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Sunday, May 22, 2022

Example of how exceptions to rules can create loopholes

A10093, Middle Class Tax Relief, introduced in New York on April 29, 2022, provides tax relief by removing overtime pay and tips from AGI. Overtime is working beyond 40 hours per week and likely means hourly workers rather than salaried ones. 

While the intent might be good if aiming to help people who are seeking jobs with overtime to earn extra money to make ends meet, the reach (and the drop in tax revenue to the state) will be much broader than this. 

The "justification" from the bill sponsor: "With inflation on the rise. The Middle Class is struggling. This Legislation would help lighten the load on Middle class families by suspending all sales tax on non exempt food items, no income tax on any work beyond a 41 hour work week and no tax on any tippable wages."  (there doesn't seem to be any sales tax aspect to A10093 though)

While aimed at the "middle class" there is no definition offered of that. This bill seems to help a high income earner working overtime or receiving tips for services rendered. Some employers might try to change some of a worker's salary to tips (with customer assistance) to help their employees get a tax break (if this were to be enacted, which seems unlikely).

What would be better? Use existing rules, such as increasing the state's earned income tax credit. That would help the group this sponsor seems to want to assist. Or reduce the tax rates for lower income taxpayers.

And think of the compliance issues that would accompany carrying out this proposal? Forms W-2 for New York would need to be modified or have an attachment that goes to the worker and the state showing how much overtime and tip income was earned.

So, a few principles of good tax policy are not satisfied here including equity, simplicity and transparency.

What do you think?

Saturday, May 14, 2022

15th Anniversary of the 21st Century Taxation Blog

Today marks the 15th anniversary of my blog. I still try to post at least once per week on a tax policy matter and hope for comments and discussion to promote greater focus on various tax policy issues that exist in our current tax systems and in proposals to make tax changes. I also note where provisions and proposals meet principles of good tax policy but more often we see proposals that are contrary to good tax systems.

This year I plan to blog and write more on tax transparency so that we can all better understand how our tax systems work. I think if more people understood spending in our tax system (tax expenditures) versus direct spending (such as what you see in agency budgets), our tax system would look different.

I like this observation from a 2006 congressional report on tax expenditures:

"A major criticism of the mortgage interest deduction has been its distribution of tax benefits in favor of higher-income taxpayers. It is unlikely that a housing subsidy program that gave far larger amounts to high income compared with low income households would be enacted if it were proposed as a direct expenditure program.

The preferential tax treatment of owner-occupied housing relative to other assets is also criticized for encouraging households to invest more in housing and less in other assets that might contribute more to increasing the Nation's productivity and output."

Similar comments are made in the 2016 version of the report (see page 323 et seq).

The report also notes that home ownership rates in the U.S. are similar to those in the UK and Canada and they don't have a mortgage interest deduction. 

Basically, the mortgage interest deduction mostly helps higher income individuals purchase a more expensive home and even a vacation home too since the deduction is for mortgage interest on a principal and second home.

Today, only 11% of individuals itemize and not all of them have a mortgage. This would be a good time to repeal this deduction. It should be down via a phaseout with a longer phaseout period for individuals with income below $150,000. A better replacement would be a first-time homebuyer credit that is available only once in your lifetime and phases down as income goes up. It should be adjusted for the regional home price.

We don't often see these proposals. President Bush's 2005 Advisory Panel on Federal Tax Reform suggested replacing the deduction with a 15% credit based on the regional home price. I think we don't see such proposals because too many people believe that the home mortgage deduction is key to being able to purchase a home and don't see that the bulk of this subsidy goes to higher income individuals - basically, spending money on people who really don't need it (they could purchase a less expensive home with a smaller morgage).

So, I'm working on another paper on tax transparency focused on tax expenditures to highlight issues with them such as highlighted above.  I think a unified budget that shows both direct spending and spending in the tax law in the same document would shed a lot of light on government spending such that people would then ask questions on why subsidies for a vacation home exist or why a good deal of subsidies help higher income individuals more than lower income individuals.

What do you think?

What do you think of when you hear "tax transparency"?  Please leave me a comment.  Thanks for reading my blog!

Sunday, April 24, 2022

Prop regs fix a PTC issue 7 years later

The Affordable Care Act enables individuals to not only purchase insurance on an exchange but to also get a subsidy for it if they qualify. That subsidy is the Premium Tax Credit (PTC). There are eligibility criteria such as purchasing the coverage on an exchange (such as Covered California), if the person is employed the employer does not offer affordable coverage and the household income is below 400% of the federal poverty level.

When regs were issued in 2014 at the start of the PTC, section 36B(c)(2)(C)(i) that includes this clause:

"This clause shall also apply to an individual who is eligible to enroll in the plan by reason of a relationship the individual bears to the employee."

Reg. 1.36B-2(c)(3)(v)(A)(2) interpreted that clause to mean that if the coverage offered to the employee was affordable, no one in that employee's household would qualify for a PTC even if the coverage offered to the family was not affordable.

I always thought that was an odd interpretation of the vague clause and contrary to the purpose of the ACA - to help more people get affordable coverage.  I think a possible reason for the odd interpretation is that the ACA is designed to encourage employers to offer affordable coverage to employees AND family members. So perhaps the thought was that employees would encourage employees to ask the employer to provide affordable coverage. Unfortunately, that is unrealistic, particularly where employees are low paid (such that their household income if below 400% of the federal poverty level (about $43K for a single person)).

Well, this month, the IRS issued proposed regs to fix this (REG-114339-21 (4/7/22)). A 4/5/22 Tweet from the Treasury Dept indicates that this change should enable about 1 million people to save hundreds of dollars per month on their coverage. Why is this finally being fixed? Apparently it is Executive Order 14009 (1/29/21) where Treasury was directed to find ways to strengthen the ACA via administrative actions. This is a good fix.

What about other needed fixes? One major one is that the PTC includes a cliff rather than a phaseout. So once household income exceeds 400% of the FPL, the taxpayer must pay back all of the PTC it received for that year. That can easily be $1,000 to over $10,000. That is harsh.  Also, the measure of household income is based on the entire year. So, if someone is out of work, say for the first 7 months of the year and can't afford health insurance, they can get the PTC, but if the job they get for the last 5 months of the year puts them above 400% of the FPL, they have to pay back the PTC even though they needed it for the first 7 months to buy health insurance.

That will need a legislative fix though.

And, before I leave this topic, in case anyone is thinking that this PTC subsidy of thousands of dollars is too good of a tax break, millions of individuals get tax breaks on health insurance. About 65% of employees have an employer who pays all or some portion of their health insurance. That benefit is tax free to the employees. So, if someone's employer contributes $10,000 to their health insurance and is in the 24% tax bracket, they save $2,400 in taxes. BUT, they also save shelling out $10,000 for the coverage paid by the employer. This is the most expensive tax break in the tax law in terms of reduced tax collections (see page 33 of this JCT tax expenditure report). And not all employees get this subsidy and it is worth more to those in a higher tax bracket.

What do you think?


Saturday, April 9, 2022

Increasing teacher's deduction for classroom supplies masks problem rather than fixes it

Most employees don't have to bring their own supplies to work or pay for materials customers need. For example, workers at most places that use cash registers to total up customer purchases are not required to fund and bring their own registers to work. Most employees required to travel for work get reimbursed for that expense.

But K-12 teachers are expected to buy supplies for their workplace and their students and about 94% of public school teachers buy these supplies (U.S. Dept of Education, May 2018). I say "expected" because clearly, most teachers use their own funds to buy supplies and since 2015 there has been a permanent tax rule that allows these teachers to deduct for AGI up to $250 of that spending. An inflation adjustment increases that to $300 starting in 2022. Prior to 2015, the deduction was temporary.

S. 3992, the Educators Expense Deduction Modernization Act of 2022, proposes to increase the $300 per year amount to $1,000. Per Senator Sherrod Brown's April 6 press release, he proposes to quadruple the deduction (using the 2021 and earlier maximum of $250 rather than the 2022 amount of $300). He notes that $250 is "far less than most teachers spend each year out of their own pocket on classroom supplies."

The existence of this deduction and the proposal to increase it seems to take for granted that this is just the way it is. The presumption is that K-12 teachers should be using some of their salary for classroom supplies. This is outrageous! Where is the proposal to better fund K-12 schools so employees don't have to pay for job-related costs?

And, if lawmakers think it is proper to expect school teachers to fund classroom supplies, why not at least change the tax rule from a deduction to a tax credit?  Among states, the average teacher salary ranges from a low of $45K in Mississippi to a high of $87.5K in New York (2019-2020 per Business Insider). 

So, what is the after-tax cost of $300 of classroom supplies (assuming the teacher did not spend more than that) for 2022? Let's assume a single teacher claiming the standard deduction with a salary of $65,000. Taxable income before the deduction is $65,000 - $12,950 standard deduction = $52,050. That amount of taxable income has a marginal tax rate of 22%.  So the $300 deduction saves the teacher $66 of federal taxes and the supplies, in effect, cost $234. That is still a lot. A 50% credit would produce a savings of $150 and a 100% credit would produce a savings of $300 (the federal government would be funding 100% of the cost of the supplies up to the credit maximum).

How much do teachers tend to spend out-of-pocket for classroom supplies? The Department of Education reported for 2014-2015 the average was $478 and the median was $297. A few spent over $1,000.

Worse yet, the Consolidated Appropriations Act 2021 (P.L. 116-260, 12/27/20) modified the deduction to also include COVID-19 protection items teachers purchase for the classroom (Rev. Proc. 2021-15). How many other types of employees are expected to purchase PPE for customers? I find it disappointing that it clearly has become the "norm" to expect that teachers are to personally fund these supplies.

What do you think?


Sunday, March 27, 2022

Law and Tech Modernization Needed to Get Tax Refunds To Taxpayers

 In recent years, a few weeks before April 15, the IRS issues a press release such as these two:

2021: IRS has refunds totaling $1.3 billion for people who have not filed a 2017 federal income tax return (IR-2021-75 (4/5/21))

2022: IRS has $1.5 billion in refunds for people who have not filed a 2018 federal income tax return; April deadline approaches (IR-2022-66 (3/25/22))

For 2021, the IRS estimated that 1,345,900 individuals were owed that refund (average of $966 per taxpayer).

For 2022, the IRS estimated that 1,514.627 individuals were owed that refund (average of $990 per taxpayer).

These news releases show the number of taxpayers and dollar amount per state. Presumably, these totals come from data, such as W-2 data, that the IRS has but without a filed return, cannot refund the tax withheld which the IRS is presuming would be refunded if the return was filed.

Why can't the IRS just issue the refund? The law doesn't allow it. I had an op ed in The Hill last year about the need - and capability, to modernize compliance and administration such that for many taxpayers, they would not even need to file a return. If payroll and similar data, most of which is already digitized, could be used to determine a taxpayer's tax liability at any point in time, the IRS / technology would just issue the refund.

And we know the IRS has the capability to issue payments as evidenced by three rounds of economic impact payments since March 2020, the advance child tax credit for 2021, and millions of other tax refund situations. 

The law should be changed to allow the automatic return of withholdings to individuals after the IRS runs its check based on information reports it has for the person. Or send each a reminder 13 months in advance of the expiration of the statute of limitations to have the individual confirm their income. But the tech solution would be best as it allows for more improvements beyond the return of taxpayer money to the taxpayers.

What do you think?