New 21st Century Taxation Website

Finally, I have updated the 21st Century Taxation website to its new URL:

http://www.21stcenturytaxation.com

I hope you'll take a look and you can let me know here what you think or send me an email.

Thanks for taking a look!

Happy New Year!

Taxes and Health Care Bills - Considering Tax Policy

With the Senate passing health care legislation on December 24 and the House having done so on November 7, we now have 2 different health care bills that Congress will have to meld into a single bill. Each version has a variety of tax provisions. I'll note a few of them here with some analysis on how they stack up against principles of good tax policy.

First, the list of tax provisions and their cost or revenue effect can be found in Joint Committee on Taxation documents:

• JCX-53-09 - House bill H.R. 3962
• JCX-61-09 - Manager’s amendment to the revenue provisions in HR3590: Patient Protection and Affordable Care Act

Selected provisions of the House bill:

1. Impose an extra tax on individuals without acceptable health care coverage - well, the tax law can be used as both a carrot and a stick. This is an example of it being used as a stick. Neither approach is really ideal as the tax system should exist to raise revenue, not to modify behavior. But, if legislators believe there is no other way, it might be justified, particularly since the tax law already reaches almost all adults. This unfortunately makes the IRS the enforcer of health care law though, when it is supposed to be administering the tax law. Reporting on Form W-2 will indicate whether the individual has health care coverage from their employer. If they do not, this rule should require some type of documentation on the return to prove insurance coverage.
2. 5.4% surtax imposed on individuals with modified AGI in excess of $500K ($1 million in MFJ). This is expected to generate $460 billion of revenue over 10 years. What is the logic of having high income individuals (and uninsured (see above)) pay for health care reform? If Congress wants to raise taxes on high income individuals, it would be more transparent to just increase the top brackets in the rate schedule. For health care reform, I believe there is a better and more appropriate way to generate revenue and I have written about this before - tax a portion of the currently excluded health care benefits employees get from their employers. This step will also bring employees into the health care decision-making. They will be more likely to ask their employer why their health insurance costs so much, they will ask their doctor if they really need a particular procedure and why it costs so much. For more on this, see Pot of Gold in the Employer-Provided Healthcare Exclusion and 5/20/09 post.
3. Codify economic substance doctrine and increase Section 6662 penalties related to non-economic substance transactions - this proposal has been inserted into many bills over the years as a revenue raiser. I'm not convinced it will raise almost $6 billion over 10 years. But to clarify the existence of this doctrine, wording it in a way to apply to all taxpayers regardless of their litigation options and strategy, should make the tax law more transparent.

Selected provisions of Senate bill:

1. 40% excise tax on "Cadillac" health plans of employers. This is an ineffective way to tax high premium plans. It is not transparent because the tax is imposed on the "coverage provider" rather than the employee. It won't be clear who ultimately pays the tax (remember, business taxes are ultimately paid by employees, customers and investors/owners). It continues to leave employees out of too much of the health care decision-making. Also, if it has the effect of employers reducing coverage, it won't generate the intended revenue. An op ed in the Washington Post on 12/28/09 ("'Cadillac' tax isn't a tax -- it's a plan to finance real health reform," by Gruber) suggests that this excise tax is not a tax but "the elimination of an existing tax break that is provided to exactly these firms." This is not accurate. The tax break is to the employees, not the firms. Under our current system, employers deduct the cost of the health insurance they provide to employees and despite the fact that that benefit is "income" it is not taxable to the employees because of a tax rule that excludes it (it also is not subject to Social Security tax). Thus, the benefit is to the employees, not the employer (although the break does allow employers to offer generous health care benefits as a recruitment and retention perk). It would be more transparent and equitable to tax a portion of one's employer-provided health care benefits beyond a specific minimum amount (see earlier link to "pot of gold"). Also, there appears to be no requirement that the employer or insurance provider pass the excise tax along to the employee who has the "Cadillac" plan.
2. W-2 reporting of the health insurance perk employers provide to employees. This is a great idea because it enables employees to know how much their employer is paying for their health insurance coverage. It is also a good first step in then taxing some portion of this benefit which will make the income tax more equitable (the current exclusion provides a much greater benefit to those in high tax brackets).
3. Change the itemized deduction for medical expenses to a floor of 10% of AGI rather than the current 7.5% floor. Ten percent is the limit for AMT purposes. I'd rather see this change as part of a bill to repeal the AMT rather than help fund health care reform. In terms of most principles of good tax policy, the AMT is one of the worst features of our tax system (see Nellen, Simplicity and transparency versus the dread AMT, Silicon Valley/San Jose Business Journal, 12/7/07).
4. Raise the hospital insurance tax on wages and self-employment income in excess of $200,000 ($250,000 joint) by 0.9 percentage points - this would bring some progressivity to this tax and help fund Medicare which needs it. This will bring about some complexity for these individuals because if they have more than one source of earned income, their employer won't be able to calculate the entire tax (but not a significant amount of complexity). With reports of financial troubles with Medicare, it seems that a broader discussion and analysis of the revenue and spending design is needed.
5. 10% excise tax on tanning salons - seems odd and inappropriate to single out these businesses and their customers.

What do you think Congress should do with revenue provisions assuming they are able to get a single bill together?

California State-Local Fiscal Relationship

This month, the Legislative Analyst's Office issued a report - Ten Events That Shaped California State-Local Fiscal Relations (12/15/09) for a hearing of the Senate and Assembly Select Committees on Improving State Government (Assembly page + Senate page). The 10 events:

1. 1910 Separation of Sources Act
2. 1930s New Deal
3. 1952 Proposition 18
4. 1972 SB 90
5. 1978 Proposition 13
6. 1979 AB 8
7. 1991 Realignment
8. 1992 and 1993 ERAF Shifts
9. 2004 Triple Flip/Swap
10. 2004 Proposition 1A

It's a bit of a cryptic list without the brief explanation of each event offered by the LAO (you can find that here). It also sounds like an odd list with words like "realignment," "shift," "flip" and "swap." The word "proposition" also showing up three times indicates that the voters rather than elected officials created some of the events.

As some of the words used in the list of events indicates, there are oddities in the California-local government relations. While Number 1 on the list - separation of sources, sounds like authority and accountability at each level of government (a good thing), such separation is limited and has been modified since enacted in 1910. Per the LAO report, the Act called for the state to tax railroads, telegraph and telephones while the local governments would tax property and set the rate.

While the bulk of property taxes are collected and used at the local level, the system for how they are allocated among local governments is controlled by the state (Numbers 5 & 6 on the list above - Prop 13 & AB 8). This makes it difficult for local governments to do their job - they can't necessarily allocate revenues to their best need.

Another problem in the state-local fiscal relationship is lack of transparency. Taxpayers don't really know where their taxes go and how they are spent. Part of this is due to oddities in the flow of some tax funds. For example, Event Number 8 on the LAO list - the Triple Flip. To help fund state bond payments, 0.25% of the local sales and use tax was shifted to the state for the Fiscal Recovery Fund. To replace the lost sales tax, cities and counties received funds from the Education Revenue Augmentation Fund (ERAF). The State then uses General Fund monies to replace the ERAF dollars. [ABX1 7 (2003) and Prop 57 (2004)]

Another problem in the state-local fiscal relationship is the sometimes opposing strategies that exist due to flaws in the tax system. For example, cities seeking revenues might aim to get a "big box" retailer to locate inside city borders. This generates sales tax revenues. However, these are not high wage/high skill jobs that would be more advantageous to the state's income tax base and prospects of attracting manufacturing and R&D businesses to the state.

A final problem I'll note is that while the state has a fair amount of control over local revenues (and some expenditures) locals are often forgotten at the state level. A recent example is the final report of the California Commission on the 21st Century Economy. One of the recommendations was a Business Net Receipts Tax (BNRT). This would replace the corporate income tax and the state-level general sales tax. One reason for this proposal was to use a more administratively simple approach to extending the sales tax to services (the BNRT is a type of subtraction method VAT making it similar in collections to a sales tax). However, no comment or effort was made to find a way to update the sales tax base for local governments or to have them share in the BNRT revenues.

It is important for any state level fiscal discussion or action to consider the effect on local governments. The National Conference on State Legislatures (NCSL) includes this in their 9 principles of a high-quality state revenue system - "A high-quality revenue system comprises elements that are complementary, including the finances of both state and local governments."

What do you think of the LAO top 10 list? What do you think are key problems with the California-local government fiscal relationship?

Tax Policy - Minimizing the Tax Gap

The "tax gap" is the difference between taxes owed and taxes collected. The amount not collected is due to both intentional and unintentional errors. Unintentional errors can be due to inadequate recordkeeping, posting errors and confusion over the law. Intentional errors include purposefully omitting income from one's return, and claiming deductions and credits one is not entitled to.

Principles of good tax policy include that the system should be designed to minimize both intentional and unintentional non-compliance (see AICPA Policy Concept Statement on Principles of Good Tax Policy).

The federal tax gap is at least $345 billion per year. States also have gaps in their tax systems as well.

Two events of this week illustrate problems in drafting provisions to minimize the tax gap.

1. Smith v. Commissioner, 133 T.C. No. 18 (12/21/09) - a case involving excessively large tax shelter penalties that are poorly designed to address non-compliance.
2. A report, Evaluation of the Internal Revenue Service’s Capability to Ensure Proper Use of Recovery Act Funds, by the Treasury Inspector General for Tax Administration, released on 12/22/09, notes that the "IRS is unable to verify taxpayer eligibility for the majority of Recovery Act tax benefits and credits at the time a tax return is processed. This includes 13 of the 20 benefits and credits for individual taxpayers and 26 of the tax provisions benefiting businesses."

Details ...

Section 6707A: In the Smith case, the taxpayer and his corporation were each assessed a penalty under Internal Revenue Code Section 6707A for failure to report a "reportable" transaction that was also a "listed" transaction. This penalty was designed to reduce tax shelters. The penalty is basically a strict liability one. For individuals, it is $100,000 and for corporations it is $200,000. For three years of assessment, the individual faced a $300,000 penalty and his corporation $600,000. The Tax Court ruled that it was not allowed to review the penalty (although the taxpayer had other options beyond the Tax Court).

The Section 6707A penalty has come under scrutiny because of its size and because it allows the IRS no leeway to consider the taxpayer's intent related to the violation and the size of the related tax deficiency (or if there even is a deficiency). While Congress could enact changes to the provision (for example, S. 2771), it has not done so. In introducing S. 2771, Senator Baucus noted that sometimes this penalty results in an assessment 20 times greater than any taxes saved by the particular investment that is a "listed transaction." He also noted: "Many of these businesses thought they were putting their money into sound investments for the benefit of their employees and learned only after they were audited by the IRS that they instead had invested in something the IRS considers to be a tax shelter." He also notes that while he is not soft on tax shelters, he realizes that the penalty structure is harming many small businesses [Congr. Rec. 11/16/09, S11384]

In 2009, IRS Commissioner Shulman twice issued a statement that the IRS would not pursue collection efforts on the penalty in light of the bipartisan in Congress to modify the penalty. He extended that commitment to 12/31/09 (see first letter of 7/09).

The design of this penalty does not improve compliance and is way too intrusive (putting a taxpayer into financial ruin when they did not do anything evil or clearly abusive, is the wrong approach).

TIGTA Report: TIGTA points out that it is much more efficient for the IRS to verify whether a taxpayer is entitled to a special deduction or credit in processing the return rather than having to audit the return and then seek a refund. But for this to occur, the IRS needs "math error authority" and documentation on the return. It doesn't always have this power - it needs help from Congress.

Comments: In drafting any tax rule, all principles of good tax policy should be considered including ways to minimize non-compliance. Sometimes, just asking for information on the return itself would help. For example, include questions about the address of rental property, the details of a home purchase (such as for the first-time homebuyer credit).

As noted by the GAO in a 1995 report (p. 13), efforts to minimize the tax gap must strike a balance between the desired level of compliance and the intrusiveness of the tax system.

Considering other principles of good tax policy, such as simplicity, neutrality and economic growth and efficiency, it is usually best to not keep adding special rules to the tax law! Alternatives include rate reductions or modifications to rules that already exist, such as the standard deduction or the Earned Income Tax Credit.

I've got more on the tax gap here. The short articles noted there have links to government reports on the tax gap and its causes.

For an overview to 10 principles of good tax policy from a recent presentation I made to the National Conference of State Legislatures - click here (ppt).

What do you suggest for reducing the tax gap and not legislating more changes that just make it worse?

Use Tax - New Attention, Old Ideas and How to Track

The use tax - despite news reports and a line on most state income tax returns for it, remains a mystery to most people. Ask anyone if they have paid their use tax and most will likely ask what a use tax is, a few will laugh as if it is not an important tax and a few will say that they have paid it. [More info on the use tax - here.]

I was quoted in a recent LA Times article on the new California rule that requires businesses with $100,000 or more of gross receipts to register ("California tax collectors want their cut on out-of-state sales," by Zwahlen, 12/21/09). (For Board of Equalization information on this new rule - here.) That story caught the attention of at least two Bay Area radio shows who had stories on the use tax:

• KQED - interviewed Professor Alan Auerbach at UC Berkeley and Assemblymember Nancy Skinner on 12/22/09. Assemblymember Skinner had introduced copycat legislation of the New York "Amazon" law which was vetoed by Governor Schwarzenegger. She said she would be re-introducing it (more on that below).
• KCBS - interviewed BOE member Betty Yee on 12/24/09. She notes that uncollected use tax in California is about $1.1 billion per year!

The California use tax has been around since 1935 - it is not a new tax. It is owed by businesses and residents in California that purchase something subject to the sales tax (such as books or equipment) but for which the seller did not charge sales tax because the seller is not subject to sales tax collection. If a vendor does not have a physical presence in California - they do not have to collect sales tax (per the US Supreme Court's analysis in Quill). BUT - the buyer has to self-assess and pay the use tax. Both businesses and individuals can use a line on the California income tax return to report that. The rule that requires that line is expiring, but likely will be (and should be) renewed.

A few more observations:

1. How to make compliance easier - some states, such as Maine, include a table with the individual income tax form where the filer looks up their income amount to find a use tax amount. While that is an estimate (so not accurate), it means that the consumer doesn't need to keep records unless they want to report the true amount of use tax they owe. That would make compliance easier. Also, software programs for tax return prep would likely incorporate the table and compliance would go up. Such a law should also include that if a purchase for which no sales tax was collected was $1,000 or more, the actual use tax amount for such purchases should be added to the table amount. This enables the table to be more realistic of people buying low-cost items on line including on eBay. AB 1957 (March 2008) called for this change, but was not enacted. It should be re-introduced and enacted.
2. Getting more people to know about the use tax - a public awareness campaign - public service announcements by the Board of Equalization, pop-up ads by the BOE on popular websites, AND let's create education standards for high school students that will require that they learn about federal and state taxes, their obligations and public finances in general. This should help students become responsible citizens and knowledgeable (and hopefully compliant) taxpayers.
3. Skip the Amazon approach started by New York - this won't work and diverts time from more effective approaches. This approach creates a rebutabble presumption that if a vendor has associates in the state that have links to the vendor's website for purchases and such purchases total at least $10K in the prior four quarters, there is a rebuttable presumption that the vendor is required to collect sales tax. When NY introduced this in April 2008, Amazon started collecting the sales tax, but Overstock.com cancelled its associate relationships so was no longer subject to the new rule. A trial court decision in New York ruled in January 2009 that the law was fine. But that will be appealed. Other states have attempted to introduce the legislation. Governors in Hawaii and California vetoed the bill, but it was enacted in North Carolina and Rhode Island. In those states, Amazon cancelled its associate relationships. So, it is questionable if any use tax is getting collected from the new laws. A BETTER approach - state legislators should work with Congress to see what would get Congress to use their Commerce Clause authority to let states require remote vendors to collect sales tax. Also, be sure auditors are taking a close look at the operations of remote vendors to see if they have any physical presence in the state such as use of an agent to help make sales. AND, keep educating consumers about the use tax and the importance to everyone of being tax compliant. I've got more on all of this, including - (1) articles and links, (2) 8/4/09 blog entry, and (3) Grabbing Remote Vendors, AICPA Corporate Taxation Insider, 7/31/08. For a view favorable to the Amazon law approach, please see the excellent analysis by Michael Mazarov of the Center on Budget and Policy Priorities (11/09) - here; it highlights the severity of the problem and why change is needed.
4. A simple way for consumers to be compliant - most Internet purchases are charged to a credit card or Paypal account. Just highlight the purchases on each month's billing statement for which sales tax wasn't collected. At year end, go through the year's statements, total the amounts, multiple it by your local sales tax rate and enter that amount on your Form 540 or 540A.

Improvement is needed. It is very easy to be an Internet vendor with locations in one or just a few states, but with customers in all 50 states. And Internet sales as a percentage of retail sales continue to grow. A 12/22/09 Harris poll indicates that at least 50% of people online made a purchase.

I continue to stress the need for educational efforts as necessary for use tax compliance and for effective legislation. Unfortunately, some policymakers either do not understand the use tax or take advantage of the public's low understanding of it. When Governor Schwarzenegger vetoed AB 178 (CA's version of the NY "Amazon" law), he implied that it would be a tax increase on Californians. This of course is not true because the use tax has been around since 1935. If being compliant is a tax increase, federal, state and local coffers are in trouble. (For the governor's 7/1/09 statement upon vetoing AB 178, click here.)

How do you think states could get consumers to pay their use tax or for states to be able to get all vendors to collect it without putting them out of business due to compliance costs?

Australian Tax Reform

Australia’s Future Tax System Review Panel formed in May 2008 released its final report to the Federal Treasurer on 12/23/09 (ABC News). The report won't be made public until 2010.

Per documents on the Panel's website, the review of the tax system was extensive and over 1,000 public comments were received. The Panel's website notes that its objective was to create
"a tax-transfer structure that will position Australia to deal with its demographic, social, economic and environmental challenges, and enhance Australia's economic, social and environmental wellbeing." The review considered both national and subnational taxation, the role and size of government, trends in society and ways of doing business such as increased globalization, environmental issues including climate change, changes in technology, simplification and equity.

Per a May 2008 press release, a comprehensive study of the tax system had not been performed for 50 years. However, the study did not include the GST.

Per the Panel's website: "The Review took a ‘root and branch’ approach and examined Australian and State government taxes, and interactions with the transfer system in order to make recommendations to position Australia to deal with the demographic, social, economic and environmental challenges that lie ahead."

I look forward to reading the final report. I think it is interesting and appropriate that the Panel considered how changes in demographics, the workforce, technology, environmental concerns, world markets and more might require changes to the tax system. It is also interesting that they considered federal-state interrelationships since what one level of government does with its tax system affects other levels and economic growth, societal well-being and environmental goals will best be achieved with the national and state governments work together rather than at cross purposes.

While the final report has not yet been released, there is a lot of background information on the Panel's website.

Bottled water tax proposed in Michigan

The Lt. Governor of Michigan has proposed a 10 cent per bottle tax on water to help fund education (Lt. Governor John Cherry press release of 12/14/09). Per Lt. Governor Cherry, it makes sense to tax one resource to fund another (Mlive.com 12/14/09). Is this a good idea? Based on principles of good tax policy and budgeting - no.

Equity - why a tax on bottled water and not other bottles or other acquisitions of water?

Economy in collection - there will be costs to both businesses and the government of collecting and auditing this new tax.

Neutrality - the tax will affect taxpayer decisions on whether to buy bottled water and where to buy it.

Appropriate government revenues - while the government should be able to estimate how much it will generate from a new bottle tax, the fact that the tax is tied to a specific use and one that is unrelated to bottled waters (education), makes this earmark a problem for the budget process. I've written about the problems of earmarking before (San Jose Mercury News, 3/21/08).

Complexity - as a new tax, new forms and processes would be needed. It might also be difficult to define bottled water - does that mean pure water? What if a few vitamins are added or flavoring?

Minimum tax gap - people will be encouraged to buy water outside of the state if convenient to do so (they live on the border of another state).

The tax does meet the transparency principle assuming the tax would be added to a buyer's bill.

Constitutionality - it is not unusual for state constitutions to have a variety of prohibitions that will defeat some taxes unless the Constitution is first changed. The likely unconstitutionality of a Michigan water bottle tax has been noted by The Tax Foundation (12/17/09 blog post) and others.

This is not the first time states have suggested or enacted odd taxes:

• Chicago's bottled water tax
• New Mexico TV/video game tax

While Michigan, like other states, is facing budget shortfalls, desperate measures, such as a bottled water tax, are not the best way to go. They should look more broadly at reform, which should include consideration of polluter pays taxes. A polluter pays tax on all plastic bottles might make sense. If Michigan already imposes a deposit on plastic bottles, a system is already in place to assess such a tax. Also, it is likely that general fund dollars today are being used for waste disposal including plastic bottles. But, this still seems like a small measure in light of larger tax and budget problems.

What would you suggest for Michigan?

Corporate Tax Reform - options, prospects and issues

I've written frequently about the status of, need for and possibilities for reforming the corporate income tax. The 12/7/09 edition of Tax Notes has a wonderful, short article on this topic by Marty Sullivan - "A Hitchhiker's Guide to Corporate Tax Reform" (p. 1043) (also on Lexis-Nexis and excerpt here). The author notes four types of possible reforms:

1. Broaden base and lower rate of existing corporate income tax.
2. Integrate the corporate and individual tax system (no more double taxation).
3. Replace the corporate income tax with a VAT, such as a subtraction-method VAT that would apply to all forms of business. Sullivan notes that the burden of the tax would fall on consumers, not tax new capital and "would bring about a major improvement in economic efficiency" and would be better than the first two options.
4. New business tax with asset expensing - such as the flat tax or Growth and Investment Tax proposal of President Bush's Tax Advisory Panel. Sullivan notes that this consumption tax approach would yield the greatest positive effects on long-term economic growth among the four approaches.

Sullivan predicts that in the next few years, only approach 1 will be considered but that others might be of greater interest after the 2012 presidential election.

The article has a reference list of reports on each of the four approaches and on the incidence of the corporate tax. Sullivan notes that some economists of late believe that the corporate tax falls more on domestic labor than on capital, yet public perception seems to be that it falls upon corporations and their shareholders, which hinders effective reform.

I think the way that Sullivan has laid out the four approaches would lead to more meaningful discussions on reform than what we are likely to see - we'll lower the corporate rate, but how will it be paid for - what mix of tax breaks, such as LIFO and MACRS, will give. Instead, we should be looking at what makes sense in terms of economic growth, international competitiveness and simplicity. Also relevant is the effect on state taxation (most states already rely on consumption taxes for about 1/3 of their revenues).

Here is some information I've got on corporate tax reform and reform in general:

• List of short articles
• What is a consumption tax + VAT examples
• Links and government reports on tax reform

What do you think? Also, the California Commission on the 21st Century Economy proposed replacing the corporate income tax and state-level general sales tax with a form of subtraction-method VAT. One obstacle to the proposal is that this proposed new tax - the business net receipts tax (BNRT) is a tax on wages - but that is what a VAT taxes - the value added by the firm, which is primarily wages. How can a tax on wges be viewed as a job creator? It is more efficient for businesses? Must it be part of broader reform?

Iowa to review tax credits

On November 19. 2009, Iowa Governor Culver called for state tax agencies overseeing tax credit programs to review them - all 30 of them (click here for press release). The directors of these agencies "will then serve on a panel to review the programs and submit a report to the Governor addressing oversight, accountability, transparency, public reporting, cost-benefit, and which programs should be continued, curtailed, and or eliminated."

Per Governor Culver: "we are reviewing all areas of state spending, including annual state investments in the form of tax credits. It is essential that we evaluate the expense and effectiveness of each tax credit program to ensure that Iowans are receiving an appropriate return on our investment."

This is a post-enactment accountability approach. I think it is good to see the governor remind people that tax credits are a form of spending. In tough budget times, there are calls to cut spending. But not everyone realizes that a good amount of state spending is built into the tax law - deductions, credits and exemptions for certain taxpayers or activities.

The state agencies were to submit their initial reports on the credits they oversee by December 4, 2009. I'm guessing that the goal is to have better information ready soon for the governor and legislators so that they can see if it makes sense in cutting spending to cut some from the tax law.

RadioIowa compiled a list of the credits - here.

Ideally, the governor should also call for a group to look at other tax provisions, such as special deductions and exemptions that like credits, are a form of spending.

Here is a nice letter of support from Joseph Henchman of the Tax Foundation.

What do you think?

Lowering Corporate Tax Rates

Despite a few years of various elected officials and business groups noting that the US corporate income tax rate is surpassed only by the rate in Japan, the rate remains unchanged.

I've got a short article from the AICPA Corporate Taxation Insider on the background and prospects for lowering the rate. It includes a brief summary of a few proposals offered to lower the rate.

What do you think should be removed from the base, if anything, to help lower the corporate tax rate?

Interesting Tax Reports of 2009

Every year, the federal governments issues lots of interesting reports. They are from the GAO, CBO, Joint Committee on Taxation, Treasury Inspector General For Tax Administration (TIGTA), National Taxpayer Advocate, and Congressional Research Service. It is far to much to read - but hopefully, Congress is reading them because many point out problems in the law and often have suggestions on how to fix them. Sometimes, the recommendations are for the IRS.

Here is an example of an interesting (alarming) finding from a report by TIGTA of August 2009: A good number of individuals receiving a Form 1098 on mortgage interest expense are non-filers or reporting less income than would support the mortgage interest amount. TIGTA estimates that roughly 136,000 taxpayers likely owe about $1.4 billion and recommended that the IRS make better use of Form 1098 in finding non-compliance.

For a link to that report and a summary of several other interesting reports, I've got a short article in the AICPA Tax Insider this month - here.

What do you think? Any other government taxation report you'd like to note? Thanks.

Temporary or Permanent - Which Is Better?

The Joint Committee on Taxation notes that 73 provisions in the federal tax law expire at 12/31/09 (JCX-20-09). These include:

• Personal tax credits allowable against AMT
• Increased personal exemption amount for AMT
• Additional standard deduction for state and local real property taxes
• Above-the-line deduction for qualified tuition and related expenses (§222)
• Exclusion of unemployment compensation benefits from gross income
• Refundable credit for government retirees
• Increased §179 expensing to $250,000/$800,000
• New markets tax credit
• R&D credit
• Add’l 50% first year depreciation
• Credit for construction of new energy efficient homes (§45L)
• FUTA surtax of 0.2 percent
• 65% subsidy for payment of COBRA health care coverage continuation premiums

While there have been numerous bills introduced that extend just one expiring provision, such as the research tax credit or the special deduction for teacher supplies, we only just yesterday, saw a bill that extends many of the provisions and is promoted as revenue neutral. That bill, H.R. 4213, introduced by House Ways & Means Chairman Rangel, is projected to cost about $30 billion but has offsets. The bill is 110 pages long! The offsets:

• Foreign Account Tax Compliance Act of 2009 (H.R. 3933 & S.1934)
• Tax carried interest as ordinary income

The bill also calls for the Joint Committee on Taxation to submit report on each extended provision by 11/30/10.

The bill does NOT include a "patch" for the individual AMT for 2010. If such a patch is not enacted, millions of individuals for whom the AMT was not intended, will owe it in 2010. It is likely that the patch will be enacted, but perhaps was omitted from H.R. 4213 due to the cost and the desire to get something passed by year end. Unfortunately, the longer it takes to enact the "patch" the more complicated taxes become for millions of individuals because they won't know what their estimated 2010 taxes will be.

Most of the extended provisions in H.R. 4213 are extended for just a year. Several have been extended many times before. So, this all begs the question - is it best to keep special rules in a temporary form so they DO get reviewed by Congress regularly or is it best to not waste the effort and problems of delayed extension and just make these provisions permanent?

The answer depends.

• Some of these temporary items were for stimulus and should not be extended unless it is clear they worked and stimulus is still needed.
• Any provision that has been extended more than 5 times should be seriously looked at to see if it should become a permanent provision. The research tax credit is a good example. Yet, since it is an incentive provision rather than a provision that defines "taxable income" it should still be reviewed regularly. But, moving it beyond repeated one-year lifes would enable the credit to be better utilized because businesses could better factor it into future R&D plans.
• Accountability measures should be created for new tax breaks and they should all likely start off as temporary. When a deduction or credit is permanently enacted, it becomes "off budget" in that Congress has no obligation to review it ever (unlike line item budget items). When new provisions are enacted as temporary measures, they need attention when the expiration date comes up. THE PROBLEM with our current federal system is that there is no accountability measure designed with new provisions that would ensure that Congress has DATA it can use to determine if the provision should be extended, modified or left to expire. States have similar problems, but some do enact accountability measures to ensure that they have DATA before it is time to consider renewal of the provision.

Here is an example of an accountability measure. The State of Washington’s reduced B&O tax rate incentive available to certain manufacturers of solar energy systems sunsets on 6/30/14. The enacting legislation included a requirement that by 12/1/13, the Department of Revenue provide the legislature with a report that notes the number of solar energy system manufacturers in Washington, the change in number, and the effect on job creation from the reduced tax rate. [Washington, SB 5111, Chapter 301, Laws of 2005 (7/1/05)]

So, Congress should include some type of data reporting mechanism for incentive provisions and they should be enacted on a temporary basis. Renewal should then depend on whether the incentive is having the intended effect. This would ensure that provisions are not extended just for expediency.

Provisions that are design features, such as the AMT patch (an inflation adjustment should have been part of the original provision), should be permanently enacted.

For more information on H.R. 4213:

• Ways & Means summary
• Text of the bill
• Joint Committee on Taxation revenue estimates (JCX-59-09)

What do you think?

Sales and Use Tax Collection and the SSUTA

Perhaps we'll see Congress reintroduce the streamlined sales tax bill that would allow states that have simplified their sales tax to require remote (out-of-state) vendors to collect sales tax from customers in the state. The bill in the 110th Congress was H.R. 3396. The Multistate Tax Commission (MTC) has a draft of legislation on its website - here. This would be a significant benefit to states. After all, it is much more effective to collect sales tax from thousands of vendors than to collect use tax from millions of customers.

Will Congress be more willing to pass the bill given budget shortfalls in almost all states? Also, 20 states have adopted the Streamlined Sales and Use Tax Agreement (SSUTA) meaning there is some high level of uniformity among these states.

Also, there are businesses and business groups that support this type of legislation because they want to see the playing field leveled as between Internet vendors and those that collect sales tax.

There has even been some support in the press - see this 11/26/09 opinion in the New York Times. And a 11/1/09 piece from the Grand Rapids Press calls upon Congress to help the states out.

The SSUTA is not without its faults though. It still allows for local jurisdictions to set their rate so we don't have the significant simplification of one rate per state. Also, states that have not yet conformed, such as California, might not do so. California is a big state and might not want to have the same voting power on the SSUTA Governing Board as, say, Wyoming, with a population smaller than that of San Jose, CA.

In July 2009, the California Assembly Revenue & Taxation Committee held an informational hearing on the SSUTA. The Board of Equalization submitted a report noting some of the problems for California in adopting the bill including the need to make changes in our sales tax base and and how some transactions are sourced (destination versus origin).

I think 111th Congress will introduce and enact the streamlined sales tax bill. That will cause remote vendors (above a certain size) to implement systems to enable them to collect sales tax from customers in the states that have adopted the SSUTA. Perhaps some of them will also start collecting from all customers! That would depend on what they sell and if it is clearly subject to tax in the non-adopting state both before and after adoption of the SSUTA in that state.

The SSUTA does provide for vendor compensation and that's a good idea given the costs of collecting the sales tax.

It wouldn't hurt for California to consider what would be involved in adopting the SSUTA - how many changes would have to be made and what is their significance. With that, the legislators can either act or stay the course. If it just stays the course, it can hope that residents start doing a better job of remitting use tax (unlikely) or hope that if all other states adopt the SSUTA, it might be able to keep its own system. After all, sales tax compliance would really not be complex if there is one system used by 45 states (4 states do not impose a sales tax) and 1 used by California, so perhaps then it would be constitutional for California to collect sales tax from remote vendors.

What do you think are the prospects for 111th Congress enacting a streamlined sales tax act?

Obama Tax Task Force to Miss December 4 Deadline

President Obama's Tax Task Force was supposed to issue its report on Friday 12/4/09. Paul Volker, Chair of the task force has announced that the report will be delayed. He notes that they received over 500 comments and had to cut off submissions due to the 12/4 deadline. The comment page has been re-opened (see above link).

This is not surprising. They did not have much time and had a lot to consider. Hopefully they will take a careful look at the numerous ideas already studied about tax simplification and how to reduce the tax gap (such reports have been issued for years by the Joint Committee on Taxation, Treasury, GAO, AICPA, ABA and many others).

Do you plan to submit comments?