New models challenge tax laws

You may have heard the news report that a women in Omaha, battling cancer, received about $50,000 from strangers after she set up an account with GoFundMe. It was also reported that the IRS is seeking $19,000 of income taxes from her on this amount. [See ABC8, 4/27/15 story and KETV.]

The power of the Internet includes to easily reach many people throughout the world enabling vendors to have a larger market, writers to have more readers, and people seeking funds to potentially raise a lot. Crowdfunding websites can generate funds for many purposes and many of these purposes result in taxable income to the recipient. However, not always. What the woman in Omaha received is a non-taxable gift under the income tax law.

A well-known US Supreme Court defines "gift" for tax purposes (Commissioner v. Duberstein, 363 US 278 (1960)). Per the Court:

"A gift in the statutory sense ... proceeds from a "detached and disinterested generosity," Commissioner v. LoBue, 351 U. S. 243, 246; "out of affection, respect, admiration, charity or like impulses." Robertson v. United States, supra, at 714. And in this regard, the most critical consideration, as the Court was agreed in the leading case here, is the transferor's "intention." 286*286 Bogardus v. Commissioner, 302 U. S. 34, 43. "What controls is the intention with which payment, however voluntary, has been made." Id., at 45 (dissenting opinion)."

Basically, if the giver expects nothing in return and the transfer is not for goods or services provided in the past, it is a gift. Clearly, the $50,000 was given with detached and disinterested generosity. The only tax consequences should possibly be gift taxes to the givers if the gift exceeded $14,000.

But, how does GoFundMe know that the transfers to the person in Omaha were a non-taxable gift to her?  GoFundMe is liable for penalties if it fails to report information under any rules it may be subject to. While the law is not entirely clear on what reporting is required by the crowdfunding sites, it likely issues a Form 1099-K to recipients of the funds because it handled the transfer of funds. 

It would be helpful for the IRS to create a new form or schedule allowing recipients of information returns that may be incorrect or improperly sent, to report them, explain them, AND back them out of their income. This would prevent the IRS computers from finding unreported income when it matches a 1099 with the recipient's return and sends out a notice. The new reporting form or schedule would prevent the computer from doing this.

New approaches are sometimes needed for new transactions and this simple solution should work here.  Congress also needs to update information reporting laws to make it clear to web-based businesses when they are required to issue a 1099 (and which type) for funds they collect and transfer to someone.  This would help many companies today beyond the crowdfunding platforms - for example, Uber, Lyft, Amazon Mechanical Turks, Task Rabbit, and more.

What do you think?

Revenue magic (that should be avoided)

Revenue magic!

H.R. 1891 (114th Congress), the African Growth and Opportunity Act Extension and Enhancement Act of 2015, sponsored by Congressman Paul Ryan, extends the "African Growth and Opportunity Act, the Generalized System of Preferences, the preferential duty treatment program for Haiti, and for other purposes." It is a revenue loser, but has a supposed revenue offset. That offset is really a fake in that it doesn't raise any revenue, it just accelerates revenue into an earlier year that falls within the 5-year budget measurement period for the bill.

The shifting of tax revenues is accomplished by accelerating corporate estimated tax payments. H.R. 1891 proposes to modify IRC Section 6655 as follows:

"Notwithstanding section 6655 of the Internal Revenue Code of 1986, in the case of a corporation with assets of not less than $1,000,000,000 (determined as of the end of the preceding taxable year)—

   (1) the amount of any required installment of corporate estimated tax which is otherwise due in July, August, or September of 2020 shall be increased by 5.25 percent of such amount (determined without regard to any increase in such amount not contained in such Code); and

   (2) the amount of the next required installment after an installment referred to in paragraph (1) shall be appropriately reduced to reflect the amount of the increase by reason of such paragraph."

A revenue estimate by the Joint Committee on Taxation (JCX-82-15) shows the estimated tax payment shift as raising about $2 billion in fiscal year 2020, but that is then made up in FY2021. But, since FY2020 is in the five-year budget window, it is a revenue raiser for that time period.

There is though, a real revenue raiser in the bill, but is is small - $293 million over 10 years. This proposal denies the refundable aspect of the child tax credit to individuals who exclude foreign earned income. That makes sense.   (See JCT explanation (JCX-81-15) for details.

A mark-up hearing is scheduled for April 23, 2015, for this and related bills. If they are looking for true revenue raisers, here are a few suggestions:

• Perhaps the entire child tax credit and a few other tax preferences should be denied for individuals claiming the foreign earned income exclusion or the foreign income exclusion amount should be reduced.
• Address a spending problem documented by the GAO in their series of reports on duplication, fragmentation and overlap in government programs that result in excess spending (click here for the report released in March 2015).

One more issue - the one year change in calculating estimated tax payments adds complexity and confusion to the law.

What do you think?

Guest Post - Resolving a Premium Tax Credit Problem

In a 3/26/15 post, I described an Affordable Care Act oddity of someone starting the year getting the Premium Tax Credit (PTC) in advance because their income qualified them for it. But later in the year, their income increases and they lose all or part of their PTC.  That caught the attention of financial executive Randall Bolten, author of Painting with Numbers: Presenting Financials and Other Numbers So People Will Understand You (John Wiley & Sons, 2012).

He suggests that a compensation practice can be used to help address this payback problem. He notes that this problem is caused by the legislation’s failure to address the impact of significant income fluctuations throughout the year. An approach that could deal with this takes a page from “accelerated” sales commission plans, where commission rates increase as sales volume increases. To see how this might work, he offers an explanation along with charts and graphs.

Please click here to see Randall Bolten's full post with all of the graphs and details. Thank you.

What do you think?

IRA Contribution by April 15 May Prevent Paying Back Premium Tax Credit

The Premium Tax Credit (PTC) for individuals who purchased health insurance on the Exchange (Marketplace) is an important tax break.  As income goes up, this subsidy in the form of a refundable credit decreases. Then, it hits a cliff and completely disappears if one's household income exceeds 400% of the Federal poverty line (FPL). This can result in a tax bill of thousands of dollars!

Here is an example. A married couple, both age 64, thought their 2014 income would be about $62,000. Being eligible for insurance on the Exchange, they purchased a policy and obtained a PTC of $14,112. When they file their return, they realize they actually have $63,000 of income for 2014. this is above 400% of the FPL so they must repay all of the $14,112 PTC!  If they can drop their income to $62,040 (400% of the FPL for 2014), they don't have to repay the $14,112 (which they already used to be able to buy the insurance so no longer have). If they are eligible for an IRA deduction, and make a contribution of at least $960 (let's say $1,000 for safety) by April 15, they have engaged in some terrific tax planning (click here for IRS info on an IRA contribution by April 15). If they paid someone to prepare their return and that preparer was astute enough to give this advice - and the couple gets their return completed and filed in time to get the IRA contribution made on April 15, great for everyone. [Note: I used a 64 year old couple to generate a high PTC - health insurance costs more when you are older. See this 12/31/14 post.]

Given how the Administration wants to promote retirement savings, I'm puzzled why the IRA contribution idea wasn't built into the Form 8962 for the PTC.

This cliff is bad tax policy for the reason noted above AND because it makes the law inequitable. If this couple instead had employer-provided health insurance and the employer paid all or part of the cost of coverage, that benefit would not be taxable to the couple regardless of their income level.

What do you think?

Challenges of taxing gambling winnings

Gambling winnings are taxable - include them on line 21 of Form 1040 as other income. You can only deduct your gambling losses if you itemize your deductions (Schedule A).  How do you know if you had winnings or losses?  Often, it is easy. You buy ten lottery tickets at $1 each and one is a winner, let's say $500.  Of the $500, $1 is considered a return of your investment and is not taxable. So, $499 goes on line 21.  The $9 spent for the losing tickets is a loss for Schedule A.

What about a trip to the casinos? or multiple trips during the year? Do you track each bet, such as at a slot machine?  That sounds unrealistic.  The IRS says a session of play can be the bet. So, start at a machine with $100 and end up with $150 and you have $50 of winnings.  Even if that also includes a $1,300 jackpot (for which the casino will give you a W-2G form, with a copy to the IRS).  That gets a bit more complicated to report because the IRS will want to see the W-2G reported.  So, an attachment with the explanation would be needed for line 21.

The IRS recently issued a proposed safe harbor for "electronically tracked slot machine play."  I've got a short article on it, as well as some additional background on the current reporting rules, in the AICPA Tax Insider (4/9/15) - here.

I think it is interesting that the IRS is spending time on this issue when there are bigger issues out there and this safe harbor won't address all types of gambling.

Also, with tax reform continually a discussion topic, why allow a loss for that $9 of losing lottery tickets or any gambling loss?  Doesn't seem necessary and arguably, today's system if flawed since the loss is only for those who itemize.  AND, check out the article to see how the identification of "session of play" impacts how much is reported.

What do you think?

Politics and Taxes - Why call for abolishing the IRS?

 

We now have two presidential candidates who promote abolishing the IRS - Senator Ted Cruz and Senator Rand Paul. (For example, see Christian Science Monitor of 3/25/15 on Cruz and Citizens United on Paul.)  Why would they make such an odd statement? They must know that a government agency is needed to help taxpayers comply with the tax law, collect taxes, and use audits and other techniques to be sure taxpayers have properly computed and paid their taxes. While both men also call for tax reform, there would still be taxes.  And there would still be complexities. The size of a tax return (such as a postcard) does not mean it is simple.  It all depends on how much information is summarized and given to the IRS. Today's income tax could go on a postcard (total income less deductions, and the net tax); it would still be complicated to compute these figures.

So, why do these elected officials, who know how government works, spend so much time talking about abolishing the IRS?  Hopefully the public will be asking more specific questions about their tax plans such as:

• Is your tax reform plan revenue neutral?  If not and it collects less, who pays less and what spending will be cut? If it collects more, what will be done with the additional revenue?
• Is it distributionally neutral or will some income groups pay less while others pay more? If yes, which groups?
• Is it regressive (such as is typical with a flat (consumption) tax unless other mechanisms are used to address that) or progressvie? To what degree?
• How will it simplify the current system?
• If you are going to lower the rates in a revenue neutral manner, give me the honest truth about how this means that the largest tax expenditures will need to be reduced (exclusion for employer-provided health care, lower rate for capital gains and the mortgage interest deduction)?  Remind me that these large tax expenditures mostly benefit high income individuals. Show me the math that to get any meaningful rate reduction, you have to make permanent changes to the biggest deductions and exclusions. Don't show me timing changes (such as postponing deductions) or budget gimmicks.
• Won't there still need to an administrative agency to collect taxes and enforce the rules? (yes)
• If you just plan to rename the IRS, what is the point?

What do you think?

Designing sales tax exemptions - what is necessary?

Several sales tax exemptions fall under the "necessity of life" category - or at least that is typically how a state might describe them. For example, see page 1 of California Board of Equalization Pub 61 which lists food, health and housing under this category. One that caught my attention recently is Idaho's addition of  “eyeglasses and eyeglass component parts” as a sales tax exemption effective July 1, 2015.

While the lens are health related, the frames are often fashion related. Frames range in price from $50 including the lens (!) to over $250 for just the frames. If I'd been asked, I would have suggested that Idaho just exempt the cost of the lens and the cost of a basic frame (perhaps $20). The rest should be subject to sales tax. That helps the system be more equitable as expensive frames are not a necessity of life and more likely to be purchased by individuals who can afford the more expensive frame AND the sales tax.

For a bit more and the links, see a short post originally posted to Sales Tax Support.

Idaho recently amended its list of sales tax exemptions to include "eyeglasses and eyeglass component parts" (HB 75, 3/24/15, effective 7/1/15).  There were already exemptions for drugs, hemodialysis supplies, braces and orthopedic appliances, dental prostheses and other medical related items. While eyeglasses seem to fit the list, there is a significant difference between eyeglasses and most medical supplies and devices. Eyeglasses are also a designer item where the cost can be quite high due to the choice of frame. Also, for most medical items, the doctor prescribes the item and the patient has no choice of style or manufacturer. In contrast, patients have a lot of choice in eyeglass frame.

So, the exemption helps any one in need of corrective lenses, but provides a bonus to individuals who want the $300 (or higher) frame rather than a $40 frame. This could be alleviated by only providing the sales tax exemption for the glass and then only the first $50 of the cost of the frame. It would not be difficult to compute. It also sends the message to consumers that the exemption is only for the medical aspect of the purchase, not the designer element of it.

What do you think?