Idaho Pumpkin Stand Debacle - Lessons to be Learned

In case you missed it, there was a story in a few newspapers this week about the Idaho Tax Commission closing down a pumpkin stand operated by two children ages 4 and 6. While there might be more to the story than reported, the Associated Press story includes that the Tax Commission said that even roadside stands need a permit. (Washington Post, Tax collector tries to squash Idaho pumpkin stand, 10/22/10)

Well, this is a bad PR story, although apparently a self-inflicted one, for tax administrators.

But, I think there are lessons to be learned that would make tax administration simpler, less mysterious to taxpayers, and reflect the realities of today's business environment (whether that business is small and temporary or likely to be large and longstanding).

• Assume that people do want to properly comply with the tax law because the majority do. The reality is that people will try to make a little money by selling something on a short term basis. Yes, there are sales and income taxes to deal with. Why not just create a simple online and paper form where a family or school group can register for sales tax for a single event (and do so for all of their single events). The website tells them they need to either collect sales tax from customers or pay it themselves and the rate. Then after the event, they go back online and report and remit the payment or can print the form and mail a check. The seller doesn't need to register, get a resale certificate or file quarterly reports. If they do want to do all of that, they need to indicate that they are a business and follow the normal seller registration and filing procedures. Basically, tax administrators should recognize that there are individuals, families, school and non-profit groups that occasionally hold a sale, want to be compliant, but don't want to be stopped by paperwork and filing that is beyond what is necessary to collect the tax. (I realize that the answer could instead just be - exempt these small activities. But then it gets to an issue of what is small and it misses an opportunity for budding entrepreneurs to learn about the complete financial picture that also includes the reality of tax obligations.)
• Take opportunities to get some good PR. Why didn't the Idaho Tax Commission just explain about collecting sales tax and help the family do what they needed to do? Of course, they may have and it was so burdensome that the family realized that the answer was to shut down the stand. This is why the suggestion in the prior bullet point should be pursued by tax administrators.
• Be sure the income tax is simple for small activities. For income tax purposes, the family should be allowed to just report the sales as miscellaneous income. If they want to deduct expenses, they should be able to get the cost of sales but not other expenses unless they want to show they are in a trade or business (they would otherwise be miscellaneous itemized deductions subject to the 2% of AGI floor). BUT, even the income tax can and should be simplified by a law that just exempts up to $400 (or some other amount) from income tax (so no reporting of the income or expenses) for isolated sales activity (such as the annual garage sale or seasonal pumpkin sale by children). The tax law includes a far more generous exclusion- the Section 280A exclusion for rental of a residence for 14 days or less.

I hope the Idaho Tax Commission will re-evaluate its system in light of the bad press it got and set an example for how the tax system can be friendly and help people to easily comply with realistic rules and systems.

What do you think?

Employment Tax Problems + Need for Effectve Tax Administration

In addition to the decades old problem of distinguishing an independent contractor from an employee, is the problem of uncollected payroll trust fund taxes. That is, when some employers pay their employees and withhold employment taxes, not all of those taxes get remitted to the government as required.

The Treasury Inspector General for Tax Administration (TIGTA) released a report yesterday (9/22) - The IRS Should Improve Collection Actions For In-Business Trust Fund Accounts Closed As Currently Not Collectible. TIGTA reports that in their sample review, the IRS did not adequately review whether taxpayers were current in filing obligations in 33% of cases.

"TIGTA estimates that improving controls to ensure required collection actions are pursued could potentially prevent approximately $84 million in liabilities from accruing per year, which is approximately $420 million over the next 5 years."

TIGTA reminds readers that "Taxpayers who do not voluntarily pay their share of taxes create unfair burden on honest taxpayers and diminish the public’s respect for the tax system."

A reminder that an effective tax system needs an adequate administrative structure to ensure that taxes owed are collected. This also requires an appropriate infrastructure with the revenue agency (such as IRS) - training, information technology, public education, etc.

This reminds me of some claims I've heard regarding the fair tax (national sales tax) that the tax will allow for elimination of the IRS (although states would take over collection). The uncollected payroll tax situation should also be a reminder that with a sales tax, not all of that gets paid over to the government either.

So, just an observation and reminder that tax system design also needs to consider the appropriate administrative structure.

Tax Administration and the Internet

We do a lot of things with the Internet - search and find lots of information, order goods and services, pay bills, transfer funds, apply for a job or for college, and e-file. With respect to tax administration, we can probably do more. For example, our W-2 and 1099s are computerized. Why can't they be transmitted to the recipient's tax file so they are already on our electronic return - whether that return is self-prepared or to be given to a paid preparer? Why are we typing information into tax prep software that has already been stored elsewhere electronically?

The IRS has been doing more with the Internet. For example, did you know about their website for checking whether you received an economic recovery payment - here? At the site, a person is asked to input their Social Security number and date of birth. They can also call a toll-free number if they prefer.

The IRS Strategic Plan for 2009-2013 includes: "We must become more technologically sophisticated to meet increased taxpayer expectations and maintain data security – modernizing our systems, improving our training, and continually enhancing our safeguards."

A recent report from Pew Internet - Government Online (4/27/10) states that 61% of American adults have used the Internet to get information from the government. The report notes that government use of social websites can further increase participation.

It would not just be the IRS that could make better use of secured Internet tools, but also state tax agencies. Why don't states create software for their citizens to help them track their online purchases for which sales tax was not collected, but is owed, with that software producing a year end statement of use tax owed (and the citizen would have an option to add in its mail order and travel sales for which use tax is owed). Privacy would not be an issue because the state would just provide the software, it would not monitor or operate it.

How else might tax administration be improved and simplified via the Internet, assuming it can be done securely? What do you think?

Earth Day and Taxes

Today is Earth Day! There is a significant connection to San Jose State University where I teach because the co-founder of Earth Day - Gaylord Nelson, is an alum.

Back to taxes - the Treasury Department announced its green initiative earlier this week (TG-644; 4/19/10). It will be moving more paper transactions to electronic ones. Treasury expects that this will save both money and trees. Specifically, they estimate their new initiatives will reduce costs by over $400 million in five years and save 12 million pounds of paper.

Some details from Treasury:

1. "First, Treasury will require individuals receiving Social Security, Supplemental Security Income, Veterans, Railroad Retirement and Office of Personnel Management benefits to receive payments electronically. Individuals will be able to receive benefits either through direct deposit into a bank account or Treasury's Direct Express debit card."
2. "Second, businesses currently permitted to use paper Federal Tax Deposit coupons will have to make those deposits electronically beginning in 2011 with a few exceptions, primarily businesses with $2,500 or less in quarterly tax liabilities that pay when filing their returns."
3. "Treasury will eliminate the option to purchase paper savings bonds through payroll deductions for federal employees on September 30, 2010 and for the private sector by January 1, 2011. This policy covers only paper savings bonds purchased through payroll sales; individuals will still be able to purchase paper savings bonds at financial institutions for themselves and as gifts. Payroll savers will be encouraged to continue their purchases through Treasury Direct, a web-based system that allows investors to buy and hold electronic savings bonds. Transitioning employees to electronic payroll purchases saves employers administrative costs and allows employees to manage their own bond accounts. This is estimated to save nearly $50 million in the first five years."

Moving tax systems into the 21st century involves both structural changes as well as administrative ones. I think this move by Treasury is a good one as these transactions should be done electronically to make good and appropriate use of today's technology, save money (which should also help reduce the deficit), and electronic can be done more securely than paper transactions. It also helps the growing number of people who keep all of their financial statements electronically.

What do you think?

COST Rates California Tax Administration a D-

The Council on State Taxation (COST) released its 2010 report - The Best and Worst of State Tax Administration: COST Scorecard on Tax Appeals & Procedural Requirements in February 2010. The factors COST uses to evaluate state tax administration systems include:

• Is there an independent tax tribunal with judges trained and experienced with the tax law.
• Do taxpayers have to pay first to get a hearing?
• Are the statute of limitations periods and interest rates the same for both assessments and refund claims?
• Is the protest period that arises upon issuance of an assessment at least 60 days (ideally 90 days)?
• Is the state return due date at least 30 days later than federal return due dates?
• Is the law clear as to what is considered a "final determination" by the IRS that would then trigger the taxpayer's obligation to report tax return changes to the state? COST recommends that taxpayers have at least 6 months to correct the state returns after a final determination by the IRS as to federal changes.

California received the lowest score of D- from COST. Reasons for this include (see page 9 of the report):

• Having an elected tribunal that is not required to have any tax expertise.
• Taxpayers must pay first to have a case reviewed at Superior Court.
• The interest rate that applies to underpayments and overpayments is not the same.

Tax reform discussions typically focus on just the base and the rate structure. However, if should also include reform of tax administrative practices to improve ones that are inefficient, do not make good use of technology, are out of sync with federal income tax procedures, are unfair or too burdensome.

One reform that has been suggested multiple times including by the last two tax commissions in California is to have an independent tax forum, such as a tax court, to resolve disputes between the state tax agencies and taxpayers. See:

• Commission on the 21st Century Economy (9/09) report at pages 46 and A-19 to A-20
• California Commission on Tax Policy in the New Economy (12/03) report at pages 4, 33 to 37, 77 to 83

I expect to have more on this later. What do you think are appropriate changes to improve California's tax administration system?