRS to issue guidance on which is likely to take many years (we are still waiting for some guidance on the Tax Reform Act of 1986). It's also a lot for taxpayers and tax professionals to deal with.

We likely need another year of data to know if the TCJA might stimulate the economy. According to the Congressional Research Service in a June 2019 report (page 14), the lowering of the top corporate rate from 35% to 21% led to a "record-breaking" amount of corporate stock buybacks.

For most individuals, the law did not add any complexity other than dealing with no more personal and dependency exemptions and that effect on wage withholding. A bigger complexity might be the IRS change to the Form 1040 including eliminating 1040-A and 1040-EZ. For about 15% of individuals, there is new complexity from new deduction and loss limitations.

The Joint Committee Bluebook indicates there are about 74 technical corrections needed to make the statute do what the lawmakers suggested. Who knows if these will ever be enacted now that we are two years out and nothing has been fixed.

On 12/20/19, President Trump signed the Further Consolidated Appropriations Act, 2020 that funds the government through 9/30/20 and includes several tax changes. They include:

1. Renewal of over 30 provisions many of which expired at the end of 2017, generally through 2020. Affected taxpayers will need to file amended 2018 returns.  Query: Why weren't these addressed by the Tax Cuts and Jobs Act?

2. Repeal of three Affordable Care Act taxes including the Cadillac tax which never went into effect.

3. Change the "kiddie tax" to go back to the calculation that existed before the TCJA with taxpayer being able to elect to do the same for 2018 and 2019 returns. This change is due to the TCJA change resulting in some children to have a higher marginal rate on unearned income than their parent's marginal rate which was not the outcome intended by the kiddie tax.

4. Change in the TCJA making tax-exempt employers who provide certain fringe benefits, such as parking or transit passes, to no longer be subject to unrelated business income tax on that cost, effective back to  2018. This change exacerbates a flaw in the TCJA. The House Republicans wanted to have greater parity between what employers deduct as employee compensation and employees report as wages. That means doing something with fringe benefits where the employer deducts the costs of providing them but employees are allowed to exclude them from income. For qualified transportation fringe benefits, Congress decided to get to parity by having the employees continue to exclude that income. Congress could have instead (and likely should have given that these benefits are similar to cash wages) repealed the employee exclusion for these benefits and continue to let employers deduct the cost of providing them to employees.

Many tax-exempt employers complained of having to pay tax on their cost of providing qualified transportation fringe benefits to their employers.  That makes sense because they don't necessarily have funds to pay that tax. But, this is the right result once Congress opted to provide parity of employee and employer compensation amounts by denying employers a deduction for the cost of the benefits.  So, we have one provision of the TCJA now modified contrary to good tax system design, but helpful to the tax-exempt entities.

Beyond the kiddie tax and tax-exempt employer/transportation fringe benefit change, will other changes by made to the TCJA?  We'll see. Some candidates for office are calling for repeal of the TCJA. We'll see if that happens as it provided a tax cut to the vast majority of individuals (voters) although the issue of how the tax cut should be distributed among different income levels was not discussed.

What do you think? If you could change one item in the TCJA what would it be and why?

50th Year of AMT - Past Time to Repeal It

The alternative minimum tax (AMT) on individuals was created in 1969 - by the Tax Reform Act of 1969 (P.L. 91-172; 12/30/69). This problematic tax is about to reach its 50th anniversary at the end of the year. With the Tax Cuts and Jobs Act of 2017, the corporate AMT was repealed, it is time to repeal the individual AMT and deal with the reasons why it was enacted in a more equitable and logical manner.

Here is the description from the Joint Committee on Taxation's Summary of H.R. 13270, The Tax Reform Act of 1969 (8/18/69): "Limit on Tax Preferences.—In those cases where tax preferences are not fully subject to tax, provision is made for a minimum tax on individuals having tax preferences in excess of their taxable in- come. The additional tax in this case is determined by adding to the regular income subject to tax, one-half of the tax preferences but only to the extent they exceed the regular income."

The JCT report lists reasons for and against the minimum tax, as follows.

"Arguments For.—(1) The limit on tax preference is based on the premise that individuals generally should be required to pay tax on at least one-half of their economic income.
  (2) The limit on tax preferences has the advantage of making sure that individuals generally pay tax on a substantial part of their 48 income. It, therefore, serves as a second line of defense against the avoidance of income taxes, to back up the first line of defense against such avoidance offered by the remedial provisions in the House bill which limit the scope of specific tax preferences.
  (3) The bill corrects the unfair discrimination in present law which favors those taxpayers who derive their income from the ownership of property as contrasted with those who earn their living from wages and salaries.
  (4) The present law improperly encourages investment of capital in certain areas for tax consideration rather than good business reasons and violates the principle that taxes should have a neutral impact on economic decisions.
  (5) Many individuals with large incomes benefit from tax preferences to the extent that they pay lower average rates of effective tax than many individuals with moderate incomes. This makes a mockery of a tax system based on the ability to pay.

Arguments Against.—(1) This limitation is an imperfect substitute for direct action on the preferential income tax provisions which cause today's tax injustice. Each particular item of tax preference should be considered on its own merits and should be adjusted accordingly.
  (2) Enactment of a limit on tax preference complicates present law by imposing a new income tax system on top of our present system thereby compounding the complexity of the tax laws and adding considerable administrative difficulties to the existing system.
  (3) This new approach could become the forerunner of a gross receipts tax on all taxpayers.
  (4) The bill raises a constitutional question as to the power of Congress to tax income from State and local government obligations, particularly obligations already outstanding.
  (5) The bill is inadequate; the excess of percentage depletion over cost depletion and the excess of intangible drilling and development expenses over the deductions allowed under straight line depreciation should be added to the list of tax preference items subject to the limit on tax preferences.
  (6) The limit on tax preferences will discourage charitable gifts.
  (7) If Congress has seen fit to provide a specific tax benefit, there is no reason why it should be denied to some merely on the ground that it, in combination with other items, represents a large proportion of that individual's income.
  (8) Since this limit will not affect individuals until the sum of their tax preference income equals one-half of their total income, it will still be possible for some individuals to exclude substantial amounts of tax preference income from tax."

The Tax Reform Act of 1986 modified the minimum tax making it the alternative minimum tax. The goal remained mostly the same - to be sure high income individuals do not use a combination of deductions, exclusions and credits to reduce their tax liability below a perceived minimum level. While some of these items could have instead been repealed or scaled back, Congress believed each individually had merit.

The Tax Cuts and Jobs Act does cut back on some deductions which causes far fewer individuals to owe AMT. It is debatable whether the best items were cut back (such as with the $10,000 state and local tax deduction cap), with over 150 special provisions in the law, it seems more could be done to reduce tax preferences, particularly those used by a small number of higher income individuals such as the exclusion for tax-exempt interest income, the high mortgage interest deduction and the exclusion for employer-provided health care could be reduced for higher income individuals. These changes (and perhaps others) should be enough to allow repeal of the AMT

After all, shouldn't there just be one "minimum tax" - your regular tax calculation?  [Also see my 2007 op ed on this topic!]

What do you think?

Note: For more on the history of the AMT, see this 2016 CRS report, The Alternative Minimum Tax forIndividuals: In Brief.

Guest Post - Will Bitcoin Ever Be Regulated?

This post is provided by Albaron Ventures and raises a question relevant to application of laws, reporting requirements, and more, to virtual currency, aka cryptocurrency. Many laws such as those dealing with taxation, banking, and credit card usage and liability are based on a third party handling most transactions such as to resolve problems that may occur between a merchant and customer regarding a credit card charge. How can such rules work in a decentralized system? What happens when they cannot so work? Read on ...

Albaron Ventures notes: 
"Before diving deeper, it’s worth asking whether Bitcoin can be regulated in the first place.  The cryptocurrency was built with the primary purpose of being decentralized and distributed– two very important qualities that could make or break Bitcoin’s regulation."

Please visit their website for the complete article.

And, consider that technology and smart contracts can create new opportunities for decentralized transactions such as matching a buyer and seller or service provider and service recipient.

What do you think?

Repeal the Kiddie Tax

The TCJA changed the tax calculation for the kiddie tax which results in the child possibly having a higher marginal tax rate than the parents. This was highlighted by survivors of deceased members of the military in that a pension a child received was subject to more tax in 2018 than in prior years. A report on Military.com, “This Year’s Tax Cut Cost Some Gold Star Families Dearly,” 4/23/19, included an example of a child paying tax of about $1,150 on the benefits but owing $5,400 for 2018. This child’s parent is in a lower bracket than 37%.

While the TCJA does make the calculation one where the child can compute the tax without the need for the parent's return, using the tax rate schedule for trusts where the 37% bracket is reached at just below $13,000 is wrong. Query - Why didn't Congress say to use a rate structure 20 times the trust income tax bracket or some other percentage?

This issue caught the attention of some in Congress with proposals offered for relief for these benefits. S. 1370 and H.R. 2481 propose to treat the benefits as earned income so they are only taxed at the child’s tax rate. H.R. 2716 would not apply the TCJA changes to these benefits (so apparently still taxed at the parent’s marginal tax rate). H.R. 1994, a retirement bill passed by the House in May 2019 would change the kiddie tax calculation back to pre-TCJA times.

My proposal is to just repeal the kiddie tax. It is complex and isn't taxing the owner of an investment at their own tax rate as intended by an income tax. If a family member gives a dividend-paying stock to a child, for example, it belongs to the child. The giver has forever parted with it.

Also, the kiddie tax is poorly targeted at trying to discourage parents from giving investment assets to their children because the tax calculation doesn't ask about the source of the funds. For example, a child movie star with a big bank account is subject to the kiddie tax even though the source of the funds was her own efforts.

There is also something odd that happened with the kiddie tax back in 2013.  When the kiddie tax was created by the TRA86, it was often described as taxing investment income of minors (it then applied to children under age 14). However, the language was broader to include unearned income using a definition under §911. It was also intended to address situations where family members transferred investment assets to children. So, a fix to treat the military benefits as earned income should help.

In 2013, IRS instructions for the Form 8615 and its title changed from Tax for Certain Children Who Have Investment Income of More than $1,900, to Tax for Certain Children Who Have Unearned Income. One notable change in the instructions was the IRS now calling taxable scholarships unearned income subject to the kiddie tax. Yet, Prop. Reg. 1.117-6 called that income earned. This was not an issue prior to the law change that increased the age of a “kiddie” from under age 14 to up to age 23 for certain full-time college students. [See Chambers, “Kiddie Tax May Be Due on College Scholarships,” The Tax Adviser, 4/1/16).] This treatment also seems odd in that there is no family transfer involved with the scholarship.

The Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222 (5/17/06) changed the age of a “kiddie” from under age 14 to under age 18, effective for tax years beginning after 2005. The Small Business and Work Opportunity Tax Act of 2007 (P.L. 110-28, 5/25/07) changed the age to its current levels. This also makes no sense to take the unearned income of a legal adult at the parent's marginal rate.

The tax law would be simpler and more equitable and neutral to just repeal the kiddie tax.

What do you think?

Gig Worker Compliance Challenges Including AB 5

On 10/1/19, the Franchise Tax Board (FTB) held a meeting, chaired by State Controller Betty Yee, focused on compliance for gig workers. You can see by the agenda that many topics were covered including background data on understanding the gig economy which for the meeting meant those finding income opportunities from web platforms such as Uber, Postmates, TaskRabbit or hundreds of other similar sites. A video of the meeting is available.

I was honored to participate on a panel on Challenges and Opportunities for Tax Compliance in a Gig Economy. A few points I offered:

• The issue of worker classification is decades old and a big issue that Congress left unaddressed since at least 1978 with "Section 530" of the Revenue Act of 1978. This provision results in some workers being contractors for purposes of the employer's employment taxes, but employees for other purposes including for the worker's tax obligations. It is unfortunate that the multitude of classification schemes among federal and state laws has been allowed to continue for so long. I was hoping that the emergence of the platform work arrangement might finally be a time to look at this broken system, but apparently not yet. Instead we are getting more variations (such as California's AB 5 making many workers employees where other states enacted laws in 2018 clarifying that the platform workers were contractors).  The hearing didn't delve into the possibility of the need for a third category of work arrangement as this was focused on compliance rather than policy changes via legislation.
• We need to provide wider tax education to everyone, such as by including tax education in K-12 curriculum!
• For contractors – change the law to require the hiring person to get a Form W-9 and electronically submit it to IRS and State tax agency. These agencies then check if the person has filed a Schedule C or equivalent form (W-9 requires taxpayer to note type of business entity).  If yes – likely nothing need be done.  If no, email and mail that worker clear information about their tax obligations as a new self-employed entrepreneur. Connect them to tax agency YouTube videos as well. Ideally, this could also be when the federal government deposits $500 into their new retirement account (or perhaps does that once the first return with the Schedule C is filed).
• Lower the Form 1099-K threshold to match Form 1099-MISC ($600). California should not wait for Congress to do this but should instead do what Massachusetts and Vermont already did and drop the threshold to $600. This will help workers and reduce non-filing and the tax gap. It will also mean that more folks renting their property through Airbnb and similar thresholds get a reporting form (and that the government does as well).
• The  IRS has an online withholding calculator for employees that freelancers can also use – but it only works if the taxpayer has wage withholding.  The IRS and FTB should create online calculators to make it easy to compute quarterly estimated tax payments (federal and state) and to pay them online even if a taxpayer doesn't have wage income.
• A gig worker testifying lamented that she would not be able to prove her expenses for mileage on her own but would have to rely on the information provided by Uber and Lyft. That's a great point.  Rather than duplicate the recordkeeping, I suggest that the tax agencies find a way to "certify" the platform's recordkeeping so that the workers can use that information for tax preparation without issue. This should also help the worker understand the information. For example, did the app also track miles  between a drop off and next pick up (it would be helpful for tax recordkeeping if it did).

What about AB 5 enacted in California in September that will cause all employers with California contractors to determine the classification standard under the ABC test. That test starts with the presumption that the worker is an employee. To see if they are not an employee, the ABC test is met requiring meeting each of the following 3 requirements:

  (A) The person is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.

  (B) The person performs work that is outside the usual course of the hiring entity’s business.

  (C) The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

If not met, next see if one of the roughly 50 exceptions in AB 5 is met.  If an exception is met, then apply the Borello factors which are basically the common law approach to see if the service recipient has the right to control the manner and means of how the work is performed. If the service recipient can control the manner and means, the worker is an employee; otherwise, is a contractor.

It is important to read the AB 5 exceptions carefully.  I have seen summaries that say accountants are excepted. That is far too simplified. The exception actually reads: "An individual who holds an active license from the State of California and is practicing one of the following recognized professions: lawyer, architect, engineer, private investigator, or accountant." Like this one, more exceptions will raise interpretive issues such as what does "practicing" mean. In addition parts of the ABC test, particularly "B" will raise interpretive issues. Unfortunately rather than clarifying worker classification by using objective factors, AB 5 leaves us with mostly subjective criteria. 

The results of AB 5 are many but include:

• A worker might be an employee for California law but a contractor for federal. It will be very important for the worker and payor to understand the tax consequences. For example, there is no form equivalent to a Form W-2 that is only issued to a worker and the EDD and FTB (rather than also to the IRS and Social Security Administration); one will need to be created. While this different in classification is not new, it is likely to affect far more workers starting in 2020.
• A worker may continue to be a contractor for both California and federal but more documentation is needed to show that the work arrangement met the ABC test or met an exception.
• The worker is unfortunately out of a job because the payor doesn't want to hire them as an employee. I'm concerned that this may be the case for many part-time workers. The person presenting on October 1 from Postmates noted that many on the platform work just 3 to 5 hours per week and then only for about 3 to 5 months. It's a lot of work to hire these short-term workers as employees.  It is also possible that those hired will not get all benefits, such as offering of health insurance as they might be hired to work less than 30 hours per week with no legal requirement to offer coverage. And virtual workers might find that the employer prefers now to just use workers outside of California.
• And there are other possibilities - let's see what happens.

One additional tax compliance issue I raised involved freelancers that provide services to people outside of California, such as a virtual worker might who is consulting, providing graphic art services or tech services (such as Amazon Mechanical Turks provide). Like all of the tax issues, this is not unique to gig workers but any contractor or any-size business, what is the guidance for sourcing the income to California or other states - and what are the rules in other states. Unfortunately, this can be a complex tax issue not only for individual sole proprietors but also large multistate corporations.

So, lots of issues for compliance, not only for gig workers but other contractors PLUS new complications of the ABC test and its exceptions added by AB 5 effective 1/1/20. All employers with California contractors need to take a look at this legislation to see what changes. While the worker might still be a contractor, the service recipient (payor) will need new documentation to show that the person is a contractor beyond what was needed before 2020.

What do you think?  (btw, I expect to write more on AB 5 later as it is not an example of law changes that help move tax systems into the 21st century to reflect how we live and do business today. There are much better ways to actually get more safety net benefits and beyond to ALL workers.  Also, note that lots of employees don't get many benefits and have very low wages. I think we need to do more as a civil society to address levels of pay and safety net and retirement benefits for EVERYONE and there are ways to accomplish this!