Interesting tax expenditure example

The analysis to California proposal SB 508 includes an interesting observation about tax expenditures that I had not heard before. Here is it: "the late economist David Bradford stated that instead of purchasing weapons systems from defense contractors, Congress could instead provide a Weapons Supply Tax Credit for defense contractors equal to the cost of goods sold. Defense spending would then vanish from the spending side of the federal government's accounting ledger, and revenues would concomitantly decline by an equal amount." That's a good example of how spending, such as for higher education, K-12 education, health care, welfare and a lot more, gets hidden because made via tax deductions, exemptions and credits rather than direct spending.

Greater transparency proposals for California budgeting - SB 14, SB 15 and SB 503

Two bills introduced in December 2010 to modify California budget processes will be the subject of a hearing in the Senate Governance and Finance Committee on March 30, 2011. SB 14 calls for performance-based budgeting. SB 15 calls for 2-year budgets, 5-year projections for revenues and expenditures and creation of an estimate of the long-term effect of the budget on the economy. In addition, the hearing will include SB 503 introduced in February that calls for analyses of personal and corporate tax credits in order to know if they are having the desired effect.

There are a few items in these bills that should bring about greater transparency in the budget process and tax system. I'll highlight two of them.

First, SB 14 would add Section 9147.8 to the Government Code to read as follows:

"9147.8.(a) Within one year of the effective date of the act that added this section, the Joint Sunset Review Committee shall adopt a process, schedule, and deadline for reviewing the performance of all programs at least once every 10 years. The schedule shall provide for reviewing programs with expenditures that total one-third or more of total expenditures by July 1, 2015, and that total two-thirds of total expenditures by January 1, 2018. For purposes of this section, "expenditures" include all funds as reflected in the Budget Bill submitted by the Governor, and statutory exemptions, deductions, credits, or exclusions from taxes or fees that would otherwise apply. For purposes of this act, "expenditures" also shall include the revenue and expenditures of state departments that are not reflected in the Budget Bill. The process established by the committee to review the performance of public programs shall reflect the principles of performance-based budgeting and shall include the participation of the Senate Committee on Budget and Fiscal Review and the Assembly Committee on Budget."

Second, SB 503 calls for data gathering and analysis for any new tax credit added after 2011. Specifically, such a new credit must "contain all of the following:
(a) Specific goals, purposes, and objectives that the tax credit will achieve.
(b) Detailed performance indicators for the Legislature to use when measuring whether the tax credit meets the goals, purposes, and objectives stated in the bill.
(c) Data collection requirements to enable the Legislature to determine whether the tax credit is meeting, failing to meet, or exceeding those specific goals, purposes, and objectives. The requirements shall include the specific data and baseline measurements to be collected and remitted in each year the credit is effective for the Legislature to measure the change in performance indicators, and the specific taxpayers, state agencies, or other entities required to collect and remit data.
(d) A requirement that the tax credit shall cease to be operative seven taxable years after its effective date, and as of January 1 of the year following the end of the operative period is repealed."

This all sounds good, but I don't expect it would apply too often as I don't see the state enacting new credits given the current budget problems.

It would be beneficial to the legislators and public if they had some of the information for existing tax credits.

What do you think?

Sales Tax Exemptions - outdated and inequitable

An editorial in The State (South Carolina) on March 27, 2011 - "Overhaul broken tax system" points out problems with the numerous sales tax exemptions. These are problems in many states including California. The paper points out that South Carolina has 85 exemptions that end up exempting more items from sales tax than are subject to it. One special rule that I had not heard of before, but is quite inequitable is that the sales tax on cars is capped at $300 of purchase price. So a college student who struggles to buy a used car for $6,000 pays the same amount of sales tax as a high-income individual buying a $73,000 Jaguar (at 5% tax rate, they both pay $300 of sales tax on the purchase).

This seems odd and is something that the South Carolina Tax Realignment Commission proposes phasing out. Per their December 2010 final report, "The cap, entirely appropriate and necessary in 1984, 26 years later, represents one of the most regressive aspects of the State‘s entire sales and use tax code today." The cap was added years ago because neighboring North Carolina had one.

The editorial notes other problems with the South Carolina sales tax: "The tax that was created when we spent nearly all of our money on things hasn’t kept up as we became a service economy. Between the untaxed services and all those product exemptions, a full 72 percent of gross sales in our state go untaxed. The result is a sales tax that doesn’t grow with the economy, that forces poor people (who buy mostly things) to pay a far higher portion of their income than wealthier people and that is much higher than it needs to be. As the Legislature’s own Taxation Realignment Commission found, we could easily reduce the sales tax by a penny or two simply by expanding the reach of the sales tax more in keeping with other states."

This is true for California as well. We could broaden the base and lower the rate and use some of the money to create an exemption for businesses to avoid pyramiding of the tax. For more on this, please see my reports and op eds here.

What do you think?

Tax reform and small business

There have been a few hearings this year in both Senate and the House on tax reform. For one of them, I submitted testimony for the written record - the House hearing on Small Business and Tax Reform. I hope it gets looked at. I've posted it to my 21st Century Taxation page - here. Here are the points I made and further explain in the written testimony:

1. Define "small."


2. Recognize trends including the growing number of self-employed individuals (part-time and full-time) and modernize the tax law to tie to today's ways of living and doing business.


3. Use principles of good tax policy to identify weaknesses and how to address them.


4. Simplify (and don't continue to complicate such as with numerous changes and temporary provisions).


5. Consider integration of the corporate tax system before making rate changes.


6. Consider administrative improvements including use of technology.


7. Clarify worker classification rules.


8. Resolve state tax issues that need to be addressed by Congress such as because the commerce clause is involved (nexus issues).

What do you think?

The Journey to a Lower Corporate Tax Rate

There have been a few congressional hearings, a comment by President Obama in his state-of-the-union address and a few other activities focused on prospects of lowering the corporate tax rate. The discussions have also raised questions about why so few businesses operate as C corporations. In fact, questioning at one hearing led to some statements that perhaps more entities should be taxed as C corporations. I think the intent was more looking at small versus large and the fact that not businesses operating outside of the C corp form are small. That led to Senator Snowe introducing S. Res. 88 saying that businesses should be free to choice their form. Interesting. I attempted to summarize the themes of the activities so far this year in discussions about lowering the corporate tax rate in an article in the AICPA Corporate Taxation Insider - The Journey to a Lower Corporate Tax Rate (3/24/11). In that article, I also have some links to some charts I prepared using IRS data on the mix of business entities in 1980, 1990, 2000 and 2007, as well as the receipts generated. I encourage you to take a look at the article. I also have some additional data here. So, key issues:

• How to pay for a lower corporate tax rate? The Administration wants a revenue neutral approach.


• Should the tax rules vary based on small versus large businesses or by type of legal entity?


• What problems arise if the corporate rate drops while the individual rate likely goes up to 39.6% in 2013 (even higher with the new Medicare taxes)?

What do you think?

Higher Ed Subsidies - The Need for Brighter Light (transparency) on Tax Expenditures

I have seen a few stories about funding problems and possible reductions in funding of Pell grants that provide funds for low-income college students. For example, the Chronicle of Higher Education has a story for 3/20/11 - "Pell Grants Face Cuts, Possible Overhaul" by Kelly Field. Per this article:

"As Congress grapples with a $10.7-billion shortfall in the Pell Grant program, some lawmakers are beginning to ask whether the program, which has been the cornerstone of the federal system of student financial aid for almost 40 years, has become unsustainable."

(For more on the issue, see Representative DeLauro's post on The Hill blog of 3/15/11.)

Also this week, the Joint Committee on Taxation released a report (JCX-19-11) on the cost estimates of President Obama's FY2012 budget. That budget calls for the American Opportunity Tax Credit (AOTC) to become a permanent provision of the law, replacing the Hope Scholarship Credit. The estimated average annual cost of the AOTC is $11 billion.

The AOTC provides a tax credit of up to $2,500 per year for each of the first four years of college. And there is no need to complete a FAFSA (needs) form because as long as a married couples income is below $180,000, they will qualify (the AOTC phases out between $160,000 and $180,000 of income).

I find this shocking because at that level of income, one would not qualify for needs-based financial aid. My searching for income levels for Pell grants turned up that most go to students of families with $30,000 or less of income and perhaps up to $60,000 of income.

Of course, the AOTC figure is just an expectation because the AOTC will expire at the end of 2012. But it already got a 2-year extension with the 2010 Tax Relief Act at a cost of about $9 billion per year (JCX-54-10). I think if greater attention is not brought to operation of the AOTC and its cost, along with a discussion of where in the budget subsidies for scholarships and grants should be and who should get the subsidies, we are likely to see AOTC become a permanent tax provision.

A unified development budget that shows all government spending in one document would help shed light on this oddity in the budget. The oddity is that Congress wonders where it will find money for Pell grants to help low-income individuals go to college while a tax provision helps send high income students to college. A unified budget would have a category for spending on higher education and both the Pell grant direct spending and the AOTC spending would be shown. Then when Congress says it needs more money to help low-income college students, it would be obvious that the funding for AOTC be shifted to Pell grants. And it might even push the question of why any spending for higher education is in the tax code rather than in the Department of Education budget or in the form of a lower tax rate for everyone. This will greatly improve transparency and accountability.

For more on -

• The AOTC and how it compares to the Hope Scholarship Credit and the realities of what college even costs today, please see my short article - "Hope versus Opportunity," AICPA Tax Insider, 7/15/10.
• Unified Development Budgets - see New Rules Project information - here.

What do you think?

CA Film Credits Hearing on March 21, 2011

The California Assembly Revenue & Taxation Committee is holding a joint oversight hearing on the Film and Television Tax Credit Program. Whoever published the agenda was creative - it reads like a movie premiere event - take a look - here. Very nice!

I think it is a sad state of affairs when California - home of Hollywood, needs to have tax incentives to help the movie and television industry. But, competition for this business by other states and countries leaves California having to compete in a similar fashion by offering subsidies to producers.

In a few other states, this has been very controversial in practice because of stories in the press about the money going to wealthy stars who are unlikely to spend their money in the state, for lavish set properties or lavish equipment for the crew. See for example, Michigan and Iowa.

A few other states have examined their tax incentives including the film credit. For more information on this see Nellen, "States Examining Business Tax Incentives," AICPA Corporate Taxation Insider, June 2010. Massachusetts issued a report in January 2011 on its incentives and Iowa, a year earlier.

Mark Robyn of the Tax Foundation will be testifying on March 21. The Tax Foundation opposes film credits as they violate a few principles of good tax policy. (See Tax Foundation Special Report of January 2010 - here.)

In looking for statements or reports on the benefits of such credits, I found:

• 2008 State Tax Notes article on Louisiana film credits
• Pennsylvania PR Newswire story of 3/8/11 and $60 million of film credits

While tax policy weighs against the tax incentives, economic development may weigh in favor - but at what cost to the state versus the many other spending items in the California budget seeking scarce dollars? Should be an interesting hearing!

What do you think?

California likely to get use tax look up table - SB 86 and AB 110

In California, SB 86 and AB 110, that are moving along, having passed in Assembly and Senate. One of the provisions in this legislation is to start using a "look up" table for use tax for taxable purchases under $1,000. This means that individuals do not need to keep records of every purchase they make for which they were not charged use tax. They can instead opt to use the "look-up" table which based on their income, will tell them what amount they can report on the use tax line on their state income tax form. For any purchase of an item costing $1,000 or more they would have to keep track of such purchase and add its use tax to the table amount. The table is optional; buyers could keep records instead.

I have suggesting this since at least 2007 as one of a few ways to improve use tax collection and make it easier. So I am very pleased to see this improvement. It had been included in AB 1957 as amended on March 25, 2008, but that bill was not enacted.

What does a look-up table look like? Well, examples exist because other states, including New York and Michigan, have been using them for a while. I included examples in testimony I submitted to the Assembly Revenue & Taxation Committee for their use tax hearing on 2/28/11 (see picture at end of this blog post or see page 11 of my testimony for a nice one-page explanation of use tax that Michigan provides to its taxpayers - here).

I think the look-up table is going to cause more people to report use tax. Hopefully the line on the 540 for use tax will direct people to the table and tax prep software will likely ask if people want to use the look up table or report actual (and ask if any individual purchase was $1,000 or more). The bill includes a revenue estimate of $10 million annually (including a portion that belongs to local government). This is NOT a tax increase because the tax is already on the books (since 1935!) it just makes it easier for people to pay their tax.

Some additional measures to increase use tax compliance:

1. Require that individuals and businesses without seller's permits may only pay use tax on the state income tax form (540 or 100) and the line cannot be left blank.
2. Continue and broaden educational efforts about the use tax - what it is, its importance and now, the ease of computing it. For an approach used in Michigan, see page 12 of my 2/28/11 testimony.
3. Main street resellers should consider promoting use tax education as well. This should help them, the state and perhaps encourage some Internet vendors to voluntarily start collecting. Sometimes, at the grocery store, they have two shopping carts piled with goods. One has a sign that says this costs you $121 at Store X and the other says this costs you $99 at this store. Main street retailers could have signs that say - "This book costs $21.76 here, while at Amazon, it costs $x + $y shipping ++ $z use tax that you have to pay on your own (and the total is more than $21.76 - otherwise, not a good ad!). Here, we will take care of the use tax for you!"
4. Be sure state agencies are not buying from vendors that don't collect sales tax. In fact, it would be interesting to see if state agencies (including state schools) pay their use tax when they buy items from out-of-state vendors.

What do you think?

Tax reform - should all businesses be taxed the same?

Today's Wall Street Journal includes an article, "Tax Plan Aims for 25% Cap" by John D. McKinnon. It notes that House Ways and Means Committee Chair Camp wants to drop both the corporate and individual tax rates to 25% and eliminate or reduce various deductions including "popular" ones.

This is an interesting goal and I wonder if it stems from hearings held so far by the tax writing committees as well as the Senate Budget Committee where discussions have included the issues that arise when the corporate rate is lower than the individual rate. There was also testimony (particularly at the Senate Finance Committee hearing of 3/8/11) that perhaps there is inequity in allowing businesses, particularly large ones, to operate outside of the C corporation form. Even Senator Baucus apparently has questioned whether all pass-throughs should be taxed outside of the corporate tax structure (see The Hill blog post of 3/8/11 - "Baucus skeptical of businesses taxed as individuals").

This has led to introduction of a resolution by Senator Snowe that businesses should be allowed to chose their entity form rather than being taxed as C corporations (Senator Snowe 3/3/11 press release + resolution).

Hearings will continue (the 1/20/11 tax reform hearing in Ways and Means was described as the first in a series). As reported in today's Wall Street Journal - "Rep. Richard Neal of Massachusetts, a top Ways and Means Democrat, said Mr. Camp's proposal faces difficult going. "As long as tax reform is offered in the abstract, everyone rallies to the cause," Mr. Neal said. "When it becomes specific, people start to fall off.""

That is a good point! It seems that hearings are moving beyond "abstract" in terms of rates and that not all entities operating outside of the C corp form are "small." These are difficult issues and perhaps a warm-up to the difficult issues of cutting back on the $1 trillion of tax expenditures. It should be interesting!

For a link to hearings and related documents on tax reform - click here.

What do you think about whether all businesses should be taxed at the same rate structure and with double taxation? Should businesses be taxed differently based on legal form or size?

1099s - manageable for small businesses?

The New York Times article - "Why the New 1099 Rules Aren’t That Bad for Small Businesses" by Robb Mandelbaum (3/14/11) suggests that with software and technology, it is not that difficult to file 1099s including for purchases of goods. It notes, for example, that QuickBooks can track the information and print the 1099s.

I don't think that is entirely correct because the 1099s have to be on scannable forms that are obtained from the IRS, unless electronic filing is used.

The article also notes that if payments are made on credit or debit card, they don't need to be included on a 1099 issued by the purchaser of the goods or services. Well, what if a business uses both check and credit card when buying from particular vendors? I think it has to track it separately and just file a 1099 for the check payments. While software can separate these amounts, will the 1099s be that useful to the recipient?

Also, some of these recipients are publicly-traded corporations that are likely compliant. And, large companies, likely to also be on accrual method and a fiscal year, won't bother reconciling the 1099s - it will be a waste of time.

The cost-benefit of the expanded reporting just doesn't seem to be there. See "1099s - the good, the bad and the ugly," AICPA Corporate Taxation Insider, 11/11/10.

Comments?

IRS FAQs - Modern Guidance or Risky Stuff?

I have written on this before -"How Heavy is an FAQ" in the AICPA Tax Insider (11/11/10). The IRS has been making significant use of FAQ to get quick guidance out. Many of the FAQs just summarize the Code and legislative histories so in following those, you are really following primary authority. But a few are beyond that primary authority and thus are something we'd instead expect to see from IRS or Treasury in regulations or revenue rulings. An FAQ is not binding guidance as it is not published in the Internal Revenue Bulletin or even released as a news release. FAQs are also not "authority" for "substantial authority" purposes. 

When a revenue ruling is changed by the IRS, there is a process for announcing that. When an FAQ is changed or removed, there is no history of its existence. Also, I don't think all FAQs are like IRS publications (which are not binding guidance) because publications should just be summaries of primary authority rather than guidance that only exists in the publication. That is not true for all FAQs, some are interpretations by the IRS. 

I think it is good for the IRS to use FAQ because it is a modern way to reach so many people using the website for getting information. But to continue with them including at times in place of regs or revenue rulings, they or Congress needs to elevate them to official guidance. 

 

In late 2010, I submitted my concerns to the National Taxpayer Advocate website for such purposes and got a response back yesterday. They do not think there is an issue and note that FAQs can't be relied upon to avoid penalties (yet, I think many practitioners are likely doing just that - particularly when there is no other guidance). Here is the text of the message: 

 

"In your submission, you question whether Frequently Asked Questions (FAQs) can be designated as official guidance, and if the guidance provided in FAQs can be used to avoid penalties. FAQs are intended to offer timely information to the general public. The IRS abates penalties on a case-by-case basis and considers all of the facts and circumstances of a taxpayer’s unique situation when making an individual penalty abatement determination. FAQs do not consider the taxpayer's individual facts and circumstances, and as such, FAQs do not meet the standard of reliance for court cases. Therefore, taxpayers would most likely not be able to avoid penalties based on FAQ reliance. More information explaining what constitutes “authority” for the accuracy-related penalty on underpayments is published in the Treasury Regulation §1.6662–4(d)(3)(iii). 

 

Every submission helps us identify trends, which lead to new approaches to improving the IRS and tax administration. We carefully review and assess all issue submissions, then score them based on uniform criteria to decide which ones should become advocacy projects. Those that are not immediately selected to become projects still help us analyze trends and provide us data for the National Taxpayer Advocate’s Annual Report to Congress. If you have further questions on your submission, you may contact our office at systemic.advocacy@irs.gov. If you do, please refer to the issue number above. We appreciate you bringing this to our attention and taking the time to report it on SAMS." 

 

What do you think?

The Competent Tax Return Preparer

I've been intrigued by a few aspects of the new IRS system to regulate all paid return preparers. In particular, what types of questions are they going to ask of preparers who are not CPAs, attorneys or Enrolled Agents (that is, they are not exempt from testing)? It would seem that the tests should be shorter and/or simpler than the tests (otherwise, why not make everyone become an EA)?

In the famous "10,000 letters" campaign the IRS started in the 2010 filing season - where they mail letters to some preparers reminding them of how to fulfil their preparer obligations and let them know they may get a visit from the IRS, the IRS says preparers should know substantive law. Yet, in describing the tests they just give the form numbers to be covered. So, do they expect that all preparers have access to the Internal Revenue Code and other primary authority and how to use it? Or is use of IRS publications and form instructions sufficient?

I've got a short article on this topic in the 3/10/11 AICPA Tax Insider - here. I hope you take a look and post here your ideas about the testing. Here a few of the questions I suggest they ask:

• How did you prepare to become a tax-return preparer?
• How do you find answers to tax questions?
• How do you access substantive law?
• What tax-preparation software do you use? If none, explain why.
• What is the review process for the returns you prepare?

What do you think?

Illinois Governor Quinn's Request for 21st Century Tax Code - First, the Commission

On 2/16/11, Illinois Governor Pat Quinn delivered his budget speech to the legislature. He said he would form a commission to write a new tax code.

"We must be a state that has a dynamic, growing economy. We must provide a first class education for our people and training that helps our workers succeed at all levels. But we must also be a state with a tax system that is fair and responsible. For too long Illinois has had a tax code that is not fair. It is regressive and is not based on ability to pay.

We can do better.

For this reason, I will appoint an Illinois Revenue Reform Commission—and charge the members with recommending a plan to write a 21st century tax code for Illinois that focuses on fairness and promotes economic growth." [click here for video]

Sounds ambitious - writing a new tax code. If that means starting from scratch, perhaps that is a good idea as a way to truly get a 21st century tax code rather than just a tweaked 20th century one.

Given the name of my blog and website, I am particularly intrigued. What does it mean to have a 21st century state tax law? I'll leave that for a second post of Illinois, but first ...

I repeat a set of suggestions I first offered in July 2008 (article on California Progress Report) on how to have an effective tax study commission. Ideally, "effective" should mean that the commission's work is solid in that it would truly improve the tax system and meets principles of good tax policy and is enacted. Here is a summary of my six suggestions for an effective commission:

1. Serious commitment. There must be serious buy-in from the legislature and Governor. Legislative hearings on the final report should be required within two months of its issuance. If recommendations are found to be unacceptable, the governor and/or legislature should be required to issue a statement explaining why.
2. Able, willing and non-partisan commissioners. Commission members should have a strong technical and practical understanding of our tax system and the economic impacts of taxes. They should understand today’s global economy and how it affects business decisions and how a tax system can support economic growth. Commissioners should be willing to propose changes even if they would result in tax increases for themselves or their employers. Appointments made for other reasons harm the ability of the commission to achieve its goal. A non-partisan committee would be better than a bi-partisan one which by its description already brings politics into the task.
3. Principles and goals. A set of principles should be adopted and followed that support good tax policy, such as equity, efficiency, transparency and simplicity. The National Conference of State Legislatures has a set of these principles, as does the AICPA. I have a document that includes various sets including a recent one used by Georgia by its tax reform commission - here (pages 16 - 23).
4. Reality. Taxes must make sense for the system to be respected such that compliance is high. An approach that might make great economic sense but is too difficult to comply with won’t be a lasting change. Also, change can’t happen overnight so transition rules must be considered. Helpful and appropriate uses of technology were not part of 20th century tax systems, but should be part of 21st century tax systems. Also, the reality of mobile capital and workforce and that software and machines can do some of the work done manually in the 20th century must be considered.
5. Time-saving background work. There are numerous reports from other states, think tanks, business and government organizations, and academics that can help the commission with its work. Also, lessons can be learned from other states that have recently studied and analyzed their tax systems, such as Georgia, Vermont, South Carolina, and Maryland.
6. Public education. Concurrent work is needed by the legislature and tax agencies to help the public understand current tax problems and their direct and indirect effects on their lives and the state. This will help ensure that the commission’s recommendations get the careful consideration they’ll need in order for tax system modernization to become a reality. Check out the Vermont Tax Commissions "fact or fiction" feature on its website, as one approach for broadening understanding of a tax system - here.

Illinois recently increased its corporate tax rate which got a lot of attention as it makes the US combined federal and state corporate tax rate second highest among OECD countries. [See Tax Foundation news release of 1/14/11 and 3/11/11 news release about the situation when Japan's rate drops April 1.]

I'll have a second post on thoughts about a "21st century tax code" for a state.

What do you think about Illinois Governor Quinn's suggestion on a tax reform commission and its chances of success?

AB 153 letter to editor - Mercury News

Thanks to the Mercury News for printing my letter to the editor opposing their editorial supporting the AB 153 approach to solving the online sales tax collection issue. Here it is (3/11/11):

Online sales tax bill won't fix budget mess

AB 153 is not the solution to California's budget problems (Editorial, March 9). The online sales tax bill is too easy to avoid because those subject to it can just cancel their contracts with in-state associates. And not all online retailers have in-state associates. California consumers need to pay their use tax -- there is a line on Form 540. This will help California's budget. The online sales tax matter must be addressed by California working with Congress and other states on a workable solution. A bigger sales tax issue is that California only taxes 20th Century type consumption (tangible goods) and fails to tax 21st Century type consumption (digital items and services). Real improvements would even allow for a lower sales tax rate, which could generate jobs.

Annette Nellen
Professor, Accounting and Finance, San Jose State University

• For more on my concerns with AB 153 - 3/9/11 post
• Testimony I submitted to 2/28/11 Assembly Revenue & Taxation Committee on AB 153 and the use tax gap - 3/1/11 post
• Quill is not a loophole - 3/3/11 post
• My reports on sales/use tax problems and possible remedies - here

More on California AB 153 - so-called "Amazon law"

The San Jose Mercury News has an editorial in today's paper supporting AB 153, saying it "closes the loophole on Internet sales taxes." ("California should end online sales tax break" 3/9/11) It goes on to say that AB 153 would generate revenue that "could save the jobs of thousands of law enforcement officers and teachers."

This is not correct!

Consider:

1. Very little revenue would be generated: Legislative analysis of AB 153 indicates an uncertain revenue estimate of $152 million in FY 2011-12 and $317 in FY 2012-13. The analysis notes that these estimates drop to $114 million and $234 million, respectively, should Amazon do as it has said it would do and end its relationships with its California affiliates (see Business Week article, 3/2/11). The figures go down further if other Internet vendors, such as Overstock.com, do the same. The Board of Equalization bill analysis (1/18/11) explains that the revenue estimate drops even further if eBay sellers who become subject to sales tax collection in California stop selling on eBay.
2. Income tax revenues drop slightly under AB 153: The AB 153 analysis (3/3/11) notes that "the termination of affiliate programs would have an adverse impact on state employment, which would lead to lower income tax revenues." Termination of the relationships also means that California affiliates have less income and thus pay less California income taxes.
3. AB 153 is not the same as the New York law of 2008: AB 153 sponsor Assemblymember Skinner (Bloomberg video, 3/2/11) and others have said they are not convinced Amazon will cancel its relationships with California affiliates because they didn't do that when New York first enacted this type of legislation in 2008. However, in the two other states that copied New York - Rhode Island and North Carolina, Amazon canceled the relationships making itself not subject to the revised law. And Amazon has told lawmakers it would do the same in California. I don't know why Amazon did not cancel its relationships in New York, but I'll offer two possible theories. First, Amazon just didn't think of it or thought it might be bad PR. Second, and here is where AB 153 differs from the New York legislation, the NY legislation gave amnesty to those who started collecting, AB 153 does not. (Here is a summary of this from the NY tax agency (page 11) - "Part OO-1 also includes a limited amnesty, under which a seller that is a vendor only by virtue of this bill (and that meets certain other conditions) that registers as a sales tax vendor and commences collecting tax by June 1, 2008, will not be liable for past due tax.")
4. We all still owe use tax: If AB 153 were enacted and Amazon and other vendors cancel their relationships with California affiliates to avoid collecting California sales tax, consumers still must track and self-report and pay their use tax because AB 153 does not (and constitutionally can not) require all out-of-state sellers to collect California sales tax. And, even if no one cancels an affiliate arrangement, there will still be Internet and catalog sales to California consumers by sellers who are not subject to AB 153 meaning that the customers must still pay their use tax.
5. The problem (and the solution) is us: There is a line on Forms 540-2EZ, 540A and 540 for "use tax." If you purchased taxable goods but were not charged sales tax, keep record of that transaction. When preparing your return, total up those purchases, multiple the total by the sales tax rate in your county and put that number of the 540 use tax line. Until Congress acts to fix this situation, this is how (using the Mercury News angle) we save the jobs of thousands of law enforcement officers and teachers. Yes, the recordkeeping can be a challenge. So, let's encourage legislators to pass a bill allowing us the option of using a table to compute use tax based on income level as is done in New York and a few other states).
6. Use tax is not the only sales tax problem in California: The Mercury News editorial notes that sales tax revenues are down in California due to the recession and Internet sales. But, there is also another bigger reason. California's sales tax is out-of-date. It taxes the goods of the 20th century (tangible ones) and not those of the 21st century (digital ones). A sales tax should apply to all personal consumption with limited exemptions (such as perhaps for food and medicine as is done in California). But today, we consume a lot more digital goods (such as music and books) and personal services, than we did in the 1930s when the use tax was created. California needs to broaden and modernize its sales tax base. That would bring in far more revenue than AB 153 will. And that can be done while even lowering our sales tax rate which is above the 6% median rate of all state sales tax rates.

We need to solve California's real tax problems in ways that will work. Time spent on flawed AB 153 distracts from time needed to work with Congress and other states to really solve the problem, and distracts from the bigger issue of the need to modernize our sales tax base and lower the rate - a rate that is too high, which hurts low-income individuals and the state's ability to create high-paying jobs.

Further reading:

• Prior posts on AB 153 (1/24/11, 3/1/11, and 3/3/11).
• Prior posts on New York "Amazon" law (8/8/08, 8/4/09, 2/10/09) and short article from 2008 - "Grabbing Remote Vendors."
• My written testimony to Assembly Revenue & Taxation Committee for the 2/28/11 hearing on use tax, offering alternative solutions for improving use tax collection.
• AB 153 analysis from Board of Equalization and Assembly Rev & Tax staff.
• The need to broaden and modernize the California sales tax base - here.

Federal Income Tax and Same-Sex Married Couples and RDPs

In 2010, the IRS issued new, but informal, guidance on how Registered Domestic Partners in California, Nevada and Washington, and same-sex couples in California, are to report their income and wage withholding on their federal income tax returns. Basically, the IRS is saying it will follow state law that treats these couples as having community property income. Thus, for example, a California couple who are RDPs with each having wage income, will report half of each partner's wages and withholding on their single (or head of household) federal return. While that sounds easy, it is not entirely because:

• The IRS computers will expect to see a match between one's W-2 and what is on his/her Form 1040. So consideration should be given to how to report this on each partner's 1040.
• What is community property and what is separate property?

I have a short article in an AICPA Tax Alert released today that notes the IRS guidance, considerations of amending prior year returns, and has links to more guidance from the IRS and state tax agencies.

Hopefully any tax reform actions Congress and President Obama take in the near future will address filing status for RDPs and same-sex married couples. For the same reasons that different-sex married couples can file a joint return - and have joint liability and often pay a marriage penalty, RDPs and same-sex married couples should be treated the same given similar legal obligations of the relationship. As recently pointed out in a Wall Street Journal article (Laura Saunders 2/19/11), there is likely a revenue gain to allowing RDPs and same-sex married couples to file jointly at the federal level (because many would be subject to the marriage penalty - where the tax liability of the married couple exceeds what it would be if each person filed as single). Other tax issues also exist in all of this too, including the tax treatment of employer-provided health insurance that covers a domestic partner, and estate and gift tax issues.

It is time to modernize the federal tax system to treat all legally connected couples similarly. This will also bring equity and simplification because all will be treated similarly and rules intended to apply to "married" will truly apply to all who are married or an RDP.

GAO Report on Duplicative Government Programs Including Tax Expenditures

The GAO released a 300+ page report this week - Opportunities to Reduce Potential Duplication in Government Programs, Save Tax Dollars, and Enhance Revenue (GAO-11-318SP; March 2011). This is the first annual of a required report pointing out government programs with duplicative goals or activities. The report highlights 34 areas with No. 17 addressing duplicative tax expenditures.

One duplicative tax expenditure noted are multiple tax and spending programs helping taxpayers with higher education expenses. The GAO states:

"In the case of higher education, the federal government offers seven tax expenditures and nine spending programs—grant and loan programs authorized by Title IV of the Higher Education Act of 1965—to help students and their families pay for postsecondary education. In 2005, the number of tax filers claiming a higher education tax credit or tuition deduction surpassed the number of Title IV aid recipients. Perhaps due to the multiple, complex tax provisions, hundreds of thousands of taxpayers in 2005 failed to claim tax incentives or did not claim the most advantageous tax benefit. Simplifying the tax, grant, and loan programs may reduce complexities in higher education financing, including reducing the number of eligible taxpayers that do not claim tax benefits. However, GAO reported in 2008 that Congress had received little information about the roles and effectiveness of the tax and Title IV programs."

GAO recommendations dating back to 2005 are noted:

• "Present tax expenditures in the budget together with related outlay programs.
• Develop and implement a framework for conducting performance reviews of tax expenditures. This includes (1) outlining leadership responsibilities and coordination among agencies with related responsibilities; (2) setting a review schedule; (3) identifying review methods and ways to address the lack of credible tax expenditure performance information; and (4) identifying resources needed for tax expenditure reviews.
• Develop guidance on incorporating tax expenditures in agencies’ strategic plans and performance reports.
• Require that tax expenditures be included in Executive Branch budget and performance review processes."

These recommendations should improve transparency. One of many problems with the number and size of today's tax expenditures is that they are hidden. For example, if someone asked how much the federal government spends on higher education, a respondent would likely just look at the Department of Education budget. But, that budget would not note the 7+ tax benefits that are in essence government expenditures with the payments being made to taxpayers via lower tax bills. So the true cost is hidden. It is also hard to be accountable for the expenditures when people are not responsible for them. No one is really responsible if the expenditures are really helping students go to college or to graduate.

Not all budget problems can or should be addressed via tax increases, but sloppy spending as well as bleeding of budget dollars through many high cost and often poorly targeted tax expenditures needs to be addressed. Often, tax and budget problems are in the base, not the rate.

The GAO report also includes links to prior reports it issued on tax expenditures including a 1994 (!) one stating that tax expenditures need more scrutiny! And since 1994, there are a lot more unscrutinzed tax expenditures on the books!

What do you think?

Senate Finance Committee Continues with Tax Reform Hearings

On March 8, the Senate Finance Committee will hold another hearing on tax reform. This one is entitled - "Does the Tax System Support Economic Efficiency, Job Creation and Broad-Based Economic Growth?" That is a good question. Some may ask whether that is what the tax law is supposed to do. Principles of good tax policy call for a neutral system - one that does not affect decision-making. It would be a good question to ask committee members if they think the answer to the question falls more into (a) or (b):

(a) The tax system should not be counterproductive to an efficient economy and job creation. For example, there should not be an extra tax charge for each employee hired or a 30-year depreciable life for manufacturing equipment.

or

(b) The tax system should have all kinds of special rules members of Congress and lobbyists think of to help some industries or taxpayers and for which everyone else can subsidize through higher taxes.

We have had (b) for a long, long time. Not only does it create inefficiencies, such as varying tax rates on different types of investment, it also makes the tax system more complicated from all of the special rules. And there are a lot of these special rules including for oil and gas, some energy activities, and shortened depreciable lives for certain restaurant equipment and race car tracks.

What do you think?

Bill Gates Commentary on State Budgets

The Wall Street Journal of 3/3/11 had an article -"Gates Calls for 'Clear and Honest' Accounting of State Budgets" by Robert A. Guth. Bill Gates commented that the lack of transparency in state budgets harms public education funding. He offers a blunt commentary:

""It's riddled with gimmicks," Mr. Gates said of the "tricks" states use to balance their budgets. Citing moves such as selling state assets and deferring payments, he said some methods are "so blatant and extreme," that "Enron would blush," referring to the energy company that collapsed a decade ago amid an accounting scandal."

He also questions funding priorities including making payments for early retirement while K-12 funding suffers.

Certainly in California, lack of transparency in the budget process, including the exchanges of funds between the state and local jurisdictions, is a problem. Legislators and voters have created a confusing budget system that includes "swaps," "triple flips," and "subventions." There are restrictions on some funds, tying the hands of legislators. To get a sense of the complexity of one California-local government financing system, see this almost 200 page report, SB 1096 Guidelines (2005), by the California State Association of County Auditors - here.

What do you think?

Paying for Repeal of Revenue Raisers + A Peek Into Complexity of Section 36B

In 2010, Congress twice expanded 1099 reporting requirements. I think the primary reason for doing so is that the revenue estimates for both indicated they were revenue raisers and that allowed for a tax cut or spending increase. The health care legislation enacted in March 2010 expands, starting in 2012, 1099 reporting to require that they be issued to corporate payees and for goods purchased if the total exceeds $600 for the year. Then in September 2010, Congress added a requirement that landlords, even if not in a trade or business, start issuing 1099s starting for 2011. When both the issuers and recipients of these 1099s start thinking about what it means in terms of hassles and costs and then start thinking about whether it is going to result in more income being reported, it was quite clear that the cost-benefit wasn't there. After all, is the tax gap going to go down if a small business issues a 1099 to Office Depot or American Airlines? No.

But, these provisions went into the law as revenue raisers. I don't really think they were enacted as any serious effort to address the tax gap because they do not really get at the tax gap. And, because of earlier enactment of Section 6050W to require credit/debit card processors and Paypal to issue 1099-Ks to the merchants, to avoid duplicate reporting of items, if you pay using a credit card you don't report that on the regular 1099. What a mess. And, again, this isn't really the way to best address our $345 billion federal tax gap. (For more on that, see a short article of mine - (The Slow Pace of) Closing the Tax Gap.)

Well, the most recent effort to repeal these 1099 requirements is H.R. 4 that passed in the House on Monday with all Republicans voting for it along with 76 Democrats. The apparent objection of some who voted no is that the bill also reduced a particular health care subsidy for taxpayers. More specifically, it modifies IRC Section 36B to increase the amount of overpayment of the health care credit subject to recapture. Those opposing the bill said that was a tax hike requiring a 2/3 vote, but others said a reduction of subsidy is not a tax hike. Wow! A few observations:

1. The 1099 requirements went into the law as revenue raisers, it makes sense that if they go out, some other revenue raiser should take their place.
2. Pay back of a subsidy, a tax hike, a spending cut - does it really matter in terms of the overall effect on the federal budget? No, but ...
3. Isn't a reduction to a benefit provided by a tax rule (IRC Section 36B) a tax increase? If a credit amount were reduced, wouldn't that be a tax increase? Isn't that effect of the proposed Section 36B modification? But, see below on transparency...
4. I encourage you to take a look at Section 36B as added by health care legislation. It is long and complicated. You can find a copy here - go to page 237 (Act section 1401) and it goes on for about 20 pages!

A focus on transparency would be the best approach - just clearly state that when the 1099 requirements were enacted, a revenue increase amount was attached to them. If they are to be repealed, Congress sticks to the same revenue amount and states how it will make up that revenue and how that new provision works. If the 1099 provision was enacted with a simple majority, shouldn't that also work for its repeal (in theory)?

There is an interesting summary of the issue in The Hill's Floor Action Blog of 3/3/11 - here.

Will the new 1099 requirements be repealed? I think so, but it sure is taking a while to get past the revenue aspect of it - being honest about items 1 to 3 above should help move this along. Will there be a more concerted effort to address the tax gap in place of the mostly pointless 1099 provisions enacted in 2010? It doesn't seem so. What do you think?

Is the Quill decision a loophole?

I just saw two references to the effect of the 1992 Quill decision being a loophole. For example, see the Stand With Main Street website (http://standwithmainstreet.com/). And a Bloomberg video with California Assembly member Skinner of March 2. And perhaps there are other examples as well. (Click here for the Bloomberg article that talks about Amazon threatening to cancel its contracts with California affiliates.)

Is the Quill decision a loophole? Well, first, what is a loophole? I define it as a law written for one purpose, but not written well enough, so taxpayers are able to use it for other purposes. For example, if a state wanted a lower property tax rate for commercial farms, but did not define the term well enough such that a homeowner with ten fruit trees in his backyard also gets the exemption, that is a loophole that needs to be fixed. (I had an op ed in the San Diego Tribune on this topic in 2008 - here.)

Does an interpretation of the commerce clause of the US Constitution by the US Supreme Court constitute a loophole for online stores? That just doesn't sound right. While we didn't have e-commerce in 1992, we had catalog sales. I don't recall anyone calling the decision a loophole for catalog stores before.

Also, sales of the same item by an online store and a bricks-and-mortar store are both subject to sales/use tax. There is no exception for the particular sale. So, the loophole is not that online sales are tax free. But, it often appears that way because so few buyers know what a use tax is and therefore don't pay it. If there was more publicity given to educating people about the use tax, buyers would know that when they see the price of goods at the online store, they need to add in the sales/use tax --- and they also need to pay it, which in most states, including California, they can do on their state income tax form (rather than having to file a separate return). If this rule was better known and enforced, I think many consumers would stop buying from online stores unless they told them they would take care of the tax compliance for them.

Why almost 20 years after the Quill decision do so few people know about the use tax?

I think it would help if more people talked about the use tax - including hearing from state officials that they paid their use tax. We have a continuing budget problem in California - let's collect taxes already on the books (use tax has been around since 1935). While it won't solve the entire budget problem, collection of this longstanding tax needs to improve.

Well, I've been paying my use tax even before there was a line on the income tax form. Have you paid your use tax? For more, see my prior blog and link to testimony on this topic - here.

Collecting Use Tax in California

I'm always surprised when people ask "what's a use tax?" For several years, in California and many other states, there has been a line on the state income tax form for reporting one's use tax. Now I suppose that if people don't know what "use tax" means, they are just as likely to skip that line as they are to go to the instructions to figure it out.

Well, today, many people owe use tax primarily because they buy taxable items online from Amazon, Overstock, eBay sellers and similar places and are not charged sales tax because the seller doesn't have a physical presence in the buyer's state. That is, the seller doesn't have a sales tax collection obligation. Well, that is where the use tax comes in. The buyer must self-assess and pay the use tax.

Yesterday (Feb. 28), the California Assembly Revenue & Taxation Committee held a hearing on use tax collection which in California yields a $1 billion tax gap. I wasn't able to attend, but I think two bills were part of the impetus for the hearing - AB 153 and AB 155. They are similar to legislation introduced and sometimes passed, in other states, although not always yielding the desired collection result, but instead yielding a challenge as to the constitutionality of the law.

I think more can be done to collect use tax. One of the most important activities is to educate people as to what it is, how they compute it and how they pay it. People need to be as aware of the use tax as they are of the income tax. There are also some things that can be improved on the state income tax form to make recordkeeping and paying simpler.

I offered some written testimony to the hearing offering nine suggestions to help reduce the use tax gap (please see the testimony for the details):

1. Establish a Public Awareness Campaign and Educational Activities
2. Mandate Use of Form 540 or Form 100 to Pay Use Tax
3. Clarify and Improve the Use Tax Line on Form 540
4. Implement Simpler Compliance Techniques for Individuals
5. Pursue Technological Solutions
6. Support Efforts to Find Non-Compliant Vendors
7. Encourage Out-of-State Vendors to Voluntarily Collect Use Tax
8. Avoid Legislation With a High Likelihood of Being Defeated
9. Work with Congress and Other States

What do you think? Have you paid your use tax? If not, here is a recently released short video from the California tax agencies on paying your use tax. I offer a few suggestions in my testimony on how the filing can be even easier - with changes needed by both the legislature and the tax agencies to get us there.