Reform “hobby” rules for equity and possible improved compliance

Following up on my 6/25/23 post about an idea I included in testimony submitted for the written record of a small business tax complexity hearing held on June 7, here is another idea I proposed:

Reform “hobby” rules for equity and possible improved compliance

IRC Section 183, Activities not engaged in for profit, imposes limitations on deductions for activities that generate revenues but not IRC Section 162 deductions. Under this provision, deductions are allowed up to the amount of gross income from the “hobby”, with gross income measured as receipts less cost of sales. The allowed deductions though are only deductible if the taxpayer itemizes deductions and are treated as miscellaneous itemized deductions subject to the 2-percent-of-AGI threshold of IRC Section 67. For 2018 through 2025, such deductions are not allowed at all.

IRC Section 183 should be reformed to treat the allowable deductions as deductible for AGI, but still limited to gross income without any carryforward if deductions exceed gross income. The Joint Committee on Taxation defines the “normal structure” of the individual income tax as including deductions for investment and employee business expenses. [JCT, Estimates Of Federal Tax Expenditures For Fiscal Years 2022-2026, JCX-22-22 (Dec. 22, 2022), page 4]  The logic for this is that these expenses are incurred to generate taxable income and a “normal” income tax would allow such deductions. This argument also justifies allowing a deduction for the reasonable expenses of producing hobby revenues.

Another benefit of reforming IRC Section 183 is that it may reduce the inclination some taxpayers might have to treat a hobby as a business in order to claim the deductions for AGI.

What do you think?

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?

Tax system now 3 pages more complex; yet more will claim standard deduction

Annually, the Joint Committee on Taxation releases a report entitled - "Overview Of The Federal Tax System As In Effect For [current tax year]." The report for 2018 (JCX-3-18) was released February 7, 2018 and is 38 pages long. The last report for 2017 (JCX-17-17; 3/15/17) was only 35 pages long! And the 2018 report was issued two days before more tax legislation was enacted that mostly affects 2017 - the Bipartisan Budget Act of 2018 (H.R. 1892; P.L. 115-123 (2/9/18)). This new legislation mostly is the continuing budget resolution (CR) but also extends 33 tax items that expired at 12/31/16, mostly through 12/31/17 (retroactively that is!). These expiring provisions are generally not covered in these 30+-page overview reports by JCT. P.L. 115-123 also includes some disaster relief tax provisions and several miscellaneous items such as regarding whistleblower awards and the user fee for installment agreements to pay taxes.

Why is the 2018 report longer? It appears to be due to brief descriptions of new items added by the Tax Cuts and Jobs Act P.L. 115-97; 12/22/17) such as half a page for new Section 199A on the qualified business income deduction that is a 7-page long, temporary provision in the law, plus a few more data tables. These overview reports include interesting data and graphs, such as on sources of revenue, the make-up of income reported by individuals, and distribution of income and taxes.

A few interesting items from the reports:

• Projected for 2018, 1% of individual filers have income over $500,000. For this purpose, AGI is increased by tax-exempt interest, employer contributions for health insurance, employer share of FICA tax, worker's comp, nontaxable Social Security benefits, AMT preference items, Section 911 foreign earned income exclusion and a few other items.

• For 2017, JCT estimates that 31.7% of individual filers will itemize deductions rather than claim the standard deduction. For 2018, their estimate is that 13.1% will itemize.  This is a significant drop due to the increase in the standard deduction by the TCJA as well as removal of several itemized deductions.

What do you think?

Tax Cuts and Jobs Act, Complexity and Data

There is certainly some new complexity in the Tax Cuts and Jobs Act (P.L. 115-97 (12/22/17)). But it won’t affect most individual filers. Here are some data points to support that statement.

• Prior to reform, IRS data indicate that 69% of individual filers claim the standard deduction rather than itemize deductions. The increase to the standard deduction by the TCJA will increase that number significantly. Thus, fewer people deal with itemized deductions.

• 16% of filers file a Schedule C (2015 data; about 18.8 million reporting income and 5.9 million reporting loss). Those generating income will likely qualify for and need to (and want to) deal with the new Section 199A, Qualified Business Income deduction but most will be below the income limits in this rule which means the calculation will be simpler than for the minority of individuals with higher income ($157, 500 if single and $315,000 if married filing jointly).

• IRS stats indicate that 83% of individual filers have adjusted gross income (AGI) of $100,000 or less. Individual filers hit the top 10% of filers by AGI once they reached AGI of $133,445 (for 2014).

• Also, per IRS stats, only about 6% of individual returns report S corp or partnership income, so will deal with the new Section 199A deduction but some of these folks overlap with the Schedule C filers.

• Also per IRS stats, about 7% of individual filers report rent or royalty income which can also lead to calculating a Section 199A deduction. But again, there is overlap among the filers meaning that they might have a Schedule C, partnership income and/or rental income.

• Zillow Research estimates that with the lower acquisition debt cap of $750,000 for qualified residence interest (mortgage interest) (note it is up to $1 million if it existed at 12/15/17), and the cap on state and local tax deduction, only about 14% of homes are likely to lead the owner to itemize deductions. They note that the percentage varies from county to county. (! – that’s my comment living in an area where the median home price is just over $1 million! [see 1/29/18 Mercury News article])

So, yes, complexity exists along with getting used to a variety of new rules depending on the types of income you have, but compliance remains relatively simple if you only have wage income and can file a Form 1040-EZ or 1040-A. But so far as transparency, I think many individuals may be confused as to what has changed for their income tax calculation (such as personal and dependency exemptions versus a child credit and non-child dependency credit, etc.).

For CPAs, their client base tends to include the individuals in the top 20 to 30% of income levels and so they deal with the complexity, as well as dealing with business returns which can often involve complex multijurisdictional transactions and complex tax rules.

What do you think?

Tax complexity and filing status

It doesn't seem that one's filing status should be confusing.  You're single or you're married. But, many people qualify for head-of-household status. That one is confusing because of its multi-faceted definition. 

The IRS offers an online questionnaire to help people figure out if they qualify for head-of-household status. For many years, the California Franchise Tax Board mailed questionnaires to individuals who claimed this status to let them know their status would be reviewed and provided information to help them confirm if they selected the proper status (click here for a sample letter). Starting in 2015, the FTB created a new form that must be completed and attached to the California income tax return if the head-of-household status is claimed (Form 3532).

The complexity of the head-of-household status and its interaction with other provisions is highlighted in a recent Tax Court decision. In Walker, TC Summary Opinion 2017-8 (2/13/17), the IRS denied the taxpayer’s claim of head-of-household status. W’s girlfriend and her son lived with him. The girlfriend’s son was not related to W and W had not adopted him. W provided over half the support for the son. On his return, W claimed a dependency exemption for the son, child tax credit, earned income tax credit and head-of-household filing status.

The court found that the son was W’s dependent because W provided over half of his support, and although not a relative, met Code §152(d)(2)(H) – “An individual (other than an individual who at any time during the taxable year was the spouse, determined without regard to section 7703, of the taxpayer) who, for the taxable year of the taxpayer, has the same principal place of abode as the taxpayer and is a member of the taxpayer’s household.”

The court denied W’s claim of a child credit under §24 because the girlfriend’s son was not W’s child. The court also denied W’s claim of the EITC under §32 because the son was not a “qualifying child” and W’s income was too high.

The court upheld W’s claiming of head-of-household status though. Per the court: “An individual qualifies as a head of household if, as relevant herein, he or she maintains as his or her home a household that constitutes the principal place of abode of a “qualifying child” as defined in section 152(c) or a dependent under section 151. Sec. 2(b)(1)(A).”

The court did not make any mention of Code §2(b)(3). Instead, the court only referred to §2(b)(A)(ii), finding that because the girlfriend’s son was W’s dependent, W qualified for head-of-household status. If the court had continued reading to §2(b)(3) it would have found that if a child is claimed as a dependent only because of Code §152(d)(2)(H) member of the household, the taxpayer doesn’t qualify for head-of-household status. Thus, the court reached an incorrect result, truly indicating the complexity of the head-of-household status.

Some tax reform proposals have called for repealing the head-of-household status as a simplification measure. For example, see the Tax Reform Act of 2014 (H.R. 1 of the 113rd Congress; also see Joint Committee on Taxation summary). 

What do you think?

ACA Complexity Evident in IRS Incomplete Tax Tip

For the past few weeks, the IRS has been publishing Health Care Tax Tips.  The one I received by email today was troubling because it includes an error or at least not enough detail to be entirely useful. Today's (3/23/16), HCTT 2016-25 - Understanding the Terms Affordable Coverage and Minimum Value, is directed to people interested in the employer mandate. This mandate applies to "applicable large employers" (ALE) meaning employers who had 50 or more full-time and full-time equivalent employees in the prior year. An ALE has to offer coverage to at least 95% of their full-time employees and their dependents up to age 26 to avoid version (a) of the penalty at IRC Section 4980H. To avoid version (b) of the penalty, that coverage has to be affordable and minimum value.

The statute says that affordable means the coverage most not cost more than 9.5% of the employee's household income.  A similar concept is used in explaining who is eligible for the Premium Tax Credit (PTC) (the individual cannot have been offered affordable coverage by their employer).  But, the measure of "affordable" described at Section 36B for the PTC says that measure is indexed annually.  That language should also be at Section 4980H but is not.

In late 2015, the IRS addressed this problem and told us that the affordability percentage at Section 36B will also be used at Section 4980H (see Q&A 12 of Notice 2015-87). For 2015, that factor is 9.56% rather than 9.5%. The tax tip issued by the IRS on 3/23/16 says the affordability factor is 9.5%. While it doesn't say the year, it should be assumed that the year is 2015 or 2016.  AND, the factor is 9.66% for 2016! (per Rev. Proc. 2014-62)

Why can't the IRS tip provide this information?  Did the IRS just overlook it?  Perhaps. These are some of the most complex tax provisions of the Affordable Care Act.

There is no penalty risk to ALEs by the error or oversight because if the plan is affordable at 9.5%, it is also affordable using 9.66%.  Also, to note even more aspects of the complexity of Section 4980H, the last sentence of Q&A 12 of Notice 2015-87 states: " For all periods, applicable large employers may rely on the 9.5 percent standard as adjusted pursuant to §36B(c)(2)(C)(iv) in applying the alternative reporting method for qualifying offers."  btw, there are safe harbors employers can use to meet the affordability measure which is a great idea given that employers don't know the household income of their employees!

Does it have to be this complicated? No.  I believe there are numerous ways the ACA tax provisions can be simplified and made more equitable.

What do you think?

Recent Tax Law Change Cautions

 

There were numerous public laws enacted in 2015 changing our federal tax system. The largest in terms of number of change (over 130) is Public Law 114-113 (12/18/15). See basics and links in my 1/10/16 post. That's a lot of changes.  There are a variety of effective dates including many that are retroactively effecting back to 1/1/15. Did we need all of these changes? I don't think so.  Or at least not all at once. 

I want to note a few cautions based on what I've learned from reading this and thinking about it for the past several weeks.  I've been covering many of these updates in update presentations I've been making for the past few weeks.

This is not all of the cautions.  Please comment to this post if you have more to offer.

• Look at the legislative language (go to Division P and Q) and Joint Committee on Taxation explanation to get the real understanding of the change. As noted in my 1/10/16 post, some quick summaries implied that the Section 25D residential energy credit was extended to 2021. That is an overstatement as only two items from the five items at this section were extended. The other three continue to expire at the end of 2016 as was the case before PL 114-113. See the 1/10/16 post for a track change version of Section 25D.
• At least one change required quick action.  If you have a 529 qualified tuition plan and in 2015 you paid for a qualified expense, such as tuition, but got all or part of it refunded, you have 60 days after 12/18/15 (that should be 2/16/16) to return it to your 529 plan to avoid taxability of it. Going forward you'll have a 60 day period to rollover the refund. Click here to see a track changes version of the changes to Section 529 qualified tuition programs.
• There are significant changes to bonus depreciation and Section 179 expensing. Take a careful look to determine if property (personal or real) might fall under both and what only falls under one. Still, bonus is only for new assets (original use with the taxpayer) and Section 179 applied to qualified used or new property. But there are also differences between 2015 and beyond 2015 as well as for leased property. And don't forget about the de minimis safe harbor election at Reg. 1.263(a)-1(f).
• The temporary provision allowing an individual age 70 1/2 or older to transfer up to $100,000 from her IRA directly to a qualified charity and omit the income and the donation from her tax return was made permanent (Section 408(d)(8) - qualified charitable distribution). Be cautious in doing this.  Notice 2007-7 and Pub 590-B (see page 13) and the legislative history to the Pension Protection Act of 2006 (which was the originating legislation) stress that the rules for charitable contribution deductions must be followed. Here an excerpt from the 2006 legislation (PL 109-280; 8/17/06):  “exclusion applies only if a charitable contribution deduction for the entire distribution otherwise would be allowable (under present law), determined without regard to the generally applicable percentage limitations. Thus, for example, if the deductible amount is reduced because of a benefit received in exchange, or if a deduction is not allowable because the donor did not obtain sufficient substantiation, the exclusion is not available with respect to any part of the IRA distribution.”
  I believe that means you can have a very bad result if you don't do the charitable contribution part correct. Let's say an eligible person transfers $100,000 but does not get the required "contemporaneous written acknowledgement" from the charity prior to filing the return. The result is that the individual must report the $100,000 of income and doesn't get a charitable contribution deduction!  It would be good to see a draft of the letter before making the contribution and be sure you get it before filing the return and be sure it meets the requirements of Section 170(f)(8) and Reg. 1.170A-13(f).
• Watch the effective dates. There are several, such as the ability for small businesses to use the research credit against payroll tax or AMT, that are effective for tax years beginning after 12/31/15. However, when you read the Code section, that does is not in the text of the law. Thus, you might think it applies on your 2015 return. Similar issues occur to some of the bonus depreciation changes.  Again, check the legislative language or the Joint Committee on Taxation summary. 

Our tax law became more complicated with PL 114-113, but that's true of every law we've seen in the past 20+ years (post a comment if you know of a law that simplified the federal tax law in the past twenty years). While we tend to like special deductions and credits and exemptions, they make the law more complex.

What do you think?  Any other cautions you have to offer?

“Abolish the IRS” Distracts from Needed Reforms

Republican presidential candidates Senators Ted Cruz and Mike Huckabee would like to abolish the IRS. They are not saying they want to abolish taxes, just the agency that collects them. Even if either is able to simplify taxes to the point that no taxpayers have questions or need guidance, we still need a tax collector, as well as an auditor to ensure compliance.

A call to abolish the IRS is a distraction. That’s too bad because there are significant improvements needed to our federal tax system – a system that includes not only the income tax, but also employment, excise and estate and gift taxes.  Tax reform must be the focal point, not termination of the entity that collects revenues to fund schools and roads, provide national defense, and much more.

The IRS is an easy scapegoat for complaints about our tax laws. But those laws come from Congress. Yes, the bills must be signed by the President to become law. But if no tax bill arrives at the President’s desk, no statutory change is possible. For reform, let’s first look to where Senator Cruz resides – Congress.

Reforms are needed. Here are just three examples to illustrate problems in our federal tax system. Resolving these types of problems can enable our tax system to be simpler, more equitable and better promote economic growth.

First, our federal tax system is too complex resulting in excessive compliance costs and errors. According to the IRS National Taxpayer Advocate, businesses and individuals devote over 6 billion hours annually to tax compliance – the equivalent of over 3 million full-time jobs. Examples of this complexity include a 43-page instruction book for Form 1040-EZ and over eight rules for tax benefits for college costs, explained in a 96-page publication from the IRS (Pub. 970).

Second, our tax system is inequitable. For example, for decades, employees have been allowed to exclude the value of employer-paid health insurance from their income, thereby lowering their income and employment taxes.  Employees get this exclusion regardless of income level (and employers deduct what they pay for the health coverage). Starting in 2014, the Affordable Care Act (“Obamacare”) provides a refundable tax credit to individuals without employer-provided health coverage who buy insurance on the exchange (such as Covered California). However, these individuals losethat subsidy if their income exceeds 400% of the federal poverty line ($45,960 for a single person for 2014). 

Take for example, Jane and Sara, each 50 years old, single and having $100,000 of taxable income for 2014. Jane obtains health coverage from work with her employer covering the entire cost of $6,000. Jane is allowed to omit this $6,000 benefit from her taxable income. Sara obtained her insurance from Covered California at a cost of $6,000, paid out of her own pocket. Because Sara’s income exceeds $45,960, she obtains no tax subsidy. Meanwhile, Jane gets a tax subsidy of $1,680 (based on a marginal tax rate of 28%). Sara is out-of-pocket $6,000 while Jane gets a $1,680 subsidy (and has no out-of-pocket costs for health insurance). Why does this inequity exist? This is just one of many tax system inequities where some individuals receive tax reductions while others at similar, or even lower income levels, do not.

Finally, our tax system has not kept up with technology and new business models. Today, most countries only tax businesses on income earned within their borders rather than the U.S. approach of taxing worldwide income. Corporate tax rates in other countries are lower while also supporting R&D on a permanent basis rather than the temporary approach used in the U.S. since 1981. Also, today, any size business likely has international operations yet tax rules can be as complex for small ventures as they are for large companies. And, technology should be used to make tax compliance for most people as easy as ordering goods online.

We need to improve our tax system, focusing on all federal taxes, not just the income tax. Our tax system can be simpler, more equitable and better support today’s ways of living and doing business.  Let’s focus on these important issues and not be distracted by absurd rhetoric about abolishing the tax collector.

More to come - "abolish the IRS" is not the only odd tax reform coming from candidates.

What do you think?

10th Anniversary of Bush Tax Reform Report

In January 2005, President Bush created his Advisory Panel on Federal Tax Reform. It was tasked to examine the tax system and propose simplified options that were revenue neutral, pro-growth and internationally competitive. One option was to be a consumption tax. The report was due and was issued on November 1, 2005.

The panel held public hearings, reviewed lots of data and studies and suggested reforms. One of their initial findings was the high cost of tax system complexity which they estimated to be $140 billion per year. Per the panel:

"To put this amount in perspective, it is roughly the same as giving $1,000 to every family in America or the amount of money needed to fund all of the following: the Department of Homeland Security, the State Department, NASA, HUD, the EPA, the Department of Transportation, the United States Congress, our Federal courts, and all foreign aid."

I think this type of information needs to be better publicized.  Most individuals will tolerate complexity if it gets them a deduction. But, they are not usually considering the cost to them and the aggregate cost to all taxpayers and the IRS of the provision. They are often not thinking that perhaps the deduction can be replaced with a higher standard deduction amount at no additional complexity cost.

I like the report because I think the panel did a great job getting at the problems with our federal tax system in terms of complexity, inequity, inefficiencies and lack of accountability and transparency. Unfortunately, the report really died upon issuance in November 2005 most likely because they proposed improving the mortgage interest deduction contrary to what "conventional wisdom" says it should be. The panel proposed that the home mortgage interest deduction be replaced with a credit equal to 15% of the interest paid with the debt limited to the average regional home price (about $227,000 to $412,000).

If that is what killed the report before it could get its hearing, I hope things have changed, but I suspect they have not. The panel's proposal would make the credit available to all homeowners with debt rather than only to the 1/3 of individuals who itemize deductions.  Also, as a credit, it is worth the same to everyone (although higher income individuals tend to have bigger mortgages). It likely would also reduce one of the largest tax expenditures in the tax code (about $80 billion per year) and distribute this amount more equitably among taxpayers.

Here is an excerpt of the panel's chart showing some of the changes and how incorporated into their two key proposals:

Source: Executive Summary, page xvii.

I also like Figure 5.5 below showing the effective tax rate on different types of investments. The many tax preferences for housing produces a zero effective tax rate. This highlights another problem with our tax system - it distorts investments leading to over investment in some areas and under investment in other areas. What would the economy look like if we did not over invest in housing (perhaps had fewer expensive homes and more investment in businesses)?

Source: Panel Report, Chapter 5, page 71.

I hope the report is not completely forgotten and will be considered in ongoing discussions on tax reform. It raises some good issues and observations necessary for reform to happen.  We can't keep talking about lowering the rates in a revenue neutral manner without talking about reducing or eliminating the largest tax expenditures, the costs of complexity and the distortions caused by a tax system that causes investment inefficiencies. Reform also needs to recognize the tremendous income gaps we have (relevant in determining just how low the rate can go), and the reality that much of our tax system does not reflect today's ways of living and doing business (the subject of my 21st century taxation website and blog).

What do you think?

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?

National Taxpayer Advocate report to Congress released

On 1/14/15, Nina Olson, the National Taxpayer Advocate released her required annual report to Congress about problems with the tax system. As noted on the NTA website, the key parts of this 700+ page report are:

• Most Serious Problems
• Legislative Recommendations
• Most Litigated Issues
• Volume 2: TAS Research and Related Studies

 Some key points noted include:

• Tax law complexity (here + Executive Summary)
• The need to put taxpayer bill of rights into the Internal Revenue Code (here)
• Problems due to inadequate funding of the IRS (here + Executive Summary)
• The burden many taxpayers will face from Affordable Care Act provisions (here)
• The need to provide tax return assistance to low income individuals (here)

A few surprises (for me, so far - I haven't read it all yet)

• No mention of any need to modify Section 330 of Title 31 to allow the IRS to regulate all return preparers. The NTA was one of the first offices to call for such regulation years ago. It was noted in the 2013 report.
• No mention of the continued low level of binding guidance issued by the IRS while we instead get lots of FAQs, Chief Counsel Advice memorandums and information letters. The NTA has noted this issue before though.
• Failure of the IRS since 2003 to issue its required annual tax law complexity report to Congress (details here).
• One of the top litigated issues for the past year was Section 469 on passive loss limitations with 28 opinions between 6/1/13 and 5/31/14 (details here). The IRS won 23 of the 28 decisions.

I'll likely have more later.

What do you think?

IRA and 401(k) rulings - the law is complicated!

There have been a few rulings recently involving IRA or 401(k) distributions that led taxpayers to court. That's a lot of time and expense. One taxpayer was a tax lawyer in a large law firm who would be viewed as a tax expert - with tax knowledge well beyond most (he lost in court). Another involved a wife (later to become ex-wife) taking funds from her husband's IRA without his knowledge. And another case involved an ex-wife using her ex-husband's 401(k) to obtain money he owed her. Without knowledge of the tax law or how to think in a tax-like manner, she did not realize she would owe tax on that distribution and should have instead told the husband to take the distribution and pay her from those funds.

Yes, the law is complicated. I don't think it can be fixed to help someone stealing funds from a spouse, but it should not be so complicated as to trip up a tax expert or someone who really thought she was just getting a debt repaid.  I think there are ways to simplify all of this. Perhaps only allowing Roth IRAs would be a way to go. What do you think.

Click here for my summary of and links to the three rulings at CPELink's blog site.

What do you think?

How sales tax exemptions can waste one's time

Recent litigation in Missouri over whether converting frozen dough into baked goods is "processing," such that the electricity used is exempt from sales tax, shows the time and money that can be wasted with pointless rules.  The solution is to not have businesses pay sales tax - instead, only have it paid by the final consumer (the same was a VAT works).  Please see my summary of the case and issues in this SalesTaxSupport.com post.

Tax mistakes to avoid - WSJ article

A 1/31/14 Wall Street Journal article lists a lot of mistakes that can easily be made when filing your Form 1040 - "Don't Make These Tax Mistakes," by Laura Saunders. She also has a graph at the start on how large the federal tax law has become.

I encourage you to take a look - it's a good list.  And a good reminder of the growing complexity of our federal tax system.

Another reminder while we are in "tax season" is to be sure to carefully review your tax return to see if anything is missing or looks confusing or odd.  Even if you hire someone to prepare your return, you are responsible for what is (and is not) on it.

Good luck!



Excerpt from instructions for the 2013 Form 1040.