Reforming Treatment of Business Start-up Expenditures

Today, once a business starts carrying on business (when it is no longer getting ready, but is instead ready to serve customers), it can start amortizing its start-up expenditures as defined under IRC Section 195 over 15 years. If the total is $55,000 or less, up to $5,000 can be expensed immediately and this amount phases down as the aggregate expenditures range from $50,001 to $55,000.

S. 5204, Tax Relief for New Businesses Act, would increase the expensing amount from $5,000 to $50,000 and the phaseout point to $150,000. The bill sponsors note that the average small business spends about $40,000 to get their businesses from getting ready to carrying on.

Those with over these amounts today or per S. 5204, are amortizing expenses over 15 years. Meanwhile, we allow use of the cash method of accounting by most businesses, and have Section 179 expensing of over $1 million. Why not just allow the small business to expense up to the Section 179 amount along with other eligible section 179 property? This sounds like simpler and would truly help small businesses. That is why amortize something over 15 years when Section 179 expensing is over $1 million?

This proposal is in a list of proposals from several years back from the AICPA Tax Division on modernizing the tax law for small businesses. I hope that upcoming tax reform will not just extend expiring or expired TCJA items but also take a look at reforms that would help businesses and make sense given other provisions in the law.

I've offered additional tax reforms to help small businesses in this blog. One of my favorites (beyond what is in the AICPA paper which I'm pleased to say I was able to assemble with other volunteers and staff when I was chairing the AICPA Tax Executive Committee), is allowing co-owners of a new business to elect to be a Qualified Joint Venture something which today is only available to spouses (where both file identical Schedule Cs). This would be very helpful for a start-up run by two or more people because while they are getting started, they don't have to deal with setting up an LLC or filing a partnership return - which is a lot of work when unfortunately, they might not survive. After a few years, they would be required to shift to a partnership or C or S corporation.

I'm sure many people have ideas to truly help simplify tax rules for small businesses. 

What do you think?

Modernizing California's Tax System for Equity and Logic

Excerpt: California Tax Expenditure Report

California's tax system has a few longstanding weaknesses including volatility in its income tax and a sales tax system designed for the early 20th century economy. Also, like the federal government and other states, California has special deductions and exclusions in its income tax system that provide oversized breaks (subsidies) and upside down benefits to high income taxpayers. Upside down refers to a situation where if the government wanted to, for example, use funds to help taxpayers pay for something like housing or health insurance, they likely would provide higher payments to lower income individuals than higher income ones on the premise that the lower income individuals need greater assistance. However, when the assistance is provided in the income tax without any phaseout as income increases, higher income taxpayers get a bigger subsidy because their higher bracket provides a greater tax savings.

I had two short articles published this month that describe equity and logic issues with California's tax system and offer a few suggestions for improvement.

1. State tax law opportunities to address inequality - published in the Joint Venture Silicon Valley blog (11/6/24).

2. Apple Settlement Shows Why California Needs a Sales Tax Overhaul - published in Bloomberg's Tax Insights & Commentary (11/14/24)

I have been writing about these topics since I started this blog back in 2007 and they are not getting better.  Encouraging broader understanding of the issues, possible improvements and how they can benefit many individuals as well as the economy, can hopefully encourage people to ask lawmakers to work on legislative improvements.

What do you think?

Improving the American Opportunity Tax Credit

Excerpt from Pub 970

In May 2024 I had the opportunity to participate in the California Lawyers Association Tax Section's DC Delegation. Participants identify a tax rule in need of reform and draft a paper explaining why change is needed and offer proposals for that reform.

My May paper was on modifying and clarifying the American Opportunity Tax Credit (AOTC) which offers up to $10,000 of tax credit (subsidy) to most families for a child (or themselves) in the first four years of college ($2,500 maximum credit for year for up to four years).

The phaseout income levels for the credit are quite high so at least 80% of families qualify.

But there is a bit of unneeded confusion and complexity in the provision including exactly how the "first four years of college" are determined. An example on the IRS website makes it sound like you can select which of the four years of college count which seems out of sync with Code Section 25A (Q&A 16).  But in sync if we are only required to ask if the student has reached "senior" status at the university. This basic issue should not be confusing, but is.

The IRS has an Interactive Tax Assistant tool on its website which can help but I found it might cause some users to give up such as asking if your spouse has an ITIN after answering "single" to the question about whether you are married.

There is also some complex planning possible if a student receives a scholarship, including a Pell Grant, that is partially taxable. One fix to help Pell Grant recipients has been proposed a few times but not enacted is to not require a Pell Grant recipient to reduce AOTC-eligible expenses by the amount of the grant.

For more background and my recommendations for both legislative and administrative improvements, see "Modify and Clarify the American Opportunity Tax Credit," Tax Notes Federal, 9/26/24.

What do you think?

Need for More Red Flags and Enforcement to Pursue Tax Cheaters

Every week, there are several news releases from the Tax Division of the Department of Justice and the IRS Criminal Investigation (CI) unit about people caught in tax evasion and sometimes not only stealing from all of their fellow taxpayers but also employer or others. I encourage you to scan recent headlines for the reports of catching some of these bad actors.

• Department of Justice Tax Division news - https://www.justice.gov/tax/tax-division-news
• IRS CI news - https://www.irs.gov/compliance/criminal-investigation/criminal-investigation-press-releases

But, of course, many are not caught and some are caught after the statute of limitations has closed for some years of taking deductions they were not entitled to. If civil fraud is involved, the statute of limitations remains open, but some cases have not involved fraud but instead negligently claiming, for example, unallowable hobby losses as allowable business losses (and not getting caught until after doing it for many years) or claiming large charitable contributions of grossly overvalued property with the deductions carrying forward (recent example - 4th Circuit case with conservation easement charitable deduction claimed at $5.1 million on property bought a year earlier for $652,000. The court noted that because the initial years of the deduction are closed and the IRS had not examined the initial year, the taxpayers "received the benefit of having deducted $1.75 million").

A 9/26/24 news release from IRS CI describes a person who over three years made over $1.2 million as a software engineering manager. So he would owe some taxes on this $400,000 of annual income. But he greatly reduced his taxes by claiming over $1.1 million of medical expenses which were actually under $100,000. A jury found him guilty on three counts of tax evasion. Per the news release, this high paid person "deducted nonexistent medical expenses from his taxes for multiple years because he had not been 'caught' the first time he did it."

But why wasn't this person's return flagged by the IRS as needing an audit? Why is an employee with wages well beyond the median U.S. income (about $64,000 for the years involved), allowed a very large medical expenses exceeding 7.5% of his AGI when it is extremely likely he has good health insurance from his employer who pays his high salary?  This should be a "red flag" to trigger an examination - high paid employee with medical expense deduction.

For the overvalued charitable contribution deduction, why didn't data on Form 8283 trigger an audit in the initial year of the donation? While the taxpayers overstated the basis making it look just a little bit less overvalued, how can a $5.1 million deduction of property purchased a year earlier for about $650,000 not be a "red flag". These taxpayers improperly listed the basis as $1.35 million but even this spread should have still been a red flag.

Well, likely more "red flags" to trigger audits are needed. And, of course, funding for IRS enforcement is needed. Examinations of high income individuals can be complex and human resource intensive. The IRS has reported that recent additional enforcement dollars bring in tax owed. For example, a September 2024 press release from the IRS notes that with better funding of enforcement, they "launched an initiative to pursue 125,000 high-income, high-wealth taxpayers who have not filed taxes since 2017"!!  Yes, go after these people. Also, Congress has noted that enforcement dollars bring in revenue because additional funding allocations are scored by government agencies as revenue raisers (the IRS will bring in more tax dollars than the budget allocation). Per a 2/29/24 CBO report: "A $20 billion rescission [of IRS funding] would reduce revenues by $44 billion and increase the cumulative deficit by $24 billion."

Congress cut $21 billion of the additional $80 billion provided to the IRS over 10 years by the Inflation Reduction Act of 2021 and the cut came from the enforcement dollars!  How odd. Doesn't Congress want to bring in tax dollars for which it already passed laws saying the taxes were owed?  Why should compliant taxpayers subsidize tax cheats who, like the person just found guilty of tax evasion by a jury, kept cheating because they got away with it (until now)?

Besides the medical expense and high valuations of donations on Form 8283, what additional red flags do you think would catch non-compliant filers?

40th Annual TEI-SJSU High Tech Tax Institute Nov 4 - 5

This is a wonderful milestone - 40 years of the collaboration of the Silicon Valley TEI Chapter, the IRS and the SJSU MST Program to reach our 40th Annual TEI-SJSU High Tech Tax Institute. We'll be back at the Crown Plaza Cabana in Palo Alto on November 4 & 5, 2024.

We have an outstanding group of experts in many hot tech areas including equity comp, M&A, IP location, Pillar 2, international developments, how generative AI is being used in the corporate tax department, federal controversy, ASC 740, the latest in R&D tax rules, and more.

AND ... IRS Commissioner Danny Werfel will be speaking on Monday November 4 and former Assistant Secretary for Tax Policy Dave Kautter, now with RSM, will provide a DC Tax Update on November 5 (Election Day!).  

This conference is known not only for fantastic, cutting edge topics, but also tax experts from throughout the US. Also, attendees have fun amidst the tax complexity and this is an outstanding networking event.

Please check out the complete agenda and list of speakers and register. 

Hope to see you there!