Digital Economy, Tax Issues and Due Diligence

We've been in the "digital economy" for some time, yet it continues to evolve with new business activities and ways of living. And, we see "old economy" businesses, like Ford Motor, move more into the new economy.

I define the digital economy fom the perspective of how people and businesses engage in it:

• Transacting business with virtual currencies, such as Bitcoin;
• Providing digital goods and services; and
• Transacting business enhanced by the Internet, such as finding customers, including working in the “sharing economy.”

There are numerous federal, state and local tax issues with these transactions usually due to the fact that existing tax rules were not written with these new ways of doing business in mind. 

I've got an article in CCH's Journal of Tax Practice and Procedure (May-June 2015) on "Taxation and Today's Digital Economy," with more details as to the issues.  It also includes a due diligence worksheet that hopefully tax practitioners will find useful.

What do you think? Any additional issues or due diligence tips?

Importance of lease terms for desired results

A recent Tax Court case serves as a reminder on a few items:

• If you want a particular tax result, be sure the lease agreement supports that result.
• Section 467 is tricky (and complex).
• Preparers need to be sure clients have and take sufficient time to review their return before signing. They should be asking the preparer questions where something is not clear, confusing or missing.

I've got a short article on the case - Stough, 144 T.C. No. 16 (2015), in the 8/16/15 AICPA Tax Insider - Is it rent? That depends on the lease.

What do you think?

Willis Commission Report 50th Anniversary Approaches - Multistate Tax Issues Continue

Many of you about the Willis Commission. And for many, it is a mystery - ancient history. And it sure is.  Oddly or unfortunately though, the state and multistate tax issues discussed in this 1,200+ page congressional report and its recommendations mostly read like it could have all been written today.

Volume 1 was released June 15, 1964 (see cover above) and Volume 4 was released September 2, 1965. Here is more, originally posted to Sales Tax Support.com.

In 1964 and 1965, the “Willis Commission” issued a four-volume, 1,200+ page report on multistate problems and possible solutions. The commission was named for its chair, Congressman Edwin Willis (D-LA). It was created as part of P.L. 86-272 (9/14/59), more famously known for providing a rule for when a business that sells tangible personal property will have income tax nexus in a state. In 1962, legislation extended the due date of the report and expanded it beyond income tax.

Much of this report reads like it could have been written today. For example, part of the conclusion reads: “It has been found that the present system of State taxation as it affects interstate commerce works badly for both business and the States.”

A few observations made in the report about sales and use tax follow:

·         At the time, only 38 states and about 2,300 local governments assessed sales tax.

·         Rates, definitions, exemptions and administrative procedures varied among states.

·         It was difficult to get information about the state and local tax base and rates (no Internet and apparently even the commercial tax services could not track it all down).

·         Evasion occurred as many cities had insufficient enforcement resources.

·         States wanted businesses to take a national view of their sales tax obligations, yet States had taken no responsibility for helping to create the type of system needed for “nationwide liabilities.”

·         Congress needed to step in to resolve the issues.

Recommendations for improvement included:

·         Many mail order companies sell unique items that don’t compete with local businesses so don’t bother trying to collect the tax from them. (I don’t think this sounds good today, but the dollars and number of remote sellers in the 1960s was much less than we have today.)

·         Have business customers handle sale and use tax on their own (direct payment approach). (This would be similar to a VAT system and would certainly take the burden off vendors of getting correct exemption certificates from business customers.)

·         Consider a permanent establishment approach to nexus. This “has the effect of requiring collection only in cases where sales are being made in circumstances very similar to those of local companies and where an apparent tax advantage would be most resented.”

·         Devise a uniform tax base with exemptions only possible for food or prescription drugs. If a state wants more, it can “grant refunds to purchasers.”

Since at least 1994 (two years after the Quill physical presence rule), some version of the Marketplace Fairness legislation has been introduced in Congress. Will a version ever be agreed to? Will any state take on Justice Kennedy’s statement in his 2015 concurring opinion in Direct Marketing Association v. Brohl, Executive Director, Colorado Dept. of Revenue (USSC 3/3/15)? He suggested it would be good to revisit Quill, noting it was “questionable even when decided.”

And, of course, the issues are more complex today due to there being more remote vendors, issues of collecting sales tax on services and digital items in some states, and figuring out cloud computing.

What do you think will be different by the 60th anniversary of the Willis Commission report (or perhaps sooner)? Do any of the 1965 suggestions sound good today? Please submit your comments below.

Tax and non-tax issues of sharing residences

We hear a lot about the sharing economy - making money by sharing something you are not fully using, such as a room in your home, or your entire home or vacation home. Sounds like a good way to make some extra money and perhaps raise your standard of living* (note- the rental income is taxable unless the dwelling is rented out less than 15 days for the year (Section 280A(g)). The federal tax treatment (and state as most states follow the federal income tax rules) can be complicated due to the need to determine which of two rules apply to measure deductible expenses and what to do with any loss generated. If the average rental period is 7 days or less, treatment of any income and loss also depends on whether you materially participate.  The income tax rules easily get complex.

But what about non-tax aspects of short-term rentals? Local governments and residents are noting a variety of concerns, such as:

• It may crowd out the availability of long-term housing and raise prices.
• It may cause increased fire and police protection needs (for example, does that house renter know how to get out of the neighborhood in case of an emergency or even have a car)?
• If there is rent control, might a tenant be generating more rent than the owner is allowed to charge?
• Does the rental violate local laws on zoning, residential rentals, number of people in a property, etc.?
• It can change communities to have more renters and fewer long-term residents (the "whereas" clauses in the Santa Monica ordinance stress this).
• For tenants, are they even allowed to rent out their leased property? Similarly, many homeowner associations don't allow certain rentals. 

Some cities have already changed laws to either allow short-term rentals or to place restrictions on them. For example, the City of Santa Monica enacted Ordinance No. 2484 in May 2015 to remind property owners that vacation rentals were never allowed. The ordinance allows home-sharing (where the owner or resident is present throughout the visitor's rental period).  There is also a reminder about the need to register for a business license and pay the transient occupancy tax (hotel tax), although the host platform (Airbnb, for example) is allowed to collect it for the property owners (a good, easy arrangement for the homeowner and the city).

The City and County of San Francisco had allowed short-term rentals, but is reconsidering. It looks like the main concern is the crowding out of long-term housing.  The ease of renting property and making lots of money via Airbnb or similar web platform has led some people to either buy a property solely for the purpose of using it for short-term rentals, or to convert their property to full-time short-term rentals. One way to limit that activity is to place a limit on how many days during the year a property may be rented out for short-term use.  For example, one of the proposals to be considered by the SF Board of Supervisors at its upcoming July 14 meeting calls for the following:

“to limit short-term rental of a residential unit to no more than 60 days per calendar year; require hosting platforms to verify that a residential unit is on the City Registry prior to listing, remove a listing once a residential unit has been rented for tourist or transient use for more than 60 days in a calendar year, and provide certain usage data to the Planning Department. …” (150295 - see link on the 7/14/15 agenda)

Another proposal on the 7/14 agenda is similar only limits rentals to no more than 120 days per year. (150363 - see link on the 7/14/15 agenda)

There is likely to be a ballot initiative in SF this year on the topic as well. If signatures are approved, it will limit hosted and unhosted rentals to 75 days per year total. Hosting platforms would be required to not list a property once the limit is reached for the year.  The required registration with the city must include, for tenants, whether the property owner allows the tenant to sublet. The city would be required to post the approval notice on the property and alert owners and neighbors.  [See summary here,and status of this initiative on short-term rentals here.]

Tax relevance? Well besides some complications in the federal and state income tax laws for the property owners, there is tax relevance for most cities. Many cities have a hotel tax, usually called a transient occupancy tax (TOT) that usually applies for any rentals of 30 days or less.  These taxes can be high. For example, 14% in SF, 15% in Anaheim (home of Disneyland), 4.5% in Chicago, and 6% in Houston. Prior to web platforms, such as Airbnb, it would be difficult to rent out your spare room for short periods so you'd seek a long-term tenant and the city would get no TOT. So, cities should be getting more TOT today.  Also, renters need to see if they might also owe sales tax, tourist taxes and other special taxes (check the city's website). Flagstaff, has a 2% BBB tax (bed, board and beverage); apparently instead of a TOT.

But, there are other issues to consider as noted above. Also, cities likely need to hire a few more employees to handle administration including enforcement. Also, they should aim to be sure the TOT is simple to comply with. Finally, cities should consider changing their law to require the web platform to collect. It appears, that Airbnb wants cities to do this. That makes good business sense for them - it is likely easy for Airbnb to collect the tax as it already has the information on the rental rate and period. (See 2/13/15 article in Slate magazine, and Airbnb website about locations where it handles the TOT compliance.)

I plan to post more later on the rules about the federal income tax rules on rentals (I co-authored an article on this topic, with a helpful flowchart, back in 1990(!); it needs minimal updating).

 *Airbnb issued a report in June 2015 on who rents out their residences in five cities, average age and income and the impact to their income - here.

What do you think about the economic benefits to homeowners and cities? Regulating short-term rentals, and anything else about this multi-faceted topic?

Supreme Court Premium Tax Credit Decision - 4 thoughts

IRS Flowchart on whether you qualify for the PTC - from Pub 974. Also see IRC Section 36B.

As we all know by now, the US Supreme Court upheld the government regulations that provide that an otherwise qualified individual who obtains health insurance through the federal exchange (rather than a state exchange) is entitled to a Premium Tax Credit (PTC). This is the 6/25/15 decision in King v Burwell. I think this is the logical ruling because the Act does provide that if a state doesn't create an exchange, the Department of Health and Human Services (HHS) is to establish one. Also, since this is the "Affordable Care" Act we are talking about, the PTC is a key part that helps make insurance affordable for many who have household income at or below 400% of the federal poverty line (more so for younger people in regions where the cost of living is not high - not for all individuals).

Four quick thoughts about the PTC and ACA:

1. It seems that states with exchanges should consider ending them to save costs and let people go to the federal exchange.  This seems to be an unintended consequence of the decision and the feds might not have sufficient resources to handle this possible action.
2. This survival of the PTC should lead Congress and President Obama to fix it.  It is too complex (see the flowchart above and the Section 36B and regulations). Also, the IRS likely does not have the resources to determine if people properly claimed it.
3. Address policy issues with the PTC and other tax benefits tied to health insurance: The PTC unrealistically behaves as if individuals of all ages and all geographic regions can spend about 8% of their income to obtain health insurance.  Because insurance costs more as you age and housing costs a lot more in some regions, that assumption is unrealistic.  Health insurance tax rules should be examined as a whole to try to better equalize the treatment among different ways to obtain health insurance.  The best deal is to get employer-provided coverage because it is tax-exempt to the worker - no income or payroll tax. And you get this benefit regardless of your income level - whether your household income is at the federal poverty line of 100 times or more of the federal poverty line. In contrast, you can only get a PTC if your household income is at or below 400% of the federal poverty line.  This is a completely unfair way to subsidize health insurance costs.
4. Why not take the bold step of divorcing health insurance from employment?  It drives up costs, it creates unfair tax advantages for those who have it, and the cost to employers helps make them uncompetitive in the global market.  The tax cost of the employer-provided health insurance exclusion is over $200 billion per year.  Why not use this money to lower rates and improve and expand the PTC?  Also - note that the King ruling also affects the employer mandate.  With more individuals eligible to avail themselves of the PTC, it is more likely that an applicable large employer can have at least one full-time employee claiming it thereby possibly exposing the employer to the employer mandate penalty.

What do you think?