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Friday, March 13, 2020

Tax Change Ideas to Address Coronavirus Costs

The coronavirus pandemic is scary. Thousands of people are afflicted and there is uncertainty as to what will happen next. To reduce the spread, many public venues are shut down. While many workers can continue to work at home, not all can. How, for example, does a hotel, store, and other affected businesses and their workers make it through this hardship both in terms of health and financial survival?

Some businesses may have insurance or reserves that can help. Given this is a tax policy blog, I'm going to share some ideas about tax changes that can free up and provide some financial resources for workers and businesses.  I hope you'll add your ideas in the comments.

Also, H.R. 6201, Families First Coronavirus Response Act might get enacted soon. It provides a variety of relief although is limited in tax relief. It includes:

  • expand unemployment benefits
  • exclude from income any "emergency leave benefits"
Here are some tax changes I suggest for consideration:
  1. Postpone the March 15 and April 15 filing dates for taxpayers and preparers who were affected by the virus either because they were sick or had to reduce hours or had fewer employees due to the virus or local / state restrictions. But encourage all who can still meet the deadline to do so. The March 15 fix needs to happen with an official announcement from IRS and Treasury this weekend (ASAP)!

    The AICPA has already requested such relief (see 3/11/20 press release). Also see this AICPA state tax chart of what states have offered to date + additional resources from the AICPA.
  2. Provide three more months for paying taxes without incurring a penalty. Likely this won't affect most taxpayers as they are going to file as soon as they can because they are getting a refund. But some who have filing delays might also have delays in getting a good handle on what they owe, or need the funds for living expenses. Perhaps add a caveat that the penalty relief is for those facing financial hardship at April 15 or are unable to get assistance or access to records needed to accurately compute their 2019 liability. This could be provided only for individuals and businesses with income below a specified level (but a level high enough to capture 90% of individuals).
  3. Increase the EITC by a set percentage. Since the EITC is for workers, it will benefit a group in need of relief. Many of these individuals likely already filed their 2019 returns. The IRS can do the calculations and issue refunds. Also increase the EITC for 2020. States should do the same (most states also have an EITC, but not all).
  4. Allow individuals below a certain income level to claim a casualty loss for lost wages or sole proprietor income where they can show they lost income due to shutdowns tied to the virus. Perhaps for 2020 they attach a new schedule to their return where they explain what happened and perhaps it only applies if their 2020 AGI is less than 2019 AGI ignoring investment income and retirement distributions. This loss should be allowed for AGI. Yet, this isn't a big help because it won't hit until they file 2020 returns and as a deduction for a low bracket taxpayer, the savings would be low. But, still, some relief as many individuals will struggle beyond the end of the pandemic to get back to some financial stability.
  5. Allow above the line deduction for costs of virus testing and medical expenses for individuals affected by the virus.  And as with presidentially-declared disasters, they can claim this on their 2019 return. Waive the 10%-of-AGI and $100 casualty limits and the need to have insurance.
  6. Provide a direct payment to low-income individuals similar to what was done with the American Reinvestment and Recovery Act of 2009 which, for stimulus purposes, provided $400 for single and $800 for married. These amounts likely need to be larger. due to government funding challenges and benefit people who lost income due to the virus, payments should just go to employees and Schedule C filers. A payroll tax cut is another good way to deliver this to employees (although it would take longer), but there should also be a way to get it to Schedule C filers below the specified income level.
  7. Allow individuals to pull a maximum amount of their retirement account without penalty and the ability to put it back in within the next five years. If they are below retirement age, it is taxable, but for those who lost income, the tax should be minimal. They should be encouraged to withdraw with at least 10% withheld to be sent to IRS as part of the tax payment.
  8. Provide a tax credit to employers who continue to pay workers even if they can't work.  This is usually done in disaster tax relief packages although the credit is not too large (40% on up to $6,000 of wages). This could be increased and a system could be created to allow employers to claim it in advance of filing their 2020 tax return.
  9. While the Tax Cuts and Jobs Act of 2017 repealed the ability to carry back losses, individuals and businesses should be allowed to carry back a loss for at least three years (likely sufficient given our strong economy of recent years).
  10. The TCJA offered simplified accounting methods, such as use of the cash method, to businesses with average annual gross receipts in the past three years of $25 million or less (now $26 million adjusted for inflation). Increase this to $35 million. This would help companies between $26 and $35 million of gross receipts as the change likely creates a negative "481(a) adjustment" for the year of change. And, allow the year of change to be either 2019 or 2020. While this lowers their tax for the year of change, it doesn't affect lifetime income, so isn't really a loss of revenue for the government, just a postponement. The dollar amount could even be increased. Also, it could be with the caveat that in five years, the threshold goes back to $26 million and they change back (that positive adjustment gets picked up in taxable income over four years).
  11. Offer tax incentives to companies who make their products or services available to the public where these offerings help people to work remotely.
  12. Encourage the well-off to help. For example, increase the qualified charitable distribution amount to $500,000 for 2020 if the donation is made to a state or local government for pandemic relief. Also, lower the age form 70 1/2 to enable those well-off and younger with extra large retirement accounts to pull the funds out to help.
  13. Enact the TCJA technical correction to make qualified improvement property have a 15-year life so it is eligible for 100% bonus depreciation. This may help some businesses that have to shut down for customers but may find safe ways to have workers stay and do improvement work. This change could also include a tax credit for modernization and deep cleaning work a business performs within specified guidelines.
  14. Encourage states to also come up with programs to help, including temporary hiring of folks who have lost jobs or hours at hotels, airports, arenas, etc.  Also encourage state and local governments to help subsidize costs of screening and helping people to work remotely. Some people might have trouble working remotely because they don't have the right equipment at home. State and local governments, as well as some nonprofits, may be able to bulk purchase and distribute iPads, temporary subscriptions to conferencing tools, etc.
What would you modify or add to this list?

Thursday, February 27, 2020

AB 5 Alternative or How Business Owners Can Better Spend $800 Per Year

In September 2019, California enacted a new worker classification approach called the ABC test (AB 5 - see Oct 2019 post). Basically, AB 5 starts with the presumption that all workers are employees rather than independent contractors (unless they work for the State of California which is exempt from many state labor laws). If A, B and C of the law are met, the worker is a contractor.  If A, B and C are not met, the parties need to see if any of about 50 exemptions apply and if yes, then apply the pre-AB 5 classification system which primarily looks at factors to determine if the employer has the right to control the manner and means of how the worker does his/her work.

While one goal was to be sure workers are not disadvantaged by some employers who may pay low amounts, I believe the law has far more disadvantages than advantages, there were definitely better and more modern ways to improve the law, and there are a lot of new complexities and confusion.  The new legislative year also started with over 25 proposals to add more exemptions and clarifications or even to repeal AB 5.

One aspect I want to address here is a 2/20/20 press release on AB 5 sponsor Assemblymember Gonzalez website. It includes:

"“We know many of California’s independent contractors who operate as actual small businesses are making a good faith effort to comply with AB 5 and formalize themselves and their business licenses,” Assemblywoman Gonzalez said. “This one-time relief will help these business owners with the transition to becoming LLCs.”

Under AB 5, some independent contractors who operate as bona fide small businesses can maintain contractual relationships with other businesses. This has resulted in a number of independent contractors forming single member limited liability companies (LLCs) to maintain their prior business relationships.

To form an LLC, a business pays an annual tax of $800, also called the Minimum Franchise Tax (MFT). To assist these independent contractors with the transition to formalizing their small businesses, this budget request proposes a one-year exemption of the $800 annual tax for the contractors who formed their businesses from September 2019 through December 2020."
I believe the underlying matter that led to this press release is a proposal in Governor Newsom's budget that new LLCs be exempt from the $800 minimum tax in their first year just as corporations are.  I don't see in his budget that he thinks forming an LLC makes someone a contractor as the press release incorrectly assumes. [See page 52 of the governor's budget summary.]

While there may be legal and business reasons for some businesses to form an LLC, it is not required.  An individual can operate as a sole proprietor and buy insurance in many cases. Also, when a person forms a single-member LLC, it is taxed as a sole proprietor for tax purposes BUT must pay an annual minimum tax of $800 (btw, minimum tax means you pay it even if you don't have any income).  I don't see what that sole proprietor gets though for that $800.

If there is any eagerness by lawmakers to see sole proprietors pay $800 every year, why not instead change California law to require ALL workers to pay SDI (State Disability Insurance). SDI is paid by employees, but not contractors. If all workers paid it, contractors would have a protection they don't have today unless they buy their own disability insurance. The cost is 1% of earnings capped at $1,229 for 2020.  So, let contractors pay SDI up to the maximum based on their net earnings.  This would provide a benefit they don't get by paying $800 LLC minimum tax each year.

Also, the press release is puzzling in implying that forming an LLC makes a worker a contractor.  That is not part of the ABC test and likely does not cause a worker to meet ABC or an exception. [Also see this 2/8/20 SF Chronicle article.] Also, take a look at AB 5 and note that it says in a few places that a legitimate business entity form for contractors includes a sole proprietorship. 

Also, a business license is completely different than the $800 minimum tax. Business license is generally a fee or tax paid to local government and some types of businesses may have additional license fees (workers required to have a license such as CPAs and manicurists).

I think what the press release is inferring about the governor's proposal harms his proposal. His proposal is a good one because it would make the law more equitable by giving all corporations and LLCs the same first year exemption from the $800 minimum tax (today only corporations get this tax break). 

What do you think?

Saturday, February 15, 2020

Confusion Abounds - What is Virtual Currency? Issues for Your 2019 Federal Return

Likely, most people think of bitcoin, now over 10 years old, when they hear "virtual currency."  If you look at CoinMarketCap, you'll see over 2,000 cryptocurrencies listed with bitcoin at the top given its market value. Others at the top include Ethereum, Bitcoin Cash, Litecoin, and Monero.

Well, what makes something a virtual currency in the eyes of the IRS? This is even a more important question for this current tax filing season due to a new question on Form 1040 Schedule 1 - At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?

Schedule 1 is used to report other income, such as business and rental income, as well as deductions for AGI. So a lot of people file it. According to page 81 of the 1040 instructions, if the answer to the question is "no" and you don't otherwise need Schedule 1, you don't need to attach it.

This question raises a lot of questions, such as:

  • What if move your VC from one wallet to another?
  • What if receive VC by gift or something else with no tax consequence? Should you attach an explanation?
  • What if a passthrough entity owns it? Need to ask apparently.
  • What if your VC had a fork or airdrop and you didn’t know that? Per Rev. Rul. 2019-24, the IRS views that as receipt of something and arguably that is correct although you might not have income at that time or the value of what you received may be zero (but this still seems to warrant a “yes” answer).
  • What if your child plays online games and there is some type of currency used in the game? Is this a virtual currency? (see more on this below and IRS activity on this question during the week of February 10, 2020)
  • What if your child has unearned income subject to the kiddie tax and parent elects to report it on parent return AND child though has "yes" answer to the Schedule 1 question - must the child file return on own? I don't think so as IRS can override the statutory provision at IRC Section 1(j)(7) that parent can elect to report child unearned income on parent return if all specified requirements are met.
Additional issues:
  • What happens if person doesn’t know about question such as because doesn’t otherwise need a Schedule 1?
  • What if you don’t otherwise have a filing obligation but the answer would be “yes”?
  • What if you are paid in VC and keep it rather than convert it or spend it? Should you attach an explanation?
If the answer is "yes" for you but there is nothing reported on the return to indicate any tax consequence because there were none, such as for someone who received virtual currency as a gift or had an airdrop even of zero value, it is likely a good idea to attach an explanation to the return. So, at that line, add "See Statement 1" and attach the explanation as Statement 1.

What about the gaming question? When the IRS issued Rev. Rul. 2019-24 on hard fork of a virtual currency and about 40 FAQs in early October 2019, it also expanded what had been a short paragraph on its website on virtual currency. With the expansion, the following paragraph was present (obtained from the Wayback Machine for 10/12/19 since removed from the IRS website around February 12, 2020):

"Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin, Ether, Roblox, and V-bucks are a few examples of a convertible virtual currency. Virtual currencies can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies."

After the change around February 12, 2020, that paragraph now reads:

"Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies."

Notice that the reference to the gaming currency - Roblox and V-bucks, is gone.  The IRS added an explanation in a statement added to its website (but not added as part of the FAQs or a news release, but instead added where hard to find)"

"February 14, 2020
The IRS recognizes that the language on our page potentially caused concern for some taxpayers. We have changed the language in order to lessen any confusion. Transacting in virtual currencies as part of a game that do not leave the game environment (virtual currencies that are not convertible) would not require a taxpayer to indicate this on their tax return."

That doesn't fully answer the question for all gaming currency because some of it can be sold outside of the game for dollars (and it is obtained for USD typically as well). See post of 2/15/18 about selling Roblox for real money. What are people willing to pay for it? Does it have a fixed exchange rate or does it fluctuate?

What about certain gift cards or merchant point systems? Might they be a virtual currency?

Why doesn't the IRS clarify the definition of virtual currency and be sure it is something that is a substitute for real currency, and does not have a fixed exchange rate to USD (as most gift cards do). The IRS definition works to keep many gaming currency out (including when playing Monopoly with digital cash!), but not all.

Seems more is needed to help people with the new Schedule 1 question such as the questions I note above.

What do you think?

And, more on this later, but this same week, the GAO released another report on tax and virtual currency: Virtual Currencies: Additional Information Reporting and Clarified Guidance Could Improve Tax Compliance, GAO-20-188 (2/12/20).

And for more on virtual currency, please see tax and other information at my virtual currency/blockchain website -

Tuesday, February 4, 2020

Taxing (or Not Taxing) Services is Wrong Focus - How to Improve Sales Tax

The sales tax, used by almost all states, is a consumption tax. Generally, consumption is what the final consumer does.  For example, a company manufactures paper, a greeting card company purchases some of that paper to make greeting cards and sells them to the final consumer or to a distributor who sells them to the final consumer. As the paper or cards move through this supply chain, a sales tax exemption for items purchased for resale prevents sales tax from being charged. The final consumer is the only one who pays sales tax when the card is purchased (reaches the end of the supply chain).

Supply chains and tax systems are not always this "simple" though because not everything a business buys is directly for resale.  A recent case in Kansas found that electricity purchased by Southwestern Bell Telephone, Co. LLC (No. 120,167 (2020)) to help in the delivery of telecommunications services was exempt from sales tax because it was used in this production. A lot of time and effort though went into the determination of whether Southwestern Bell owed sales tax.

A simpler approach is possible and is really part of a proper sales tax system. This approach is that businesses should not pay sales tax on any of their purchases; only the final consumer should pay sales tax.

The Kansas case is just one of many decided every year in addition to ones settled on audit and dealt with by sellers in determining if they should be charging sales tax to a customer. This is a lot of wasted time given that the sales tax should be just on the final consumer. This required element of a sales tax avoids "pyramiding" in the system which occurs when a business pays sales tax and factors that into the price it charges customers leading to tax charged on tax.

There are annual discussions in many state legislatures and by taxpayers and industry associations about not imposing sales tax on services. I think the better focus is on changing the law to tax a broad base of consumption (including services except perhaps for some medical services) and only charging the tax to the final consumer.

This is how a value-added tax (VAT) works. In a pure VAT system (one without lots of exemptions or special rates), everyone pays VAT on all purchases. If that buyer is a business, they get their VAT back. This helps ensure collection by collecting the tax throughout the supply chain. It also prevents the need for a seller to accept an exemption certification from a business buyer and then be liable for the sales tax if it turns out the certificate is invalid.

Will this system work? In theory. In reality, states rely on sales tax paid by businesses so it is hard to replace. But I think a gradual shift to broaden the base, such as to include digital goods that are equivalent of taxable tangible goods (such as iTunes and digital books), entertainment, and personal services will help. Also, not including business purchases in the expansion of the sales tax base. AND, it is important to lower the rate so this is not a tax increase but a tax system improvement effort to make it function better today and in the future. It will also avoid the eroding sales tax base that affects many states today, such as technology allows us to buy non-taxable digital versions of what was previously a taxable tangible purchase (books is a good example).

So, let's eliminate time spent arguing for sales tax exemptions for businesses and expanding tax bases to include more services and instead pursue:

  • Prohibiting any sales tax base expansion from applying to items purchased by business (so as not to make the existing pyramiding problem worse).
  • Expanding the sales tax base to cover all final consumption with very few exemptions, while lowering the rate. 
What do you think?

Sunday, December 22, 2019

2-Year Anniversary of Tax Cuts and Jobs Act

On December 22, 2017, the Tax Cuts and Jobs Act (P.L. 115-97) was signed into law with most of it starting to be effective just ten days later. Give the roughly 115 changes in the law, that was a lot of work for the IRS to issue guidance on which is likely to take many years (we are still waiting for some guidance on the Tax Reform Act of 1986). It's also a lot for taxpayers and tax professionals to deal with.

We likely need another year of data to know if the TCJA might stimulate the economy. According to the Congressional Research Service in a June 2019 report (page 14), the lowering of the top corporate rate from 35% to 21% led to a "record-breaking" amount of corporate stock buybacks.

For most individuals, the law did not add any complexity other than dealing with no more personal and dependency exemptions and that effect on wage withholding. A bigger complexity might be the IRS change to the Form 1040 including eliminating 1040-A and 1040-EZ. For about 15% of individuals, there is new complexity from new deduction and loss limitations.

The Joint Committee Bluebook indicates there are about 74 technical corrections needed to make the statute do what the lawmakers suggested. Who knows if these will ever be enacted now that we are two years out and nothing has been fixed.

On 12/20/19, President Trump signed the Further Consolidated Appropriations Act, 2020 that funds the government through 9/30/20 and includes several tax changes. They include:

1. Renewal of over 30 provisions many of which expired at the end of 2017, generally through 2020. Affected taxpayers will need to file amended 2018 returns.  Query: Why weren't these addressed by the Tax Cuts and Jobs Act?

2. Repeal of three Affordable Care Act taxes including the Cadillac tax which never went into effect.

3. Change the "kiddie tax" to go back to the calculation that existed before the TCJA with taxpayer being able to elect to do the same for 2018 and 2019 returns. This change is due to the TCJA change resulting in some children to have a higher marginal rate on unearned income than their parent's marginal rate which was not the outcome intended by the kiddie tax.

4. Change in the TCJA making tax-exempt employers who provide certain fringe benefits, such as parking or transit passes, to no longer be subject to unrelated business income tax on that cost, effective back to  2018. This change exacerbates a flaw in the TCJA. The House Republicans wanted to have greater parity between what employers deduct as employee compensation and employees report as wages. That means doing something with fringe benefits where the employer deducts the costs of providing them but employees are allowed to exclude them from income. For qualified transportation fringe benefits, Congress decided to get to parity by having the employees continue to exclude that income. Congress could have instead (and likely should have given that these benefits are similar to cash wages) repealed the employee exclusion for these benefits and continue to let employers deduct the cost of providing them to employees.

Many tax-exempt employers complained of having to pay tax on their cost of providing qualified transportation fringe benefits to their employers.  That makes sense because they don't necessarily have funds to pay that tax. But, this is the right result once Congress opted to provide parity of employee and employer compensation amounts by denying employers a deduction for the cost of the benefits.  So, we have one provision of the TCJA now modified contrary to good tax system design, but helpful to the tax-exempt entities.

Beyond the kiddie tax and tax-exempt employer/transportation fringe benefit change, will other changes by made to the TCJA?  We'll see. Some candidates for office are calling for repeal of the TCJA. We'll see if that happens as it provided a tax cut to the vast majority of individuals (voters) although the issue of how the tax cut should be distributed among different income levels was not discussed.

What do you think? If you could change one item in the TCJA what would it be and why?