Minnesota Examines Tax Expenditures

Tax expenditures are special rules in a tax system that are not part of a "normal" tax. For example, special deductions, exclusions and credits in our Federal Tax system generally are tax expenditures. This includes the exclusion for employer-provided health insurance (the largest tax expenditure at $296 billion costs per year per the Treasury Department), step-up in basis at date of death ($40 billion per year per Treasury), mortgage interest expense, tip and overtime deductions, and vehicle loan interest deduction.

The federal income tax has over 100 special rules. States typically have more, particularly in their sales tax system that usually has numerous exemptions.  And many items of personal consumption that states do not tax do not get measured or identified as tax expenditures because they are not part of the state's statutory definition of the tax base. For example, California's sales tax applies to tangible personal property. So the fact that California doesn't impose sales tax on digital goods as textbooks and iTunes, isn't measured - which also masts who is getting tax savings.

Well, in 2021, Minnesota created the Tax Expenditure Review Commission consisting of legislators and the commissioner of revenue. They meet to evaluate the effectiveness of their state tax system's 327 special tax rules (tax expenditures). Apparently this past year they looked at 15 of these and made recommendations on their effectiveness and determined if changes were warranted. That is better than not looking at all, but out of 327, more seems needed.

But I applaud the lawmakers in Minnesota for creating the commission because tax expenditures result in lower revenue, and higher tax rates than would otherwise be needed without the special tax rules. They are spending that is easily overlooked in the state budget because only direct spending (sending money directly to an individual or business) is noted, not the spending this is done by lawmakers lowering your tax liability.

What do you think?

Should All Gains on Home Sales Be Tax Free?

Since 1997, a significant tax break is the ability to exclude up to $250,000 of gain on sale of your principal residence if used 2 years of the 5 years prior to sale ($500,000 gain exclusion if married filing jointly and both spouses meet the 2 years of use requirement). This exclusion can be used every two years.

In December 2025, the U.S. Census Bureau reported that the median home price in the U.S. is $414,400. That sure makes a $500,000 gain exclusion seem like a big number.

Of course, there are a few parts of the country, such as San Jose, where people may easily have over $500,000 of gain upon sale of their residence.  In that case, if married, they exclude $500,000 (saving taxes possibly of up to 18.3% or 23.8% on that excluded gain).  Let's say the gain is $600,000 and they are in a 20% capital gain bracket + likely owe the 3.8% NIIT. They will have to pay $23,800 of capital gain tax on the $100,000 taxable gain.  That sounds like a great deal given they had $600,000 of income!  If that had instead been wages, stock gain or gain from sale of real property that was not their residence, it would all be taxable.

There are a few bills in the 119th Congress that would exclude all of the gain on sale of a principal residence, such as H.R. ____, Don't Tax the American Dream Act. Per sponsor Rep. Goldman, this would increase the national housing supply and repeal "costly taxes" on homeowners. He also notes that the $250,000 and $500,000 amounts have not been adjusted for inflation since 1997. Similarly see H.R. ___, Middle Class Home Tax Elimination Act. Sponsor Rep. Fitzgerald also notes that the Section 121 dollar amounts have remained constant since 1997.

I don't think the lack of inflation adjustment justifies this possible tax change because the exclusion amounts were already quite high in 1997 - particularly given that 29 years later the median home price is roughly $414,000 (making a $500,000 gain impossible).  The relatively few people who will benefit from allowing any amount of gain to be excluded is much smaller than the number of individuals who would benefit from adding an inflation factor to other rules that lack them, such as the child care credit ($3,000 for 1 child and $6,000 for 2 or more children at this dollar amounts for over 20 years) and the taxation of Social Security benefits (dollar amounts set over 30 years ago).

And why no limit at all for the proposals that allow all of the home gain to be excluded.  This is a tremendous benefit to those with very high value homes that have far more appreciation than lower value homes.  Do a search for example, for movie and music stars who have sold homes for millions of dollars of gain - why should that all be tax free?  (here is one example I found - perhaps $46 million of gain in 2021 (although there may have been improvements made in the 25 years of ownership reducing that gain) - but still a multimillion dollar gain  - story here).

So, why not keep the high exclusions where they are now and use the savings from not increasing them for a small number of individuals and instead use those dollars to either keep our deficits lower or to add inflation adjustments to provisions that would benefit many more taxpayers, such as people paying for child care so they can work.  I'm not sure where you find child care today for $3,000 per year for one child (note that OBBBA increased the rate of this credit, but not the decades old dollar amounts).

What do you think?

Trump Accounts - Interesting Idea

https://www.trumpaccounts.gov/ 

The OBBBA created yet one more savings vehicle for parents and other relatives of children under age 18 to consider. While the new provisions are lengthy and a bit complicated, a good deal of understandable information is being pushed out by Treasury/IRS (such as https://www.trumpaccounts.gov/) and it is an interesting savings vehicle worth looking into.

New Section 530A basically allows new accounts that operate much like a traditional IRA only they are for kids under age 18 and have restrictions on what they can invest in. Up to $5,000 can be contributed to the account annually (this amount is adjusted for inflation starting in 2028) until the year of the child's 17th birthday. Of this amount, up to $2,500 can be contributed by an employer (per employee per year rather than per employee Trump Account) if the employer creates this employee benefit, written, per guidance to be issued by the IRS. The $2,500 is tax free to the employee (Section 128).

For a baby born in 2025 through 2028, the government will put $1,000 into the account if the baby is a US citizen and has an SSN and the parent or other relative makes the election. This doesn't count towards the maximum $5,000 contribution per year. The $1,000 is treated as a tax refund so not taxable. 

No distributions are allowed until the year the child turns 18 but the goal is for the child to learn about future value, savings and perhaps a bit about taxes, and let the money continue to grow. The child can start contributing via IRA rules once working and keeping the account. If disciplined, to keep the account and not pull it out for a new car or big party, the account could grow tremendously. For example, parents starting one in 2026 (contributions can't start until 7/4/26) for their 3-year old child, contributing $5,000 per year until age 17 (15 contributions), assuming a 5% rate of return will have almost $108,000 at that time. If no further contributions, when the child is 60, the balance would be about $837,000.

You need to track basis in the account and if a state doesn't conform, also track state tax basis in the account. If would be a lot simpler if states conform.
For more information:

• Website where apparently by July 2026 you can elect to set up an account - https://www.trumpaccounts.gov/

• Form 4547, Trump Account Election(s)

• Notice 2025-68

I offer a few suggestions to make these accounts more enticing and protected:

1. Add a provision similar to Section 529(c)(2)(A)(i) that contributions to the account on behalf of any designated beneficiary is treated as a completed gift to that beneficiary which is NOT a future interest in property to make it clear that the gift can be exempt from reporting and gift tax under the $19,000 annual gift exclusion.

2. Encourage contributions and people not forgetting about the accounts by allowing tax refunds to be directed to the account(s).

3. Rather than have parents or someone elect to set up an account for an eligible baby born in 2025 through 2028, set it up automatically when the parents apply for an SSN for the baby, and sent information to the parents about the account and encourage them to continue to add funds as they can and set them up for eligible siblings too if possible.

4. Add more than a 10% withdrawal penalty to discourage 18-year-olds from emptying the account at age 18 or soon thereafter.  Provide an incentive to encourage them to convert the account to a traditional IRA and continue making contributions; the incentive might be another $1,000 into the account at age 21.

5. Encourage states to conform to the OBBBA Trump Account provisions to simplify tracking basis in the account and for conformity on annual tax effects.

6. Require trustees to make contact with beneficiaries (and parents until beneficiaries turn 18) because it is possible beneficiaries will forget about the account and the trustee will end up sending it to the state as unclaimed property at some point in the future. This regular contact would ideally include some financial literacy tips.

What do you think?

Let's stop hiding the income and outlay pie charts in an instruction booklet few read

Pie Charts from Form 1040 Instructions for 2025
see links below to get to a larger version

I've written and blogged on this topic before,* but I think it is worth repeating ...

IRC §7523 enacted in 1990 requires the IRS to include pie charts with explanation in the Form 1040 instruction booklet - actual text at §7523(a) is for "any booklet of instructions for Form 1040, 1040A, or 1040EZ."  We don't even have 1040A or 1040EZ anymore and people have not been mailed instruction booklets since 2010. While a pdf of the instructions is readily found on irs.gov, who looks at them?!  Someone might look at them to find information about a line on a return, but they likely don't get to page 121 out of 125 pages of the 2025 instruction booklet (see draft here and soon it will be here).

The charts show the percentage of income and outlays of the federal government within broad categories. The income one also show how much comes from borrowing (27% for 2024) and the outlays one shows that 13% of them go to pay interest on the this borrowing. While these are general charts, I think they are helpful for anyone to get a basic understanding of federal government activities and perhaps generate questions for elected officials and those running for office.

I suggest the following basic enhancements for this information:

• Along with the % put the dollar amount.
• Highlight that outlays are direct spending and not also spending in the tax system via special exclusions, deductions, and credits. Another pie chart showing tax expenditures by category, as the Joint Committee on Taxation and Treasury use when they present reports on tax expenditures. These categories include national defense, int'l affairs, energy, housing, transportation and education.
• Information on the tax gap should also be included such as from the IRS website which at 12/30/25 shows a net tax gap of $606 billion which is more than we collect from the corporate income tax ($530 billion for 2024 per JCT report at page 30).

And the pie charts need to be published beyond the 1040 instruction booklet and moved to the digital era.  They should be an icon perhaps on all federal government websites where people can click to get more details.

What do you think?

*"Time to move Sec. 7523 budget information into the Digital Age," AICPA Tax Insider, 11/8/12.  This article includes the first pie charts that appeared in the 1991 Form 1040 instructions + the 2010 charts.

Blog post of 11/10/12

"'Oh, I see:' Suggestions for Greater Tax Transparency," Tax Notes State, 11/20/17

Challenges with Tip Income Deduction, Particularly for 2025

I've blogged already on the inequities of the tip income deduction (9/10/25 post).  It also has some recordkeeping and compliance challenges for employers and employees, and payors and contractors. These challenges will be greater for 2025 because tipped workers won't have their qualified tips separately reported on their W-2, or 1099-NEC or 1099-K. That won't happen until 2026.

Recently, the IRS provided relief to employers and 1099 filers for 2025 because otherwise they could face penalties for not reporting the qualified tips. The IRS does encourage employers and others to find some way to get information to employees on their qualified tip amount and occupation code, such as via a written statement or online portal (see IR-2025-110 and Notice 2025-62).

Now you might think, don't tipped workers know how much their tip income is?  Well, they might, but do they know what their "qualified" tip amount was?  They are not the same thing!

For example, the following are tips, but not qualified tips that will generate a deduction for the worker.

• Tip received by a waiter at a restaurant but it was automatically added to the bill such as because it was a party of 6. This is not voluntarily paid so is not a qualified tip, even if the restaurant gave it to the waiter.
• The employee works for an employer who is a "specified service trade or business" (SSTB), such as theater or other performing arts business. This might also be confusing for employees with multiple jobs. For example, the bartender employee at the restaurant gets qualified tips (if paid voluntarily), but when she works at the performing arts center as an employee, those tips are not qualified.
• The worker might not be in one of the many listed occupations per a table in the proposed regulations (§1.224-1 at REG–11003225 (9/22/25)). The IRS says it will have the lists at this website, but it is not operational at 11/15/25 - https://www.irs.gov/TippedOccupations. 
• The tipped worker is an independent contractor such as a gardener without a 1099. Their tips are only qualified if they are reported on a Form 1099-NEC or 1099-MISC or 1099-K. If the gardener works for households and gets paid in cash, they won't get a 1099.  If they do work for businesses, they will get a 1099-NEC for 2025 if paid $600 or more. I'm assuming the contractor reports all income including the tips.  As soon as they can, contractors who don't get a 1099, such as because paid in cash by households, they should start taking credit or debit card or PayPal or Venmo so they will get a 1099-K.  We still don't know how PayPal and Venmo will get the tip info, likely they will be required to have the payor specify these amounts.

There is a lot of work here, particularly for the issuers of the W-2 and 1099s.  For example, one example in the proposed regulations is a restaurant where the point of sale machine only offers 3 options on tips:15%, 18% and 20%.  Since there is not an option to put in your own number including zero, this is not voluntary. BUT, since 15% is the minimum in this scenario, if someone tips 18% or 20%, that differential is a qualified tip!  Of course, the restaurant or other establishment with this fact pattern will need to have its recordkeeping system set up to capture this.

Payors will definitely want to get recordkeeping systems ready very soon to be ready to report qualified tips on reporting forms. They might also want to see about changing customer billing arrangements to ease compliance, by, for example, making all tip amounts voluntary.

What do you think?