Protecting Taxpayer Information - Greater Focus Needed on IRS Rather than Preparers

Both the IRS and tax return preparers have access to sensitive taxpayer data that is prone to theft or misuse. A recent report by the Treasury Inspector General for Tax Administration (TIGTA) - Increased Management Oversight of the Sensitive but Unclassified Waste Disposal Process Is Needed to Prevent Inadvertent Disclosure of Personally Identifiable Information (5/9/09) found that some taxpayer sensitive data in the hands of the IRS was not properly disposed of. For example, the report notes: "At every location we visited, we found documents containing PII [personally identifiable information] or other SBU [sensitive but unclassified] information in regular waste containers and/or dumpsters." It found that while most contractors disposing of waste met National Association for Information Destruction, Inc. certification standards, the background checks on employees did not meet IRS standards. TIGTA also found that in two locations, cleaning staff were found "without either proper identification or an escort."

TIGTA made various recommendations to the IRS that the IRS agreed with.

A few months ago, I blogged about the seemingly overkill with the recently reissued regulations under Section 7216 on disclosure and use of taxpayer information by income tax return preparers. The regulations are complex leading to innocent violations by preparers with a harsh misdemeanor penalty. The regulations should have instead provided key principles to be followed to guide protection of taxpayer/client information.

The client-preparer relationship should be less of a security concern that that of the IRS and taxpayers. Clients can easily (and should) take responsibility to ask questions of their preparers to be sure their data is secure. Greater attention should be paid by the IRS instead on what it must do to protect taxpayer data that taxpayers MUST provide to it without the opportunity to query them on their data protection processes.

Moving tax systems into the 21st century will require high security approaches by the IRS and greater proactiveness by individuals to protect their sensitive data - something they can easily do with their paid preparer, but not so easily with the IRS. Thus, greater attention needs to be paid to IRS practices and security rather than preparer practices.

What do you think?

Senate Finance Health Reform Financing Options

On May 18, 2009, the Senate Finance Committee released Financing Comprehensive Health Care Reform: Proposed Health System Savings and Revenue Options. It offers a variety of approaches for finding money in the government's health care spending and for improving the system. It includes possible ways to cut back on the employer-provided health insurance exclusion. This is good to see because as I mentioned other times in this blog, there are too many dollars in this exclusion that need to be reworked so as to benefit more people and to get more people, particularly higher income individuals, to pay more of their health care expenditures. Even having them pay tax on a portion of the benefit leaves a generous subsidy from the employer and federal and state governments.

For example, if high income individual Sarah in a 35% bracket had to include 20% of her employer-provided benefit of $10,000 of health care insurance, she'd include $2,000 of that in her taxable income and pay $700 of tax. She gets $10,000 of health care coverage for a cost of $700. The government can use that $700 (or it likely would take more) to provide benefits not just to employees getting health care coverage at work but to others.

The SFC's finding options all tie to health care which is good to see.

An interesting addition to the list of options is to impose an excise tax on sugar-sweetened beverages. While a good idea as a user-pays type of tax for unhealthy behavior, it will raise a lot of issues including complexity and fairness. After all, there are a lot of foods that may be worse for people including fried foods. Perhaps incentives and education programs to get people to drink water out of the tap would be good.

Anyway, it is nice to see a range of funding options that include reducing overly generous tax breaks that do not benefit everyone, ways to reduce costs, and new ideas like "unhealthy eater" taxes. It is a better list than offered recently by the Administration because it finds health care reform dollars in the health care system where there are a lot of dollars available (although the Administration's approach might be easier to enact). Good for the Senate Finance Committee!

Additional information:

• Senator Baucus and Grassley press release on the options report
• 111th Congressional hearings on health care reform
• my 5/17/09 post on the Administration's tax changes to help fund health care reform

What do you think?

Finding Appropriate Tax Dollars for Health Reform

President Obama's revenue proposals for FY2010 released on May 12, 2009 (the "Greenbook") include 30 revenue raising proposals where the taxes generated are to be dedicated to the "Health Reform Reserve Fund." It is estimated that over 10 years, these 30 provisions will generate $325.6 billion. These 30 proposals are a wide gamut of provisions including capping the tax benefit of deductions of high income earners at 28%, new information reporting requirements, new enforcement tools, new penalties, repeal of LIFO, and estate tax modifications. It does not appear that any of the 30 revenue-raising provisions are related directly to health care. (The list of specific provisions can be found on pages ii - iii and 130 of the Greenbook.)

I find this approach troubling for two reasons:

1. The current tax rule that exempts the value of employer-provided health insurance from income (even though the employer takes a deduction for it) is a very generous provision of our federal tax system. The Joint Committee on Taxation estimates that for 2007, the exclusion resulted in a cost to the income tax system of $145.3 billion plus $100.7 billion to the Social Security system. Why are we ignoring this tremendous tax expenditure and ignoring the reality that federal dollars, via this exclusion, are being spent to favor employees with employer-provided health insurance while the government struggles to find dollars to help more people be insured. The dollars spent on the generous exclusion could be used more equitably to benefit more taxpayers. One approach would be to require high income individuals receiving the benefit to pay tax on part of that benefit. This should still make the benefit worthwhile (such that they would be unlikely to cancel their health insurance thereby jeopardizing the employer's ability to afford health insurance for all employees). President Bush had proposed eliminating the exclusion and replacing it with a standard deduction to also help cap the dollar amount of the benefit employees receive. A starting point towards bringing employees (the insured) into health care spending decisions would be to at least start having high income employees pay tax on a portion of their benefit. Also, the benefit is worth a lot more to high income individuals because they are in a high tax bracket.*
2. If a tax change is going to be earmarked to generate funds for a specific purpose (other than increasing the General Fund), there should at least be some connection between the items changed and the program to be funded. For example, if gasoline excise taxes were to be increased to fund the Highway Trust Fund, that would make sense.

* Note - the exclusion for employer-provided health insurance is a tremendous benefit because the employee never comes out-of-pocket to pay for anything. For example, if Amy's employer pays $10,000 of her health insurance annually, Amy saves a $10,000 outlay that she would otherwise have to make if she bought her insurance on her own. If Amy had to pay tax on 10% of this benefit and is in the 35% tax bracket, she would pay tax of $350 ($10,000 x 10% x 35%). She still gets a tremendous benefit because she gets $10,000 of coverage and it only costs her $350.

There have been hearings on various aspects of health care reform and the tax law. Several people testifying have noted concerns about reducing the health insurance exclusion as it may lead to some employers dropping plans and increases in the number of uninsured. People have also noted flaws in the health care system that need to be addressed because they increase costs for employers and individuals purchasing insurance.

Certainly, there are issues that need to be addressed in health care which cause us to have such high costs without the highest quality health care relative to other countries. I hope the discussions do look at other models of health care that don't tie it to employment and requiring employers to purchase health insurance for employees. We are entering an era of employees not tied to a single employer for their entire career and I think we'll see more individuals be self-employed entrepreneurs. Their health insurance costs will always be high due to the tremendous federal subsidy via the tax law that goes to employees getting health care coverage from their employers. Also, if other countries don't use our model, US employers face greater costs of doing business which will hurt their ability to compete in the global economy.

Health care reform is not easy due to the many broken pieces we currently have including inequitable government subsidies, the reliance on an employer-provided system that exists due to the historic artifact of wage controls in the 1940s, and an unwillingness to be more transparent, overt and focused on the need to generate at least some of the funds for health care reform from the current subsidy. Also note that the current tax subsidy for employer-provided health care is 8 times larger than what President Obama expects to raise from the 30 tax increases. This means that even a relatively small change in the subsidy - and even just for higher income individuals, would be sufficient to cover what he needs for the health care reform reserve fund.

I hope we can move to a more honest effort to generate funds for health care that include finding ways to reduce costs and to spread tax dollars more equitably to benefit more individuals. Let's start with connecting new funds for health care reform from the existing generous subsidy for health care.

What do you think?

Greening of Tax Practitioners

The quantity and complexity of federal, state and local tax incentives for green activities - using certain renewable energy sources, purchasing certain energy efficient equipment or building a structure with specified energy devices, presents a significant challenge for tax advisers.

Tax advisers are well educated on business strategy, accounting, auditing, taxation, systems and more - in the business field. Almost all lack an understanding of such terms as biomass, fuel cell, U factor, lean burn, SHGC of 0.30 and Standard 90.1–2001 of the American Society of Heating, Refrigerating, and Air Conditioning Engineers and the Illuminating Engineering Society of North America.

If a client asks their tax adviser what tax break they might get for solar panels, purchasing a plug in vehicle, new insulation, an energy efficiency audit, it is going to take the adviser some time to see if there is any tax incentive and if there is, exactly what the client needs to do and when. And, the tax adviser or client also needs to look at the federal and state environmental agencies to see if they offer any rebates or direct grants, and whether the utility company offers any incentive payment.

The American Recovery and Reinvestment Act of 2009 added another federal green incentive in that instead of claiming certain credits, the taxpayer can request a direct grant - from the Treasury Department! Why not from the Department of Energy?

Why bog down the tax law and the work of non-energy experts with figuring out how the help the environment and reduce one's tax bill? Why aren't the subsidies provided by the Department of Energy or EPA?

I've got a short article on this - The Greening of the Work of Tax Advisers, on the problem of giving this work to tax advisers and some additional policy issues with plethora of energy tax incentives.

Of course, there are consultants who specialize in particular energy tax incentives that taxpayers can hire to help them claim a credit or deduction. The extra compliance cost to claim some of the incentives make them worthless after a cost-benefit analysis. So, what is the point of that?

Also - I can't overlook a few policy oddities of so many energy subsidies in the tax law. Here are some more oddities:

• A business or household that performs an energy efficiency audit might find that the best way to reduce energy usage warrants no tax benefit. Is that a good approach?
• The system also can give someone a credit for solar panels or insulation who drives a gas-guzzling SUV. Is that what the rules should be incentivizing?

Where, if anywhere, should energy incentives be placed? How can incentives be designed to truly reward behavior that helps the environment?

Tax Law Complexity and Small Busineses

On May 7, 2009, the House Committee on Small Business held a hearing - “How the Complexity of the Tax Code Hinders Small Businesses.”

• Committee home page - Majority - Minority
• Links to May 7 testimony
• Hearing videos on YouTube

Complexity is a more serious issue for small businesses relative to large ones (where it is still a problem) because the costs of compliance might even exceed the tax owed (see links from the Tax Foundation).

Some of the suggestions from the people who testified before the House Committee on May 7 included:

• Repeal the AMT
• Simplify the ability to select the cash method by allowing taxpayers to base the decision just on gross receipts level (rather than also business classification)
• Reduce the recordkeeping required for deducting the cost of using cell phones
• Provide equal treatment for small business owners for costs of their health insurance as all other employees and employers get
• Make permanent the current $250,000 expensing election of Section 179
• Allow a standard deduction for home office expenses
• Simplify the worker classification rules

I've blogged on this topic before (just as the committee has held hearings on this topic before) - here.

There are many ways that the tax law can be simplified and the burdens placed on small businesses and individuals by the tax law warrant reform. Time spent on complex tax calculations when simpler ones could generate the same amount of revenue could be better spent growing one's business.

What do you think are the top simplification changes that should be enacted for small businesses?

Will President Obama's International Tax Reform Proposal Move Us Into the 21st Century?

Today, the White House announced details of its cryptic 2/09 budget proposal that included a “robust portfolio of IRS international tax compliance initiatives” that would generate $210 billion over 10 years.

The Administration aims to "curb tax havens and replace tax advantages for creating jobs overseas with incentives to create them here at home." President Obama describes these changes as a start in simplifying the tax law and making it more fair. Specific elements of the plan include:

• Deferral reform: "with the exception of research and experimentation expenses – companies cannot receive deductions on their U.S. tax returns supporting their offshore investments until they pay taxes on their offshore profits. "
• Modify the "check the box" rules to "require certain foreign subsidiaries to be considered as separate corporations for U.S. tax purposes."
• Tax havens: "a comprehensive package of disclosure and enforcement measures to make it more difficult for financial institutions and wealthy individuals to evade taxes." Reporting requirements would be tightened, penalties increased and the statute of limitations would be extended. In addition, 800 new revenue agents would be hired to help with international enforcement.
• Make the research tax credit permanent.

Further details are in a "fact sheet." Additional international tax reforms will be issued in May.

Today's announcement also states: "it will take time to undo the damage of distorted provisions that were slipped into our tax code by lobbyists and special interests." This seems like an odd and unfortunate way to describe how tax laws are enacted - isn't Congress responsible for what gets passed in the House and Senate.

Will these proposals move the US tax system into the 21st century ways of doing business? I don't think it is enough. The issues noted are not new ones. The tax haven one has been around for at least 50 years (see short article that notes that). It is way past time to resolve this matter that contributes to the tax gap and is not all included in the $345 billion tax gap figure we always hear of.

US companies have a variety of reasons to have offshore operations beyond tax benefits. I'd like to see discussion of a territorial tax system like many countries already use, perhaps consideration of some type of consumption tax for businesses that would tax imports but not exports, and a lowering of the tax rate. US businesses seem somewhat disadvantaged in competing against companies located in other industrialized countries because our system is taxing worldwide income and at higher rates.

What do you think would be the best international and domestic business tax reforms that would help US businesses to compete in the global economy and strengthen the US economy?

E-commerce and uncollected use tax

The Streamlined Sales Tax Project website includes a report dated 4/13/09 by Professors Bruce, Fox and Luna entitled State and Local Government Sales Tax Revenue Losses from Electronic Commerce. This continues work they have undertaken over many years to estimate and track revenue losses of the states due to uncollected use tax on e-commerce transactions. They track this for both B to C and B to B transactions.

In addition to the revenue loss, they note additional problems that result from the current tax system challenges of collecting sales and use tax from remote vendors (the e-commerce business model makes it easier to be a remote vendor because you don't need many physical locations in order to sell worldwide). The problems they note are:

• Vendors can arrange their selling and warehousing activities to limit nexus and sales tax collection obligations.
• Main street retailers are at a disadvantage as some customers will browse there and then make their purchase online to avoid the sales tax.
• Distributional equity issues exist in that low-income customers are more likely to buy on Main Street and pay sales tax than buy online and potentially avoid sales tax.

The authors estimate in the baseline case that "annual national state and local sales tax losses on e-commerce will grow to $11.4 billion by 2012 for a six-year total loss of $52 billion."

They estimate that California's uncollected sales and use tax from e-commerce will total $8.7 billion for the 5-year period 2007 through 2012 (page 11).

The report also estimates use tax loss from any federal law that allows for an exemption for small vendors. They estimate that a de minimis level of $1 million would result in $2.6 billion of use tax uncollected for the states in 2010. The authors note that a considerable amount of e-commerce is via small vendors.

The report also includes data based on other possible e-commerce growth projections and a detailed section on the methodology used to derive the estimates.

So, what is the solution? Clearly, minimal efforts by the states to educate buyers about their use tax obligations and providing a line on the state income tax form are not working well. This is leading states to broaden the definition of nexus to find ways to make remote vendors "present." For example, New York recently enacted an affiliate nexus provision that would make companies connected through a common trademark (and other ways) present in the state. And several states have introduced bills similar to what New York did in 2008 to make "associates" in a state more than advertisers, but to make them sales helpers. (For more on this see my earlier posts: 2/10/09 and 4/22/09.)

New York State's Executive Budget report includes the following statement about the need to find ways to expand nexus:

"Many brick and mortar retailers also have mail order and Internet sales operations that are tightly integrated with their brick and mortar activities. Some of these retailers have circumvented the requirement to collect sales and use tax on their catalog and Internet sales by attempting to avoid nexus with New York, segregating their Internet and catalog operations into affiliates that are separate from their brick and mortar stores, as well as their distribution, headquarters, and other functions. This bill seeks to preclude such a practice and increase the number of remote sellers that are required to collect the State’s sales and use tax."

Is that the best way? Should Congress step in and prohibit such practices unless the state has taken efforts to make their sales tax law more similar to other states or added specified simplification measures?

Certainly, a lot of revenue is at stake and this is not new tax revenue - it is owed from laws that were enacted in most states decades ago (to create a use tax). The sales tax model doesn't work well in an e-commerce environment, yet it yields about 1/3 of state revenues so isn't easily replaceable.

Solutions to address the lost revenue:
1. Better efforts to collect the use tax from consumers. States could provide a table for computing the use tax to avoid the need to keep records except for items costing over $1,000. Better educational efforts should also help, such as states running ads online that inform people that their remote purchase is taxable.
2. Finding incentives for remote vendors to voluntarily collect. Perhaps ads by state tax agencies reminding customers that when they buy from Amazon or other large Internet vendors that they need to keep their records and pay the use tax. Maybe customers would ask Amazon and other vendors to collect it for them. These vendors should also be given an option of adding a link at the payment website to enable the customers credit card or Paypal account to be separately billed for the tax by their state tax agency.
3. States should stop raising sales tax rates making the problem worse in many ways.

What do you think?