17th Anniversary of the 21st Century Taxation Blog

Today is the 17th anniversary of when I started this blog while I was a fellow with the New America Foundation. There is always plenty to write about regarding the topic of how taxes should reflect how we live and do business and follow principles of good tax policy. Time to regularly blog is not so plentiful.

Today the topic is taxation and coin-operated claw machines that are amusement games from which the player tries to pick up a toy with the claw and drop it in the chute. I'm not sure these are all coin-operated today as some likely only take folding money and some might take your credit or debit card.

A ruling from the Texas Comptroller of April 24, 2024 caught my attention. There are all types of taxes and one in Texas is the coin-operated machine tax! It defines the machine and like many taxes, has at least one exemption that then creates added complexity to define that exception. Here the exception is for "amusement machines designed exclusively for a child." This means a "machine that can only be used for skill or pleasure by a child under 12 years of age."

Well, what does exclusively mean and how does one really know if a machine is for ages 11 and below rather than ages 12 and more? Well, in a 2002 ruling, the comptroller defined "exclusively" as a machine "designed such that no person other than a child can use the machine." Also, "it doesn't matter if an immature adult or older child actually uses the machine" because it is the design that is relevant and the kind of prize a player can win is not relevant.  That seems odd, what if the prize is a pack of cigarettes? 

I'm sure the Texas comptroller must have better things to do than determine if a coin-operated machine is for kids age 11 and under rather than for immature adults or for anyone.

Ok, this is a bad way to draft a tax rule. At least two problems here. Coin-operated is too limiting if that means actual coins are dropped into a machine as these machines will certainly get converted to Apple Pay or debit/credit card tap as fewer people carry real money around. And there is no need for any exception here (I think that is true for most taxes - exceptions should be avoided).  If there is some need to provide relief to certain machine operators, find another way such as have them apply for a grant based on financial need (I'd say an income tax credit but Texas doesn't have a personal income tax).

And before leaving these claw machines, back in 2001, the IRS had a funny TAM on the topic. The issue was whether the items inside the machine such as stuffed animals or novelty toys or other prizes were inventory to which the unicap rules of §263A would apply. The conclusion was yes!

The taxpayer claimed that the prizes were supplies for tax purposes, but called them inventory on its balance sheet. The IRS also found that the taxpayer was selling these items and title transferred to the winner, making them merchandise!

I call this funny because either the drafter of TAM 200121006 was very skilled at using these claw machines or had never used one. I think most people put money in and don't get anything making it clear this is not the way a retailer sells goods. These should have been treated as supplies consumed in the process of providing entertainment services. The TAM does provide a good review of code, regs and cases on inventory for tax purposes.

One more relevant tax here is sales tax. As supplies, sales tax would be paid by the buyer (owner of the machine) when they buy the prizes.

Tax policy relevance here ... the Texas ruling is a reminder that just about anything can have a special tax on it, but if too special and with exceptions, it gets complicated quickly. It would be better to find a more simple and equitable way to generate revenues (equitable in that similar businesses might not have a special tax).

What do you think?

Two States Using Wayfair Economic Nexus Standard More Broadly

As we know, the June 2018 U.S. Supreme Court decision in South Dakota v. Wayfair, Inc., et al, allows for an economic nexus threshold for all types of taxes. Many states already had an economic nexus threshold for income taxes. Many states have adopted the South Dakota threshold for nexus. This standard generally starts use tax obligations when a vendor has over $100,000 of sales in the prior calendar year or the current year to date or 200 or more transactions.

Now, one state - Hawaii, has adopted that same threshold for its state income tax effective for tax years beginning after 12/31/19.  [SB 495 (Act 221, 7/2/19)] Hawaii's sales tax nexus threshold based on the South Dakota law upheld by the Court started 7/1/18.

Also, the Texas Comptroller has proposed the same via a proposed regulatory change for its franchise tax. The Texas sales tax Wayfair threshold though is over $500,000 of sales and it doesn't matter how many transactions there are (there is only a dollar sales threshold).

Remember that a state cannot override P.L. 86-272 which still applies to limit nexus if a taxpayer has no physical presence other than sales personnel who solicit orders that are approved and shipped from out-of-state. This is relevant for Hawaii's state income tax, but doesn't apply to the Texas franchise tax because it is not a net income tax.

Making the thresholds the same should be a lot simpler for small businesses. I don't agree with the South Dakota threshold's 200 or more transactions because for many small businesses though because that can be a small dollar amount, such as if selling items that cost less than $10 each. I think that is not sufficient nexus for commerce clause purposes.  I think states should do like California and Texas did and drop the transaction threshold and only use a dollar of sales gross receipts that is at least $100,000 and perhaps higher in large states (after all, buyers not charged sales tax still have to pay use tax on their own, and the higher threshold keeps the burden on the state tax agency more manageable and more likely that most remote vendors will be found and have to collect.

Not all states define sales the same for these purposes so there is still complexity for multistate sellers. But for a remote seller to know that once they have use tax collection obligations in a state they also have income tax obligations (assuming they are not protected by PL 86-272), should provide greater certainty to businesses and state tax agencies and simplify recordkeeping.

What do you think?

Sales Tax Discounts - Still Warranted?

I've got a blog post on the sales tax discounts that several states offer to vendors to help address the costs they incur in getting sales tax remitted. See below for post originally at SalesTaxSupport.com on 4/10/18. Two things caught my attention recently that led to me to this topic.

1. Governor Greitens of Missouri has proposed repealing that states 2% unlimited discount. Certainly, it would raise revenue, but he also states that with improve compliance technology, the discount is no longer needed.

2. I reviewed many parts of Texas' tax law in preparing for testimony I presented to the Texas Commission on Public School Finance on April 5. I first noticed that they gave a discount for paying hotel taxes on time. They also have penalties for filing and paying late. The discount along with the penalty seemed to me worth addressing. After all, who gets a bonus for doing what they are supposed to do? I have not heard of employees getting bonuses for showing up for work on time. I also noted they had both a discount and a prepayment bonus in their sales tax system. A prepayment bonus is intriguing and one that technology can certain eliminate the need for.  If states want their tax dollars earlier, such as to pay bills rather than have to borrow to pay bills, why not use technology to get the payment to the government real time rather than have the sales tax first go to the vendor and then to the government (see my 6/23/08 (!) post for this topic).

For more on discounts, what states use them, which have limits and which do not and the tax policy considerations of them, please take a look at the post.

What do you think?

With Sales Tax Software, Are Sales Tax Discounts Still Appropriate?

Anyone looking at their sales receipt upon leaving a store will believe they paid the sales tax rather than the vendor. The vendor though, must maintain proper records, file a sales tax form and remit the sales tax collected from customers. Should the vendor be compensated for its efforts? Many states do so, typically referred to as a vendor discount.

The Federation of Tax Administrators maintains a list of what each state offers as a discount, if any, and if there is a cap on that amount. The discount is often based on a percentage of tax collected. The likely rationale for providing a minimum is that the compliance costs are unlikely to increase much as the amount to collect and remit goes up. But not all states have a cap on the discount.

Per the FTA list, 28 states offer a discount with 18 of them imposing a cap on the discount. The discount amount ranges from .25% in Nevada to 5% in Alabama and New York. Some states have a range of percentages, typically, higher for a initial stated amount of collections, and decreasing for collections above that amount, to account for the economies of scale that exist in the compliance process. The discount is also likely to only apply for timely compliance.

Why don't all states offer a discount? Well, cost is an obvious one. The discount in effect lowers the rate of the sales tax. The 0.5% discount offered by Texas cost the state $132 million in 2017. Texas also offers a 1.25% early payment discount which also cost the state about $132 million in 2017. These are significant costs for governments running on tight budgets.

States that don't offer a discount may also just view the collection costs as the cost of doing business. That hinders economic efficiency though in that not all businesses have to collect sales tax.

Missouri Governor Greitens has proposed repealing the state's sales tax discount as part of a tax reform plan to lower rates and close loopholes. His rationale for repealing the state's uncapped 2% discount for sales tax collection follows (from a 1/29/18 press release):

"Eliminating Timely Filing Discounts: Missouri currently offers a 2% discount to businesses for filing withholding taxes on time. Missouri is one of the only states in the country to provide an uncapped discount as high as 2% to vendors for filing sales taxes on time. At one time in history, it was a great difficulty for businesses to manually calculate and send their sales tax to state and local governments. This discount was intended to factor those difficulties into the tax collection system, and reward those who paid their taxes on time. Today, with modern technology, paying taxes on time is the norm, not the exception. In effect, Missouri's tax system rewards businesses for doing what they are required to do by state law. Families do not see a similar discount for following the law, and the issue that this attempts to address is not relevant in today's modern economy. These discounts complicate the tax code and offer no competitive advantage to Missouri. The Withholding Tax Timely Filing Discount and Vendor Timely Filing Discount should be eliminated, in favor of a simple reduction in tax rates."

So, Governor Eric Greitens raises another consideration for not offering a discount for sales tax compliance - technology has lowered the costs.

Well, technology has certainly made sales tax compliance a lot easier in recent years, but it still requires purchase and maintenance of the software and hardware, as well as humans to make it all work.

Perhaps it would be better to lower the discount percentage and impose a cap. For Texas and any other state offering a discount for early payment, technology should be considered that would allow the sales tax to go directly to the state at time of sale without even the need to file a return (even cash payments could be converted into immediate transfer of the sales tax when those deposits are made to the bank). That is, when a person's credit card is charged, the cost of the goods are charged to the vendor and the sales tax is charged to the state (who also then pays the credit card charge fee for the tax rather than the vendor). (See Texas Comptroller report, pages 12 - 15.)

The topic of sales tax discounts for vendors could get even more attention in all states with a sales tax should the U.S. Supreme Court rule for South Dakota in the South Dakota v. Wayfair case it will hear on April 17, 2018. If vendors without a physical presence in a state have to collect sales tax from customers in those states, their compliance costs will go up (including for the technology they will need) and they are likely to demand some type of compensation.

We'll see what happens in Missouri and more broadly.

Your thoughts?

Sales tax simplicity, equity and economic efficiency

The Texas Comptroller of Public Accounts publishes an interesting and informative monthly Tax Policy News. The March 2012 issue includes an article - "Spring is in the Air." It explains how Texas sales tax applies (or does not apply) to seeds, bulbs, trees, landscaping, stepping stones, pool cleaning and more.  The article is almost 2,500 words long. There are a variety of special rules depending on who is selling, the income derived, etc.

Here is an excerpt from the article:

"Dirt and Stepping Stones

Purchases of stone or rock that is cut, crushed or mixed with other products (such as processed soil, dirt, sand or gravel) are taxable as processed materials. But, purchases of unprocessed dirt, sand, gravel, stone, rock or similar materials are not taxable.

Dirt, sand, rocks and gravel that are merely sorted, sized, screened, washed or dried are not considered processed materials.

A person performing a taxable real property service, such as landscaping, may issue a resale certificate instead of paying tax on the purchase of processed materials that will be incorporated into a customer’s real property as part of the taxable service. See Rule 3.356 for more information about real property services. A person performing a nontaxable service must pay tax on processed materials.

A charge to a customer for unprocessed materials that are incorporated into the customer’s real property as part of a taxable real property service, such as landscaping, becomes taxable as part of the total charge for the taxable service. A charge to a customer for unprocessed materials that are incorporated into the customer’s real property as part of new construction (under either a lump-sum or separated contract), such as a rock wall, is not taxable. See Rule 3.291 for more information about contractors who add new improvements to real property."

Special rules, rules that are not intuitive (such as washed, dried and sorted gravel is not considered processed), and the need for long explanations of the rules, indicates a complex tax system. Special rules usually often create inequities where similarly situation taxpayers (or items) are not taxed similarly. Also, the exemptions do not seem to be aimed to serve the only two good purposes - a sale to a business or a necessity of life.  (Note - as I've often noted in this blog, a problem with exempting necessities of life, such as food, is that it provides a tremendous savings to higher income individuals who spend more on necessities.  Taxing them with some type of relief to low-income taxpayers, such as a refundable income tax credit or monthly subsidy would be better.)

How could these rules be simplified?  How about this for a statute:

Texas sales tax is imposed on all items sold to non-business customers. Such tax is to be collected and remitted by the seller.  Sellers must register with the state and will receive a tax identification number. Such number must be provided to sellers in order to receive a sales tax exemption. The only sales transactions not subject to sales tax are non-elective medical care and school tuition. Sellers with less than $10,000 of sales in the prior year may elect to remit sales tax on an annual basis either on a special sales tax reporting form or with their business income tax return.

With a broad base (although all business purchases would be exempt), the sales tax rate could be lowered. The above language could apply to any state, not just Texas.

What do you think?