Should Sales Tax Deduction Be Made Permanent? House Says Yes

Since 2004, individuals who itemize can chose to deduct either state income tax or state sales tax. It's an obvious choice if you live in a state such as Nevada without an income tax. But this has been a temporary provision, renewed many times. It last expired 12/31/14. In April, the House passed HR 622 to make this a permanent provision.

For more on the background, why the House passed the bill and the policy considerations, please see my post at SalesTaxSupport.com, reproduced here:

Since 2004, there has been a temporary provision to allow individuals to take an itemized deduction for either state income tax or state sales tax. This works well for individuals in states without an income tax. On April 16, 2015, the House passed H.R. 622, State and Local Sales Tax Deduction Fairness Act of 2015, to make this provision permanent (vote 272-152). The Joint Committee on Taxation estimates the cost of H.R. 622 at $42 billion over ten years or about $4 billion per year (JCX-41-15; 2/11/15). If the state tax deduction were not an AMT preference item, the cost would be higher. And, bear in mind, that only about one-third of individuals itemize, and most states do have an income tax which is likely to be larger than the sales tax someone pays.

Per House Report 114-51 accompanying H.R. 622, the rationale for permanence is (1) to provide certainty to individuals and (2) provide parity with individuals deducting state income tax. Arguments against the bill include the cost, lack of any revenue offset, and not looking at all of the expired provisions together.

The House Report notes that tax reform may eliminate all itemized deductions for state taxes, but the majority believes that until then, there should be parity for all itemizers regarding state tax deductions.

So, for ten years, there has been a choice of which tax to deduct (although without certainty regarding the sales tax). What about the years dating back to the Tax Reform Act of 1986, when the sales tax deduction was stripped from the Code? The reasons why TRA'86 repealed a deduction for sales tax while leaving the itemized deduction for state income taxes include the following (per pages 46-48 of the TRA'86 Bluebook):

·         Sales tax mostly ties to personal purchases so it allowed a deduction for personal expenditures.

·         The sales tax deduction was a small portion of the total state tax deduction. Per 1984 data, only one-fourth of sales tax was deducted in contrast to over half of state income taxes.

·         Substantial recordkeeping was required for the sales tax deduction if the sales tax table was not used.

Is there any justification for allowing individuals a deduction for state taxes? Yes and no.  One justification is the ability to pay concept. State taxes represent income not available for paying federal income taxes. An opposing view is that state taxes provide personal benefits so should not be deductible.  [For more on the tax policy related to the state tax deduction, see Nellen, Goodbye State Tax Deduction, AICPA Tax Insider, 5/8/08.]

Some points missing from the discussion on what to do with the option of deducting sales tax:

·         These deductions are likely to be repealed as part of comprehensive tax reform to help pay for lower rates and repeal of the AMT. Congress making the sales tax permanent allows for more revenue to be raised, although if extended without a revenue offset, the revenue is questionable.

·         Repeal of the state tax deduction will make the law simpler. For example, Section 164(c)(5) to be made permanent by H.R. 622 is 638 words long!

·         Why no focus on the property tax deduction?  Why not repeal it or cut it back? While there is an ability to pay argument supporting it, the current deduction is too broad. For example, if someone lives in a very expensive home or has multiple homes, all other taxpayers subsidize that decision (regarding the property taxes paid) - why? For an extreme example, note Mitt Romney's $214,000 of real estate taxes on his 2011 return, and no mortgage interest deduction.

So, what do you think? Should the provision to allow a sales tax deduction in lieu of a state income tax deduction (for those who itemize) be made permanent?

IRS Data Breach Unfortunate in Many Ways - PIN?

The IRS news release that its "Get Transcript" web tool was hacked is distressing in many ways.  First, of course, is the exposure of highly sensitive taxpayer data - apparently of about 100,000 taxpayers, with attempts on about 200,000 accounts.  Additional concern is the the possibility of modernizing tax compliance is harmed.  I have often suggested that tax compliance for many taxpayers (with fairly straightforward tax computations), should be as easy as buying something from Amazon.com (for example, see my 5/14/15 post).  

Sounds like greater security hardware and software is needed.  Why not use of a PIN as is used to access bank data and use credit cards?  Would that help?

Are stricter laws needed to punish hackers?

What do you think?

IRS News Release of 5/26/15.

Filing season tax updates

The first few months of 2015 have not brought anything extraordinary for 2015 and beyond. However, there was important guidance from the IRS relevant to the filing of 2014 returns - namely, some Premium Tax Credit payback relief, health reimbursement arrangement relief (HRA), and the need for small taxpayers to file Form 3115 and compute a Section 481(a) adjustment in order to adopt the final repair regs (Rev. Proc. 2015-20).

I've got a short article with quick snippets of a few interesting rulings and activities from 1/1/15 to the end of April.  See Catching up after filing season, AICPA Tax Insider, 5/14/15. Take a look; I think you'll find it useful.

What do you think has been an important tax update so far for 2015? Is there anything you are waiting for in terms of guidance?

8th Anniversary of the 21st Century Taxation Blog

Today marks the 8th anniversary of this blog!

I started it years ago for reasons that still strongly exist today - to help promote dialog and discussion on the need to help tax systems reflect today's ways of living and doing business and to follow principles of good tax policy.  I don't plan to give up!

How is this for a modern tax system - why can't my W-2 and 1099 data be gathered by an electronic system (software, a blockchain (!), a secure server) and populated onto my electronic return. Why can't I use a webpage to input any information not on a W-2 or 1099, and the return magically be filed?  For many people, why can't they do this at a kiosk while at the grocery store?

What do you think of that or what modernization approaches do you suggest considering today's technology?

Thanks for reading!

Narrow exemptions cause inefficiency, inequity and complexity - HR 867 and S. 1179

H.R. 867 and S. 1179 (114th Congress) propose to modify IRC Section 263A(f) on interest capitalization to add an exemption to the rule. It would read:

“(5) EXEMPTION OF NATURAL AGING PROCESS IN DETERMINATION OF PRODUCTION PERIOD FOR DISTILLED SPIRITS.—For purposes of this subsection, the production period for distilled spirits shall be determined without regard to any period allocated to the natural aging process.”

The current interest capitalization rule was added as part of the Tax Reform Act of 1986. The logic is that if a taxpayer is producing a tangible item, such as inventory or a building, it must identify all of the costs incurred that relate to that item. Those costs are to be capitalized rather than currently expensed. These costs include direct materials and labor and many types of indirect costs. If the producer borrowed money to aid the production process, the interest expense incurred during the production time period is yet one more indirect cost to capitalize. The rules to compute the interest are complex because the producer must identify both traced debt and avoided cost debt.

The rule at Section 263A(f) does not apply to all production though. The rule only applies to property produced that has:

1. a long useful life, or
2. an estimated production period exceeding 2 years, or
3. an estimated production period exceeding 1 year and a cost exceeding $1,000,000.

In TAM 9327007, the IRS ruled that the time that wine was aging in the bottle was considered part of the production period such that if it took over two years, interest capitalization was required. 

S. 1179 is sponsored by Kentucky Senator Mitch McConnell. In a 5/4/15 press release, he notes some interesting statistics about bourbon production and his state:

“Kentucky produces 95 percent of the world’s Bourbon supply. Over 15,000 jobs in Kentucky are attributed to the Bourbon industry and it brings in billions of dollars to our state’s economy. This legislation will not only put Kentucky’s Bourbon industry on a level playing field with its competitors, but it is a pro-growth measure that will also help provide a boost to our economy and help create jobs in Kentucky.”

If interest capitalization has such an adverse affect on the bourbon production industry, it would seem that it has a worse affect on the much larger U.S. wine production industry (particularly red wine that requires longer aging).

So, why only pull bourbon from the interest capitalization rule?  Why not just repeal the rule if it is that burdensome?

When one item is singled out for different treatment, problems result:

1. Inefficiencies - one industry is favored over others; the law violates the principle of neutrality and support of economic growth.
2. Inequity - why should a bourbon producer not have to capitalize interest expense but a red wine producer (and likely other producers of alcoholic beverages) have to, even if they are the same size business?
3. Complexity - it can be difficult and take many words and sometimes litigation to determine exactly what falls under the exemption. When a rule applies to all transactions, it is easier to apply.  If the rule itself is complex for everyone, it should be redesigned or repealed.

No doubt, our Senator Majority Leader is well-intentioned in his effort to help a key industry in his state. But why be so narrow and violate principles of good tax policy?  While his proposed change will score as a revenue loser over ten years, it is really just about timing - when is the interest expense deducted (when incurred or only when the bourbon is sold).  And, the rest of Section 263A should be reviewed as part of comprehensive tax reform, particularly regarding its application to inventory. Inventory practices have changed since 1986 and the provision likely isn't needed today as companies use just-in-time inventory practices.

What do you think?

Tax Outlook for 2015

I've got a short (1 page) article in the CPELink Spring/Summer 2015 magazine on my take on the tax outlook for 2015. I note three items to watch - ACA, preparer regulation and tax reform. I have a brief summary below. For the full page article - click here and go to page 9.

1. Affordable Care Act (ACA) – By late June, we should have the U.S. Supreme Court’s decision in King v. Burwell, 759 F.3d 358 (4^th Cir. 2014), on whether individuals obtaining coverage through the federal Exchange (because their state did not create its own Exchange), are entitled to the PTC they likely have been receiving since January 2014. If the government loses this case, millions of individuals will likely terminate their coverage as it is unaffordable without the PTC subsidy. Or, perhaps Congress will step in with a remedy. 
2. Preparer Regulation – At the start of the 114^th Congress in January 2015, Senator Wyden introduced The Taxpayer Protection andPreparer Proficiency Act of 2015 (S. 137) to give the IRS authority to regulate preparers by having them “demonstrate competency to advise and assist persons in preparing tax return, claims for refund, and associated documents.
3. Tax Reform – In the last few days of the 113rd Congress, key outgoing and incoming tax committee leaders indicated that tax reform discussions would continue.  House Ways and Means Committee Chair Dave Camp formally introduced his tax reform proposal as H.R. 1. He had introduced it for discussion in February 2014, but formally introducing it as a bill means it easily lives on forever, even though Congressman Camp retired at the end of 2014.  The fate of the 51 provisions that expired at the end of 2014 will likely be tied up as part of tax reform.  If nothing happens by early December 2015, we are likely to see a repeat of December 2014 with most items extended retroactively for one year (back to 1/1/15).

Again - for a few more details - go to page 9 of the magazine.

What do you think? What does your tax outlook list for 2015 look like?