Tax Benefits for Home Ownership

There are many tax breaks for owning a home (for a nice summary of these - see this DoorFly.com page). In addition, if the owner uses the principal residence for at least two years in the five years prior to sale, $500,000 of any gain can be excluded from income (not taxed) if the owners are married ($250,000 gain exclusion if single). And, there was an $8,000 first-time homebuyer credit which has now expired. There is also a special temporary rule to exclude income from relief of any debt used to acquire a principal residence. There are a lot of tax breaks related to owning a home!

There seems to be more talk today, than I've heard before about reducing these benefits. I find that in talking about the tax rules related to home ownership, many people who are not tax practitioners are surprised to find out that the law allows for deduction of mortgage interest and property taxes on not only your principal residence, but also a second home, such as a vacation home. I think they are surprised because they think the home-related tax deductions are there to help and encourage people to buy a home. But, why would the government want to help you to own a second home? Some are also surprised that the mortgage deductions are so large - you can deduct interest on up to $1 million of debt used to acquire or improve a principal or second residence and up to $100,000 of home equity debt where the debt proceeds were used for any purpose (other than buying tax-exempt bonds). Even in California where homes are expensive, the median home price has always been under $500,000.

In terms of "tax expenditures" the mortgage interest deduction is one of the largest in the individual income tax system. In its report of tax expenditures for 2010-14, the Joint Committee on Taxation lists the mortgage interest deduction as a "cost" of about $95 billion per year (revenues not collected due to the deduction).

There has been much written about this tax expenditure and I won't repeat it here, but would suggest:

• Center for American Progress - they are looking at one tax expenditure per week. For the week of January 24, 2011, it was the mortgage interest deduction - here. This is part of their "Doing What Works" project.
• My 5/29/10 post which also refers to a Forbes article on tax expenditures.
• Information from the final report of President Bush's Tax Reform Advisory Panel - pages 70 - 75, which provides a rationale for reducing the current high deduction amounts.
  

Should the deductions and exclusions for home ownership be eliminated? I don't think so in that one principles of good tax policy is economic growth and efficiency. Home ownership does provide many benefits to the economy and governments. Do the tax law have to offer tax breaks beyond the "norm"? No. This is quite costly and can even drive up home prices. The reports on the generous mortgage interest deduction find that they primarily benefit higher income individuals who can both afford to have a large mortgage and are in a higher tax rate so get a larger deduction. Also, why two homes rather than just one? Phasing out the overly generous/unwarranted tax deductions can provide funds to lower the deficit and perhaps even individual tax rates.

What do you think?

Tax Reform Talk - Will Action Follow?

The President's Deficit Commission, President Obama, Treasury Secretary Geithner, the chairs of the congressional tax committees, National Taxpayer Advocate Nina Olson and others, are all saying the words "tax reform." Of course, that is talk and not action, but does this much talk increase the likelihood of action? I think so. I think the focus on corporate tax rates and international competitiveness and continued efforts to stimulate the economy might lead to serious tax reform proposals this year.

For more information:

• I've got a short article in today's AICPA Corporate Taxation Insider (1/27/11) - "Can the President's Deficit Commission's Proposals Lead to Corporate Tax Reform?"
• President Obama's State of the Union address (1/25/11) where he said such things as - "I’m asking Democrats and Republicans to simplify the system. Get rid of the loopholes. Level the playing field. And use the savings to lower the corporate tax rate for the first time in 25 years –- without adding to our deficit."
• The National Taxpayer Advocate says that the "time for tax reform is now." (2010 report released in January 2011)
• On January 20, 2011, the House Ways & Means Committee held the first in a series of hearings on tax reform - here.

What do you think - will there be action or just talk?

IRS has an app!

The IRS has been adding new uses of technology in its outreach to taxpayers and tax practitioners. For example, they have some interactive web features (such as checking if a taxpayer received a recovery act payment), webinars, Twitter and YouTube, and now an app for your smartphone (IRS2go) where you can check the status of your refund and get tax tips. See IR-2011-8, Jan. 24, 2011. You can also follow the Taxpayer Advocate on Facebook.

I think this all represents interesting possibilities for compliance. For example, taxpayers could get a notice that a reporting form for them has been received by the IRS. The IRS could do the first determination of an individual's tax liability based on the information it receives including W-4 information on filing status and number of dependents. It would show this on the phone or web device and the individual could say, correct, please file, or good starting point for me to finish the return.

What do you think? What more could the IRS be doing to use technology to make compliance and administrative more efficient and user friendly?

California proposal (AB 153) for expanded sales/use tax nexus

Legislation has been introduced in California again to try to improve collection of use tax, such as what is owed on many Internet purchases of tangible personal property. AB 153 follows the New York approach enacted in April 2008. It would add the following to R&T Section 6203(c) on retailer engaged in business in this state:

"(5)(A) Any retailer entering into an agreement or agreements under which a person or persons in this state, for a commission or other consideration, directly or indirectly refer potential purchasers of tangible personal property to the retailer, whether by an Internet-based link or an Internet Web site, or otherwise, provided that the total cumulative sales price from all of the retailer's sales, within the preceding 12 months, of tangible personal property to purchasers in this state that are referred pursuant to all of those agreements with a person or persons in this state, is in excess of ten thousand dollars ($10,000).
(B) This paragraph shall not apply if the retailer can demonstrate that the person in this state with whom the retailer has an agreement did not engage in referrals in the state on behalf of the
retailer that would satisfy the requirements of the commerce clause of the United States Constitution.
(C) An agreement under which a retailer purchases advertisements from a person or persons in this state, to be delivered on television, radio, in print, on the Internet, or by any other medium, is not an agreement described in subparagraph (A), unless the advertisement revenue paid to the person or persons in this state consists of commissions or other consideration that is based upon sales of tangible personal property."

The constitutionality of this approach is still being examined by the courts in New York. Meanwhile, two states that adopted it - Rhode Island and North Carolina, saw that big vendors, such as Amazon, who would be subject to the collection, canceled the agreements with in-state associates such that they are no longer subject to the law.

It is unfortunate to see lawmakers spending time on this approach to use tax collection when it is so easy for those who it is trying to reach, to avoid that reach. Instead, lawmakers could be:

1. Working with the Congress and the Streamlined Sales and Use Tax group to modify California and federal law to allow states with simplified sales tax regimes to collect sales tax from remote vendors within the bounds of the commerce clause. (See H.R. 5660 (111th Congress).)
   
2. Educated consumers, such as their own constituents, about the existence of the use tax and the importance of taking the time to figure out what they owe and reporting it on their Form 540. They can remind constituents about our budget shortfall, that paying the use tax might avoid the need for increasing other taxes, and that it is easy to report it on their Form 540. I'd like to hear lawmakers telling people that they themselves are compliant with their use tax obligations.
3. Changing the law to allow taxpayers the choice of either keeping records to determine how much use tax they owe or using a table amount where they estimate it based on their income level + add to it use tax on purchases costing over $1,000. For example, see page 81 of the New York individual tax return instructions - here.

AB 153 is intended to increase revenue and could do so it vendors subject to it did not cancel associate agreements so they are not subject to it. But, since it is just shifting collection of the use tax from the customer to the vendor, it is not a tax increase and so should be passable with a majority vote. In fact, a similar bill passed in the legislature before and Governor Schwarzenegger vetoed it. In that July 2009 veto, he demonstrated the low understanding of the use tax - even by the chief tax collector for the state (the governor) by saying there was no need for tax increase given recent tax increases already passed! (Collecting the use tax is not a tax increase - the tax has been on the California books since the 1930s.) Click here for the July 2009 statement about the use tax.

Changing the law to allow the option of computing the use tax using a table should also not require a 2/3 vote because the use tax is already on the books - it would just allow for a simpler technique for individuals to calculate their use tax liability.

We'll see what happens!

Technology, Unemployment, and Our Children's Future - Guest Post

This is a guest post by Hunter Richards of Software Advice (originally published here). It ties well to one of the rationales behind "21st century taxation" - to consider trends in the economy, society and technology and how they can help us see how to update tax systems. Hunter's article is reposted with his permission.

Technology, Unemployment, and Our Children's Future

Got a teen playing Wii instead of doing homework? You might want to share this post

Despite the obvious benefits it brings, information technology (IT) also comes at a human cost - the displacement of less-skilled employees. As software and systems automate an increasingly large portion of business processes, the displacement is affecting a wider set of workers. 9.5% unemployment might last a bit longer than expected for many people.

Here we walk through a fairly simple story of man versus machine. It’s not a new story, but it's quite compelling when the concrete data is presented visually.

Looks like it’s time drop that Wii-mote and hit the books.

IT spending has risen dramatically over the last 40 years...

IT spending has steadily risen since 1970. Trendlines and new opportunities like cloud computing suggest that the current dip in spending is only temporary.

...making us more productive...

Technology has made labor more productive. There’s a long-term upward trend in labor output rates, and it isn’t slowing down.

...which has led to rapid growth in corporate profits.

The resulting productivity have been great for business - greater productivity means higher profits. But these profits don’t benefit everyone. They accrue to the executives and shareholders.

IT is slowly replacing many functions. There’s an ever-widening divide in the labor market between skilled occupations and what one might call “low-level jobs” - simple clerical roles, plant-floor workers, and low-level support roles.

While national unemployment rates have ebbed and flowed...















...the uneducated are consistently left behind...
















This polarization between highly-skilled and less-skilled workers is part of what’s eroding the middle class, pushing more and more people into the low income bracket.

...and wealth has shifted toward the highest earners.















The less-educated workers who manage to keep their jobs are falling further and further behind in the national income distribution as the relative value of their services declines.

Alas, high-tech industries are growing...

So how can you avoid being replaced by a machine? You’ll need to be one of the people who work in an advanced field that still requires highly-skilled human capital. Take the IT field, for example. The Tech Pulse Index tracks the growth of national economic activity in technology by combining data on employment, investment, production, shipments, and consumption. The Tech Pulse Index has risen sharply (with the exception of the dot-com bust around the year 2000), reflecting continued demand for high-tech workers. The same is true in other engineering disciplines, healthcare, and finance.

...but an advanced education is required.













Are we educating people enough to slow the widening of labor market gaps? The graph above shows the percentage of all 18- to 24-year-olds enrolled in degree-granting institutions since 1970. There’s an upward trend, but is it growing fast enough?

IT is good for society in the long term, but it’s a double-edged sword when considered together with labor market trends. Sure, the current economic despair owes its severity to many different issues - offshoring of jobs, the real estate collapse, and the national debt are just a few - but education and income disparities are long-term problems that demand attention. We must align education growth with productivity growth to close the gaps.

How to simplify the tax law

Recently, two students noted to me separately that perhaps the only route to simplify the tax law would be to require that all members of Congress prepare their own return without using a preparer or software - just the IRS instructions and publications. I saw today on a Tax Foundation blog entry (1/13/11) that Governor Pawlenty of Minnesota has suggested the same.

I agree. I've had this same thought many times - particularly after the passage of the Tax Reform Act of 1986, which was touted, not only as a lowering of the tax rates, but as simplification. Ever have to fill out a Form 8582 Passive Activity Loss Limitation form and its worksheets? Form 6251 for AMT? I was with EY after the '86 Act passed and spent a lot of time on these topics including writing partner/K-1 instructions explaining to partners how to report the passive activity losses showing up on their K-1s.

And, of course, the law has only gotten more complex subsequent to the Tax Reform Act of 1986.

I do think members of Congress would focus more on simplification approaches and not add so many tax breaks if they had to fill out their tax return by hand.

What do you think is the most complicated rule or form? Do you think members of Congress should be required to complete their return by hand?

Conference - State of Tax Policy in California - Feb 11 in Palo Alto

TEI and the SJSU College of Business are sponsoring a timely conference - The State of Tax Policy in California, on Friday, February 11, 2011, 8:30 am - 5:15 pm, at the Crowne Plaza Cabana in Palo Alto.

If you are interested in knowing more about California's tax and budget challenges, I hope you will register to attend. Details and registration information:

http://www.tax-institute.com/

Fee (includes lunch and materials):

• $130 General ($115 TEI member)
• $ 65 Government and non-profit

Program includes 7 hours of continuing education credit (based on California State Board of Accountancy rules); approval pending for 3.5 hours of MCLE.

Speakers include:

• Dr. Nancy Sidhu, Los Angeles County Economic Development Corporation
• Scott Hodge, Tax Foundation
• Michael Coleman, California League of Cities
• Dean Andal, PwC, former member CA legislature and Board of Equalization
• Carley Robert, Morrison & Foerster

And I'll be presenting on my favorite topic of principles of good tax policy.

There will also be time for discussion and sharing of ideas among attendees.

Good NPR story on tax breaks (expenditures)

NPR has a great story and audio posted for 1/13/11 -"Can Washington Break Its Tax-Break Habit?" by Scott Horsley. It includes a statement from Dr. Laura Tyson who previously served as an economic advisor to President Clinton. She notes that while special tax rules make the tax system more complex and reduce government revenues, they can come about because someone wants a special subsidy or financial award (such as for college students) and finds that it is easier to create a tax credit than to try to increase the federal budget allocation for Pell grants.

This is a reminder that tax expenditures - special tax rules that are not necessary for measuring the tax base, are really a form of spending. To further explain, for an income tax for individuals, you just need to measure income. There is no need for any deductions. BUT, what about the reality of "ability to pay" and ensuring that some portion of one's income is available to live on? The standard deduction and personal exemptions help address this matter and so should be elements of any income tax. But do we also need tax breaks for higher education and mortgage interest as well as exclusions for employer-provided health insurance? Such deductions also raise equity issues. For example, why those deductions and not ones for credit card interest and costs of your child playing sports? Also, deductions and exclusions are worth more (are greater subsidies) for those in the higher income tax brackets.

The Joint Committee on Taxation publishes an annual report of tax expenditures (here) and most states do as well.

I have written about this before in my reports and blog and even in 2008 in the SF Chronicle - 'Spending problem?' - some of it's hidden in our tax laws.

What do you think - how should tax expenditures fit into federal and California tax and budget reforms?

Massachussetts Analyzes Its Film Credits

Like many states, Massachusetts offers tax incentives for film production activities in the state. The Massachusetts Department of Revenue issued a required report this month analyzing the costs of the credit and its economic effect on the state.

The film incentives "are composed of a tax credit equal to 25% of a film’s production and payroll costs and sales tax exemptions for film productions." And, it is refundable! If the credit exceeds the producer's Massachusetts tax liability, 90% of the remaining credit is refunded. Credits can also be transferred or sold to other taxpayers. Non-wage spending does not have to be from Massachusetts vendors, but can be from out-of-state provided the items purchased are used in Massachusetts. The report notes that the state does not get as much economic benefit when producers purchase supplies and other items from out-of-state vendors.

Another assumption made to determine the economic impact to the state is that "non-resident wages and salaries generate little additional economic activity in the Commonwealth. As is the case in most other studies, we assume that none of the (above-the-line) wages of those earning $1 million or over is spent in Massachusetts because virtually all their local expenses, including lodging, food, entertainment, and miscellaneous expenses, are typically covered in the production budgets. There is greater uncertainty about what portion of other non-resident wages and salaries ... is spent locally. However, because lodging is provided and meals are catered or otherwise covered by per diems for these non-resident employees, we assume that only 5% of wage and salary payments to non-residents earning less than $1 million per production (which includes a portion of above-the-line employees who are paid high salaries) is spent in the Commonwealth."

The report also notes that for 2009, the roughly $82 billion of credits claimed (representing about $330 billion of spending) included about $11 billion of spending that likely would have occurred even without the credit. The report also notes:

"The largest category of new spending was wages and salaries, where $194.7 million in new spending was generated, with $42.3 million, or 22% paid to Massachusetts residents, and $152.3 million, or 78%, paid to non-residents. Of that amount, $82.0 million, or 42.0% of total new wage spending, was paid to non-resident actors earning over $1 million per production. "

Well, big surprise, that statement - that the state had issued a tax credit to help subsidize $82 million of salaries paid to non-resident actors who earn over $1 million per production, generated a lot of press coverage. For example, the Minneapolis-St.Paul Star Tribune published an article on January 12, 2011 - "A quarter of Massachusetts' film tax credits in 2009 helped cover the wages of Hollywood stars," by Steve LeBlanc of Associated Press. This article has more information about the credit, recent law changes and that many people still like the credit because it helps bring film production to the state that otherwise would not happen.

And worse yet of course is that these non-resident actors aren't going to spend much of their salary in Massachusetts. The report notes though (page 21) that it likely received about $4 million of state income taxes on these actor's salaries.

It will be interesting to see if the report and bad press it got nationally will lead to lawmakers changing the credit or even eliminating it. The credit is an example of how state competition leads states to do things that might not make a lot of sense. Does every state need to subsidize film production? (Click here for a list from the Screen Actors Guild.) Even California - home of Hollywood, offers such credits. Isn't there any other industry (not already given tax credits) that states want to subsidize? Could funds be used to improve infrastructure to make the state more business friendly? Can subsidies be used to help in-state businesses grow?

And can the credit be modified to better encourage the film production companies to spend in the state? Why not only allow in-state spending to be included in the calculation? And, why refundable?

Tax policy considerations:

• Equity - a tax credit for one industry and not others is not equitable. Companies with similar income levels can pay drastically different tax amounts if some qualify for a tax credit not available to the others.
• Simplicity - any special rule that is only available to a subset of all taxpayers makes the tax law more complex because rules are needed to define the special category of taxpayers, expenses, etc.
• Neutrality - film credits are intended to affect decision-making - to encourage film companies to produce in a particular state.
• Economic growth and efficiency - this is what the Massachusetts film credit report was trying to analyze. It is not easy because another aspect of the affect of the credit on the state is what the state could have done with the money instead of subsidizing one industry. Also, is film production the type of industry the state most needs? Does it lead to long-term employment of residents?

The film credit doesn't do well when evaluated against principles of good tax policy.
What do you think?

Paid Return Preparer Categories - More

The new IRS program to requires paid tax return preparers to register for a Preparer Tax Identification Number (PTIN) and pay a fee, has added some complication to the tax law for some preparers. The IRS most likely believes that the added complication will still be worthwhile if it all improves tax administration and compliance.

In early 2011, the IRS released Notice 2011-6 which exempts some preparers who are not CPAs, attorneys or Enrolled Agents, from the requirement to pass a test and obtain a certain type and amount of continuing education each year. This is welcome relief for CPA firms concerned about whether they would not be able to have interns/future CPAs be involved with tax preparation without having to pass a test.

I have an article that summarizes the categories within which a tax return preparer must fall to be able to file any return for pay. Notice 2011-6 also modifies the PTIN rule in specifying some returns fro which if a person only prepares those returns, they will not need a PTIN. The list includes such returns as W-2s and 1099s.

Here is a link to the article - Yet More Paid-Return Preparer Categories!, AICPA Tax Insider, 1/13/11.

What do you think about this new system of regulating paid return preparers in terms of tax administration?

CBO Director, Taming Budget Deficits, Reality Check

Congressional Budget Office Director Elmendorf's blog on 1/9/11 about reducing the budget deficit notes the need for actions that would "affect popular programs or people’s tax payments." I think this is a good explanation of the reality that is upon us.

I'm puzzled as to why I'm getting a new tax cut for 2011 through my Social Security payments.

The more tax cuts we get, the more we come to not only view them as the status quo, but either want more or Congress wants to give us more.

We really are past due for a reality check!

Treasury Secretary Geithner and Corporate Tax Reform

More on possible corporate tax reform ...

During and after Secretary Geithner's speech at John Hopkins University on January 12, 2011, which was mostly about our economic relationship with China, the subject of corporate tax reform came up. According to Reuters ("Geithner gauging support for big tax change," Kim Dixon, 1/12/11), he noted that effective tax rates tend to be lower than the statutory tax rate due to use of deductions and credits. But he also acknowledged that the statutory rate can influence business decisions as to where to invest.

Geithner is reported to be meeting with CFOs of some large companies this week about corporate tax reform. Why isn't he also meeting with tax practitioners? (Of course, the CFOs most likely had some extensive discusisons with their tax directors or tax VPs before going for the chat.)

Will we a corporate rate reduction? As I've noted in prior blogs (such as Jan 6), that would bring the current 35% rate down below what the current temporary top rate is for individuals (35%). That raises some issues. Also, just take a look at the 2010 Tax Relief Act (P.L. 111-312) and its list of almost every temporary provision in the law (over 100) many of which are not there to define taxable income, but to provide a special benefit to some group of taxpayers (and every possible group gets something). And it cost around $800 billion dollars to keep these special, complicated rules in place for 2 years. We can't afford to keep them forever unless there are significant spending cuts and reductions in entitlement benefits. So, I think broader tax reform will happen first or simultaneously with any corporate tax reform.

What do you think?

Corporate Tax Reform on the Horizon?

A January 6, 2010 Wall Street Journal article - "Momentum Builds for Corporate-Tax Overhaul" by McKinnon and Williamson, states that while there is yet no consensus on how to do it, President Obama and Republicans in Congress are all noting that corporate tax rates need to be lower.

We'll see ... Some obstacles that come to mind for me:

• The recent enactment of the $858 billion 2010 Tax Relief Act - additional tax cuts might have to wait.
• Public perception that often views corporations as not paying their fair share (whatever that means) and not wanting to see the top corporate rate below the top individual rate (which is only temporarily at 35% rather than 39.6%).
• The stated top rate of 35% versus the typically lower effective tax rate many corporations report in their financial statements.
• Agreement on what offsets will accompany a bill to reduce the corporate tax rate.
• Other matters on the congressional agenda.

But, it looks like there will be additional hearings on tax reform. I say additional because there were such hearings in the 111th Congress - they didn't get much attention in the press though. I have a list of such hearings here.

What do you think?

Canada further drops its top corporate tax rate

The Wall Street Journal reports that starting 2011, Canada's top corporate tax rate is 16.5%, down from 18% and slated to go to 15% in 2012 ("Canada Slashes Business Levies," Dvorak, 12/30/10) The combined federal/provincial rate in 2012 will be 25% when back in 2000 it has been 42.6%. That is quite a drop. The article doesn't say how they managed to do this, but notes that opponents say the change adds to the budget deficit and debt.

While the Canadian economy is much smaller than the US economy, it can be attractive to US businesses for many obvious reasons. I think it will catch the attention of many members of Congress if they continue or even ramp up discussions of significant tax changes including lowering the top corporate income tax rate. But that change is most likely to be accompanied by a cut back in tax expenditures such as the manufacturing deduction and some tax credits. Some foreign provision might also be cut back, but it would be better to examine the taxation of worldwide income of US companies from a broader perspective rather than the piecemeal changes of the past few years. Congress should consider what other countries do, the way all sizes of businesses operate today in the global marketplace and what would help US companies and the US economy.

I think the final report of President Obama's Deficit Commission referencing the $1.1 trillion of tax expenditures in the tax law has and will continue to catch attention leading to more people viewing these expenditures as a form of government spending. Do we need all of it? Will people be willing to give up some favored deductions, credits and exclusions in exchange for lower tax rates? This change would also simplify the tax system and reduce compliance costs.

How soon do you think tax-writing committees of the 112th Congress will get to discussing major tax reform?