International Tax Reform - Tax Havens and More

Much of the recent attention on international tax reform is centered around tax havens. Recently, there have been a few congressional hearings and mention in President Obama's budget proposal.

Tax havens have been a concern for over 50 years - why? TIGTA estimates that the $345 billion annual tax gap doesn't sufficiently report the international tax gap. Corporate tax rates in most OECD countries have dropped in recent years, making the US rate one of the highest - doesn't that adversely affect competitiveness of US firms?

What should the US income tax rules for international activities look like to eliminate or reduce longstanding issues that are harming the economy and why is it taking so long to bring our income tax into the 21st century global business environment we operate into today?

I've got a short article on current international tax reform activities with links and the need to stop studying, use the gathered information and to move to action.

What do you think?

Associates vs Teachers - What Creates Sales Tax Nexus?

On April 9, 2009, the Superior Court of Connecticut issued an opinion in Scholastic Book Clubs v. Commissioner (Docket CV 07 4013027S). This issue has been litigated in other states and this opinion is similar to a 1997 Michigan case (567 N.W.2d 692). The Connecticut Court found that the roughly 13,000 to 14,000 grade school teachers in the state who helped Scholastic generate sales did not cause Scholastic Book Clubs (SBC) to have nexus in the state.

You may have personal experience with SBC. The system is that SBC mails catalogs to teachers who distribute them to their students. Students place orders and give the order form and a check to the teacher. The teacher sends it to SBC, who then ships the books to the teacher. The teacher distributes the books to the students. If there are any problems, the teacher contacts SBC. Teachers earn points for their classroom (technically not for them) which can be used to buy books and equipment from SBC.

Some highlights from the decision:

• SBC does not have any property, employees, representatives, independent contractors or sales personnel in the state.
• SBC doesn't advertise using local media.
• SBC uses no state or local government services.
• Teachers are not obligated to participate in the program.
• SBC encourages new teachers to contact the parent company in Missouri to learn about the ordering process.
• The court did not agree with the Commissioner that SBC was engaged in business in the state by having representatives sell, deliver or take orders. The court interpreted representative in this context to mean an employee or contractor. Instead they serve an "important administrative role." The teachers are not a "sales force."
• The teachers really operate like parents in helping kids to order books and we wouldn't say a company has nexus because parents help kids order from their catalogs.
• The situation is different from the independent contractor sales force in Tyler Pipe (483 US 232 (1987)). The Tyler Pipe workers "maintained Tyler Pipe's name recognition, market share, good will and customer relations."

So, it really comes down to perhaps that the teachers' main business isn't selling books for SBC - they aren't sales staff. But is that the right approach? It doesn't take much to sell SBC books because unlike Tyler Pipe contractors who had to travel to get to existing and new customers and probably give a good sales pitch, the teachers have a ready supply of customers. The job is very easy. SBC sends the order forms and teachers hand them out to their students. If you get 13,000 to 14.000 teachers to do this, you've got quite a market. Without the teachers, it would be a lot more work for SBC to get order forms to hundreds of thousands of students.

Should it matter that the teachers don't earn bonus points but that the classroom earns them? That is, if the teacher leaves the school, the points remain for the next teacher to use. Many teachers make long careers in the same classroom. Also, teachers tend to need books and supplies - how many keep their points banked for more than 1 year?

And to illustrate oddities of state sales tax law - let's contrast this result to the rebuttable presumption in New York that can cause a remote vendor to have to collect sales tax if they compensate NY residents for directly or indirectly referring potential customers and over $10,000 of sales to NY customers occurr as measured in the prior four quarters.

The presumption can be administratively difficult and time-consuming to rebut. In New York, Amazon didn't try to rebut, but started collecting sales tax. But let's contrast what the Amazon Associates do for Amazon to what teachers do for SBC (note - I'm not implying that all of the factors below are relevant to nexus determinations, but just that they are interesting contrasts between the two situations and the propects for sales):

How they "solicit" sales:

• Associates - have an Amazon link on their website and may have a note encouraging people to order from Amazon by first clicking on the Associate's link. Some Associates might be encouraging people to buy a particular product. The Associates can't make someone click on the link or place an order.
• Teachers - they get order forms from SBC and hand them out to their students and tell them when to return the completed orders and payment. They probably can't force a student to take an order form, but students are trained to take what their teacher gives them to take home. The teachers don't have to guess if a potential customer will walk into their classroom and pick up an order form because the customers are in their room 40 hours a week - a captive customer base.

Role played in processing orders:

• Associates - none. Orders are placed on the Amazon website and shipped by Amazon to the customer. If there is any problem with the orders, customers contact Amazon directly.
• Teachers - they hand out the order forms, collect the completed forms and payment, sent that to SBC, receive the books from SBC, distribute the books to SBC and work with SBC to resolve any problems.

Agent?

• Associates - no
• Teachers - no

Compensation:

• Associates - earn a commission based on sales placed by people who reached Amazon from the Associate's website.
• Teachers - their classroom earns bonus points, but it takes a human being to use them. I'd guess that in the majority of situations, it is the teacher who earned the point from their students who ends up using them.

Obligated to sell?:

• Associates - no; they could end up not putting the link on their website.
• Teachers - no; they don't have to hand out the forms.

Likelihood of a sale:

• Associates - probably low. The website owner must first hope that someone visits the website and then that they click on the Amazon link and that they place an order.
• Teachers - probably high because they are working with a captive seller base and are offering something very appealing to families - low cost books, a large selection and extreme convenience.

Training:

• Associates - none.
• Teachers - are encouraged to contact Scholastic to "walk through" the process.

Necessary for a sale?

• Associates - Amazon will still have sales without the Associates. People likely to buy from Amazon have probably already done so before. Amazon advertises and is a well known name - people can find Amazon.com on the web without the Associates link.
• Teachers - yes - SBC would need a whole different strategy if the teachers didn't hand out order forms. It would be expensive to find families and mail them forms and process them each individually. (It seems odd for the court to conclude that the teachers are not a sales force when the reality is that SBC would have no sales in Connecticut if it were not for the teachers - or they would need a completely different business plan.)

Relationship to customers:

• Associates - varies; links on PTA sites are only going to be visited by families that belong to that PTA. The PTA is using the Amazon link to encourage parents to make purchase from Amazon through the link rather than elsewhere or not via the link. On other sites, the Associates may not have any relationship with website visitors.
• Teachers - per the court - they were like parents helping kids to decide what books to buy

I think the teachers look far more like sales helpers than Associates. But, it comes down to how the state law is written. States could change their laws to add a rebuttable presumption that sellers are presumed to be soliciting sales if they have residents distribute order forms and receive some type of compensation. The presumption could be rebutted if the seller can show that the teachers did not solicit sales in the state.

Another angle on this is whether schools and teacher organizations should be finding a way for SBC to collect sales tax to help generate more tax revenues for schools. I'd guess that very little use tax gets collected in Connecticut from the SBC orders. Seems odd that schools are eager to get more funds, yet so many participate in activities that actually diminish tax collections.

What do you think?

Confusing Tax Cuts with Simplification

President Obama's tax day (4/15) press statement notes that he is committed to a simpler tax code:

"President Obama will underscore his commitment to a simpler tax code that rewards work and the pursuit of the American dream and supports a future of sustained economic growth that creates good jobs and rising incomes for all Americans."

Then the bulk of the statement lists provisions of the recently enacted stimulus bill (PL 111-5; 2/17/09) that provide tax cuts to individuals. Unfortunately, these provisions mostly add complexity to the system, most of which could have been avoided.

Here is the list and my take on what would have been a simpler way to provide the relief.

Making Work Pay Tax Credit - despite the credit being given via withholding tax table changes, many people will need to refile W-4 statements to avoid being under withheld because of the phase-out of the credit for high income individuals and the credit's interaction with other stimulus payments. For example, if Bob's wages qualify him for the credit, but his wife's are much higher such that they are not entitled to any or all of the MWPC, they should adjust their W-4 to increase their withholding to avoid owing on 4/15/2010. A simpler alternative would have just been to increase the Earned Income Tax Credit or lowered the rate for the first tax bracket.

Expansion Of The First-Time Homebuyer Tax Credit - as long as this is kept temporary, it should be fairly easy for individuals to address.

Increased Earned Income Tax Credit and Expansion of the Child Tax Credit - it is good to provide relief through existing tax provisions. The only confusing part is that the change is temporary.

American Opportunity Tax Credit - this takes an existing tax credit - the Hope Scholarship Credit and renames it for 2 years and expands it. First, it is confusing to rename something for two years. Second, why not just use the funds to increase scholarships and grants that already exist at the federal and state levels.

Benefits For Retirees, other Social Security Beneficiaries and Disabled Veterans - similar problems to the MWPC. Why not just reduce the lowest tax rate for 2 years and increase the EITC.

Auto Sales and Excise Tax Deduction - this temporary deduction provides a small benefit - particularly compared to the difference in price between a new and a used car. This provision will confuse people - it should have been skipped.

Carryback Of Net Operating Losses For Small Businesses - while it is nice to give small businesses a temporary choice of how far back they want to carryback an NOL (but no longer than 5 years), the choice leads to the need to perform multiple calculations and use your crystal ball as to how this change interacts with any possible NOL generated in 2009. It is a helpful way to get some dollars in the hands of struggling small businesses, but perhaps the choices should have been reduced to the existing 2 year carryback or a 4-year carryback to reduce compliance costs.

Let's be more vigilant in helping Congress and President Obama find simpler ways to reduce or increase taxes (I've written previously on the complications of how the President's tax plan to get more money from higher income individuals takes an approach that is more complicated than necessary).

What do you think - what are some simplifications that will enable the President to reduce taxes for 95% of taxpayers (and increase them for the other 5%) without adding unnecessary complexity to the tax system?

Lessons From Obama Nominee Tax Problems

It's been a bit surprising to hear of a variety of tax problems a few nominees for positions in President Obama's administration had. These problems were found on both self-prepared returns and those done by a paid preparer.

Two observations:

1. There are lessons from all of this for tax return preparers - I have a short article on this aspect of the errors in the 4/9/09 AICPA Tax Insider - here.
2. A few members of Congress have seen this as an opportunity to promote their major tax reform plan as being necessary to get rid of our current system that obviously is too complex as evidenced by the errors by people who should be able to understand the federal income tax law.

For example, Congressman Goodlatte said the following upon introducing legislation to repeal the Internal Revenue Code after 2012 (as an incentive to have to enact a new tax system):

" The need for tax simplification is further highlighted by the tax problems experienced by some of President Obama's cabinet nominees. These are highly educated individuals, some of whom claim specialized knowledge of the Tax Code, and one of whom will actually be in charge of ensuring compliance with the Tax Code, Treasury Secretary Geithner. And even they cannot correctly file their taxes. In addition, in today's Politico, there was an article detailing the problems that members of the Senate have in filing and complying with the Tax Code. In fact, the title is, ``For Senators, Tax Questions Are Taxing.'' If it is this hard for government officials, including those who write and enforce the Tax Code, to comply with the code, then imagine what it is like for the average American family to comply with it. All Americans find the Tax Code, well, taxing." [Cong. Rec. 2/11/09, H1204; HR 982]

Similarly, Congressman Stearns used nominee errors to promote the "fair tax":

"A simpler Tax Code may have prevented former Senator Daschle or current Secretary of the Treasury Geithner the embarrassment of having to explain their failure to properly pay the taxes due to the complicated IRS tax system." [Cong. Rec. 3/17/09, H3479; HR 25]

I'm not completely convinced on observation #2. Yes, a few of the nominee errors were due to complexities such as:

• No clear guidance on how to split tax preparation fees between Schedule A and Schedules C and E
• Extra recordkeeping such as what is needed from a charity on any contribution of $250 or more.
• Not knowing that overnight camp expenses don't qualify for the dependent care credit.

But, some errors were due to lack of understanding of the law, carelessness and taxpayers not giving enough information to their tax preparers.

Even the reforms suggested, such as the national sales tax and a flat tax, have complexities. For example, under the flat tax, an individual must pay tax on their wages and business income, but not on investment income. Suppose an individual collects and sells a few pieces of art at a profit - is that taxable business income or non-taxable investment income?

Also, carelessness is not limited to an income tax. For example, many people are careless in not paying their proper use tax.

We should certainly examine how our existing income tax can be simplified. There are plenty of ideas already proposed (see 3/25/09 blog entry on Obama's tax reform task force). It is time to act upon them. Problems such as complexity, a tax gap, inequities and inefficiencies are not unique to an income tax, but can be designed into any type of tax!

What do you think?

Pricing and Digital Goods

Today's announcement of a change in pricing on iTunes poses an interesting opportunity to test the argument sometimes made that applying a sales tax to digital consumption will hurt the industry.

There are a few arguments against applying sales tax to the consumption of digital goods such as software and music, although most states tax downloaded software and some tax other digital downloads (and the number is growing). So, certainly, it is possible to tax this type of consumption.

Two of the arguments I think I've heard most often as to why we cannot or should not tax digital goods are:

1. It will just increase the use tax gap. That is, digital goods don't need a storefront and the vendor can easily operate out of just one state. So, it is a kind of good that is likely to be purchased from a seller without a physical presence in the buyer's state. That non-present seller has no sales tax collection obligation in states where they have no physical presence. However, the buyer will need to self-assess and pay use tax on the purchase and buyers don't do a good job of this. But, this also seems like a weak argument against taxing digital goods and is really a use tax issue, not a "should the sales tax apply to more types of personal consumption" issue. There are ways to make it easier to collect use tax, such as giving taxpayers the option of computing an estimate of use tax using a table based on income (such as New York, Michigan, Maine and a few other states do). [For more on this topic - click here.]
2. A sales tax on digital goods, such as music, will hurt that industry. This also seems weak since we don't also hear people argue that sales tax on tangible goods has hurt WalMart or other retailers. Also, small vendors of digital goods likely have a taxable presence in just one state so would only have to collect tax from buyers that live in the same state. Larger vendors, such as Amazon, Tower and Apple, already collect tax in several states and collecting on digital items in those states would not be a significant burden. And, they would not have to collect in states where they have no physical presence.

With the announcement today that Apple iTunes was changing its pricing structure, the news stories have noted the potential concerns of customers. The Associated Press article, "Changes to Apple's iTunes prices take effect" by Jessica Mintz (4/8/09) states:

"it isn't clear music shoppers are swayed by a difference of a few cents if it means having to change their iPod/iTunes habit in any way."

Mintz also notes in her article that even though Amazon has been offering lower prices and a "simple software download" would allow a transfer of music to iTunes, Apple sells more music than Amazon.

So, let's see if iTunes' new pricing of 69 cents, 99 cents and $1.29, rather than only 99 cents, results in the sale of any $1.29 songs - a price much higher than 99 cents + 6 to 10 cents of sales tax (depending on the state). It all still seems like a good deal except for states, such as California, with 20th century sales tax systems that treat tangible goods as the only thing taxpayers consume.