21st Century Taxation

Bank and credit card rewards - taxable?

2012-01-26T00:26:00.000-08:00

An article in the Los Angeles Times today (1/25/12) -"Citibank deems frequent-flier miles taxable, but does the IRS?" by David Lazarus covers a story that raises question about what does the "income" in "income tax" mean. Citibank issued Forms 1099-MISC to customers who received frequent flyer miles from Citibank for opening accounts, if the points were valued at $600 or more. This caught the customers by surprise.

Are the miles taxable? Good question. And do note that the answer has little to do with their value. Even customers who received points worth less than $600 have income if this is indeed income. Just because you don't get a 1099 doesn't mean you don't have income. It is just that $600 is the threshold for reporting such income to the IRS. But, if the bank gives you a cheap pen or a cup of coffee, it's not taxable to you.

Here is what the US Supreme Court said in 1955 in holding that punitive damages were income to the recipient - "undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion" is income (Commissioner v Glenshaw Glass, 348 US 426).

Could the points be considered a gift? I don't think so. In 1960, the US Supreme Court said that a "gift in the statutory sense ... proceeds from a "detached and disinterested generosity," ... "out of affection, respect, admiration, charity or like impulses." .... And in this regard, the most critical consideration, as the Court was agreed in the leading case here, is the transferor's "intention."(Commissioner v Duberstein, 363 US 278).

It doesn't seem to be a gift because Citibank wanted something in return for the points - your money!

The Citibank situation is not like two slightly similar situations that do not generate taxable income:

You buy a new car and the dealer gives you a $500 rebate. The $500 is not income to you. The substance of this transaction is that the car really cost $500 less. This is a reduction in the purchase price. (This is also the view of the IRS - Rev. Rul. 76-96.)
You use frequent flyer miles you earned by buying airline tickets. In Announcement 2002-18, the IRS stated, "the IRS will not assert that any taxpayer has understated his federal tax liability by reason of the receipt or personal use of frequent flyer miles or other in-kind promotional benefits attributable to the taxpayer's business or official travel. Any future guidance on the taxability of these benefits will be applied prospectively." So, the IRS isn't saying the miles are not income, just that there are difficulties in making the determinations. But in some cases though it may be possible to reach a more definitive answer. For example, you only purchase airline tickets for business use. When you cash in your miles, you obtain more travel used for business purposes. This is really like the car rebate example - no income. The challenge is that many people earn miles for both business and personal travel and likely redeem them for personal travel which means they should pick up income or reduce the business deduction for the miles - but how do you value them. The IRS also notes in the 2002 announcement that, "This relief does not apply to travel or other promotional benefits that are converted to cash, to compensation that is paid in the form of travel or other promotional benefits, or in other circumstances where these benefits are used for tax avoidance purposes"

So far as benefits received from banks and credit card companies, the tax effect seems to depend on the details of the arrangements. Many of these arrangements do not seem to be like the car rebate situation because the company awarding the points has not sold you anything - they really seem to be rewarding you to use the credit card. But what about a credit card issued by Store X that rewards you with Store X gift cards if you purchase a certain amount of goods from Store X? That sounds like the car rebate. But what if it is Store X issued VISA card that you can use anywhere and all of your purchases help earn you rewards?

Perhaps the IRS will step in and say something again in light of this Citibank action. Perhaps customers will ask more questions before taking the points.

How can this be made more simple? Here are two possibilities. (1) Require the giver of the award to issue the 1099 at the time the person is about to take the action so they can stop the action if they don't want to income. Also, while you are generally not allowed to turn your back to income you should be allowed to in the case of awards and rewards. (2) Enact a de minimis threshold for rewards that are excludable from income, such as $50.

What do you think?

AMT Out of Control - Way Past Time for it to Go!

2012-01-22T12:29:00.000-08:00

Probably the most common response to what is one of the more complex and out-of-control parts of our federal income tax would be the alternative minimum tax or AMT. The "AMT Patch" which keeps about 21 million individuals from paying AMT - people who AMT was never intended to affect, expired at December 31, 2011. Who knows when Congress will extend it - it likely won't be until after the November 2012 election. So, many individuals will be paying estimated taxes this year that include AMT.

A lot has been written about the AMT (including by me - my 2007 op ed - "Simplicity and transparency versus the dread AMT, Silicon Valley/San Jose Business Journal is still relevant in 2012!). I'd like to share two items:

1. The modern AMT stems from the Tax Reform Act of 1986. The Blue Book to TRA86 (page 473) states that for 1991, the AMT for individuals was projected to raise $334 million.* The year is relevant because by then new provisions of the TRA'86 would be fully phased in (revenue estimates were higher for 1987 to 1990 probably due to fact that passive activity loss limitations (Section 469) and repeal of personal interest deduction (Section 163(h)) were being phased in for regular tax, but fully in effect for AMT) Using an inflation calculator from the US Bureau of Labor Statistics, that one year revenue estimate would be $551 million in 2011. YET - just to enact a "patch" - which does not repeal the AMT, it just helps adjust the exemption amount for the effects of inflation, costs $64 billion for a year! Clearly, the AMT is way beyond being out of control.

2. The National Taxpayer Advocate's Report to Congress for 2008 (released 12/31/08) included a blunt observation about the AMT:

"Today, we have reached a point where even one-year fixes are extremely expensive [$64 billion] – and the perniciousness and invasiveness of the AMT is demonstrated by the fact that it will cost more in 2009 to repeal the AMT than it would cost to repeal the regular income tax rules and leave the AMT in place. Absent continual one year patches, almost a quarter of all individual taxpayers will have to navigate the AMT. That is a sad statement about the complexity of our tax system, and that fact alone should compel the new administration and Congress to undertake the fundamental tax reform necessary to repeal the AMT. It is simply inexcusable for a tax system to impose this kind of burden on millions of taxpayers." (page vii of the report)

The National Taxpayer Advocate's 2011 report to Congress continues to call for repeal of the AMT (2011 report, page 468).

* For a link to the JCT Blue Book and an article of things to consider upon the 25th Anniversary of the TRA'86 (that anniversary was October 22, 2011), see my short article here (and see the "table" link) in the article.

Repeal of the AMT has many supporters besides the National Taxpayer Advocate - also many members of Congress, the Joint Committee on Taxation and the Tax Sections of the AICPA and ABA.

What do you think it will take for the AMT to be repealed? Or should it be kept and the regular tax repealed for individuals?

IRS encouraging individuals to help monitor return preparers

2012-01-20T00:17:00.000-08:00

The IRS released an "FS" (Fact Sheet) today on "Tips for Choosing a Tax Return Preparer" (FS-2012-5). Among the tips is to be sure the preparer signs the return and puts their PTIN on the form. The last tip:

"Make sure the preparer signs the form and includes his or her preparer tax identification number (PTIN). A paid preparer must sign the return and include his or her PTIN as required by law. Although the preparer signs the return, you are responsible for the accuracy of every item on your return. The preparer must also give you a copy of the return."

The IRS will have to see if this works. Certainly one outcome of requiring over 300,000 preparers who are not attorneys, CPAs, Enrolled Agents or supervised/non-signers, to pass a test to continue to be able to prepare 1040s, is that some may decide to continue to prepare but just not sign. (Click here for more information on the IRS Program to regulate return preparers);

I think the IRS is going to have to ask Congress to enact a new penalty on taxpayers who pay someone to prepare their return, but fails to sign the turns. How else can IRS regulate paid return preparers?

What do you think?

Feb. 3 Tax Policy Conference in Santa Clara - Don't Miss Out

2012-01-17T00:21:00.000-08:00

2012 Tax PolicyConference -
Tax Reform: Status, Needs and Realities

Speaker just added - Mike Hauswirth, Tax Counsel for theHouse Ways and Means Committee.

Find out how tax reform discussions and proposals areprogressing including having a lower corporate tax rate. At the 2012 Tax PolicyConference you'll have the opportunity to find out how tax reform will affectyou and your employer and have an opportunity to discuss the issues withcolleagues.

Details:

Friday February 3, 2012

8:30 - 5:15 (registration and breakfast at 8 am)

Techmart

5201 Great America Parkway, Santa Clara

Presenters include:

Mike Hauswirth, Tax Counsel for the House Waysand Means Committee
Joshua Odintz,Baker & McKenzie, former SeniorAdvisor for Tax Reform to the Asst. Secretary (Tax Policy) at Treasury
Fred Silva,California Forward
Gina Rodriquez,CalTa
Greg Turner, COST
Oksana Jaffe,Principal Consultant, CA Assembly Revenue & Taxation Committee

Registration fee = $150 ($135 for TEI members) -includes refreshments, lunch and materials

Don't miss this - you will need to be familiar with theissues, proposals and how to analyze them as you and your companies considertax planning. This is the event to get you up to speed on tax policy andreform.

Registration and more information - http://www.tax-institute.com

Due diligence reminders for 2012 filing season

2012-01-15T20:39:00.000-08:00

I teach several different graduate tax courses and make a lot of presentations including on tax law updates, so I have a good opportunity and enjoy finding themes in what is developing in new tax guidance. One that I think has been strong in 2011 is increased focus on penalties and whether the law was properly followed. I think this raises a lot of due diligence reminders for tax practitioners. So, I made that the topic for my monthly AICPA Tax Insider articles, starting in January and continuing through March.

The areas covered in Part 1:

Schedule C, Profit of Loss From Business
Schedule E, Supplemental Income and Loss
Cancellation of Debt Income
Property Tax Deduction

Areas to be covered in Parts 2 and 3:

Charitable contribution deduction
Unreimbursed employee business expenses
FBAR and Form 8938
EITC
Other taxes
Return review

You can see part 1 - here.

I wonder if any of these areas may rise to the level where a special form is created to be sure preparers have asked the right questions and viewed pertinent documents, as is required for the Earned Income Tax Credit via Form 8867 which now has to be attached to the return, rather than just kept in the preparer's files (this is covered in Part 3). We'll see.

There are certainly a few more that could be on the list. Did you notice this new one on the 2011 forms, such as Schedule E (see example). At the top of the form it asks if the taxpayer is required to file Forms 1099 and if yes, did they? So preparers are going to have to take extra steps to determine if clients need to file these forms, which is not always clear. In 2010, Congress enacted legislation calling for landlords to file Forms 1099-MISC, thus indicating that they otherwise were not required to do so absent the law change. Congress repealed this requirement in 2011. So, what is the purpose of the questions on Schedule E? Also take a look at Section 6041 and the instructions to Form 1099-MISC (although perhaps some other type of 1099 is warranted).

What due diligence reminders are most on your mind?

Growth in Passthrough Entities and Terminology

2012-01-13T07:34:00.000-08:00

A January 10, 2012 article in the Wall Street Journal caught my attention by the title - "More Firms Enjoy Tax-Free Status" by McKinnon. It explains the trend of the past few decades of the growth in passthrough entities and slight decline in the number of corporations. The graph included in this post is from the report the Joint Committee on Taxation presented to the Select Committee that was unable to find a way to reduce our growing deficits (JCX-49-11). The trend is a good reminder that taxpayers do respond to changes in the tax law. The key change was the Tax Reform Act of 1986 that dropped the top individual rate to 28% (it had been 50%) making it lower than the corporate rate that was dropped to 34% (it had been 46%). Thus, it is likely that if Congress and President Obama succeed in lowering the corporate rate from 35% (where for 2011 and 2012 it matches the top individual rate), the reverse may occur with some passthrough entities converting to C corporations (unless the double taxation feature of C corporations is an issue for them).

At one of the 2011 hearings on tax reform (I believe it was the 3/3/11 hearing on small businesses), the question was raised as to whether some large passthrough entities should be taxed as C corporations. That led to the introduction of S. Res. 88 calling for entitles to be able to chose their form.

Comments:

The WSJ article title is too catchy - passthrough entities do pay taxes, that is, the owners pay taxes.
While there are a lot more passthrough entities than C corporations, the gross receipts picture is an opposite one. Check my data page - here.
Why not talk about business tax reform rather than just corporate tax reform. Or perhaps it should be business reform for large businesses such as those that are not sole proprietorships and have receipts over $500,000. After all, there are a lot of small businesses where the owners are not in the top tax brackets (because less than 2% of individuals are in the top tax brackets - see Tax Policy Center data).
How will we pay for lower tax rates? Will the offsets hurt businesses, such as moving to slower depreciation methods and longer lives? (see 11/16/11 post on challenges of moving to even a 28% corporate tax rate).

What do you think about all of this?

Not Giving Up on Simplification

2012-01-11T00:47:00.000-08:00

In mid-November, IRS Commissioner Shulman spoke at the Harvard Kennedy School, mostly about simplifying the tax law. I was struck by how much his words tied to the AICPA Tax Division's simplification policy statement. I have an article on this in the January 2012 AICPA's CPA Advocate. The article is entitled - "Not Giving Up on Simplification." And I hope we don't give up despite the challenges due to a federal tax system that grows in complexity every year.

What do you think?

IRS Now Estimates Annual Tax Gap at $450 Billion

2012-01-09T06:35:00.000-08:00

On Friday (1/6/12), the IRS released updated tax gap data showing that the annual tax gap is $450 billion (based on 2006 liabilities). The prior estimate based on 2001 liabilities was $345 billion. They describe this as the gross tax gap meaning that after additional enforcement efforts, it drops to $385 billion (and old net tax gap was $290 billion).

The tax gap is the amount of tax that should be collected if all taxpayers determined and paid their tax liability correctly and what is actually collected.

The IRS notes though that compliance rates have not really changed much. Per the IRS new release: "The voluntary compliance rate — the percentage of total tax revenues paid on a timely basis — for tax year 2006 is estimated to be 83.1 percent. The voluntary compliance rate for 2006 is statistically unchanged from the most recent prior estimate of 83.7 percent calculated for tax year 2001." So, the larger dollar amount of the gap is due to increased tax liabilities and better estimation methods by the IRS.

The broad reasons underlying the gap are:

Underreporting 84%
Underpayment 10%
Non-filing 6%

There is a "map" with further details on the above percentages.

$450 billion of uncollected tax is a lot of money. While IRS estimates that its efforts bring it to $385, that is still a lot of money and there are costs of collection. Congress has enacted various measures to address the gap, a few of which we'll see on information returns issued for 2011. These two measures, which I don't think will do anything to reduce the gap are:

1099-K issued to businesses that let customers pay via credit or debit card or Paypal (per IRC Section 6050W)
1099-B issued for security sales where some of these forms will show not only the sales proceeds, but the basis of the stock.

Why I say these measures likely won't do much is because these are areas where there is already a paper trail and the 1099-B provision won't show basis for all securities (and the basis amount might be wrong).

I am puzzled why in 2008, the tax gap measure was to have an information report for transactions with a significant paper trail - the credit and debit card processing. Tax gap measures need to be focused where there is little or no paper trail, such as cash transactions of businesses.

Tax gap measures should also include NOT enacting provisions that are likely to lead to increased tax gap. For example, the first-time home buyer credit led to improper use and education credits have led to people overclaiming them. These two measures did not need to be in the tax law and could instead have been implemented in a different way where verification could have been made more easily and timely. For example, students in need of financial aid complete a FAFSA form and grants are sent to the university if eligible. The higher education credits funds could have instead been directly through existing structures, such as the Pell grant program. Similarly, the first-time homebuyer credit could have been directed at the state level with the verification done through the escrow process where verification could have been made as to whether the person was a first-time homebuyer (lenders check assets and borrowing history - they know if you owned a home in the past three years).

Simplification of other provisions will also reduce the gap because it will reduce unintentional errors which contribute to the gap.

Benefits of reducing the tax gap, of course, are to help pay down the deficit and debt without raising taxes to do it - collect more within the existing system. Of course, our deficit and debt are greater than $450 billion, but it will help. A tax gap also means that compliant taxpayers pay more to help fund non-compliance which doesn't bode will for tax system.

What would you suggest to reduce the tax gap?

Non-partisan tax reform

2012-01-04T13:53:00.000-08:00

Les Samuels has an op ed in the Los Angeles Times suggesting six principles to help guide tax reform - "Sensible Taxation" (1/3/12). Mr. Samuels was Assistant Secretary for Tax Policy under President Clinton.

He describes his six general suggestions as non-partisan. I think that is great and have suggested it myself for tax reform, including in the formation of tax reform commissions (July 2008 article). While taxes are shaped by politics, the basic design should be shaped by principles of good tax policy. Use of the principles helps bring more objectivity into the discussion and reform work.

I encourage you to read the op ed - it is brief and the six points are helpful. He reminds readers of a few key points in the six principles:

Why we have taxes (it is to raise revenue for government operations - with so many special rules in the law, we might forget).
Tax expenditures, which he refers to as subsidies (and if more people did, perhaps it would be easier to remove more on them), should be reduced to broaden the tax base. He states: "Our tax code delivers these subsidies in an upside-down manner: a 35% rate taxpayer gets a $35 savings for $100 of home mortgage interest, while a much lower 15% rate taxpayer gets only a 15% benefit. Tax reform that scales back these special tax deals will subject more income to taxation, thereby broadening the tax base. But it won't be painless. Almost all taxpayers claim these tax benefits, but some benefit far more than others."
All types of taxes should be considered in reform.

What do you think?

Over 4 Million Kindles Sold in December 2011

2012-01-02T22:16:00.000-08:00

A December 29, 2011 press release from Amazon states: "Throughout December, customers purchased well over 1 million Kindle devices per week." That seems like a lot for just one month, even if it is December. Assuming the new owners prefer to read books on their Kindle, they will purchase electronic books. In many states, including California, the electronic books are not subject to sales tax. This is because the California sales tax only applies to tangible personal property. So, even though the end result is that both the buyer of an electronic book and the buyer of a tangible book, have a book to read, only the buyer of the tangible book is charged sales tax. This is not a nexus issue, it is an "eroding tax base" issue and one of growing significance.

I suspect that sales of Kindles and Nooks and iPads will continue to increase. The books downloaded onto these devices represents consumption and should be subject to sales tax. California has serious budget problems. One contributing factor is the eroding sales tax collections caused by having a 19th century sales tax in a 21st century economy.

It is way past time to broaden the sales tax to also apply to almost all personal consumption, Raising the sales tax rate fails to address the underlying problem. The problem is the base, not the rate.

What do you think?

Tax regulations issued in 2011

2011-12-31T12:48:00.000-08:00

I deliver tax update presentations throughout the year (see http:www.21stcenturytaxation.com for a list of upcoming presentations - live and webcasts). In 2011, I started keeping a chart of federal tax regulations issued during the year. The chart provides the cite and link to the regulations, a brief overview and the relevant Code sections addressed. I hope this may be of use to you. It can be found here - http://www.cob.sjsu.edu/nellen_a/2011regs.html.

I plan to continue this in 2012.

Happy New Year! (please check this blog on New Year's Day for a 2011 tax policy recap and a looking forward for 2012)

Deliberative Democracy and Tax System Improvements

2011-12-29T14:18:00.000-08:00

In June 2011, What's Next California and a few others sponsored a Deliberative Polling with over 400 Californians participating (see my 6/26/11 post and information and links from Stanford's Center for Deliberative Democracy and this brief summary). One of the topics for which participants were polled before the discussion and after was tax and budget issues. What's Next California has a video (from PBS Newshour) on the tax issues discussed and changes in polling. For example, support for some type of a split roll for differences between how residential and non-residential property is taxed changed from 52% in support before the group discussion and 72% afterwards. Support for subjecting services to sales tax and lowering the sales tax rate changed from 38% before to 45% afterwards.

And, this was a weekend for discussions that included more than tax issues. I was there that weekend. I think great process on helping people understand complicated tax issues was a great start, but was just a start.

I think for both federal and state tax reform, a significant obstacle is that most people do not have a good understanding of how the system works. For example, many individuals believe the income tax has to have a mortgage interest deduction. But do they know how generous the current deduction is (up to $1.1 million of debt, a mortgage on a vacation home and home equity debt that can be used for personal purposes although interest on your credit cards is not deductible), they do not see how it is worth more to individuals in higher tax brackets and whether they would be better off with lower rates and/or a higher standard deduction. It takes a lot of information to get at understanding just this one issue.

I encourage you to take a look at the tax video or the entire PBS video (1 hour) - here.

Some ideas:

1. More information provided with tax forms to explain policy supporting various parts of the system. For example, when you pull up Form 1040 online, there are links for each item to provide background on the rule, its "cost" and how it is used among the income quintiles.
2. Having elected officials explain the rationale, with data, for all proposed tax changes, who benefits, the cost, and alternatives.
3. An informative taxpayer receipt (see 4/17/11 post). (I'm still working on this topic - more later.)
4. Simplifying existing rules.

btw - there is a presentation on the June deliberative polling event on January 3 in San Francisco - here.

btw - if you watch the full video, around the 32 minute mark, a young participant says that if it isn't easier to understand and isn't fun, youth won't want to be engaged or interested in voting. I hope that is not true! But, I'm willing to add that to the list above - let's make it fun! Any ideas?

What do you think?

Tax Complexity Due to Multiple Provisions and Future Benefits

2011-12-28T07:28:00.000-08:00

This morning I was looking at a tax update presentation of mine from May 2010 to get some information on the enactment of the FATCA (Foreign Account Tax Compliance Act) provisions that were added by the HIRE Act (Hiring Incentives to Restore Employment Act (HIRE) (P.L. 111-147; 3/18/10)). I was reminded of a part of the HIRE Act that won't provide a benefit until employers file their 2011 income tax forms. The key part of the HIRE Act was a temporary payroll tax exemption for employers who hired an unemployed worker in 2010. If that worker is employed a consecutive 52 weeks and his/her wages for the second 26 consecutive weeks equaled at least 80% of his/her wages for the first 26 consecutive weeks, the employer can claim a $1,000 income tax credit. This is an all-or-nothing credit. That is, if the worker was employed only 51 weeks, no income tax credit. The credit is claimed on Form 5884-B, New Hire Retention Credit.

Sources of complexity described above:

Will employers remember to claim the $1,000 income tax credit? This ties to a provision enacted in 2010 which provided a payroll tax exemption in 2010. The income tax benefit can't come until 2011 (an eligible worker was one hired after 2/3/10, so can't have 52 weeks continuous employment until 2011).
Will employer income tax records have the necessary data? The original tax benefit is in payroll records, the 2011 income tax credit needs to pull that payroll information into the income tax calculations. There is a reminder on Form 3800, General Business Credit, in that line "aa" lists the worker retention credit (it is line "aa" because a - z are already taken with other business credits! (another source of complexity in the law - too many special provisions)).
Will the tax prep software help? Probably. Many of the problems of complexity are lessened (but certainly not excused) through good tax prep software. To be sure eligible employers claim the worker retention credit in 2011, their tax prep software should ask a question about it to reminder the employers to pull this data out of their HR and payroll records.

The worker retention credit is not the only tax benefit that spans a few years. Another one is Section 1202 that provides a tax break to non-corporate shareholders who have "qualified small business stock" (QSBS). The general rule provides that if the QSBS stock is held over five years and sold at a gain, 50% of the gain is not taxable for regular tax purposes. As part of a few economic stimulus provisions enacted in 2009 and 2010, this percentage was changed to 75% and then to 100% (for stock purchased before 1/1/12). The tax benefit won't come until over five years from the purchase date. Again, tax prep software will help by asking the questions - is the stock sold QSBS and when was it acquired?

Complexity problems:

Having to maintain records over a span of years to be sure the tax benefits are obtained.
Mixing of different records such as the payroll/HR records for an income tax benefit.
Varying effective dates. For example, the dates for the payroll tax exemption are not identical to the dates to qualify for the retention income tax credit. Also, the QSBS benefit is either 50%, 75% or 100% depending on when the QSBS was acquired.
Funding short-term tax breaks with permanent provisions, such as was done with the payroll exemption and retention credit funded by FATCA which is a permanent provision in the law. The complexity lasts beyond a temporary time period.

Solutions:

Only enact temporary tax provisions for a really good reason (such as to stimulate the economy and avoid a longer recession).
Avoid multiple possible solutions such as was done with the various economic stimulus provisions. Identify two or three best stimulus provisions and enact them and no others.
Pay for temporary tax provisions with temporary tax increases that are as simple as possible such as ones that do not add new rules, but modify existing ones.
Have provisions last an entire tax year, such as by having the effective date be for the tax year starting on or after 1/1/11.

What do you think?

Tax Reform: Status, Needs & Realities -Conference on Feb 3, 2012

2011-12-23T08:00:00.000-08:00

TEI and SJSU are once again holding a 1 day Tax Policy Conference to provide an opportunity for people to get up to speed on the inevitable tax reform of some degree that will happen at the federal and California levels due to deficit issues, complexity, inequities, inefficiences, and competitiveness.

The 2012 conference will be February 3, 2012 at Techmart, 5201 Great America Parkway, Santa Clara, CA. We have a great slate of speakers including Joshua Odintz who recently left Treasury where he worked on various tax reform projects. We also have Dean Andal, formerly with BOE and the State Assembly, Fred Silva with California Forward, Gina Rodriquez with CalTax, Greg Turner with COST and several more.

We will cover federal activities and prospects and delve into the Camp territorial proposal, we will also explore some reforms suggested for California including upcoming ballot proposals. There will also be time for attendees to share ideas and provide input.

For a detailed agenda and to register - please see http://www.tax-institute.com. Registration fees are $150 general and $75 for government/non-profit attendees.

Time to adjust gas tax

2011-12-21T09:41:00.001-08:00

The federal and California gasoline excise tax are each 18 cents/gallon and have been at these low rates for many years (see CRS table). At the federal level, the tax doesn't generate enough to support the needs of the Highway Trust Fund (see posts of 7/28/08, 9/5/08 and 6/17/10). We drive less when gas prices rise and there are more people driving fuel efficient cars (I only put gas in my Prius about every 5 weeks but drive about the same as before I had this car).

The Institute on Taxation and Economic Policy has released a report on the gas tax and the need for states to increase the rate.

I agree. The amount should be adjusted for inflation from what was set at 18.4 cents/mile at the federal level in 1994 with an annual inflation adjustment built into the law. Perhaps it should also be raised beyond inflation adjustments, at least in California where we have ambitious greenhouse gas emission reduction targets.

Here are the recommendations of the ITEP:

Increase gas tax rates
Adjust the rates to tie to increased rates of construction costs
Create targeted credits to assist low-income taxpayers

We also need to rethink the cents/gallon approach because with more fuel efficient cars, we are driving the same (or maybe even more), but paying less gas tax because we buy less gas. While cents/mile approaches have been approached, they are difficult and perhaps intrusive to implement. While my lightweight Prius isn't causing much road damage, I still benefit from maintained roads and items are delivered to me via trucks and my garbage is picked up weekly by very heavy trucks so I am contributing to wear and tear on the roads and should be paying more to maintain them. Perhaps garbage fees should include a road maintenance fund.

What do you think?

Mainstreet Fairness, Small and Equity

2011-12-20T00:59:00.000-08:00

The House Judiciary Committee hearing of November 30, 2011 on federal legislation to allow states meeting certain simplification requirements to collect sales tax from remote vendors highlighted a key issue. The issue is whether such legislation should exempt small sellers and if yes, what is the appropriate de minimis level. At the hearing the suggestions for "small" seller were basically $100,000 of sales and $30 million of sales, with nothing in between (other than the $500,000 in S. 1832). How can the definitions be that disparate?

While there are good reasons for exempting small businesses from certain rules, defining small is challenging. The federal tax law has numerous definitions (see "The Many Sizes of "Small," AICPA Corporate Taxation Insider, 10/28/10).

The reasons for suggesting a low dollar amount for "small" ...

Ensure that the bulk of e-commerce sales are subject to the tax.
Reality that there are third party collection agents and software that make it easier for small businesses to collect sales tax from all customer.

Reasons for a larger dollar amount for "small" ...

To ensure that small businesses have greater likelihood of succeeding against large vendors.
Costs to comply may exceed tax to be collected.

$30 million for small - saying that sellers below this threshold cannot collect sales tax from customers is puzzling. These are decent size companies that likely engage in many sophisticated transactions that are more complicated than setting up a system to collect sales tax in all states with customer (or at least those that meet the simplification requirement of the legislation).

One item I did not hear mentioned at the hearing (I watched the archived webcast) was that some good number of sellers, such as on eBay, are not in a business and would not be registered to collect sales tax. Customers will still need to maintain records of such purchases and self-assess the use tax.

I have a short article in the AICPA CPA Insider on the hearing and the small/equity issue - "Repeal of Quill Hinges on Defining Equity."

What do you think the sales level should be to define any small business exempt from collecting sales tax in states in which it doesn't have a physical presence?

More on proposals to reverse Quill

2011-12-15T22:38:00.001-08:00

Amazingly, there are three bills in Congress to allow certain states to collect sales tax from remote (non-present) vendors. The last bill introduced S. 1832 has the support of Amazon and the chair of the California Board of Equalization (among others). Unlike the typical bill we have seen in recent years, it allows states that have adopted the Streamlined Sales & Use Tax Agreement (SSUTA) as well as those who have not but have made specific simplifications in their systems to be allowed to make remote vendors (above a de minimis level) collect sales tax.

There are a variety of issues and considerations here. I was recently interviewed by BNA about this topic. You can find the Q&A here - California's Delay in Online Collection Law Sets Stage for Federal Solution, With or Without Streamlined System.

For links to the federal proposals and background on the nexus and affiliate nexus issue - click here.

BOE ideas for reducing the use tax gap

2011-12-14T14:56:00.001-08:00

Today I came across a memo from the California Board of Equalization dated June 2011 that lists many suggestions for reducing the use tax gap. That is, the use tax owed but not collected by vendors or remitted by buyers to the state. Some of the ideas:

Use information from shipping companies to identify people buying out-of-state
Media campaigns
Ask vendors to include information on invoices about use tax
Provide buyers easy way to pay when they buy
Use tax amnesty for past purchases
Require CPAs and tax preparers to complete CE on sales and use tax law
Require return preparers to explain use tax and ask clients if they have a liability to report

Several of these are good ideas, such as asking vendors to include use tax information on their invoice. Or perhaps it should be a URL to the BOE website. I support finding a way for the buyer to pay the tax right away - such as having the state charge their credit card at the same time the vendor does. The vendor would not need to report such sales because the use tax was already paid.

What do you think?

Interesting tax development(s) of 2011

2011-12-12T07:25:00.000-08:00

I spend a lot of time throughout the year reading, writing about and presenting on federal, multistate and California updates. This week I'm presenting webinars on California tax developments and a quarterly federal update (see http://www.21stcenturytaxation.com for details on that if you're interested). In presenting on or writing on annual updates, I try to find themes from everything that has occurred and even see if there are a few developments of particular significance - that might change tax practice or a tax system in a significant way. I'll share with you what I think and encourage you to post a comment on whether you agree and what you think was most significant taxwise for 2011.

First, themes that emerge from federal and state tax developments of 2011 (in my opinion):

Due diligence reminders - several cases and IRS actions remind practitioners of the need to be sure clients have proper documentation such as for charitable contributions and the need for reasonable and timely documentation of hours to prove that a person is a "real estate professional" if they are claiming benefits of being one.
Tax planning remains challenging due to items expiring at the end of 2011 and the likelihood nothing will be renewed until sometime in 2012 (including the AMT patch). And the 2001/2003/2010 tax cuts expire at the end of 2012.
Continued focus on the tax gap - but Congress repealed some of these measures this year (the extra 1099 reporting added by 2010 health care legislation and the 3% government contractor withholding). And 1099-K reporting started in 2011 (Section 6050W) on credit/debit card and Paypal reporting. I expect that this provision will do little towards the tax gap but will make it difficult for Congress to enact better tax gap measures that will really get at the tax gap because they have to carve out from any new 1099 reporting requirement, payments made by credit/debit card or Paypal to avoid duplicate reporting.
State and multistate tax actions - there has been continued movement to economic nexus for income tax by more states, legislative activities to broaden sales tax nexus with questionable constitutionality; some efforts to provide guidance on taxation of coupon deals (such as Groupon) and cloud computing. State legislatures focused on accountability for special credits and deductions - more so than in the past.
Federal tax reform - over 25 hearings on the subject were held by the Senate Finance Committee and House Ways and Means Committee. I'm sure they learned a lot, but a lot of it were obvious things about complexity and burdens on small businesses. It is time now to take all of this testimony, identify goals for reform, and start writing legislative language.

Next, the most significant developments, I think:

The continued rollout by the IRS of the regulation of paid return preparers including the exam that 1040 preparers who are not active CPAs, attorneys or Enrolled Agents must pass to continue to be eligible to prepare 1040s. I have been including this topic even in my updates to CPA groups because I think they are going to soon have clients asking them if they are a "Registered Tax Return Preparer" so they need to know what that even means.
I think we are going to see a major reduction in the number of special tax credits, deductions and exclusions ("tax expenditures") to help pay for a lower corporate tax rate and to pay for keeping some rate cuts for individuals and to help pay down or multi-trillion dollar deficit and debt.
2011 actions may lead Congress to finally enact legislation to effectively overturn the 1992 Quill decision to allow states with the right kind of simplification measures in their sales tax to collect sales tax from remote vendors. I think the bill that will be taken up is S. 1832 - the Marketplace Fairness Act which is supported by Amazon and California BOE chair Horton. States are in need of revenue and the feds can't offer much assistance due to its one revenue problems. So, passing S. 1832 will be one way to help get money to states because compliance by vendors will be much higher than the very low compliance by consumers self-assessing use tax.

What do you think?

The New Marketplace and Relevance to Tax

2011-12-08T09:12:00.000-08:00

A year ago, eBay announced its acquisition of Milo which provides online information on prices and availability in local stores. This should aid in the merger of online and in-store shopping and use of mobile applications. It potentially brings about a new meaning of “marketplace.” With the acquisition, Mark Carges, CTO and senior VP, global products, eBay Marketplaces stated: “Since eBay is an online marketplace and doesn’t compete with brick-and-mortar stores, adding local store inventory to the eBay marketplace is a natural extension of what we’ve been doing for 15 years – bringing buyers and sellers together to access the largest selection available anywhere.” (12/2/10 press release)

Here is a recent article from Internet Retailer, "Updated Milo app enables mobile checkout and in-store pick up" by Kevin Woodward, 12/6/11 on the use of Milo for shopping ease.

On 12/6/11, Amazon issued a call for people to help it get price information. A press release of 12/6/11 is entitled - "Is That Deal Really A Deal? Use the Price Check by Amazon App to Make Sure." It calls upon consumers to download the free "Price Check" app for the iPhone and Android and use it to check prices against what Amazon and its sales partners offer. There are four ways a consumer can input a price into the app for verification: (1) scan the product's bar code, (2) take a picture of the item for a photo match, (3) speak the name of the product into your device, or (4) type in the product name.

This all seems to get Amazon more data for helping to set its prices - and to help make sales. For example, you are in a physical store and want to see if you can get a better price at Amazon. So you use the price check app. Being connected to the Internet, you can also, of course, order the product from Amazon right then. So you get to see and touch what a store is trying to sell you, but if you find a better price at Amazon, you can purchase it right then - you, of course, won't get to take it home with you. The first two lines of the press release offer encouragement for consumers (with the right technology) to help Amazon (and help yourself at the same time):
"As an added incentive, on December 10^thAmazon is giving customers using Price Check an additional 5% discount (up to $5) off the Amazon price on up to three qualifying items in toys, electronics, sporting goods, music and DVDs."
"Shoppers can also start submitting in-store prices with the Price Check app, ensuring they are really getting a deal and allowing all Amazon customers to get the lowest prices year-round."

I think a lot of shopping will become one of checking prices (which if you are already on your computer, we have been doing for sometime) and seeing who can get it to you cheapest. Perhaps in-store shopping will just be when we want it right away. And given that we are more prone to wanting instant gratification, will keep brick-and-mortar stores in business. I think such stores though may need to find ways to bundle goods and services. For example, buy the equipment here and we'll show you how to use it or we will come to your home and set it up.

Tax relevance:

Borders become less relevant as consumers buying online may not even know where the product or service originated. But states are moving to market sourcing for goods and services so sellers do need to know the location of the buyer. Mobile and stationary electronics will likely need to have a location default in them unless states do want to source a sale, for example, to Illinois because the California buyer was at the Chicago airport waiting to board a plane. That seems too difficult to track and audit.
Build the sales tax assessment and collection feature into the selling websites - states need to create a "sales tax app." It will collect the sales tax at the same time the buyer clicks to buy the item with the same funding source (Paypal or credit card, for example). This should become the standard for sales tax collection. Sourcing will have to be worked out, but technology should also be able to handle that. If purchasing on your mobile device, it knows where you are and can default to pay the state's sales tax for the jurisdiction you are in AND if your state's sales tax rate is higher, it can charge the difference to your state's tax authority (unless it is a meal consumed on the premises).

Eventually, sellers will not need to deal with sales and use tax because:

All sales would be run through the "app" so the tax is collected and remitted to the appropriate state at the same time the goods or services are purchased. Auditors would just need to verify that the technology is working.
Sales tax bases should be broadened for many reasons (such as equity and simplicity) but would also make it easier for the app to work - full amount charged to consumer is subject to sales tax.
States should move to exempting purchases by businesses (to eliminate pyramiding of the tax). So another verification for the app would be the type of buyer - consumer or business. But, some buyers have dual roles. So, a VAT would be better. Everyone is charged sales tax and if you are a business, you keep records to apply for a sales tax refund. But, technology should be capable of even avoiding this paperwork by a dual check - let the buyer and seller both have to enter whether the purchase is for business or consumption.

Other ideas? What do you think?

California and Incentives for Job Creation and Innovation

2011-12-07T10:04:00.000-08:00

On 12/5/11, the California Assembly Revenue & Taxation Committee held a hearing on job creation and innovation (see prior post). I had the opportunity to testify. A few points I offered:

California has one of the most generous research tax credits among the states and an underutilized jobs credit. Identify why these provisions are not promoting job creation and innovation to the desired level. For example, in 2009, $400 million was set aside for a $3,000 per new job tax credit for employers with employees with less than 20 employees. In November 2011, only $75 million has been used.
Conform California law to more favorable depreciation rules of federal MACRS and Section 179 expensing. Encourage Congress to allow the IRS to update depreciable lives, such as for computers and semiconductor manufacturing equipment which generally is too long (5 years). In addition, encourage Congress to modernize Section 179 to apply to both tangible and intangible assets. While there should be discussion of whether any special rules, such as tax credits, should be in the law (they tend to add complexity and inequities and inefficiencies), there are considerations in designing the base that affect the economy. For example, to calculate taxable income of a business, depreciation needs to be calculated. If equipment can be depreciated using double-declining balance over 3 years, that has a different economic impact and affect on interstate and international business competitiveness than straight-line over 10 years.
Encourage Congress and the IRS to improve the federal research tax credit including making it permanent.
Develop a plan to phase out the sales tax on business purchases of manufacturing and R&D equipment. This might be funded by broadening the sales tax base for consumers to include consumption of personal services and digital goods, and to repeal the elective approach to apportionment (adopting the single sales factor approach due to its economic development foundation).
Be ready with incentives for corporations to utilize cash in California should the federal government enact a repatriation tax break.

I had 18 recommendations which you can find here.

Four items in particular I found interesting about the hearing:

Three people testified via Skype - we could see and hear them well and they could hear us and participate. It did go down once for a few minutes, but technicians restored the connections.
The business rep panel for the most part suggested that California needs to get rid of the elective apportionment and go to just single sales factor apportionment. I agree and had the opportunity to note that, today, the corporate income tax has become an economic development tool. Thus, if we want to use it to encourage companies to locate employees and property in the state without having their tax bills go up, we offer single sales factor apportionment. But, at the same time to tell companies that do not locate payroll and property here, we want your CA taxes to be lower too, we are just fools (I didn't say fools, but that is what we are).
Professor Robert S. Chirinko, University of Illinois at Chicago, shared some of his research findings on the benefits of jobs credits. In a nutshell, that research found that there were no benefits. He also noted that such provisions can have some negative impact because when enacted, the incentives are not usually immediately effective so employers delay hiring until the effective date.
The Legislative Analyst's Office seems to have modified its view on the California research. James Nachbaur, an economist with the LAO presented a background paper on the credit. In a 2003 report, the LAO stressed that a key purpose of a research credit is to address spillover effects, but that the federal credit already handles that so why would a state also offer a credit? The 12/5/11 report notes that 2003 comment, but does not emphasize it. I think this may be because since 2003, corporate income taxes have become more of an economic development tool meaning that we should view a state research credit primarily in terms of whether it causes companies to engage in R&D in the state rather than elsewhere.

The hearing information should be posted to the committee's website soon.

What do you think?

CA Revenue & Taxation Committee holding hearing at SJSU on 12/5/11

2011-12-02T18:12:00.001-08:00

The California Assembly Revenue & Taxation Committee is holding a hearing on the San Jose State University campus on Monday, December 5, 2011. Details:

REVENUE AND TAXATION
PEREA, Chair
9:30 a.m. to 12:30 p.m. - San Jose State University
Student Union, Second Floor - Music
One Washington Square
San Jose

CALIFORNIA'S HIGH TECH SECTOR: PROMOTING JOB CREATION AND INNOVATION
THROUGH SOUND TAX POLICY

The agenda:

1) Introductory Remarks by Henry T. Perea, Chair (3 minutes)

2) Introductory Remarks by Tim Donnelly, Vice-Chair (3 minutes)

3) Tax Policy, Job Creation and Innovation: Perspectives from the Industry
(45 minutes)

a) Corey C. Owens, Associate Manager of Public Policy, Facebook

b) Jim Hawley, Senior Vice President & General Counsel, TechNet

c) Jon Haveman, Chief Economist, Bay Area Council Economic Institute

d) Gail Maderis, President & CEO, BayBio

4) Tax Policy, Job Creation and Innovation: Perspectives from Tax Experts
(60 minutes)

a) James Nachbaur, Economist, Legislative Analyst's Office

b) Robert D. Atkinson, President, Information Technology and Innovation Foundation

c) Dan Berglund, President & CEO, State Science & Technology Institute

d) Robert S. Chirinko, Professor of Finance, University of Illinois at Chicago

e) Annette Nellen, Professor of Accounting and Finance, San Jose State University

5) Public-Private Partnerships (60 minutes)

a) Mohammad H. Qayoumi, President, San José State University

b) Carol Mimura, Assistant Vice Chancellor for Intellectual Property & Industry Research Alliances (IPIRA), University of California, Berkeley

c) Elizabeth Seifel, President, Seifel Consulting, Inc.

d) Kim Walesh, Director of Economic Development, City of San José

6) Public Comments (15 minutes)

7) Chair's Closing Remarks

I'm glad to hear the part about promoting "sound tax policy" - that's always good. How much should the tax law be used as a tool to try to promote job creation and innovation? Well, it should at least not be structured to hinder job creation and innovation. I'll be testifying on how tax policy should be considered in tax design. One point I like to make is that the taxing jurisdiction's economic, societal and environmental goals should be known and the tax law should not work counter to such goals. For example, in 2009, California adopted single sales factor apportionment which is generally good for in-state businesses, but at about the same time, increased the sales tax rate which hurts in-state companies buying equipment.

Well, back to drafting testimony!

Governor Brown and possible rate increse proposal

2011-12-01T17:12:00.000-08:00

The Mercury News reports that on Friday (12/2/11), Governor Brown may propose sales and income tax rate increases to address continuing budget problems. The income tax rate increase would likely be for individuals with over $250,000 of income. ["Gov. Jerry Brown to add income tax increases to budget plan" by Harmon, 12/1/11]

Expected budget shortfalls are $4 billion for the current year and $13 billion for next year.

These are both unfortunate proposals. Some problems:

Our sales tax rate is already too high relative to other states and for meeting the equity principle. The base should be broadened rather than increase the rate.
Our personal income tax is volatile. That problem is exacerbated with even higher rates.

There are other solutions:

Broaden the sales tax base to include digital goods and services purchased by consumers (not by businesses) (exclude non-elective medical services)
Enact an oil severance tax.
Increase the excise tax on gasoline.
Move to only having a single sales factor apportionment formula.
Reduce tax expenditures, such as the interest deduction for a debt on a second home or a mortgage greater than $500,000; phase-in the changes.

What do you think?

Growing income inequality and the federal tax system

2011-11-27T05:31:00.001-08:00

Laura Tyson of the Haas School of Business at UC Berkeley has a post on the Economix blog of the NY Times for 11/18/11 - "Tackling Income Inequality." She summarizes and analyzes data on changes in income and its elements (such as wages and capital gains) and how the income of the top 1% has "soared." She notes that there is reason for the Occupy Wall Street folks to focus on this topic.

The data is from a recent Congressional Budget Office report - Trends in the Distribution of Household Income Between 1979 and 2007 (10/11).

Tyson focuses on taxation of capital gains. She notes that when she was President Clinton's economic adviser, she led a study on the effects of reducing the capital gains rate. Per Tyson: "We concluded that a cut would decrease future tax revenue, would contribute to rising inequality and would not increase saving and investment as its advocates asserted." She also reminds readers that to reach a compromise on the budget, President Clinton signed legislation that dropped the top capital gains rate from 28% to 20% in 1997. That rate was dropped to 15% and also for qualified dividends, a few years later by President Bush and today, many believe it should stay at that rate.

Tyson also notes what is an income inequality issue and what becomes a federal revenue issue: "Capital and business income are much more unevenly distributed than labor income and have become more so over time. Capital gains income is the most unevenly distributed — and volatile — source of household income."

I have blogged on this before to offer another perspective to consider with respect to the concern some raise that many individuals with income under $50,000 don't pay federal income tax (for example, 5/8/11 post). (For more on data from Tax Policy Center that for 2011 46% won't owe federal income tax - see their blog post of 7/27/11.) A 15% capital gains rate versus a 20% capital gains rate provides a $3,000 tax savings to someone with $60,000 of capital gains. So why a focus on someone with $50,000 of income perhaps not owing $3,000 of tax rather than the higher income person (with capital gain income) saving - and it is an even greater savings if the capital gains rate had stayed at 28%.

Back to the Tyson article - she suggests to address budget problems and reduce growing income inequality, to return ordinary and capital gains tax rates to what they were when Clinton left office, taxing some carried interests as ordinary income, adding a progressive consumption tax (no details of what it might be), and lowering the corporate tax rate (paying for it with the increased capital gains rate).

I encourage reading of both Dr. Tyson's article and the CBO report - interesting data and ideas.

What do you think?

Unofficial IRS Guidance and Transparency and Possible Solutions to This Taxpayer Rights Issue

2011-11-26T04:20:00.001-08:00

An October 31, 2011 article in Tax Notes - "Olson Says Informal IRS Guidance Lacks Transparency" ties to an issue I've been highlighting for the past year. The issue is the growing amount of "guidance" being issued by the IRS that is not official guidance that could be relied upon to avoid taxpayer or preparer penalties. The items issued include FAQs and form instructions. In addition, some appear in Chief Counsel Advices (CCA) which is also not "authority" for purposes of, for example, having "substantial authority" to avoid penalties.*

Per the Tax Notes article, National Taxpayer Advocate Nina Olson observed that "the lack of high-level policy input can unintentionally harm taxpayers." (p. 564) She also observed that under the FAQ system, taxpayers do not know "what comments are submitted; there is no real deliberative process." Olson's comments were made at a panel presentation at the ABA Tax Section meeting in Denver.

Why does the informal guidance process continue? Can't Nina Olson raise this as a taxpayer's rights issue? IRS time spent on issuing informal guidance on substantive topics where there is no official guidance? Subsequent to writing an article, "How Heavy is an IRS FAQ?" in the AICPA Tax Insider in November 2010, I submitted the issue to the National Taxpayer Advocate website for submitting issues. I suggested they work to resolve this guidance problem with one way being to make the FAQs official guidance, such as by publishing them in the Internal Revenue Bulletin. The response was telling me basically, that such guidance does not avoid penalties - the exact issue I was raising. Hopefully Olson's comments at the ABA Tax Section meeting may mean that she is going to pursue this.

*The IRS website on Understanding IRS Guidance does not list FAQs or CCAs. It just lists IRS guidance that per Reg. 1.6662-4 is considered "authority" except the IRS website doesn't include General Counsel Memorandum (GCM) which the IRS hasn't issued in years. GCMs are included as authority in the regulation. I think the omission of CCAs from the website list is because they are not the same as GCMs. But it would be helpful for the IRS to clarify this. FAQs and CCAs are not mentioned in the Internal Revenue Manual (IRM) on researching the tax law.

I have heard that the IRS likes the FAQ approach because they can issue it quicker. That is because it is not getting the same deliberative attention and official documentation that proposed regs or revenue ruling revisions. But, this is like saying, my job is complicated and time consuming so I just skip the hard parts. Why is this tolerated?

Solutions:

Make the time to follow the revenue ruling process or regulations process to issue guidance. If the IRS is shorthanded, ask Congress for more resources (or to stop adding so many new provisions to the law). Seek the help of tax practitioner groups. The AICPA and ABA (and others) already devote a lot of practitioner volunteer time to commenting on proposed regs - use that brainpower and donated time to draft the guidance and critique the issues.
Make FAQs and CCAs with substantive guidance "official" by publishing them in the IRB.

What do you think?

Think Long Committee Ideas for Improving California

2011-11-24T06:45:00.000-08:00

"The Think Long Committee for California aims to offer a comprehensive approach for repairing and renovating California's broken system of governance while proposing policies and institutions vital for the state's long term future." That all sounds good!

The Think Long Committee for California of the Nicholas Berggruen Institute released a report this week that explains many of California's problems, such as outdated and decayed infrastructure and finance system. The goal of the project leading to the report was to create an "integrated set of proposals" t0 "update and modernize the state’s broken system of governance."

The multi-faceted proposal is described as having three key components:

Empowering local governments by creating a structure that enables them to make and carry out decisions

An independent citizen watchdog organization to counter short-term thinking of elected officials and too much focus on special interests

A modernized tax system with broader bases and lower rates for most taxes

The tax proposals include lowering rates of the personal and corporate income tax as well as the sales tax. The sales tax would be expanded to include services. Multistate income would be apportioned using a mandatory single sales factor

PIT rates would be 0 to 8.5% (including the mental health tax imposed on individuals with income greater than $1 million). The only deductions would be a larger standard deduction and specified itemized deductions (mortgage interest, property taxes, charitable contributions and R&D). Most credits would be eliminated.

The corporate rate would be lowered to 7%.

The homeowner's property tax exemption (currently $7,000) would be doubled with a similar change to the renter's credit.

There is mention of the need to generate revenue to address deficits

The suggested sales tax rate on services would be 5% but 4.5 % on goods. Low-income taxpayers would receive a sales tax rebate.

The structure would enable additional revenues to be collected to reduce current deficits.

Comments:

It is great to recognize the need to move California's tax system into the 21st century.

Lowering rates and broadening bases is a good way to better enable a tax system to meet principles of good tax policy such as simplicity and neutrality.

Why not further cut backs to itemized deductions? For example, there is no reason for either the federal government or the State of California to subsidize financing of an individual's vacation home. And, the $1 million debt limit should be reduced in recognition that the median home price is far less than that.

Will the sales tax also be extended to digital goods? (it should be)

Will the expanded sales tax base not apply to business purchases? (these should be exempt for businesses)

A 5% sales tax rate on services and 4.5% rate on goods will bring unnecessary complexity to a system and increase the need for audits. For example, it is not always easy to distinguish a service from a good. Also, there are many businesses providing both. For example, an auto repair shop would be motivated to increase the markup on the parts and charge less for the services in order to reduce sales tax owed by customers.

A doubling of the homeowner's exemption results in a $70 property tax reduction for homeowners ($7,000 x 1% property tax rate). It is probably not worth the change and homeowners are not, to my knowledge, calling for an increased exemption (I'm sure most homeowners don't even know about it).

Increased renter's credit - how does this tie to the sales tax rebate? Are both needed?

Will the sales tax rebate be refundable ? (it should be)

Why not also increase the gasoline excise tax to help pay for improving road infrastructure and to recognize that California as ambitious greenhouse gas emission reduction targets?

I think this is all a positive step for improving California's budget, financial and infrastructure weaknesses. The tax proposals are a good start and the focus on broader base with lower rates should make for a much better tax system.

What do you think?

USA Today - story on shopper's use tax responsibility

2011-11-23T06:40:00.000-08:00

One approach for increasing use tax collection that I have noted frequently is better education for consumers so they even know the tax exists. I think if you ask most people if their online sales where sales tax was not charged if they know they owe use tax, they would be surprised.

A 11/22/11 USA Today article - Your Money: E-shoppers' sales tax responsibilities, by Sandra Block, reminds shoppers that they likely owe tax on such purchases even though the vendor has not charged it. The article even mentions the 1992 decision of the US Supreme Court (Quill) that held that a vendor is only legally obligated to collect sales tax if it has a physical presence in that state.

What about reminders from states being published in places where shoppers will see them? I haven't seen any such reminders? Have you?

More on affiliate nexus - Amazon-style + possible federal action

2011-11-22T11:54:00.000-08:00

If you are looking for background on the affiliate nexus ("Amazon" type) legislation that has been enacted in varying forms in eight states to date, as well as legal issues and compliance considerations, see my article in the CA Bar Tax Network newsletter for November 2011:
From Website Links to Collection Points

Also, don't miss the National Retail Federation's ad - "Why you should care about online sales tax legislation." The ad encourages retailers not involved in online sales to support federal legislation to enable states to require remote vendors to collect sales tax. The NRF notes that states would gain about $24 billion. Here is a line I like: "It’s NRF’s view that businesses need a 21st century tax system that works with 21st century retail. And now is the time for Congress to act."

NRF notes that there are 3 federal proposals but does not take a stand on any particular version. Instead, NRF notes: "NRF strongly supports federal legislation that would make it easier for states to require all Internet retailers to collect sales tax in the same way as local stores."

I think something is going to pass - probably S. 1832 (112th Congress) because it helps states that adopted the SSUTA as well as states that have not and probably will not. If non-SSUTA states enact the simplifications specified in S. 1832, they would be able to get remote vendors (but not de minimus ones) collect sales tax. With states eager for funds and Congress unable to give them much given federal budget problems, passing S. 1832 would be a way to indirectly get money to states.

What do you think?

Too much bipartisanship for tax and budget reform - too bad for federal finances

2011-11-21T22:54:00.000-08:00

It is unfortunate that the Select Committee is unable to reach a compromise to find $1.5 trillion to budget changes to reduce the deficit over a ten year period. It is unfortunate for many reasons such as:

We really need bigger changes than just the $1.5 trillion.
If members cannot work together it is unlikely that the serious budget and tax problems we have can get resolved in a productive manner.
Many of the changes that are needed should not be tied to politics. There are many areas of spending that defy logical explanation.

Regarding that last point, let's hear from politicians as to why the tax law:

allows a interest expense deduction for the mortgage on one's second home.
allows an interest deduction on up to $1.1 million of debt on a principal residence when the median home price in the US is under $250,000
allows employees to exclude all of the health insurance benefit they get from their employer (why not tax at least 20% of it as a starting point - that would result in about $800 of tax for a $10,000 policy - good deal!)
allows a capital gains rate of 15% (although temporary through 2012) - after the TRA86, the capital gains rate was 28%

And there is more. For example, why are across the board cuts better than targeted ones that get at areas of waste?

For a story on the impasse - see the Wall Street Journal, Debt Panel Folds Its Tent (11/21/11).

What do you think?

Spending, recession and sales tax

2011-11-19T07:04:00.001-08:00

The California Board of Equalization Economic Perspective report for November is on Impacts of the Recession by Income Class and Type of Purchase. The report analyzes U.S. Bureau of Labor Statistics data on spending and income. Some findings:

Form 2007 to 2010, spending in all income quintiles is down except for the lowest quintile where spending increased which the BOE expects is due to prices increases for rent and food.
As shown in Chart 3 posted here, spending on items not subject to sales tax increased while spending on non-taxable items decreased. Per BOE: "This pattern of larger declines in spending on taxable goods than nontaxable goods and services partially reflects the design of the tax system, which excludes from taxation spending on necessary items such as food for home consumption."
"One component of consumer spending that seemed to be relatively “recession proof,” was spending on pets, hobbies, toys, and playground equipment."

The spending patterns affect sales tax collection as recession spending affected spending on taxable and non-taxable items differently. But the greater spending on non-taxable items versus taxable ones is a longstanding trend where consumption of services and intangibles has been growing for decades which spending on goods has declined. With movement of some purchases from tangible goods to the digital equivalent (software, music and books for example), the California sales tax base erodes. See June 2011 BEA report, table 1 - here, showing that from 1959 to 2009, personal consumption spending on goods dropped 22% and spending on services increased 22%.

As I've discussed here many times, it is well past time for California to modernize its sales tax base to cover 21st century consumption. The sales tax should be expanded to personal services and digital downloads purchased by consumers (not businesses) and the rate lowered.

See:

Nellen, sales tax base is too narrow - here
California Budget Project, Budget Backgrounder - Should California Extend Its Sales Tax to Services (October 2011)

What do you think

Problems with small business health insurance credit

2011-11-16T14:09:00.000-08:00

To help more people have health insurance, the health care legislation enacted in March 2010 included a new credit for small employers. This provision at Internal Revenue Code Section 45R - Employee health insurance expenses of small employers, is complex. Just look at what it takes to describe this credit:

IRC Section 45R

IRS website on the credit

IRS 1-page fact sheet showing 3 simple steps (note the number of terms you need to know and the data you need to gather, such as the average employee wage)

36 FAQs from IRS

Notice 2010-44 (20 pages) explaining how it works

Notice 2010-82 (19 pages) expanding on Notice 2010-44

The target audience for the credit - small employers, measured by number of employees and their average full-time equivalent wage. They will face an added expense of either having an employee figure out the credit, which also involves getting information from the insurance company, and/or paying a tax adviser to compute it.

A TIGTA report Affordable Care Act: Efforts to Implement the Small Business Health Care Tax Credit Were Mostly Successful, but Some Improvements Are Needed (11/7/11), noted:

“despite IRS efforts to inform 4.4 million taxpayers who could potentially qualify for it. According to the IRS, as of mid-May 2011, just more than 228,000 taxpayers had claimed the Credit for a total amount of more than $278 million. The IRS plans to conduct focus groups to determine why the claim rate was so low. The Congressional Budget Office estimated the Credit would cost $37 billion over 10 years and that taxpayers would claim up to $2 billion of Credit for Tax Year 2010.”

On November 15, the House Ways & Means Committee held a hearing on the credit. The complexity of the credit and its low usage were highlighted by the witnesses. For a brief summary, see Journal of Accountancy article (AICPA Tax Division Chair Patricia Thompson testified for the AICPA).

Why these problems with the credit? There are a few:

Special rules intended to apply to a target, narrow population require detailed terms to define that population and what qualifies for the credit and what does not.

Existing definitions were not used. Throughout the federal income tax there are definitions of "small" yet none of those definitions were used to for the health care credit.

The premise is flawed - why perpetuate a decades old circumstance that led employers to provide health insurance to employees? When will health care reform break this model that increases health care costs, provides a competitive disadvantage to US employers, makes the tax law inequitable in that employees with health insurance coverage from their employer get a BIG tax break while those who have to buy their own get little, it adds complexity to the law. (See a 2008 article of mine on this - "Pot of Gold in the Employer-Provided Healthcare Exclusion.")

What do you think? Should Congress try to simplify the credit or repeal it and find another solution to reduce health insurance costs to broaden coverage?

Rough Road to Even a 28% Corporate Tax Rate

2011-11-16T02:02:00.000-08:00

We have heard suggestions for dropping the corporate income tax rate from its current 35% to perhaps even as low as 15%. Typical suggestions seem to be for 28% or 25%. President Obama and others will require that any decrease be revenue neutral.

Democrats on the House Ways and Means Committee asked the Joint Committee on Taxation to estimate what the rate could drop to if all tax expenditures were repealed either just for corporations or for all business taxpayers. The JCT's preliminary data was released earlier this month. It indicates that the lowest rate would be 28%, although it a longer budget window is used, it likely has to be higher.

I have a short article in the AICPA Corporate Taxation Insider (11/10/11) on the data and its implications. The vast majority of the "pay for" are timing items, such as using slower depreciation. That doesn't really raise revenue (at least in the long run). Some of the repealed tax expenditure are really simplifications, such as allowing small C corporations to use the cash method rather than the accrual method.

Links to the report and critique of this approach to pay for a lower rate, are included in the article. Also see 11/2/11 post.

Need to Fix Sales Tax Collection Problem

2011-11-13T08:43:00.000-08:00

A headline in today's Chicago Sun Times is a good reminder of the need to address the issue of sales and use tax not getting collected on a lot of online shopping done by consumers. The story title - "Tax-free shopping doomed?" by Kyong M. Song (11/13/11).

There has never been tax-free shopping on the Internet. It has only seemed tax-free because most consumers do not know about the use tax or don't pay it. And, states have had difficulties enforcing it (and done little to really educate consumers about the use tax).

There are currently three bills in Congress calling for some way to get more remote vendors to collect the tax, which would be the easiest way for the states to collect it and for consumers (no need to track what use tax you owe if the vendor collected it from you).

For a quick summary of the three proposals, see "Federal Proposals" - here.

I am doubtful if anything will be passed this year unless Congress feels that it a necessary option to help states gain some revenues.

What do you think?

Pushing for specifics on tax reform proposals

2011-11-11T06:53:00.000-08:00

There are quite a few vague tax reform proposals being touted by presidential candidates today. We have 9-9-9, variations of a flat tax, a reformed income tax and a corporate down to at least 20%. What is missing are the specifics of the proposals. Without fairly complete legislative language, it is impossible to really understand what is being suggested.

I have an article in this week's AICPA Tax Insider that summarizes most of these proposals based on what candidates have said so far or posted to their website (which are all still fairly general). The short article includes some suggestions for what additional information is needed and how to critique the proposals. A reference list (link) is included with links to the various proposals.

Check it out - Pushing For Specifics on Tax Reform Proposals.

What do you think?

AICPA suggests that Select Committee follow principles of good tax policy

2011-11-10T02:35:00.000-08:00

I am pleased to see the AICPA Tax Division send a letter to the Joint Select Committee on Deficit Reduction (the one to create a plan to reduce the deficit by $1.5 trillion). The letter suggests the importance of following principles of good tax policy. Per the introduction of the letter:

"The public meetings of the Select Committee have evidenced an interest on the part of at least some members in addressing tax reform as part of your process. The AICPA has published four Tax Policy Concept Statements which discuss various principles of good tax policy, which we believe can frame any discussion of tax reform. This letter contains a high level summary of each of these statements, as well as links to the complete documents on our website."

It is a nice summary of four sets of policy statements the AICPA has released on principles of good tax policy. This work started in the 1990s when the AICPA was looking at what it might be able to add to the tax reform discussions underway in the mid-1990s. I was serving on the AICPA's tax policy and legislation committee at the time and got the opportunity to take the lead on the tax policy statement.

I encourage reading of the letter - it is a nice reminder of principles that can help bring some objectivity to tax reform discussions. Click here for the letter.

Economy continues to hurt states

2011-11-07T08:17:00.000-08:00

A Reuters article (11/3/11) by Nanette Byrnes - "Analysis: Economy's shifts erode states' tax bases" notes some new and continuing woes for state budgets:

Growing pressure on volatile personal income taxes for revenues.
Figuring out how taxes apply (or don't apply without legislative change) to new economy transactions such as Groupon and Living Social coupons and e-commerce in general.

States have been in tough times for several years now. Some of their woes were covered via tax shifts, such as suspending the use of net operating losses and credit carryovers. Temporary tax increases were also used, such as in California. But the temporary tax increases may have expired, such as is the case in California, under the initial thinking that the economic downturn would have reversed by now.

What should California and other states do to address continuing budget woes caused by weakened revenue collections due to the weakened economy? What do you think?

California Budget Problems and Possible Solutions

2011-11-06T09:10:00.000-08:00

This is a slide from a 10/27/11 presentation by the Legislative Analyst's Office on California's Budget Woes. I encourage you to look at the entire slide deck to get a better understanding of some of California's significant budget problems that include current revenue shortfalls and large future liabilities such as over $150 billion of unfunded pension and retiree health benefits.

Some people are not concerned with the volatility of the personal income tax (PIT) saying that just means the tax is tracking the economy. That is, incomes go up, so does the tax base. But as the LAO indicates on the slide above, the PIT is more volatile than the economy. That harms the ability of this tax to fund government expenditures, which is the key purpose of a tax. Worse yet for California is that the PIT provides over half of state revenues. This is far greater than the role it played in 1969-1970 as shown in the following LAO slide.For my list of California tax system weaknesses - check out this page.

The last slide (#36) notes that tax reform is a possible solution, but that it is "an incredibly difficult task with no clear consensus on what to do." That's sure true. Unfortunate but true. And, after Prop 26 (Nov 2010), any tax reform will need a 2/3 vote of the legislature. Any tax bill that needs a 2/3 vote will be labeled as a tax increase which will lead many Republicans who have signed the no new tax pledge to not vote for the measure even though it would help the state tremendously.

Here are a few tax and budget reforms that California needs:

Expand the sales tax base to include digital goods and personal services. Transition in the changes, provide vendors with a refundable credit to help cover their new compliance costs, and don't apply the tax to purchases by businesses. Use some of the new revenue to cover our deficit and the rest to lower the sales tax rate.
Work with Congress to get legislation passed that allows the state to collect sales and use tax from remote vendors.
Phase out the mortgage interest deduction for debt on a second home, for home equity debt and for acquisition debt greater than $500,000.
Change the senior exemption to be based on income rather than age.
Eliminate the choice of apportionment to move to a single sales factor with all sales sourced based on market.
Increase the gasoline excise and tobacco excise taxes.
Enact an oil severance tax with the revenues to go into the General Fund with no earmark.
Create a rainy day fund to start in 2 years. Funding of it should include 10% of taxes paid on capital gains.

What do you think? What would you suggest for California tax reform?

The Tax Law with a Revenue Neutral 28% Corporate Tax Rate

2011-11-02T23:37:00.000-07:00

Over the past few years, various numbers have been suggested for a lowered corporate tax rate. Typically, the range from 20% to 28%. This week, the Ways and Means Committee Democrats released a "very preliminary" (JCT words) estimate of what revenue-neutral rate is possible if all tax expenditures (special deductions and credits) are eliminated for corporations. The rate would be 28%. The Democrats are apparently touting this because Chairman Camp released a work-in-progress proposal called the Tax Reform Act of 2011. His proposal calls for a 25% corporate rate and a move to a territorial system (rather than worldwide) along with a few other international tax changes. He promises individual reforms and additional corporate ones at a later date.

I'll have more on this later, but a few things to consider now:

1. Would Congress really repeal ALL tax expenditure for corporations? The largest revenue raiser by far in the list of replacing MACRS depreciation with ADS depreciation (straight-line with longer lives). Just over 70% of the revenue raised to cover the "cost" of a 28% rate (about $71 billion per year) is from this MACRS change. Won't less favorable depreciation than we have now harm international competitiveness?

2. Won't there by some transition rules? They cost extra.

3. What will be the cost of other business entities that have a rate higher than 28% converting to C corporations?

4. Some tax expenditures, such as allowing small C corporations to use the cash method rather than the accrual method are for simplification purposes? What is the purpose of removing them?

5. Other than some credits that would go away, the changes mostly appear to be timing differences. This really doesn't raise any revenue in the long run. In fact, the JCT points out that if you look beyond a 10-year budget estimate, the revenue neutral rate is likely higher than 28%. Note that many credits are not included in the list because the projections cover 2012 - 2021 and many credits, such as the research credit expire before 2012.

For more information (again, I'll have more soon when an article of mine is published), see

"Break-Free Corporate Tax Code Misses Republican Rate Goal," by Steven Sloan and Richard Rubin, Bloomberg, 11/2/11
Democrats press release (11/2/11)
JCT release with the "very preliminary" data
Chairman Camp's Comprehensive Tax Reform proposal

What do you think?

Higher Education Tax Breaks Violate Several Principles of Good Tax Policy

2011-10-29T12:50:00.000-07:00

Laura Saunders' Wall Street Journal article of 10/29/11 - "Back to School" includes a nice summary of many of the numerous special rules in the federal income tax that provide a tax break for either saving for high education costs or currently incurring them. I have written before about the problems many of these provisions post by being in the tax law (such as 3/8/11 and 3/22/11). These provisions, such as deductions for higher education expenses and $2,500 tax credits for each of the first four years of college) violate principles of equity, neutrality, simplicity and transparency. As noted in a report issued last week by the Treasury Inspector General's office (TIGTA), they also violate the minimum tax gap principle.

The title of the press release of the TIGTA report says a lot - 2.1 Million Taxpayers May Have Received $3.2 Billion in Erroneous Education Tax Credits (10/20/11). Worse yet, 52% of these returns were prepared by a paid preparer. I think that notes the complexity of the provisions. Also noted:

"Other findings include:

370,924 taxpayers received an estimated $550 million in education credits for which they were not eligible because they did not attend college for the required amount of time and/or were post-graduate students.
84,754 students who did not have a valid Social Security Number (SSN) were claimed by taxpayers who received $103 million in education credits. Each of these students had an Individual Taxpayer Identification Number (ITIN).
63,713 taxpayers erroneously received an estimated $88.4 million in education credits for students claimed as dependents or spouses on another taxpayer’s tax return; and, 250 prisoners erroneously received $255,879 in education credits. Additionally, an estimated 52 percent of the returns with potentially erroneous education credits were prepared by paid tax preparers, who should have been aware of the eligibility requirements.

“Based on the results of our review, the IRS does not have effective processes to identify taxpayers who claim erroneous education credits,” said J. Russell George, Treasury Inspector General for Tax Administration. “If not addressed, this could result in up to $12.8 billion in potentially erroneous refunds over four years,” Mr. George added."

Among the 11 recommendations made by TIGTA, is the following (#2):

"Revise the Form 8863 to require taxpayers to provide identifying information for the educational institution that the student(s) being claimed for the education credits attended. This identifying information should include the name, address, and Federal EIN of the educational institution. In addition, the form should be revised to include specific information supporting key eligibility requirements that could be used to verify requirements were met which may serve as a deterrent for those taxpayers who intend to erroneously claim these credits."

Other recommendations include having the IRS pursue the erroneous claims and having Congress modify the law to give the IRS "math error authority" to allow for earlier identification of the errors. (footnote 23 of the report defines "math error authority" as "granted by Congress and allows the IRS to identify calculation errors and obvious noncompliance. This provides an administrative benefit to the IRS because it can correct certain errors during tax return processing without having to wait to audit a taxpayer’s return.")

Some solutions:

Any credit or special deduction enacted by Congress should include "math error authority" for the IRS.
Congress should stop creating new tax deductions and credits. If the benefits connected to them are so worthwhile, they should find a better spot for them. For example, if the education credits were instead offered as scholarships or larger Pell grants, this issues of them being given to people not even in college or without the proper identification would not happen. Also, the dollars could be distributed based on needs (those seeking Pell grants and other scholarships complete a FAFSA form) and they would be distributed when needed - when tuition is due!
Reduce the number of existing tax expenditures and use the extra dollars generated to pay down the deficit and keep lower rates for those using them (generally those under $150,000) by keeping their lower rates after 2012.

What do you think?

CBO Trends in Household Income and Relevance to Current Tax Reform Debate

2011-10-26T14:07:00.001-07:00

A lot of talk about tax reform today, including the proposals from presidential candidates, is either directly or indirectly about who should pay. The tax base and rate affect work, investment and spending decisions and affect how one's income and wealth may grow or not grow. For example, a few candidates are pushing for a consumption tax (Cain's 9-9-9 plan includes a 9% sales tax plus a 9% subtraction method VAT for businesses that will ultimately be paid by individuals; and Perry's flat tax). These are regressive taxes that without the Earned Income Tax Credit, will most likely result in a greater tax burden for low and middle-income taxpayers.

For over ten years, we have had lower capital gains rates than we had with the Tax Reform Act of 1986 which the maximum capital gains rate was 28%. In the late 1990s it was brought down to 20% (18% if the asset was held over 5 years) and the 2001/2003 tax cuts lowered the rate on many capital gains to 15%. The bulk of capital gain income is reported on the returns of high income individuals, such as Warren Buffett, bringing their average tax rate down often to a lower rate than middle-income taxpayers.

This week, the Congressional Budget Office (CBO) released a report - Trends in the Distribution of Household Income Between 1979 and 2007. Per the report:

"The share of income going to higher-income households rose, while the share going to lower-income households fell.

The top fifth of the population saw a 10-percentage-point increase in their share of after-tax income.
Most of that growth went to the top 1 percent of the population.
All other groups saw their shares decline by 2 to 3 percentage points."

The chart at the start of this post, from the report, highlights the significance in the changes between the quintiles and top 1%.

Should the lower qunitiles be taxed more? Can the top 1% pay more? These are good questions that I hope will be answered with the support of data by those touting any particular tax reform.

What do you think?

Taxes and behavior

2011-10-22T15:12:00.000-07:00

The "Up for Discussion" section of the Zocalo Public Square addresses the topic - "Taxes Hurt So Good." This ties to a presentation on 10/19/11 by Robert Frank, author of The Darwin Economy: Liberty, Competition, and the Common Good. Zócalo asked four professors (including me) about taxes and behavior. Zócalo's lead in ...

"Life has only one certainty other than death: taxes. And taxes may be less popular than death in 21st century America. Much of today’s politics is centered on opposition to taxes.

So what is the point of taxes? More than just securing money for the government. Taxes are often meant to promote good behavior. But are taxes an effective way of getting people to do something they otherwise would not do? And should we be using taxes this way? In advance of economist Robert H. Frank’s visit to Zócalo to ask, “Did Darwin Create Modern Economics?”, we checked in with some experts in tax policies about their thoughts."

That is a good question! As I noted in a blog post about today being the 25th anniversary of the Tax Reform Act of 1986, over 150 new provisions have been added to the federal tax law since 1986. That number doesn't represent modifications to existing rules, but new provisions. Many of them were intended to affect behavior in some way.

Psychology Professor Timothy Hackenberg of Reed College notes: "We have always had rules and regulations that temper unbridled self-interest. The real question is not whether to intervene, but rather, when we do so, whether we should continue to rely on intuition and conventional wisdom (as in the past) or use what is known about human behavior from a modern scientific perspective."

Take a look - here.

What Income Group Are You In? Help from Kiplinger website

2011-10-20T09:59:00.000-07:00

Kiplinger has a nice interactive website that allows you to enter your income so you can learn where you fall within various income groups, such as the top 5%. The results also provide some information on the percentage of tax paid by that group. It is a nice tool that can help people understand the debate going on now regarding various tax proposals. In addition to putting your information in, you should try a few other income levels to get an even better understanding of tax and income demographics in the US.

Here is the link - http://www.kiplinger.com/features/archives/how-your-income-stacks-up.html

What do you think?

Taxing the rich - interesting article in Christian Science Monitor

2011-10-17T05:03:00.000-07:00

Saturday's Christian Science Monitor had an extensive story on the current news item about President Obama's proposal on increasing taxes on individuals with very high income. See "Tax the rich: Should millionaires really pay more?" by Jessica Bruder (10/15/11). The article provides a variety of perspectives on the issue including some of the Wall Street protesters and some wealthy individuals. It also notes that some high income individuals in France and Germany are asking their governments to raise their taxes.

Former Labor Secretary Robert Reich is quoted as saying that the current issue is not just an economic one, but also a moral one. The article also refers to IRS data indicating that the top 400 income generators had an average tax rate of about 18%.

I encourage you to read the article - it is objective and raises a variety of things to think about in the real question of tax equity - how much should people at different income levels pay in tax.

My last post noted that 10/22/11 is the 25th anniversary of the Tax Reform Act of 1986. That Act resulted in two individual tax brackets - 14% and 28% with capital gains taxed the same as ordinary income. Today, most capital gains and dividends of individuals are taxed at 15%. Meanwhile, other income can be taxed as high as 35% (39.6% after 2012; and even higher due to some phaseout rules).

Perhaps the TRA86 structure with lower ordinary income rates and a broader base and fewer tax credits should be re-examined.

I am quoted in the CSM article noting that ideally tax reform should be non-partisan. Let's look at principles of good tax policy in identifying where improvements are needed. I also observe that any good tax change is challenged today when lawmakers are combining tax reform, deficit reduction and economic stimulus together.

What do you think?

10/22/11 - 25th Anniversary of the Tax Reform Act of 1986

2011-10-15T11:13:00.000-07:00

On October 22, 1986, President Reagan signed a bill that had been worked on by Treasury and Congress for over two years. The Treasury Department had started with an 800+ page report that examined existing law and its strengths and weaknesses and included a variety of proposals, including a VAT. That bill and its major tax revision was the Tax Reform Act of 1986.

In the past 25 years, some of the Act's key features have disappeared, such as a 2-rate structure for individuals that taxed capital gains the same as ordinary income. The TRA86's re-invigorated AMT for individuals was estimated to raise $334 million in 1991 (yes, million!). Today, the temporary "AMT patch" used to keep about 20 million individuals from owing AMT costs over $85 billion!

I have a short article in the AICPA Tax Insider this week - The 25th Anniversary of the Tax Reform Act of 1986, that provides some history and notes some of the significant changes in the law since 1986.

What do you think about Congress trying to get back to the TRA'86 along with instituting some international tax reforms/modernization?

The photo of President Reagan signing the TRA86 is from the Social Security Administration archive.

Reality Check - How Many People Have Income Above the Social Security Wage Cap + S. 1558 proposal

2011-10-12T08:44:00.000-07:00

There is an earnings cap on Social Security taxes, but not on Medicare taxes. For 2011, this cap is $106,800. Once an employee's wages or self-employed person's business income exceeds this amount, no more Social Security tax is owed for the year. In 2011, the employee's share of Social Security is 4.2% while the employer pays 6.2% (the employee's rate is scheduled to go back to 6.2% in 2012). The Medicare tax (1.45% each for employer and employee and 2.9% for self-employed) applies to all wages and self-employment income.

Much talk about the tax law and changes always sounds like the changes affect everyone directly. That is unfortunate because if we were talking about the tax issues facing the majority of U.S. taxpayers, we'd be talking about complexity of basic filing such as filing status, dependents, Earned Income Tax Credit and various education provisions. Instead, more talk is spent on the top corporate tax rate, the estate tax, repatriation, capital gains, energy credits, international tax provisions, and more. These later items involve a lot of dollars, but not always lots of taxpayers (at least not directly).

I mention this because of a report from the Center for Economic and Policy Research issued last month - "Who's Above the Social Security Payroll Tax Cap?" The issue paper explores who would be affected if the cap were removed and if it were instead raised to $250,000. It also reminds us that the vast majority of individual taxpayers (here, more specifically, workers) are not 6-digit (or greater) earners.

Their findings for 2009:

5.8% of workers had wages above $106,800 (so, 94.2% had wages below $106,800)

1.2% of workers had wages above $250,000 (so, 98.8% had wages below $250,000)

It is well depicted in a pie chart on page 3 of the report. They also break down the figures by various demographics.

The authors note that Senator Sanders (I-VT) is expected to introduce legislation that would keep the $106,800 cap (which is adjusted annually for inflation) but then remove it for wages above $250,000 (so no Social Security on wages between $106,800 and $250,000). I see that Senator Sanders has introduced S. 1558 which does just that. He calls this bill - `Keeping Our Social Security Promises Act'.

Some considerations:

What are the dollar amounts? What are the earnings for employees and self-employeds with earned income above $250,000?
Will the additional Social Security contributions lead to any increase in Social Security benefits for these individuals? If not, should there be a higher income tax rate with part of that money put into Social Security?
What other changes should be made to Social Security to improve it? I have heard some talk over many years about modifying the CPI approach for annually adjusting benefits. What has happened to that idea?
How does the S. 1558 proposal compare to the effect of the Medicare tax on unearned income of higher income individuals that goes into effect in 2013?
How doe the S. 1558 proposal tie to any discussion of keeping the 2011 tax rate cuts (originally the 2001/2003 tax cuts)?

What do you think?

SB 508 vetoed - the future of accountability measures

2011-10-10T09:00:00.000-07:00

I've discussed accountability in prior posts (such as 10/8/11 and 5/22/11 and 1/3/10) and there has been recent legislative activity in California, such as SB 364 and SB 508 both reaching Governor Brown's desk this month for signature (see 2011 posts above for information on these bills). This weekend, Governor Brown vetoed both bills as being too broad.

See Governor's veto messages for:

SB 364 (10/8/11)
SB 508 (10/9/11)

In vetoing SB 508, Governor Brown says he agrees with sunset provisions for personal and corporate tax credits, he thinks all bills should be examined to determine how long they exist rather than using a one size fits all approach.

I wish he had said more to help the legislature pass an accountability bill that he will not veto.

I wish he had said:

1. Do not be so narrow to only focus on special tax rules that come in the form of tax credits, also consider special deductions, exclusions, exemptions and rates.

2. Establish a framework that must be considered in all bills that create special rule to ensure that an appropriately tailored accountability system exists for the provision. Such a framework would get around the one-size-fits-all problem, yet would ensure that bills creating or modifying a special tax rule would have an accountability measure included with it.

In June 2009, I had an article, "Calls for Accountability: Will It Help the Overall Incentives Process?" in RIA's Journal of Multistate Taxation and Incentives. Here is an excerpt with an analogy to how businesses employ accountability measures. For the same reasons that businesses employ accountability measures to ensure they are spending their money wisely, government should do the same. The excerpt also includes an example of problems that can arise when goals and accountability measures are not included in tax incentives legislation.

"The Necessity of Accountability

While accountability often conjures up thoughts of someone looking over our shoulder or seeking reasons to deny a benefit, accountability is an important aspect in any decision for directing funds to a particular use.

Executive compensation analogy: Accountability in the incentives arena is analogous to what a business might do in designing a compensation package for an executive. Business X might use a signing bonus to entice an executive to leave his or her current job and take a new one at X. Arguably this upfront payment is risky because the executive might not work out. Yet, it is deemed reasonable due to the significance of the change X asked of the executive and the risk the executive assumed. Other incentives are likely to be performance-based, such as stock options and bonuses tied to meeting specific goals.

The executive’s compensation package is likely to include annual performance reviews, repayment of incentives for misrepresentations, and some protections for not meeting targets if due to reasons beyond the executive’s control, such as a natural disaster or an economic downturn. In designing the compensation package, X’s advisers will consider the short- and long-term goals for X and the need for accountability to shareholders.

Problems from inadequate accountability: Perhaps as frequently as the newspapers report companies leaving or moving to a state due to a package of incentives, there are reports of governments wasting funds on incentives that appear to have provided no benefit to the jurisdiction.

Lack of accountability can jeopardize incentives because with no data on use and effectiveness, the incentives are vulnerable to repeal due to the ease of arguing that their cost exceeds the benefits produced. In addition, it is important that the purpose and goals of an incentive be adequately stated up front so that accountability can occur. Otherwise, an incentive might be called into question because its supporters tout how wonderful it has been while its questioners tout that it has not lived up to its promise. For example, in California, some businesses state that enterprise zone incentives have worked effectively to stimulate the economy.[1] In contrast, the California Legislative Analyst’s Office has recommended that the enterprise zone incentives be phased out because they have not been shown to be cost effective in generating new economic activity in the state.[2] This extreme dichotomy of views likely indicates lack of sufficient data and specificity of goals to allow for effective accountability rather than an ineffective incentive.

[1] For example, see California Chamber of Commerce, “California Enterprise Zone Program Positive, Effective State Policy,” 5/1/08; available at the organization’s website at www.calchamber.com/Headlines/Pages/CaliforniaEnterpriseZoneProgram.aspx.

[2] California Legislative Analyst’s Office, “The 2008-09 Budget: Perspectives and Issues,” page 116, available at the LAO website at www.lao.ca.gov/analysis_2008/2008_pandi/pandi_08.pdf.

What do you think?

California Accountability Measures - SB 508 and SB 364

2011-10-08T09:00:00.000-07:00

Several states, including California, have proposed actions and taken actions on adding accountability to the tax system. The measures usually apply to tax credits. A common approach is to place a sunset date on enacted credits to ensure that they don't remain in the law permanently and that they get back on lawmakers' radar screens, such as when the sunset date approaches. Another approach would be to include some assessment measures so that the tax agency or other government agency can measure periodically if the tax incentive is accomplishing the goals for why it was enacted. A good example of California doing this in the past was with the Manufacturers' Investment Credit (MIC). If California did not have an increase of over 100,000 jobs in certain sectors, the MIC would go away. It lasted for sometime, but then the jobs number went down and the MIC disappeared.

I blogged on a proposal in California - SB 508 in May (here). It is focused on accountability for future enacted income tax credits. That is good, but I point out that tax incentives don't only come in the form of credits and they exist in all types of taxes (not just the income tax). Thus, the bill is too narrow.

SB 508 passed in the legislature (enrolled bill / for analyses, search for SB 508 here). It is on the governor's desk awaiting signature or veto.

SB 364 also passed the legislature (enrolled bill / for analyses, search for SB 364 here). This is an odd bill. It would impose a penalty for future credits enacted, where the claimant had a decrease in employment. Governor Brown vetoed this one on 10/7/11 saying that the approach is too broad and penalties should be tailored to a credit's unique provisions. I agree. I think SB 364 would also have made the law more complicated in measuring employment and identifying which future credits would be subject to this penalty.

There is an informative California Watch article on these bills - Kendall Taggart, "Bills seek to better regulate tax breaks," 10/6/11. (Disclaimer: I'm not just saying this because I'm quoted in the article.)

Let's see what Governor Brown does with SB 508. I think if he signs it, that would be good. I would then hope that this is a trial for how to add accountability measures to income tax credits that might then be expanded to other special rules added to income, sales, property, excise or other taxes. This approach, particularly one of requiring lawmakers to state the goal for a special rule and how its effectiveness in reaching that goal will be measured, might also end up in fewer incentive provisions which would also prevent tax laws from becoming more complicated, inequitable and inefficient.

What do you think?

New Tax Return Details for 2011 Returns - Closing the Tax Gap

2011-10-07T09:42:00.000-07:00

Who wouldn't want to see the $345 billion annual federal tax gap reduced? That's a lot of money! One way to make that happen is to be sure more taxable transactions are reported to the taxpayers and the IRS. In the past several years, we have seen a few of these items added, such as the requirement for brokers to report basis on Form 1099-B for stock sales. We also saw Section 6050W enacted to require processors of credit and debit cards have to report the amount processed for merchants to both the merchants and the IRS (Form 1099-K which is new).

Well, these forms are really only useful to the IRS if they can match them against information on taxpayer's returns. So, for 2011, we'll see a few changes in tax forms. For example, gross receipts lines for businesses will have 2 lines - one for amounts shown on 1099-K (credit and debit cards and Paypal) and amounts not on 1099-K (cash and transactions that did not require a 1099-K or someone failed to provide a 1099-K to the merchant).

New forms and lines are also needed for the basis reporting.

I have a short article on the AICPA website (for the Individual Taxation Technical Resource Panel) that explains the new forms and suggests extra activities taxpayers will likely want to undertake to be sure they are properly reporting these new 1099s and reducing the chance of notices from the IRS. Click here.

New Website for "Amazon" Click Through/Affiliate Nexus Laws

2011-10-06T08:48:00.000-07:00

With all of the activity on the affiliate nexus laws that New York started with back in April 2008 and the recent saga in California (see prior posts - 8/27/11 and 3/9/11, and others), I decided to create a website on this affiliate nexus approach. As of now, it just covers the so-called "Amazon" nexus laws where a state tries to say that just having an arrangement with someone in-state who has a link on their website back to the vendor might create nexus for the out-of-state vendor. There are other forms of affiliate nexus laws, such as those that say that a remote vendor who has some type of ownership connection with an in-state entity and the two sell the same product, have the same name or trademark, or similar advertising cause the remote vendor to have nexus in the state.

Here is the URL - http://www.cob.sjsu.edu/nellen_a/affiliate_nexus.html

Caution - the website is a work in progress. I'll keep filling it out for some prior events and actions and do my best to keep it up for news on these so-called Amazon nexus laws.

Finally, with the deferral of the affiliate nexus law in California and the apparent likelihood that Amazon will start collecting use tax from California customers in September 2012 or January 2013 (depending on whether Congress passes legislation to allow certain states to collect from remote sellers), Amazon send emails to the affiliates it cancelled a few weeks ago and encouraged them to complete the steps to get reinstated (see information here).

Spending and Tax Reform - How to fix budget and tax problems

2011-10-05T12:35:00.000-07:00

I have a guest post on the FranchiseHelp blog today on Spending and Tax Reform. I explain that there is spending in the tax law and that any spending reforms must not ignore it as it is almost as large as the discretionary spending in the federal budget!

What do you think?

Select Joint Committee hearing on revenue options and tax reform

2011-10-01T11:09:00.000-07:00

On 9/22/11, the Joint Select Committee on Deficit Reduction (the committee that is supposed to find $1.5 trillion of reductions by 11/23/11), on Revenue Options and Reforming the Tax Code (here). Thomas Barthold, Chief of Staff of the Joint Committee on Taxation testified based on an 80+ report on the topic prepared by the JCT.

The JCT report starts off with lots of data about our tax system. For example, Figure 7 (page 10) shows the changes in number of passthrough and C corporation returns from 1978 to 2008. In 1978, just under 2 million passthrough entity returns were filed. There were more C corporation returns filed, but still under 2 million. In 1983 to 1986, there was a slight increase in the number of C returns and then it dropped to for 2008, there are just under 2 million C returns. In contrast, the number of passthrough entity returns steadily increased to over 7 million returns in 2008. This likely reflects the reality that after the Tax Reform Act of 1986, individual income tax rates were lower than those for C corporations.

Data on the largest individual and corporate tax expenditures is also included. Here are the largest individual tax expenditures for 2010-2014 in billions of dollars (page 25):

Exclusion of employer contributions for health care, health insurance premiums, and long-term care insurance premiums $659.4
Deduction for mortgage interest on owner-occupied homes $484.1
Reduced rates of tax on dividends and long-term capital gains $402.9
Net exclusion of pension contributions and earnings: Defined contribution plans $303.2
Earned income credit $268.8
Deduction of nonbusiness State and local government income, sales and personal property taxes $237.3

Here are the six largest tax expenditures for corporations for 2010-2014 in billions of dollars (page 34):

Deferral of active income of controlled foreign corporations $70.6
Exclusion of interest on public purpose State and local government debt $45.3
Deduction for income attributable to domestic production activities $43.2
Inventory property sales source rule exception $38.0
Depreciation of equipment in excess of alternative depreciation system $37.1
Inclusion of income arising from business indebtedness discharged by the reacquisition of a debt instrument $28.8

The JCT report then asks a question we don't hear asked often - what happens if any existing tax expenditures are repealed or cut back? For example, if employer-provided retirement benefits were repealed, would income on existing retirement accounts still continue to accrue tax free?

With respect to possible repeal of the home mortgage interest deduction, the JCT report states (page 37):

"As of what date would mortgage interest no longer be deductible? Would the repeal apply to all existing mortgages or only to mortgages undertaken after the effective date? Either choice could be said to substantially eliminate the tax expenditure. These decisions will affect taxpayer’s behavior regarding owning versus renting, the size of a home that they may choose to purchase, as well as the amount of debt they undertake and the choice of assets that they may retain in their portfolios. These decisions will affect the magnitude of revenues that redound to the Federal Treasury from the elimination of the tax expenditure and, as discussed below, these revenues will generally be less than the value of the estimated tax expenditure."

Table A-16 (page 59 - 60) lists the 32 tax credits that are part of the general business credit.

Pages 61 - 70 lists the provisions that have been added to the tax law since the Tax Reform Act of 1986 (through 9/2010) and which Public Law added them. "Modifications and extensions of pre-existing tax expenditures are not listed." There are 157 provisions there! The JCT report notes that it might not be complete depending upon, for example, if something should have been considered a modification and omitted from the list or was it a new provision.

Observations:

There is a lot of talk about eliminating or cutting back tax expenditures (including in this blog). I think there are many that should either be removed from the tax law (such as subsidies for higher education which should instead be handled as direct grants) or reduced (such as the mortgage interest deduction). President Obama's deficit commission suggested repealing all of the $1.1 trillion of annual tax expenditures to allow for lower rates and deficit reduction. This would not be an easy task for a few reasons. First, there are many taxpayers using these provisions who don't want to lose them, even with a lower rate. Another challenge is the transition rule. For example, if the mortgage interest deduction is cut back, are existing mortgages grandfathered or phased out. Another challenge is that some of the tax expenditures are for simplification purposes and removing them adds complexity and sometimes, not much revenue. For example, requiring small businesses to use the accrual method rather than cash would be problematic. Also, repeal of the fringe benefit exclusion for de minimis fringe benefits would be costly to administer.
The Tax Reform Act of 1986 flipped corporate and individual rates in that the corporate rate was higher than the individual rate. This led to more businesses becoming passthroughs rather than C corporations. Will this reverse if the corporate rate is lowered below the top individual rate (it might not due to double taxation of C corporations)?
How does international tax reform factor into all of this?
What about improvement to filing systems as part of reform? Can we move to having the IRS prepare most returns with data it already has today? Can data reporting be modified as it is for many large businesses (with enterprise resource planning (ERP) software)? Why doesn't the tracking of my wages and interest income that feeds into my employer and bank's databases, also feed into a tax return system that would just need a few modifications to get a return filed?
Should the Select Committee address tax reform? I say no because it doesn't have time to address this big topic. It will have to offer some tax changes though. Hopefully when the committee looks at spending, it will also look at the spending in the tax law because today, it is almost as large as the discretionary spending in the budget.

Links:

Committee website
C-SPAN info

What do you think about the JCT report and the Select Committee's use of the testimony?

Incentives for Innovation - my oral testimony and the experience

2011-09-30T10:22:00.000-07:00

I have a short article in the AICPA Corporate Taxation Insider this week (9/29/11) about my experience testifying before the Senate Finance Committee on 9/20/11; my oral testimony is included - here.

For more about the hearing and if you'd like to post your reactions to what I had to say or describe your ideas on incentives for innovation (including perhaps that there should be none) - here.

Thanks.

Buffett Rule - a New Tax Principle?

2011-09-28T12:50:00.000-07:00

I think it is interesting to name a principle for tax reform after someone. That is what President Obama did in his recent tax reform proposal (9/19/11) that will help pay for some tax cuts intended to help with job creation and hiring. His 80-page plan lays out 5 principles for tax reform (page 46). These are:

"Lower tax rates. The tax system should be simplified and work for all Americans with lower individual and corporate tax rates and fewer brackets.
Cut Inefficient and Unfair Tax Breaks. Cut tax breaks that are inefficient, unfair, or both so that the American people and businesses spend less time and less money each year filing taxes and cannot avoid their responsibility by gaming the system.
Cut the deficit. Cut the deficit by $1.5 trillion over the next decade through tax reform, including the expiration of tax cuts for single taxpayers making over $200,000 and married couples making over $250,000.
Increase job creation and growth in the United States. Make America stronger at home and more competitive globally by increasing the incentive to work and invest in the United States.
Observe the Buffett Rule. No household making over $1 million annually should pay a smaller share of its income in taxes than middle-class families pay. As Warren Buffett has pointed out, his effective tax rate is lower than his secretary’s. No household making over $1 million annually should pay a smaller share of its income in taxes than middle-class families pay. This rule will be achieved as part of an overall reform that increases the progressivity of the tax code."

These are not exactly the "principles" I'd advocate for reform. I prefer the set that includes equity, simplicity, transparency, certainty, neutrality, economic efficiency and minimum tax gap. The "principles" President Obama outlines above should really be called "outcomes" for tax reform.

Some of his suggestions in the 80-page plan are specific, he lists some provisions he wants to remove such as tax preferences for oil, gas and coal companies. He is not specific on whether any of the existing 100+ special rules for individuals should be removed or cut back. To really reduce deficits though, these will need to be cut back since the majority of the $1.1 trillion of "tax expenditures" (special deductions, exclusions and credits) are for individuals.

The Buffett rule is vague. When tax cuts expire, the capital gains rate for most capital assets (such as stock investments) will go back to 20% (18% if held over 5 years). The rate on qualified dividends could be as high as 39.6% (in addition to the Medicare tax of Section 1411 that kicks in starting in 2013). Will the capital gains rate on high income individuals need to be raised beyond 18% to be sure their effective tax rate exceeds someone making $200,000 ($250K) if married? Will high income individuals be denied use of the 50% capital gains exclusion if they sell qualified small business stock held over 5 years (Section 1202)? Will a special surtax apply for incomes above $1 million (regardless of whether the income is ordinary or capital gain)?

How will lower corporate tax rates be paid for? The tax raisers in the president's plan cover the jobs provisions. They also cover some deficit reduction since his tax increases are permanent while the jobs provisions are temporary. Or will the Buffett rule be enough to cover a lower corporate tax rate? How low?

So, I won't be adding the Buffett rule to my list of principles of good tax policy (and I acknowledge that President Obama isn't suggesting it as a principle of good tax policy, but of his reform agenda). I would like to see more details on how it works to ensure that a wealthy person with only capital gains income, including from Section 1202 stock, does have a higher effective tax rate than an individual who keeps the lower tax rates promised for those under $200K and $250K of income.

I would like to see more about cutting back on overly generous and unnecessary deductions, such as for interest on a mortgage on a second home or a home equity loan, as well as mortgages over an amount tied to regional home values (which would be something less than the current $1.1 million limit).

For more on the Buffett rule and likely effect, see:

Warren Buffett's 8/14/11 op ed in the New York Times
"Obama's Tax Hikes Expected To Have Little Impact on the Rich" by Eichler, Huffington Post, 9/20/11.
Citizens for Tax Justice fact sheet showing likely effective tax rates for millionaires + slightly longer report.
Tax Policy Center - Howard Gleckman and William Gale and Samuel Brown

What do you think about the Buffett rule or any other part of the 80-page tax proposal?

More woes for state film credits

2011-09-24T21:57:00.000-07:00

Yesterday's Wall Street Journal (9/23/11) had an entertaining article, "Snooki to Snookered: States' Film Tax Credits Produce Embarrassment" by Eric Felten, points out some of the many problems with state film credits. The article starts off noting that Governor Christie of New Jersey is concerned that his state's film credit is subsidizing Jersey Short that is rife with stereotypes that have offended some residents. According to the article, the governor has threatened to revoke the show's $420,000 subsidy from the state.

There's more including some states being concerned that their credits are producing films unlikely to be Academy Award winners with some featuring cannibals and others cold-blood killers. Per the article: "even the most casual perusal of the productions being funded by state governments finds a preponderance of low-budget gore fests."

For more, see my 3/21/11 post - here.

I think these film credits highlight the fight states are in with each other for any kind of business activity and their willingness to lower the tax bill to be business friendly. The film credits show how this gets out of hand as the subsidies are quite large and the type of activity engaged in might not lead to long-term jobs. That is, the film is made and the company and crew leave. It's not quite as good as getting a manufacturing plant or R&D facility that is likely to stay for a longer time period. Of course, some film credits might lead to creation or growth of film companies in the state, but not always.

The credits violate principles of simplicity, neutrality, equity and transparency too.

What do you think?

Incentives for Innovation - Senate Finance Committee Hearing

2011-09-22T00:41:00.000-07:00

I was honored to have the opportunity to testify before the Senate Finance Committee this week (9/20) at a hearing on Tax Reform: Incentives for Innovation. A few comments I included in my oral and written testimony:

1. Tax reform should consider our country's economic, societal and environmental goals and be sure that that tax law is not hindering them, and perhaps even support them. Innovation is something that for economic reasons also warrants some support through the tax law.

2. Considerations should be given to modifying rules that potentially hinder innovation. For example, some MACRS lives, such as for computers, are too long. Also, while there is a desire to build cars with a higher mpg, Section 280F depreciation limits on cars makes them less attractive to business buyers. Why not remove or greatly reduce such limits for cars getting a certain mpg?

3. Modernize the Section 179 expensing election by also having it apply to intangible assets.

4. Look for ways to provide wider incentives for start-up innovators such as by broadening the Section 1202 gain exclusion to investments in partnerships and S corporations too.

5. Improve the research tax credit by making it permanent. Also review the exclusion for internal-use software as that term has a different meaning today than it did in 1981 when there were no web-based businesses.

6. In reform discussions about lowering the corporate tax rate, we'll need to consider the global economic reality that not only do other OECD countries have a lower statutory rate, many also have tax incentives for R&D.

For more information:

Hearing website with links to written testimony of Senators Baucus and Hatch and the four witnesses.
My website with links to other tax reform hearings held in 2011.

What do you think? Should there be incentives for innovation in the tax law or should they all be removed for simplification and rate reduction purposes? If any should be included, what should they be? Any other suggestions?

Registered Tax Return Preparer Exam Coming Soon

2011-09-19T08:08:00.001-07:00

The exam that preparers who are not a CPA, attorney or Enrolled Agent (or supervised, non-signing preparer) will need to take to continue to prepare 1040 returns after 2013 is expected to be available in October. Once the tests are available, someone getting a PTIN for the first time who is required to take the test apparently must pass it before getting a PTIN. The fee to take the exam is expected to be between $100 and $125 (for each time a person needs to take it).

The IRS has laid out the topics to be covered - here.

The IRS suggests that a person get ready for the test by reviewing these materials:
2010 Form 1040
2010 Form 1040 Instructions
2010 Publication 17: Your Federal Income Tax*
Circular 230 (Rev. 8-2011): Regulations Governing Practice Before the Internal Revenue Service
2010 Publication 334: Tax Guide for Small Business
2010 Publication 970: Tax Benefits for Education
2010 Publication 1345: Handbook for Authorized IRS e-file Providers
2010 Form 6251: Alternative Minimum Tax – Individuals
2010 Form 6251 Instructions
2010 Form 8879: IRS e-File Signature Authorization
2010 Publication 596: Earned Income Credit

As I have noted in prior posts and articles, I think there is a disconnect in what the IRS is saying a preparer should know because sometimes they say they must know the substantive law (which should mean the Code, regs and court cases) other times, they say to look at pubs and form instructions which do not make reference to primary authority.

The questions will be multiple choice and true-false. There will likely be 120 questions with 2 - 3 hours to complete the exam.

Well, if an exam is prepared by using Pub 17 (which is 295 pages long!), what might some of the questions be? Might these by the questions? Do you know the answers?

1. Don is single and his girlfriend has been living with him for the past two years. She is a full-time college student who does not work. Don supports her. Don't filing status is:
A. Single
B. Head-of-household
C. Married filing joint (because he has lived with his girlfriend for over one year)
D. Married filing separately (because he and his girlfriend are not married)

2. Mr. and Mrs. Smith file jointly and itemize their deductions. Mrs. Smith volunteers for a local non-profit agency tutoring children about 5 hours per week. If Mrs. Smith provided these services for pay, she would get $50 per hour. She hires a babysitter to watch her children while she volunteers. The non-profit is about 10 miles from her home. In 2010, Mrs. Smith spent $65 on books to use with the kids she tutors. Which of the following constitute a charitable contribution deduction for the Smiths?
A. $250 per week for value of her contributed services
B. 14 cents per mile traveled
C. The $65 of books
D. The fee paid to the babysitter
E. None of the above.

Answers:
1. A. The girlfriend can't qualify Don for HH filing status because she is not a qualifying person. See page 23 of Pub 17.

2. B & C. There is no deduction allowed for the value of donated services or for the babysitting. 14 cents per mile + $65 for expenses are deductible as charitable contributions. See page2 158-159 of Pub 17.

What do you think? Were my sample questions too easy? too hard? not relevant? What do you think should be asked?

For more on who is subject to the tests - see this IRS page.
My articles on the IRS program to regulate return preparers - here.

New Perspectives on "Small" Business

2011-09-17T22:03:00.000-07:00

The Treasury Department issued a study on how to better define "small" business. One purpose seems to be to get a better understanding on how many small businesses would face higher rates if President Obama is able to convince Congress to keep the lower rates for all but individuals with more than $200,000 of income ($250,000 if married). Only 2% of individuals have higher income than that. But some point out that a good portion of this 2% are small businesses and why should their rate be increased when President Obama and Congress want to lower the income tax rate for corporations.

Treasury uses two tests to better identify what is a true business (so tries to knock out those that may really be a hobby) and that operate as a traditional business (for example, have employees and depreciation, rather than just being an independent contractor). A business is small if gross receipts are $10 million or less. For sole proprietors, the Treasury approach finds that a little over 50% don't meet the "business" definition.

But once it identifies the small business, it matches it to the individual owner. Then it knows other characteristics of the individual. For example, does the individual have large sources of other income in addition to the small business income?

I have a short article in the AICPA Tax Insider explaining how Treasury defined "small" - "New Definitions of "Small" Business and Possible Relevance."

One finding from Treasury:

"For taxpayers reporting any flow-through income, eight percent of taxpayers reporting 75 percent of new flow-through income reported AGI over $200,000 (mean AGI of $760,000, median of $325,000). ... Taxpayers owning any business too big to meet the broad definition of small business ... are more concentrated in the upper income groups (49 percent reported AGI over $200,000, with mean AGI of $1.7 million an median over $500,000) and reported more than 100 percent of the net income from larger businesses (because of net losses and small amounts of positive income reported by lower AGI classes)."

It will be interesting to see how this data gets used.

For an analysis of the data, see Marty Sullivan's article, "Should We Raise Tax Rates on Wealthy Employers?" in Tax Notes and on his blog - here.Followed by his "The Myth of Mom-and-Pop Businesses" (9/12/11) - here.

It is a lot to sort through. I wonder if the fact that Treasury gave a "non-business" label to so many businesses if Congress will question if less favorable tax rules should apply. We'll see.

So Many Federal Tax Proposals

2011-09-11T14:48:00.000-07:00

Len Burman has another great post in Forbes today with a graphic on the number of revenue estimate and other requests the Joint Committee on Taxation has received in the past several years (here). In several of the past ten years, there have been over 3,500 requests, reaching a high of almost 7,800 in 2007!

The revenue estimate requests means that a member of Congress had a tax proposal and needed to get a revenue estimate from the Joint Committee on Taxation (JCT). The requests are confidential. Of course, most of these proposals are never enacted, but this is a lot of time spent on something other than making the tax law simpler!

For more information from the JCT on its revenue estimating process and number of requests - see this JCT page - here.

There has been a growth in the number of special tax rules as explained in a JCT report on tax expenditures (JCX-15-11, March 2011, page 16). As you can see in the JCT chart from that report included at the end of this post, the number of special provisions increased from about 150 in 1999 to just over 200 in 2007. And many members of Congress keep thinking of even more as evidenced by the revenue estimate requests.
What do you think?

IRS Releases Information on What A Paid Preparer Should Know To Prepare 1040s

2011-09-07T06:55:00.001-07:00

Another part of the IRS plan to regulate all paid return preparers was released this week - the specifications about the test that preparers must pass if they are not a CPA, Enrolled Agent, Attorney or supervised, non-signing preparer, or someone who never prepares or assists in preparing Forms 1040. These specifications were announced in IR-2011-89 (9/6/11) and a 5-page list of specifications was released as well.

The test is expected to be available in fall 2011. Preparers who are required to take it will have until the end of 2013 to pass it (if they have a provisional PTIN before the test is available). New preparers will have to pass it before they can get a PTIN and prepare Forms 1040.

The test will have 120 multiple choice and true-false questions. The testing center will provide the test-taker with Publication 17 and Form 1040 and its instructions. The time given to take the test seems to not yet been set; the IRS notice says between two and three hours. The test can be taken at a Prometric site (about 260 available throughout the country). The fee is expected to be $100 to $125 and must be paid for each attempt to pass the test.

No numerical score will be given to the test takers, just whether they passed or failed. "Diagnostic feedback" will be given to individuals who fail the test.

The IRS estimates that of the current 730,000 preparers with a PTIN, about 62% are not CPAs, Enrolled Agents or attorneys. But some of these preparers may be exempt from having to take this 1040 test (such as because they are a non-signing, supervised preparer). When IRS has people start renewing PTINs in October, they apparently will be asking if the person is required to take the test.

How to prepare for the test? Per the IRS announcement:

"To assist in test preparation, the following is a list of recommended study materials. This list is not all-encompassing, but a highlight of what the test candidates will need to know.

Publication 17, Your Federal Income Tax
Form 1040, U.S. Individual Income Tax Return
Form 1040 Instructions
Circular 230, Regulations Governing Practice before the Internal Revenue Service (rev. 8/2/11)
Publication 334, Tax Guide for Small Business
Publication 970, Tax Benefits for Education
Publication 1345, Handbook for Authorized IRS e-file Providers
Form 6251, Alternative Minimum Tax – Individuals
Form 6251 Instructions
Form 8879, IRS e-File Signature Authorization"

Comments:

1. 120 questions to be completed in two or even three hours? It seems then that these questions are not going to require making any calculations as there would not be enough time. (If the test is 2 hours, that is 1 minute per questions; if 3 hours then 1.5 minutes per question.)

2. I have blogged on this concern before and will repeat it. The IRS has said in letters to preparers and on their website that preparers are expected to know the substantive tax law. Per a website posted in January 2011 on "responsibilities of a tax return preparer", the IRS states the following (highlights added by me):

"Tax return preparers are expected to be knowledgeable in tax law and to prepare accurate returns. As a tax return preparer, you must take all necessary steps to prepare accurate Federal tax returns on behalf of your clients. These steps include reviewing the applicable tax law to ensure all income has been reported on the return, and only credits, expenses and deductions allowed under the Internal Revenue Code are taken. Tax return preparers are required to exercise due diligence in preparing or assisting in the preparation of tax returns and claims for refunds. As a general rule of thumb, that means knowing the underlying substantive law affecting an item of income or deduction."

So, why does the IRS recommend that to prepare for the test, individuals study IRS publications, forms and Circular 230, rather than also Internal Revenue Code Sections, regulations, IRS rulings and court cases? IRS publications and forms rarely ever mention an IRC section. In the test specifications, only a few Code sections are noted (Sections 121, 6694, 6695 and 7216). Also, why let test-takers have a copy of Pub 17 during the test rather than a copy of the IRC?

For more on this topic, please see my prior writings:

"The Competent Tax-return Preparer" in the AICPA Tax Insider (3/10/11)
7/7/11 post with comments I submitted to IRS for the exam

3. Will all of this make for better preparers? I think it will help, but perhaps not as much as:

Simplifying the law by reducing the number of special rules and temporary provisions.
The IRS helping all preparers to understand the substantive law, such as by requiring greater knowledge than what is in the instructions to a tax form to be a preparer.
Getting individuals to have a greater responsibility in getting competent tax prep help. While this may seem harsh, I think, for example, individuals should get a penalty if they file a return where they paid someone to prepare it, but that person did not sign it. And, greater penalties when they filed returns, even though prepared by someone else, that had items "too good to be true" such as omitted income and personal or bogus expenses.
Move to a system where more individuals can have their return prepared by the IRS (after all, the IRS has all of the information from W-4s, W-2s and 1099s for many individuals (if they don't have gains/losses or a business)). There are a variety of proposals for this, such as in Senator Wyden's tax reform proposal (S. 727).

For more background and links, see "PTIN - The Continuing Sequels," AICPA Tax Insider, 6/9/11.

What do you think?

Tax Complexity - Is Wood Food?

2011-09-04T22:46:00.000-07:00

One reason why the tax law is complicated is that many items are singled out for special treatment including often, to be non-taxed. For example, most states do not impose sales tax on groceries. Yet, some tax soda and other types of groceries or food. The complexity lies in trying to define the item(s) that gets the favorable tax treatment. If all items were taxed the same, there would be no need for special rules and the laws would be far less complicated (and the rates could be lower because the tax base would be larger).

The question of what is "food" is currently before the Streamlined Sales & Use Tax (SSUTA) group. The question is whether hickory wood that is purchased to be burned so that the scent can enter the food, is food (it is used to create "wood-grilled" food). The significance of it being food is that a state that has adopted the SSUTA, can either subject food to sales tax or exempt it. The benefit offered by the SSUTA is that all states that have adopted the SSUTA define "food" the same way.

Per the SSUTA website - "Pursuant to Governing Board Rule 902 this shall serve as official notice of the commencement of the public comment period for the interpretation request concerning whether or not wood used to create smoke is a food or food ingredient (RI11001)."

You will want to click on RI110001 to see the 73-page (!) analysis of this question by the taxpayer asking it.

My observations:

Sales tax laws could be simplified by removing most exemptions applicable to individual consumers. All food should be subject to tax. Relief can be provided to low-income taxpayers through both refundable income tax credits and food stamps (or similar transfer, such as a debit card).
For the immediate question on the wood for smoking, I would think most people would initially say it is not food because we don't eat wood. But the sole purpose is to flavor the food. Is this similar to lemons - they flavor the food but we throughout the rinds (usually).
But what if the wood is also used to cook (heat) the food. That is a tougher situation because we don't eat heating supplies.

What do you think (about both the complexity angle of exemptions and the specific question asked of the SSUTA)?

Cities and the Income Tax

2011-09-03T11:18:00.000-07:00

The 481 cities in California are not allowed to impose an income tax (per Revenue & Taxation Code Section 17041.5); neither may other local jurisdictions in California. However, they are allowed to assess a business license tax based on gross receipts. Not all states have such a restriction though.

Per a recent report from the Tax Foundation (Fiscal Fact No. 280), in 17 states, over 4,900 cities and counties impose a local income tax, affecting 23 million people. The taxing jurisdictions include school districts too. The report notes that San Francisco has an income tax imposed on employers (the payroll tax),* but as noted by California law (see above), this is not a local income tax as they are not allowed at the local level in California.**

Rationale for local income taxes:

It will encourage local jurisdictions to favor high-paying jobs in its borders rather than minimum wage jobs at retail shopping outlets that generate sales tax (this is why many California cities seek big-box retailers - to get more sales tax revenue).
It is another way to get non-residents (here, those who work in the taxing city but live in a different city) to contribute to the cost of services they use. Of course, these non-resident workers are likely paying sales tax while in the city each day. This is a question I've blogged on before - how much, if any, income tax should a jurisdiction take from a non-resident who is not entitled to many government services (see 6/19/11 post). For example, a person who lives in San Jose but works in San Francisco, is unlikely to be able to register their child in a SF public school.

I think California could benefit in a few ways if local jurisdictions had an income tax tied to the state income tax. These benefits include:

An incentive that matches the state's incentive to have high-paying jobs in the state.
A broader economic development perspective in that local governments would be interested in having more than just big box retailers. For example, they would want to have a law firm. (Note - as to whether the city should impose the income tax on the law firm's taxable income versus also that of all of the lawyers working in the city-located law office, is another issue - see 6/19/11 post).

SB 653 would allow counties to impose an income tax (see 4/24/11 post).

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* A 3/9/11 op ed in the San Francisco Examiner by former State Senator and SF Board of Supervisors member Quentin Kopp provides some background on R&T Section 17041.5 (he opposes the SF payroll tax). He says it was enacted in 1963 to prevent local jurisdictions from imposing income taxes. Apparently, at that time, San Francisco wanted to impose an income tax on those who lived or worked in the city to be sure they were contributing to the cost of city services they were using. The SF payroll tax applies to SF businesses with annual payroll over $250,000.

** The SF payroll tax was upheld as not being an improper local income tax in A.B.C. Distributing Co. v. City and County of San Francisco, 15 Cal. 3d 566 (CA S Ct, 1975). Per the court: "The short answer to plaintiffs' contention is that the payroll expense tax is not a tax on or measured by their income. Instead, the tax is imposed upon plaintiffs by reason of their employment of labor within the city and county, measured by the expense incurred by plaintiffs in conducting this aspect of their business. The fact that the tax is measured by wages paid to the employees would not convert the tax to an income tax. As this court explained in Gillum v. Johnson (1936) 7 Cal. 2d 744, 763, involving a federal social security payroll tax, such a tax may be an income tax to the employee, but "As affecting employers it is an excise tax, or a tax on the right to do certain things ....""

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Do you think California cities should be allowed to impose an income tax? If yes, should it be a percentage of the taxpayer's state income tax or some other calculation? Who should pay it?

More on Amazon, ABX 28, Ballot referendum ... and even Congress, jobs and Senator Bumpers' 1994 proposal

2011-09-02T07:41:00.000-07:00

There is more in the news regarding Amazon's opposition to the affiliate nexus law (ABX 28, Chapter 7). Amazon is reported to have offered to build a distribution center in California creating 7,000 jobs if the legislature will postpone the effectiveness of the affiliate nexus law for at least two years while Congress has time to enact legislation (presumably the Main Street Fairness Act - S. 1452). See Reuters article - "Amazon offers California jobs if it drops tax."

Some thoughts:

Will Congress pass the Main Street Fairness Act? I think the first time it was introduced was by Senator Bumpers of Arkansas in 1994 as S. 1825 (103rd Congress). I don't know if was introduced in every session of Congress thereafter, but certainly in many. It was also S. 2153 (109th Congress) in 2005, called the Streamlined Sales Tax Simplification Act. There have been hearings over the years as well and modifications. Congress has a lot on its agenda, does it include this legislation?
If Amazon really wants the federal legislation, perhaps it hopes California will push Congress to pass it. But, the current legislation would only allow states that have adopted the Streamlined Sales & Use Tax (SSUTA) to collect tax from remote sellers. So, why would California push for federal legislation that won't help it collect sales tax (other than from Amazon when it establishes a physical presence by building a distribution center in the state). Also, Prop 26 which requires a 2/3 vote for any bill that might cause someone to have higher taxes, likely requires that adoption of SSUTA needs a 2/3 vote (even adopting the rounding convention of SSUTA might cause a tax increase for some taxpayer, for example). With many Republican legislators having signed a pledge not to vote for any tax increase, they cannot vote for any tax bill that requires a 2/3 bill making it harder for California to adopt SSUTA and thus pointless for California to spend time trying to get Congress to enact S. 1452 (other than to get Amazon to build a distribution center in the state). (This is all really a wacky way to design a tax system!)
If this gets Amazon to drop the ballot referendum, I think that is good. I expect that the ballot issue would be misinterpreted by those signing to get the measure on the ballot. I think many signers would think that there would be no sales tax on Internet purchases when it would just mean that Amazon would not have to collect the tax - the consumers still owe use tax.
So far as books, Amazon announced in May 2011 that sales of Kindle books (digital) were greater than physical books. California and many states don't subject sales tax to digital books because their outdated sales tax only apply to tangible consumption. Of course, Amazon sells a lot of physical books and other items, so a distribution plant in the state would still provide sales tax collection obligations, but there would still be a lot of transactions (Kindle downloads, cloud computing transactions including the music in the cloud that California's out-dated sales tax doesn't apply to).

What do you think?

More Tax History on the Web - from Joint Committee on Taxation

2011-08-31T09:03:00.000-07:00

Discussions of tax reform tend to become repetitive decade after decade. For example, there have been discussions from at least the early 1980s on a possible federal VAT and it has been discussed every decade since (see "VAT Mania"). While government studies and reports can be found in federal depository libraries (such as at San Jose State), it isn't always easy. When more of this information can be added to the web - and particularly if easy to find, that is great! It is interesting to see what was being studied and debated decades ago.

Well, the Joint Committee on Taxation just announced this week that it has posted all of its reports since it was created back in 1926. Per their announcement (Press Release 03-11):

"The staff of the Joint Committee on Taxation (the “Joint Committee”) today announces that it has posted to its website, www.jct.gov, copies of most known Joint Committee publications from 1926, when the Joint Committee was created, through the present. The postings provide Congressional offices and the general public with a more complete and searchable set of documents relevant to the evolution of the Internal Revenue Code, than the Joint Committee previously had made available on its website."

This is a lot of information. One report I took a look at was tied to the Revenue Act of 1926. It notes that the duties of the JCT are:

(1) To investigate the operation and effects of the Federal system of internal revenue taxes.
(2) To investigate the administration of such taxes by the Bureau of Internal Revenue or any executive department, establishment, or agency charged with their administration.
(3) To make such other investigations in respect of such system of taxes as the joint committee may deem necessary.

The report briefly described 18 tentative projects. Number 18 involved cutting down on the number of "trivial" cases that went before the Board of Tax Appeals. Number 14 continues to be an interesting issue that comes up in discussions of estate tax reform. It reads:

"REFERENCE NO. 14.-LOSS OF REVENUE THROUGH GIFTS AND TRUSTS
A report on the extent of legal tax evasion through gifts and trusts as permitted under the present act.

"Note.-The revenue act is based not only on the principle of taxing the annual income of an individual or corporation, but it also taxes, in general, the appreciation in property accruing over a period of years in the year in which such profit is realized. When gifts are made or trusts established it is possible, however, to legally evade the tax which would normally accrue to the Government on the sale or other disposition of the property.

"A comparison of the taxes paid by John D. Rockefeller and John D. Rockefeller, Jr., and by Henry Ford and Edsel Ford is sufficient to show that the loss in revenue from this exception is great. A study indicating the total loss in revenue from this exception to a tax on realized appreciation in property will be valuable."

You can find the link to the reports here.

Sales Tax Holiday in Missouri (and elsewhere) - A Tax Oddity

2011-08-28T14:14:00.000-07:00

I have written about this before and included it in my list of "tax oddities" - states offering "holidays" when sales tax is not owed on certain items. Generally, they last just a few days and only apply to specified items.

Thomson Reuters has a list of the holidays - here. The Tax Foundation has an extensive report (July 2011) that lists state holidays and explains why the holidays are poor tax policy.

States not only lose revenue, retailers have extra recordkeeping and reporting burdens, inequities result - as just a few of the problems. But, there is also the problem that whenever anything is carved out for special tax treatment, it is usually complicated to define what gets the special treatment and what does not.

A recent example is Missouri which offers a sales tax holiday in early August to help families purchase school supplies (the "Back to School Sales Tax Holiday"). And this is another example of the oddity - it doesn't matter what your income level is - everyone gets the tax savings. That means there is less of the benefit to go to those who really need it because the state gave some of the benefit to people who don't need it.

Here is an explanation of the sales tax holiday from the Missouri Department of Revenue - Section 144.049. As indicated in that explanation, the holiday includes personal computers that do not exceed $3,500.

Well, a question was raised by a retailer as to whether an iPad and e-book reader would qualify for the sales tax holiday. So the Missouri Dept. of Revenue had to devote time and resources to answering this question. The answer is in LR 6870 (7/29/11):

"The definition of personal computers includes the Apple iPad and Apple iPad2 because they are akin to a laptop computer and are used to perform functions traditionally associated with a personal computer."
"Book readers that download off the internet are not personal computers because they are not akin to laptop, desktop, or tower computer systems, and are not used to perform the functions traditionally associated with personal computers."

Why the difference? Missouri law (Section 144.049(2)) defines a "personal computer" as:

"a laptop, desktop, or tower computer system which consists of a central processing unit, random access memory, a storage drive, a display monitor, and a keyboard and devices designed for use in conjunction with a personal computer, such as a disk drive, memory module, compact disk drive, daughterboard, digitalizer, microphone, modem, motherboard, mouse, multimedia speaker, printer, scanner, single-user hardware, single-user operating system, soundcard, or video card."

To bad for the Kindle, Nook and other readers that aren't really a computer. But can't these items be school supplies?

Missouri law defines "school supplies" as "any item normally used by students in a standard classroom for educational purposes, including but not limited to textbooks, notebooks, paper, writing instruments, crayons, art supplies, rulers, book bags, backpacks, handheld calculators, chalk, maps, and globes. The term shall not include watches, radios, CD players, headphones, sporting equipment, portable or desktop telephones, copiers or other office equipment, furniture, or fixtures. School supplies shall also include computer software having a taxable value of three hundred fifty dollars or less."

Sounds like the Kindle or Nook could be a school supply. BUT - the sales tax holiday only applies to supplies that do not exceed $50 per purchase!

What about buying an iPad during the 3-day sales tax holiday but having the parent use it rather than the school child? What if both use it? I could not find any prohibition on this. And, it would be difficult to enforce. Another problem with such holidays - they are easily abused. And trying to find some way to enforce that the items purchased must be used by school children is difficult.

A better approach - use an approach similar to the free or reduced lunch program states likely already use. It requires the family to file a form indicating need. These families could be given vouchers/coupons/gift cards to use for school supplies.

What do you think?

Affiliate nexus, California and Amazon - the saga and oddities continue

2011-08-27T12:42:00.001-07:00

A few unusual things have occurred since California enacted its "Amazon" - affiliate nexus law (ABX1 28; Chapter 7) at the end of June 2011. I mean unusual in that I don't think we have seen them in other states that have enacted these so-called "Amazon" laws aimed at trying to get remote sellers with affiliates in the state (generally people who get a commission for advertising the seller's website). (For background, see my 7/4/11 post, 7/19/11 post, and this short article.)

Here are some of these unusual things:

Amazon got approval to try to obtain signatures to try to get a referendum on the ballot so that voters can decide to repeal the affiliate nexus law. They need to get 504,760 signatures by 9/27/11. See item #1489 on the California Secretary of State website - here.
The Los Angeles Times reports that Amazon has invested $5.25 million to get the signatures ("Amazon ups the ante in Internet sales tax fight," 8/23/11). This is a lot of money!
Jobs and small businesses - both sides of the debate say it is about protecting jobs and small businesses! The Los Angeles Times article ("Amazon ups the ante in Internet sales tax fight," 8/23/11) refers to a group called More Jobs Not Taxes. At their website, they say they were formed to opposed the Internet tax law that will "hurt small businesses, kill jobs and undermine chances for any economic recovery in California." I'd guess that the reference to hurting small businesses is because Amazon and perhaps other Internet vendors cancelled their affiliate arrangements in California which means many will earn less commissions. Is it a job killer? I don't see that. And there are many small businesses operating in California that find it difficult to compete with Amazon because many of Amazon's customers don't know that they owe use tax when they buy taxable items form Amazon or any out-of-state vendor who does not collect sales tax. For example, see information from the American Booksellers Association (here) and Stand With Main Street (here). These groups say that not having online sellers collect sales tax is hurting small, main street businesses (the opposite of what the More Jobs Not Taxes group says). The California Retailers Association also supports the affiliate nexus law (see their 6/20/11 press release). This group says the law promotes jobs (the opposite of what the More Jobs Not Taxes group says).
The Health and Human Services Network of California is pushing a grassroots effort to get 2,000 signatures of people telling Amazon to collect the California sales tax - part of a "Think before you click" campaign. As noted in a KQED report (8/15/11), they also call for a boycott of Amazon.
A Los Angeles Times article of 8/25/11 - "California lawmakers try to head off Amazon sales tax referendum,"reports that the Senate Appropriations Committee is taking action to modify the original legislation to make a referendum impossible, thus ending Amazon's effort to get voters to overturn the law.

All of this is really odd and unfortunate. It will not lead to effective laws, an equitable and transparent tax system, and good use of money!

AND - it seems to continue the confusion many taxpayers have that when they buy taxable goods from Amazon or other out-of-state vendors, that no tax is owed. This is not correct - these customers must self assess and pay the use tax, which most can do right on their California income tax form. I'd guess that most people who sign the petition to get the referendum on the California ballot think they are signing to eliminate sales tax on these sales (rather than to just ensure that they must collect use tax rather than having the state try to get Amazon to collect it for them).

A better approach to all of this:

California should work with Congress to enact legislation (currently S. 1452, the Main Street Fairness Act) which would allow for a uniform approach for states to collect sales tax from remote vendors. Amazon has stated that it supports this approach (see Mark Hachman at PCMAG.com of 7/26/11)
California should consider adopting the Streamlined Sales & Use Tax (which it would be required to do under S. 1452 if it wants to be able to collect from remote vendors).
Continue to educate people about the use tax. Even under S. 1452, small vendors would be exempt so there would still be a requirement for consumers to self-assess and pay use tax. This will be easier though starting in 2011 when most can use the look-up table (see proposed table at last page of this BOE document).

And, there are even easier ways to collect the tax - have it collected at the same time the buyer's credit card or Paypal account is charged for the taxable purchase. Retailers would no longer have filing and collection obligations, customers would not have to worry about use tax recordkeeping and reporting and states would get their money quicker (for more on that, see my blog post and testimony - here).

What do you think?

VAT Hearing by House Ways & Means and Relevance for Tax Reform

2011-08-25T13:39:00.000-07:00

A July 26 Ways and Means Committee hearing focused on consumption-based tax systems. Although there are a few different formulations for a consumption tax, the committee only addressed two - the "fair tax" (a national retail sales tax) and the value-added tax (for example, the "flat tax" which is also a consumption tax, was ignored).

There are lessons we can learn from the over 130 countries that use a VAT. I think there is also some benefit to states if they replace their out-dated, cumbersome sales tax regime with a VAT. Also, perhaps other countries can have lower corporate income tax rates because they have a national VAT.

I have a short article published today in the AICPA Corporate Taxation Insider on the VAT discussion at the July 26 hearing and the relevance to tax reform in the US - "VAT Lessons for U.S. Tax Reform."

And for a list of tax reform hearings in the 112th Congress - see this list here.

What do you think about a VAT for the US?

US Chamber of Commerce Seeks Tax Restructuring and Entitlement Reform

2011-08-24T08:47:00.000-07:00

This month (August 2011), the U.S. Chamber of Commerce sent a letter to the Joint Select Committee on Deficit Reduction (created by the debt ceiling legislation PL 112-25, Section 401) stating that "Congress must reform entitlement programs and fundamentally restructure the U.S. tax code to bring revenue and spending back into alignment."

The Chamber doesn't provide specifics, but states that tax reform is needed "to improve efficiency, transparency, and simplicity to drive economic growth and job creation." ... and address "how the current tax laws act as an impediment to worldwide competitiveness, a deterrent to saving and investment, and an obstacle to innovation and entrepreneurship." They also suggest that reform should "lower overall marginal tax rates, to encourage saving and investment, to foster global competitiveness, increase capital accumulation, attract foreign investment, and drive job creation."

Interesting points:

That they are calling upon this committee to restructure the tax law.
That they are saying that spending reductions/reforms should not be just on discretionary spending (which is a relatively small category of federal spending), but should instead look at entitlement of Social Security and Medicare.
They are starting with tax principles to help shape the reform - efficiency, transparency and simplicity. This would mean that they would support reduction and elimination of some number of special deductions, exclusions and credits. They are also calling for elimination of special rules that benefit one industry over another. They want "the marketplace, and not the tax system, to allocate resources" (neutrality and economic efficiency).

I think this is a good, bold move. The Chamber says it speaks for about 3 million businesses of all sizes. The federal tax system has become too complex, which increases compliance costs for businesses and individuals. The AMT and too many phase-outs and special rules makes it difficult for taxpayers to know the tax consequences of their activities.

But, the special committee must vote on its report by November 23, 2011 - that doesn't give them much time. Yet, there are various proposals including from President Obama's deficit commission (here), and others (I have links to most here). And there have been several hearings this year on tax reform (see list here). Entitlement reform will likely be a bigger challenge thought than tax reform. We'll see.

Forbes post on "asking the right tax questions"

2011-08-23T00:52:00.000-07:00

I am grateful to CPA and blogger Peter Reilly now blogging for Forbes in addition to his Passive Activities tax blog, for letting me be a guest blogger on his site today. I have a blog there on the need to look at the spending in the tax law when looking at cutting spending or generating revenue. I explain though why it is harder to cut the spending in the tax law rather than the spending in an agency's budget even though the net effect to the treasury is the same.

Please take a look - here. And, of course, check out Peter's fine posts!

PL 86-272, UDITPA and the CPA Exam

2011-08-21T13:49:00.000-07:00

The CPA exam change getting the greatest attention is the addition of questions on International Financial Reporting Standards (IFRS). But, another one of interest is that starting July 1, 2011, there will be questions on Public Law 86-272 - the income tax nexus law enacted in 1959! Also added - Uniform Division of Income for Tax Purposes Act (UDITPA) which has been around since 1957!

While these are very old laws to finally be added to the CPA exam (which already has plenty of varied content), I think it must be due to the growing importance of these rules to businesses of all sizes that today can easily engage in interstate commerce. I wonder though why the content is described so narrowly. For example, why not add:

Nexus concepts for state income tax purposes.
Basic rules and concepts for determining state income tax of a multistate business.

But another question - isn't the exam already complicated enough? The multistate rules added (even though just income tax and apparently just for sales of tangible goods to which PL 86-272 applies), are quite complicated. I suspect that the questions have to be fairly general. Do they adequately measure understanding of these important tax concepts?

References:

List of 7/1/11 changes from the AICPA - here.
Complete list of exam content - here.

What do you think? How would you word a question on PL 86-272 and UDITPA for the CPA exam?

California Property Taxes in the News

2011-08-18T23:54:00.000-07:00

I found two interesting stories in the news this week about California's property tax and the famous "Prop 13." These stories are (1) Los Angeles Mayor Villaraigosa calling for a change to Prop 13 for non-residential property to help generate revenue to help fund education and (2) greater scrutiny being paid to whether non-profit organizations located in California are entitled to a property tax break. Details and tax policy observations ....

1. Mayor Villariagosa spoke to the Sacramento Press Club on 8/16/11. He stated:

"Let’s apply Prop. 13’s protections to homeowners and homeowners alone. And let’s strengthen those protections. We could take half the money we generate to fund schools and use the other half to cut taxes for homeowners – and, you know what, we can spur the housing market in the process. Phase it in over time to soften the impact on business and call it the Homeowner and Public Education Protection Act!"

He observed that this change could generate between $2.1 and $8 billion per year. He also suggests some other changes including taxing some services and reforming the corporate income tax.

He also said there is a need "to modernize and rationalize our tax laws – and yes, even to eliminate taxes that don’t make good economic sense."

The details on his proposed property tax change are not included. I would guess it could be changing the definition of change in ownership, increasing the tax rate, or modifying the valuation formula. One policy aspect of the California property tax system that warrants a look is equity. A business that has owned property for a long time will have a lower property tax bill than a business that recently acquired property even though both pieces have the same market value. That creates competitive disparities. Another policy consideration is neutrality - that tax rules should not affect business decisions. But, certain business restructurings might be done primarily to avoid a property reassessment - in violation of the neutrality or economic efficiency principle.

I'm curious as to what he has in mind to return some of the additional property tax revenue to homeowners. That statement concerns me because homeowners already get so many tax breaks in the federal and state tax rules.

As I've blogged about and written about several times - such as here, the California tax system needs modifications to modernize it and enable it to better meet principles of good tax policy. So, I think it is good that the Mayor is raising these points. He is also taking a bold step in not only calling for reform (which might be done in a revenue neutral manner although that would still need a 2/3 vote) but is calling for generating additional revenue to better fund education.

2. Property tax of non-profits - the New York Times had an article on 8/14/11 - "California Scrutinizes Nonprofits, Sometimes Ending a Tax Exemption." The article notes that "assessors in each of the state’s 58 counties make the final decision on exemptions, after determining whether that property is used in a way that is of “primary benefit” to California." The article notes that it is not always easy to determine whether a charity provides a benefit to California, such as because some of that benefit might be indirect. For example, it notes an organization that fights tuberculosis in Mexico, which provides an indirect benefit to California by limiting spread of this disease. With counties looking for revenue, the exemption is getting extra scrutiny.

This exemption highlights a tax law design challenge. When something is exempt, the law becomes more complicated in trying to define that exemption, which is usually not easy. Are there policy reasons to justify a property tax exemption for non-profits? They do use public services (such as roads, courts, fire and police). As a non-profit, they have income tax breaks in that they are not subject to income tax unless they have unrelated business income. Non-profits do not get employment tax breaks, so why a property tax break?

Tax reform should look at all special rules to determine if they are still appropriate and if yes, are they designed to meet their underlying purpose?

For more on the welfare/non-profit exemption in the California property tax, see Section 267 of the BOE Assessor's Handbook (178 pages!) - here.

What do you think?

Warren Buffett and Income Tax Progressivity

2011-08-16T21:49:00.000-07:00

Warren Buffett is in the news this week for calling for increased income taxes on very high income individuals, such as himself (New York Times op ed of 8/14/11 - "Stop Coddling the Super-Rich"). He notes the very high income of a very small percentage of the US population. Specifically he states that about 237,000 households reported income exceeding $1 million in 2009. Buffett says they should have a higher tax rate than other individuals and the roughly 8,300 filers with income in excess of $10 million should have an even higher rate. He says the rate should be higher not only for earned income, but also capital gains and dividends.

He raises an important discussion point. How wide of a range of tax rates should a progressive income tax have? In California, the highest tax rate kicks in at about $95,000 of income for a married couple. That is fairly low. For the federal income tax, a married couple in 2010 hit the highest rate of 35% at about $374,000. Less than 2% of filers see that rate. But within that top 2%, there is really quite a range of income levels. I agree with Buffett that consideration should be given to make the system more progressive given the reality that there is quite a different between $400,000 of income and over $10 million of income. Perhaps the reinstatement of the higher tax rates in 2013 should apply to these very high income levels.

Arguments against greater progressivity include that high income individuals do pay more taxes (because they have more income) and very high tax rates can be confiscatory. High tax rates provide a greater tax benefit for deductions, but this could be addressed by converting some itemized deductions to credits.

What do you think?

What is "tax reform"?

2011-08-14T14:58:00.000-07:00

Senator Grassley sent a letter to President Obama on August 11 noting some differences in how he thinks President Obama defines "tax reform" and how he defines it. Per Grassley, President Obama's version of tax reform includes:

Requiring those who "can afford it" to "pay their fair share."
"Closing loopholes, special interest tax breaks and corporate subsidies."

Senator Grassley notes his concerns that current talk about tax loopholes and tax expenditures leaves some to think that all tax expenditures are loopholes. He notes that tax expenditures are rules "intentionally enacted by Congress for certain policy goals." He also notes that "tax reform in a global economy is a serious task."

Well, I think there are good points being made in all of this that need to be funneled into a better aproach to tax reform. This is the point of this 21st Centuty Taxation website and blog - how to effeciently and effectively move tax systems into the 21st century.

While Senator Grassley is correct that tax expenditures were intentionally enacted to serve certain policy goals, they are not subject to regular review so remain even when the policy goal is no longer needed. Also, they often get enacted for the wrong reasons. For example, there usually is no discussion of why certain benefits for those paying for higher education should get some benefits via the tax law rather than through programs established in the Department of Education. Also, where was the discussion on creating a child credit rather than just increasing the dependency exemption or standard deduction?

We need to both modernize our tax system and ensure it meets principles of good tax policy. Applying those principles of the overall tax system and individual provisions can identify where improvements are needed. It is likely that this analysis would lead to reform or even elimination of some tax expenditures (of which there are about 250 in the tax law). Tax system modernization would consider how we live and do business today and what are appropriate tax rules for taxing income and consumption AND how administrative processes can be modernized to make better use of today's technology.

What do you think?

Spending in the Tax Code - Needs to be addressed in deficit reduction

2011-08-10T08:08:00.000-07:00

I've blogged on this several times, but it is back in the news, so I'll mention it again. There is and has been a need to reduce spending and adjust revenues to improve the tax system. An editorial on Fox News (8/8/11) with quotes from two knowledgeable and objective sources - Len Burman and Maya MacGuineas, reminds us that there are benefits and a need to reduce "tax expenditures." These are the numerous number of special deductions, exclusions and credits in our federal (and state) income tax system that are not needed in defining the income tax base.

Burman notes that a tax credit can (and has) been used to avoid a label of spending and to reduce scrutiny on the particular item.

For example, if an elected official wants to help parents, they could create a program for lower-cost child care or increase funding for an existing child care program. That gets a lot of scrutiny and on a regular basis - every year when that federal agency with the funds seeks budget approval. However, create a child care credit or expand the existing one and it may just slip into a tax bill and never get looked at again. Either way - there is a regular "cost" in the budget.

There are many tax deductions and credits and exclusions that can be removed or cut back, such as the mortgage interest deduction (7/3/11 post) and taxing some percentage of the employer-provided health insurance exclusion, and others.

As noted in the article, the savings from cutting back on tax expenditures can be used for deficit reduction and paying for lower tax rates. They could also be used to make the income tax system more equitable by increasing the standard deduction. Removal and reduction of tax expenditures would also make the tax system simpler and more transparent - two important principles of good tax policy.

For more on tax expenditures - see my short article from the AICPA Tax Insider - here.

What do you think?

Payroll tax cut should expire as intended - we need to stop the tax cut addiction

2011-08-05T23:24:00.000-07:00

In an August 5, 2011 speech, President Obama stated:

"when Congress gets back in September, I want to move quickly on things that will help the economy create jobs right now –- extending the payroll tax credit to put $1,000 in the pocket of the average worker, extending unemployment insurance to help people get back on their feet, putting construction workers back to work rebuilding America. Those are all steps that we can take right now that will make a difference. And there’s no contradiction between us taking some steps to put people to work right now and getting our long-term fiscal house in order. In fact, the more we grow, the easier it will be to reduce our deficits."

There is also a story on this in the August 6 Wall Street Journal - "White House Renews Push to Extend Payroll-Tax Cut" (Peterson).

The payroll cut is in effect just for 2011 and is for employees. It reduces the employee's Social Security tax to 4.2% rather than 6.2%, but leaves the employer rate at 6.2%. Self-employed individuals get a similar break on their self-employment tax. The Wall Street Journal article notes that extending this cut will cost $112 billion.

Here are three concerns I have with the cut in 2011 and for extending it to 2012.

1. This reduction was intended to get more money in workers' hands so they would spend it and stimulate the economy. I have yet to find anyone who knows they got the cut. People are surprised when I mention it to them. Will a cut have much effect if people don't know their paychecks have a few extra dollars in them to spend? Of course, this is not just a few extra dollars. For individuals at the Social Security wage cap of $106,800, it is $2,136!

Where is the value in giving people up to a $2,136 tax cut if they don't know about it (certainly, doesn't seem to be much political value). The common response I get from people when I tell them about this cut is - Why would President Obama and Congress do this when we have such a large deficit? Great question!

2. How does reduced Social Security taxes for employees (not employers), with the Social Security funds backfilled from the General Fund to make up the difference, create jobs? I don't get that. I hope this is not because employers are to pay their employees less because of the cut - that seems odd.

3. Tax policy - what is the tax policy behind the reduced Social Security tax for employees and self-employed individuals? For one thing, this is not transparent. Most people don't know about the cut. Also, since the SS fund is being reimbursed by the General Fund, seems like a convoluted way to get a tax cut and fund Social Security.

I think part of the president's call for extending the tax cut is because politicians today just seem to love tax cuts and seem to forget that we can't afford them. This is one that should end on 12/31/11 as called for in the 2010 legislation that created it.

What do you think?

Rhode Island, Vermont, accountability and unified economic development reports

2011-08-04T20:36:00.000-07:00

Rhode island enacted SB 5894 (Chapter 151) on June 30, 2011. This appropriations legislation adds some additional accountability measures for a few of its credits and other incentives, as well as modifies its unified economic development reports. The additional data to be collected by the state for some incentives are details of employees hired. Specifically:

"On or before September 1, 2011, and every September 1 thereafter, the project lessee shall file an annual report with the tax administrator. Said report shall contain each full-time equivalent, part-time or seasonal employee’s name, social security number, date of hire, and hourly wage as of the immediately preceding July 1 and such other information deemed necessary by the tax administrator. The report shall be filed on a form and in a manner prescribed by the tax administrator."

Here is the rewritten provision calling for the unified economic development report:

"42-142-6. Annual unified economic development report. – (a) The director of the department of revenue shall, no later than January 15th of each state fiscal year, compile and publish, in printed and electronic form, including on the Internet, an annual unified economic development report which shall provide the following comprehensive information regarding the tax credits or other tax benefits conferred pursuant to sections 42-64-10, 44-63-3, 42-64.5-5, 42-64.3-1, and 44-31.2-6.1 during the preceding fiscal year:
(1) The name of each recipient of any such tax credit or other tax benefit; the dollar amount of each such tax credit or other tax benefit; and summaries of the number of full-time and part time jobs created or retained, an overview of benefits offered, and the degree to which job creation and retention, wage and benefit goals and requirements of recipient and related corporations, if any, have been met. The report shall include aggregate dollar amounts of each category of tax credit or other tax benefit; to the extent possible, the amounts of tax credits and other tax benefits by geographical area; the number of recipients within each category of tax credit or retained; overview of benefits offered; and the degree to which job creation and retention, wage and benefit rate goals and requirements have been met within each category of tax credit or other tax benefit;
(2) The cost to the state and the approving agency for each tax credit or other tax benefits conferred pursuant to sections 42-64-10, 44-63-3, 42-64.5-5, 42-64.3-1, and 44-31.2-6.1 during the preceding fiscal year;
(3) To the extent possible, the amounts of tax credits and other tax benefits by geographical area; and
(4) The extent to which any employees of and recipients of any such tax credits or other tax benefits has received RIte Care or RIte Share benefits or assistance.
(b) After the initial report, the division of taxation will perform reviews of each recipient of this tax credit or other tax benefits to ensure the accuracy of the employee data submitted. The
division of taxation will include a summary of the reviews performed along with any adjustments, modifications and/or allowable recapture of tax credit amounts and data included on prior year reports."

This level of detail is unusual among states. A unified economic development report is to provide information to help lawmakers and others understand how tax incentives are being used. I think more is needed. The above description just sounds like a collection of data. Although it is more than would otherwise exist, without some analysis, it won't have much meaning.

The tax credits should have a stated purpose and some appropriate assessment measure. For example, if it is a jobs credit, collect data on number of net jobs added by those claiming the credit, state employment changes, as well as comparisons to prior years and to other states. Did the state have higher employment increases than states not offering a jobs credit?

Vermont has been preparing unified economic development budget reports for a few years (here). Vermont's March 2011 report notes:

"It is important to have clear, attainable and measurable goals (outcomes) in order to have meaningful measures of success (performance) for relevant programs and activities. The Administration and the Legislature must work toward establishing clear sets of measureable goals for all new programs including those related to economic development. A review of the current programs and their stated goals shows that a majority of programs still have only broad goals which are often difficult to measure."

The authors note that this is a difficult task as often the outcomes are worded too broadly. To help remedy this problem, the state offered 2-day workshops on the "basics of outcomes, measures and methodology."

It's not easy. If the lawmakers say the credit is to encourage use of renewable energy, how can that be measured? How can it be determined if the credit caused created use of renewable energy beyond what would have happened without the credit?

Typically, either very broad, nonspecific goals are stated or perhaps none are stated. No company would do this. They would not try a new marketing strategy without stating the goals and how to measure if it meets their goals. The same should apply for government spending which often comes in the form of tax incentives.

What do you think?

Debt ceiling and tax changes

2011-08-01T22:19:00.001-07:00

The House passed a debt ceiling bill late August 1 (amendment to S. 325) by a vote of 269-161.* The Senate if to vote on August 2. The word "tax" doesn't show up in the 74-page amendment although the word "revenue" is used several times. The amendment calls for creation of a 12-member Joint Select Committee on Deficit Reduction that is to find ways to reduce the budget deficit by at least $1.5 trillion for 2012 to 2021.

Tax law changes should be part of the plan of the Select Committee. There are several tax deductions, exclusions and credits that do not need to be in the tax law and result in reduced revenue, and make the tax system more complex and inequitable. I've written about many of these in prior posts. They could include:

- Reduce the home mortgage interest deduction to only allow for interest on a principal residence with the debt capped at $600,000.
- Removal of deductions and credits for higher education and instead use part of the savings to fund Pell Grants for those who truly need financial assistance for college.
- Make 10% of employer-provided health insurance benefits taxable and gradually increase this to perhaps 20%. I think it really should be higher, but the system is not perfect and may cause some people to drop coverage which increases costs for others. The math will need to be explained to people so they see that it is still a good deal. For example, if your employer pays $10,000 of your health care coverage, $1,000 of that would be included in your income. If you are in a 20% tax bracket, the cost to you is $200. Still a good deal for $10,000 of health insurance benefits!
- Remove the child credit and use part of the savings to increase the standard deduction amount.
- Let the 2001/2003 tax cuts expire. Once the debt is paid down, consider modifying the upper rates to have brackets of over $500,000 and over $1 million (so reducing when the 35% rate comes into play).

What do you think could be changed in our tax law to help reduce continual deficits and help pay down the debt?

* For more on the amendment, see:
- White House fact sheet
- Wall Street Journal, "Uneasy House OK's Debt Deal", 8/2/11
- PwC news release

People who pay no income tax - persepctives

2011-07-29T11:15:00.000-07:00

The Tax Policy Center has an interesting and informative post - "Why Do People Pay No Federal Income Tax?" (7/27/11). It notes that a family of four with income of $26,400 will pay no federal income tax in 2011 due to the standard deduction and four personal and dependency exemptions. Hopefully few people are concerned about this other than perhaps that the standard deduction should be higher. Despite this family owing no federal income tax (and probably no state income tax either), they have paid payroll taxes, sales tax, excise taxes and some portion of the corporate income tax. Most likely at least 20% of their income is paying taxes of some type.

The Tax Policy Center post goes on to help explain why those making more than $26,400 and up to $50,000 pay no federal income tax. For that group, it is due to tax expenditures (the standard deduction and exemptions are not tax expenditures as an income tax should exempt some minimal amount to leave money to live on). Key tax expenditures for this group are elderly benefits and the child credit (see the pie chart in the post).

I am glad to see the Center note that the tax savings in this group pale in comparison to the tax savings those with much higher income gain from lowered tax rates and an even larger group of tax expenditures available to them.

My example: How much federal income tax should a taxpayer with $50,000 of income pay? I'd think no more than 10% (and really less given the other taxes they pay). But assuming 10%, that is $5,000 of tax. Current tax expenditures likely prevent such a taxpayer from paying most of that $5,000. Consider someone with at least $100,000 of capital gain income. Today, at a 15% capital gain tax rate (rather than 20%), they save $5,000 of tax (and likely live far more comfortably than the individual or family with $50,000 of income. Or better yet, if a person had only $20,325 of qualified dividends, they would save $5,000 of taxes (difference between current tax of 15% and 39.6% maximum rate without the tax cuts in place).

The tax savings of lowered rates on ordinary income and much lower rate on dividends and lower rate on capital gains, in addition to other tax expenditures (such as itemized deductions and the exclusion for employer-provided health insurance), means that higher income individuals have greater tax savings. That is, focusing on the tax savings of someone with $50,000 of income while ignoring the tax savings that for those with very high incomes are much greater than that person's income, is missing a big part of the tax cut and tax expenditure debate.

Let's focus on how much we think people at different income levels should pay and how to design a simple, equitable and efficient tax system to reach that point.

Need to further lower CA sales tax rate - Mercury News op-ed

2011-07-24T12:22:00.000-07:00

I'm pleased to have an opportunity today to share my perspective on the need to fix the California sales tax by lowering the high rate and broadening the narrow base. This will enable the tax to meet principles of good tax policy and support business activity in the state.

The op-ed is in the San Jose Mercury News (7/24/11) - "Lower the sales tax - but reform what does and doesn't get taxed."

IRS Guidance Issues - Tax Analysts Forum

2011-07-23T16:17:00.000-07:00

As I've discussed previously here, the IRS has been issuing a fair amount of unofficial guidance, such as FAQs on its website or information in form instructions or publications that does not come directly from official guidance. By unofficial, I mean it is not published in the Internal Revenue Bulletin or as a news release. It also does not count as "authority" for purposes of determining if there is, for example, "substantial authority" for a position taken on a return. Even the IRS excludes these items in explaining "official guidance" - here.

For more information, see "How Heavy is an FAQ?" in AICPA Tax Insider (11/11/10). I thought this was also a taxpayer rights issue and raised it with the Taxpayer Advocate Office, but only heard back that, yes, it is not something that can be relied upon to obtain relief from a penalty. I was hoping they would take up the issue because not only might taxpayers rely on this unofficial guidance, but many practitioners are too. Particularly where there is no other guidance.

I think this topic is also relevant in what is expected of a practitioner - they are to follow substantive law (see IRS info on this - here). Many of the FAQs are summaries of existing substantive law in that they are summarizing the Code or regs. But not all. Some are interpretations by IRS and some are just IRS guidance - such as in explaining their program on regulating tax return preparers.

Tax Analysts held a forum on this topic on July 22, 2011 - Taxes and the Guidance Process. They discuss these issues. I'm glad to see that as this is an issue that needs more attention. You can listen to the recording of this forum - here.

FAQs are useful, but the IRS needs to make them official guidance. They could be issued as a Notice or Revenue Ruling. Then it is there forever. If the IRS modifies it, that subsequent ruling will say it is modifying an earlier specific ruling. And both the old and new guidance will be in the permanent record. That is not the case with an FAQ that is later changed or deleted. The history is gone unless you printed the FAQ before it was removed from the IRS website. This is not the way to issue guidance. The same goes for when information only appears in IRS form instructions or publications.

What do you think?

What Tax Reform Should Really be Focused On

2011-07-22T02:06:00.000-07:00

I have a second guest post on the FranchiseHelp website. It addresses some of the reasons why federal tax reform is needed. I hope you'll check it out - here.

Creating More Sales Tax Collectors - More "Amazon" Laws

2011-07-19T00:48:00.000-07:00

In 2011, 5 more states joined the existing three that had enacted so-called "Amazon" nexus laws to try to get more Internet vendors to collect sales/use tax. New York started this in April 2008. I have a short article with the background and details of the five states that joined in this year - see Creating More Sales Tax Collectors, AICPA Tax Insider, 7/14/11.

The California legislation (ABX1 28; 6/29/11), had a few modifications from the NY version. First, the CA affiliate nexus rule only applies if the vendor with the affiliates has over $500,000 of sales to CA customers. This was to prevent, apparently, creating a collection burden for any eBay seller with over $10,000 annual sales to California customers. Since eBay earns a commission on the sale, the sellers would be subject to collection.

Second, the California law also expands "retailer engaged in business in this state" to include "Any retailer that is a member of a commonly controlled group, as defined in Section 25105, and is a member of a combined reporting group, as defined in paragraph (3) of subdivision (b) of Section 25106.5 of Title 18 of the California Code of Regulations, that includes another member of the retailer's commonly controlled group that, pursuant to an agreement with or in cooperation with the retailer, performs services in this state in connection with tangible
personal property to be sold by the retailer, including, but not limited to, design and development of tangible personal property sold by the retailer, or the solicitation of sales of tangible personal property on behalf of the retailer." This is another way to apparently try to get Amazon to collect sales tax even if it cancels all of its affiliate arrangements in the state (which it did - see my 7/4/11 post).

Per a CNet article, "California targets Kindle lab in Amazon tax spat" by McCullagh (6/29/11), Amazon has two subsidiaries in California that developed and work on Kindle and other items.

A few interesting items related to this topic:

1. A 7/12/11 news release from California Board of Equalization chair Jerome Horton on how the BOE will enforce the new Amazon/affiliate nexus law in California. He also notes that a referendum petition to repeal the law was filed (still needs to get signatures to get it on the ballot). He also states that "“Once the public learns that non-California companies who currently fail to comply with the law and play by the rules are costing California approximately $12.5 billion in sales and $1.1 billion in use taxes which translates into 37,000 jobs, $52 million in property taxes, and $48 million in income taxes." No details on how these figures were determined.

2. The California Retailer's Association, a supporter of these affiliate nexus laws, issued a press release in March 2011 calling for Overstock.com to stop bullying Californians. Like Mr. Horton, they note that not collecting the sales tax results in the loss of thousands of jobs. The CRA also notes that the New York legislation did result in Amazon and a few other vendors starting to collect the sales tax. But in the other 7 states that enacted similar legislation, Amazon did not start collecting the tax but instead canceled the affiliate contracts so it was no longer subject to the law (but see earlier comment that this may not get them off the collection hook in California).

But - of the 8 states that have enacted the affiliate nexus rule, only New York offered amnesty for prior possible liabilities to those who started collecting. How important was that amnesty to Amazon and why haven't other states also offered amnesty?

I think California should continue to ramp up ways to get buyers to self-assess use tax and join with other states to get Congress to address this matter. California will likely need to join the Streamlined Sales and Use Tax Project at some point.

For more on use tax collection, see my February 2011 testimony for the CA Assembly Revenue & Taxation Committee.

What do you think?

Debt Free America Act

2011-07-16T09:33:00.000-07:00

Congressman Fattah (D-PA) has once again introduced the Debt Free America Act (H.R. 1125) (in the 111th Congress, it was H.R. 4646). This proposal calls for a 1% fee (really a tax) on "every specified transaction." That is any transaction where payment is made by cash, check, credit card, or transfer of stock or other financial instrument. A "transaction" is any retail or wholesale sale, purchase of intermediate goods, and financial and intangible transactions.

There would be a credit for low income individuals based on their adjusted gross income. The individual income tax including the AMT would be repealed after 2021 (the credit would end then as well). The stated goals are to promote economic prosperity and eliminate the debt (as well as interest on it). The text of H.R. 1125 notes that the fee is different from a sales tax and a VAT. The proposal also calls for an 18-member task force to study and make recommendations to address the country's fiscal imbalance.

Congressman Fattah's office asked me for comments on the proposal back in January 2010, which I provided. It doesn't appear that any were incorporated - oh well. I applauded his effort to reduce the debt which I noted doesn't really seem to get much attention; instead, we just keep hearing about tax cuts and more deductions and credits.

Below are the comments I provided in February 2010 on the proposed transaction fee. I believe it needs reform to improve transparency, equity and efficiency. One glaring problem is to repeal the individual income tax but keep the corporate income tax and have businesses pay the transaction fee along with individuals - often on the same transactions (there is a pyramiding problem in the proposal). The text of my earlier comments:

1. Fee versus tax: A fee is generally viewed as something paid for particular services to be received. On the other hand, a tax is something charged that is not tied to services received, but is used to generally fund government operations. Given the use of the transaction fee, it should be called a tax.

2. Base: Transactions to be taxed include retail and wholesale sales, purchases of intermediate goods and financial and intangible transactions. Why not also include services and rent? It seems that payment of a mortgage is a financial transaction, so would be taxed (and the purchase of the home also would have been taxed). It seems that rent should also be taxed as equivalent to a mortgage payment or purchase of an asset. Since it sounds like the goal is to apply the tax to any transaction, it would be inequitable and economically distortive to only apply the tax to transactions involving property and financial transactions and not also services and rents.

3. Digital: Given the varied ways some goods can be transferred today, it would be helpful to clarify that goods refers to both tangible and digital goods.

4. Double taxation: The definition of transactions seems quite broad such that the same funds could be taxed multiple times to the same individual. For example, assume an individual receives a paycheck of $300 and cashes it at a check cashing store. That sounds like a financial transaction upon which the proposed tax applies. When the individual spends the net proceeds at the store, a tax is imposed again. If this is not intended, the definition of transaction should be clarified. If this is the intent, employees might request that they be paid in cash rather than a check (assuming that avoids a transaction tax, and if it does, that seems too easy of a way to avoid the tax).

5. Pyramiding: A problem with most sales taxes as well as gross receipts taxes is that when businesses pay them, all or a portion of that tax is added to the sales price upon which the buyer also pays the tax. This results in a tax on a tax or "pyramiding." The amount of pyramiding can vary from industry to industry and company to company depending on the amount of vertical integration in the company and the complexities of the manufacturing and distribution chains. Because the transaction tax is paid by everyone with no refund to businesses, the tax will pyramid and that should be avoided. One way to avoid that is to only have the transaction tax apply to the final non-business consumer. This is how a credit invoice VAT operates.

6. Tax gap: While the rate is likely to be low because the base is so broad, there is likely to be efforts by some taxpayers to find ways to avoid or evade the tax. Appropriate compliance and penalty provisions are needed to help reduce this reality.

7. Bartering: While application of the tax to bartering transactions is to be studied and a report issued after implementation of the tax, this is likely too late. Under the income tax, bartering transactions are usually subject to tax and people figure out how to value the bartered services. Thus, there seems to be no reason not to stress that the tax applies to bartering transactions from the start.

8. EITC: The EITC is a significant social welfare program administered through the tax law. Its repeal will represent a tax increase for many working individuals who today pay little or no federal income tax, but who would be subject to the transaction tax as well as payroll taxes. Also, since the transaction tax is a regressive tax (while the income tax is progressive), some relief should be provided to low income taxpayers who will likely be burdened by the new tax. In addition, while both the transaction tax and income tax are in place, the proposed §25E credit will not be the equivalent of the EITC even if it is refundable. Consideration could be given to providing payroll tax relief to individuals currently subject to the EITC.

9. AMT repeal: While the AMT for individuals is repealed, there is no mention of whether it is also repealed for estates and trusts. Also, the minimum tax credit (MTC) of §53 appears to remain. Even when (if) the income tax is phased out, something specific should be said about MTCs that some individuals are carrying forward to use against future regular tax liability. The MTC carries forward forever and because it represents a prepayment of regular tax, individuals will expect that they can use it someday. Either it should be terminated or allowed to be used against the transaction tax (although perhaps not able to offset 100% of it in any year). Either way, it should be clear what happens to the MTC carryfoward.

10. Individual versus corporate income tax: Repealing only the individual income tax while apparently maintaining an income tax on corporations, estates and trusts can cause some problems. For example, the tax law will play too large of a role in business form. Small businesses, in particular, will be inclined to avoid the corporate form (unless S corporation status is retained and available to them). Also, individuals will still indirectly pay income tax because the corporate tax is ultimately paid by individuals – employees, investors and customers.

11. Study: Additional items to include in the study along with the EITC, AMT, child tax credit and mortgage interest deduction, include the impact on charitable contributions, fringe benefits and retirement savings planning. The study might also include whether any tax relief should be provided for spending attributable to certain casualty losses.

12. Equity: A transaction tax is regressive in that it will represent a higher percentage of the income of lower income taxpayers relative to higher income taxpayers. Unless it is clear that the proposed transaction tax will apply to deposits and investment growth, it seems that high income taxpayers will have lowered tax liabilities with the transaction tax when it entirely replaces the income tax. While it appears that if a wealthy person were buying and selling investments, the tax would apply to the purchase transactions, what if assets sit and earn interest and dividends that are not spent? Those earnings would have been subject to the income tax (at a rate greater than 1%), but do not appear to be subject to the transaction tax until there is a transaction. Data should be gathered on the distribution of the transaction tax among different income groups. It might be that the income tax should remain for individuals above a certain income level.

13. Effect on states: States tend to rely upon the Internal Revenue Code for the foundation of their income tax. Repeal of the individual income tax at the federal level may pose challenges for many states, perhaps even leading them to also adopt a transaction tax which would increase the amount of regressive taxes imposed upon individuals.

14. VAT: Why not a VAT? The U.S. is the only industrialized country that does not use a VAT. While that is not reason enough to adopt one, a VAT has some advantages over a transaction tax. These include: (1) structured as a credit invoice VAT like other countries use, it would not be a pyramiding tax; (2) the VAT is designed to minimize non-compliance; and (3) it might help the states improve their sales tax structures by converting them to a credit invoice VAT.

For more from Congressman Fattah - here.
Commentary from the Tax Foundation (7/14/11) - here.

What do you think? Is this proposal good as it is? in need of improvement? worth fixing?

Subsidyscope.org by Pew Now Has Tax Expenditure Database

2011-07-15T08:12:00.000-07:00

Yesterday (July 13, 2011), the Pew Charitable Trusts announced something new in its efforts to bring more attention to four types of subsidies issued by the government (that is, all of us!). The four categories:

Grants
Contracts
Tax Subsidies
Loan and Loan Guarantees

The Pew efforts began in 2008 with periodic reports on various subsidies, such as Amtrak.

The database launched this week allows people to look at the cost assigned to tax expenditures by the Joint Committee on Taxation and Treasury Department. Due to differing approaches to measuring the costs, the amounts are not the same, but each certainly shows the tremendous spending for these items such as housing.

For more on tax expenditures and what that means, why government agencies report different figures and some limitations on using tax expenditure reports, please see my recent article on Rethinking the Income Tax Calculation (2/10/11).

Also, for more on tax expenditures, don't miss the Center for American Progress Tax Expenditure of the Week program - here.

Why look at tax expenditures? A few of the reasons ...

They are a form of spending that is buried in the tax law. Any discussions about cutting spending that don't consider these is overlooking one of the largest spending parts of any federal or state budget. The federal spending in the tax law is about $1 trillion per year.
Many of these expenditures are inequitable (such as deductions that provide more benefit to higher income taxpayers than to lower income taxpayers).
They are special deductions, exclusions and credits that make the tax law complex.

I encourage you to try out the Pew tax expenditure database - use the box that says search. I typed in "elderly" and found a special deduction, credit and a few other items. Here is the link.

Colorado's Efforts Towards Greater Transparency

2011-07-10T16:45:00.000-07:00

Recently, Colorado enacted SB 11-184 which includes a requirement for a specific tax expenditure report. This legislation provides that by 1/1/13, and every odd-year thereafter, the Department of Revenue is to prepare a "tax profile and expenditure report" that includes

the legal reference for the tax expenditure
when enacted
description
revenue effect for most recent four years
for income tax expenditures, the effect by income classes
purpose

In addition, after 2011, any proposal for a new tax expenditure or to extend an expiring one must "include a legislative declaration stating the intended purpose of the tax expenditure."

While better than just providing the "cost" of the tax expenditures which is what is done now, the additional information will be better. But for greater transparency and accountability, it would be best to do what a company would do to see if resources devoted to a project are panning out. A company would (should) identify the goals for the project and appropriate assessment measures based on those goals.

For a state creating a new jobs credit to increase employment, the legislature should also mandate that the appropriate state agency gather data on changes in jobs among different industries and probably something about those jobs. For example, did they end up with more part-time jobs at minimum wage, or ones requiring a college degree? Without identifying the goals and measurable objectives, Colorado might not get as useful information that they are looking for.

What do you think?

Federal Return Preparer Competency Examination

2011-07-07T09:13:00.000-07:00

I submitted comments today per the IRS request for them on various aspects of the return preparer examination they are designing that will be required of preparers of Form 1040 who are not an attorney, CPA, Enrolled Agent or a "supervised/non-signing" preparer (Notice 2011-48). Given that the IRS has told all preparers that they need to know substantive law and exercise due diligence in applying it, I think that some how needs to be built into the exam.

My comments letter follows:

Comments per Notice 2011-48
Registered Tax Return Preparer Competency Examination
Submitted by
Annette Nellen, CPA, Esq.
Professor
San José State University
http://www.21stcenturytaxation.com/
annette.nellen@sjsu.edu
July 7, 2011

I am a tax professor and director of a graduate tax program. I have prior experience in the tax department of a Big 4 CPA firm and the IRS (four years as a Revenue Agent and one year as a lead instructor). I am also an attorney and CPA (so not subject to the competency testing). I have researched and written [1] on the Internal Revenue Service initiative to regulate paid return preparers which has led me to consider what appears to be expected of a return preparer based on various statements issued by the Service, and how that is relevant to the content and design of the competency tests.

Areas to Cover

The Internal Revenue Service website on "Responsibilities of a Tax Return Preparer" (http://www.irs.gov/businesses/small/article/0,,id=231827,00.html), states:

"Tax return preparers are expected to be knowledgeable in tax law and to prepare accurate returns. As a tax return preparer, you must take all necessary steps to prepare accurate Federal tax returns on behalf of your clients. These steps include reviewing the applicable tax law to ensure all income has been reported on the return, and only credits, expenses and deductions allowed under the Internal Revenue Code are taken. Tax return preparers are required to exercise due diligence in preparing or assisting in the preparation of tax returns and claims for refunds. As a general rule of thumb, that means knowing the underlying substantive law affecting an item of income or deduction."

Given this expectation of return preparers, consideration should be given to verifying and testing this expectation. Possible questions that can indicate a person's knowledge of the tax law and ability to review and apply applicable substantive law include the following:

Asking what resources the person has available to find answers to questions about how particular amounts and transactions should be reported on an individual client's income tax return.
Questions based on reading a Code section and related regulations provided as part of the examination.
Due diligence questions such as providing a possible client fact pattern and asking what questions they should ask of the client.
Due diligence questions about appropriate preparation and review procedures for a tax return.

Format
In addition to multiple choice questions, there should be a few short answer questions to address some of the questions noted above.

Other Matters
Consideration should be given to reviewing the test design, administration and questions that are used in states, such as Oregon, that already require certain preparers to pass a competency exam.

Submission Information
These comments are submitted by Annette Nellen and not on behalf of her employer or any professional organization of which she is a member.
Contact Information: annette.nellen@sjsu.edu (408) 924-3508

[fn 1] A list of articles can be found at http://www.21stcenturytaxation.com/Federal.html#Compliance.

--What do you think should be on the exam (and not on the exam)?

Senator Rockefeller Tax Proposal

2011-07-06T15:29:00.000-07:00

On June 30, 2011, Senator Jay Rockefeller (D-WV) offered a tax proposal primarily designed to address the deficit by increasing taxes on the wealthy. He offers "18 specific proposals to shave $1.29 trillion from the deficit over 10 years with a balanced mix of options to close corporate tax loopholes, rein in tax abuses, and eliminate special tax breaks for wealthy Americans and big companies." Changes include - with my commentary:

Eliminate the home mortgage interest deduction on yachts treated as second homes. Why not eliminate the home mortgage interest deduction (via a phase-out) for all second homes? There is no reason for the tax law to offer a subsidy for financing a second home.

Reduce the depreciable life for race horses to be the same as what farmers would get. There is a lot more that can be done in the depreciation area to update depreciable lives to better reflect reality (these would not all be measured as revenue raisers though because some lives are too long).

Let the "Bush tax cuts" (now also the 111th Congress tax cuts) starting in 2012 (rather than 2013) for those with over $1 million of income. He also proposes new brackets that are 3% higher for millionaires and billionaires. I think this will be a tough sell to accelerate this one year, but I agree there needs to be more brackets in the high end because in our economy, a couple with $250,000 of income certainly doesn't feel as wealthy or live similarly to people making over $1 million. But, why $1 million, why not have a bracket at $500,000 and above and then $1 million and above.

Cap the tax value of itemized deductions at 28%. President Obama has also proposed this. It violates the simplicity and transparency principles because there are already reductions in itemized deductions and having multiple rules rather than just one cut back adds complexity. Also, the effect is really a higher marginal tax rate. Why not just raise the tax rate? Also, this adds some equity, but converting some deductions, such as for charitable contributions, to a credit worth the same to all tax brackets, would be more equitable.

Enact H.R. 62 to support US jobs by treating certain foreign corporations managed in the US as US corporations. I think that instead of making piecemeal changes to how the US tax law applies to international operations, it would be good to look at the whole topic along with business tax reform including integrating the corporate tax.

Replace the corporate AMT with a 10% tax on profits over $25 million. I don't understand exactly how this is intended to work. We already have a graduated corporate tax structure with the highest rate of 35% kicking in when taxable income exceeds $10 million. Is this just adding another corporate bracket? If intended to get to a bracket of 45% (and I am not sure this is what is intended), that is too high even though in the 1980s, the rate was 48%.

Discuss a temporary 3 cent soda tax. This is described as a way that the middle class helps pay down the deficit. From the description, it appears it would only be on sugary sodas. But why on just that? Why not the other sugary drinks we consume - juice, flavored water, milkshakes, etc.? I'm not sure the administrative and compliance costs justify this tax.

There are a few more items in the list of proposals - here. I don't think it is the answer to reducing the deficit, but it is another example that there are ways to generate a trillion dollars over ten years. The ideas should get into the debate along with those of President Obama's deficit commission and others.

What do you think of Senator Rockefeller's proposal?

Amazon Cancels California Associates Contracts

2011-07-04T11:15:00.000-07:00

As promised and expected by most, Amazon has cancelled its contracts with California-based Associates. I set up an account for my daughter, which we never activated for payment of commissions, so got an email on June 29, 2011 that reads as follows:

"Hello,
Unfortunately, Governor Brown has signed into law the bill that we emailed you about earlier today. As a result of this, contracts with all California residents participating in the Amazon Associates Program are terminated effective today, June 29, 2011. Those California residents will no longer receive advertising fees for sales referred to Amazon.com, Endless.com, MYHABIT.COM or SmallParts.com. Please be assured that all qualifying advertising fees earned before today will be processed and paid in full in accordance with the regular payment schedule.
You are receiving this email because our records indicate that you are a resident of California. If you are not currently a resident of California, or if you are relocating to another state in the near future, you can manage the details of your Associates account here. And if you relocate to another state in the near future please contact us for reinstatement into the Amazon Associates Program.

To avoid confusion, we would like to clarify that this development will only impact our ability to offer the Associates Program to California residents and will not affect your ability to purchase from Amazon.com, Endless.com, MYHABIT.COM or SmallParts.com.

We have enjoyed working with you and other California-based participants in the Amazon Associates Program and, if this situation is rectified, would very much welcome the opportunity to re-open our Associates Program to California residents. As mentioned before, we are continuing to work on alternative ways to help California residents monetize their websites and we will be sure to contact you when these become available.
Regards,
The Amazon Associates Team"

As I noted in a March 9, 2011 post, the California legislation is not the same as the New York legislation in that NY offered amnesty for complying (see post). I also questioned the revenue estimates and why California doesn't do something more productive like work with the other states and Congress for a federal solution applicable to all states and all remote vendors. One good thing that California did in 2011 was enact SB 86 which will enable consumers to use a look-up table to determine their use tax liability (rather than have to keep records). This is a start towards improved use tax compliance, but without education and a law requiring taxpayers to make an entry on the use tax line on their state income tax form and indicate whether they filed a separate use tax form, it won't be as powerful as it otherwise could be (3/19/11 post).

I wonder if Amazon will find an alternative way for California residents to monetize their websites. It seems that one solution would be to change the arrangement to be cents per click rather than getting a commission. While I am not convinced that the payment arrangement is enough to distinguish advertising from sales commissions, it is likely to help as the Associate would get paid even if no sales are made (maybe).

Some think all of this will hurt Amazon's sales. I don't think so. The Amazon decision in January 2009 in New York noted that Amazon generated less than 1.5% of its NY sales from the Associates.* Today, people have heard of Amazon and can easily type Amazon.com into their browser and get there. Also, as long as the prices are better than other places (ignoring the sales tax even), they will do well. And, free shipping for orders over $25 is a good marketing approach.

But, are people fed up with Amazon and willing to go to other sites to make their purchase? Good question. I must admit, although I really like using the Amazon site for purchases, I have also checked prices at bn.com and if similar, have on occasion, purchased there (collecting sales tax is not a big deal for me as I have been keeping my records for many years and always pay my use tax!).

* Per the case (available free from The Public Library of Law), "Amazon further states that Associates' referrals to New York customers are not significantly associated with its ability to establish and maintain a market for sales in New York because they account for less than 1.5% of its New York sales (Amazon Mem at 27)."

What will you do - keep buying from Amazon or go elsewhere? What do you think California should do to reduce its use tax gap?