Senate Finance Committee's New Approach to Tax Reform

The Senate Finance Committee recently announced that it will be holding weekly meetings to discuss various topics.  There will be "tax policy option papers" posted to their website that list a variety of reforms and their source.  This seems more for discussion purposes because they also note that just because a suggestion is included in an option paper doesn't mean it is endorsed the the Chair or Ranking Member.

The first paper posted is on Simplification for Families and Businesses.  Simplification is a good topic to start with. That is likely the most serious problem with our tax system.  The complexity stems, though, from both the rules themselves and transactions that can be complex (both for families and businesses). The simplification topics also include ones focused on administration of the tax laws. They note the following key problems areas regarding administration:

Some specific concerns about tax administration today include the following:

• Overall complexity
• Identity theft
• Tax gap
• Problems with the filing schedule
• Regulating paid return preparers 

Here are a few interesting reforms (I think) from the list and my commentary:

• Repeal AMT - yeah! This is not only simplification but brings some logic to the system. Why should there by two taxes - your actual one and your perceived minimum one?
• Repeal phase-outs for itemized deductions and personal exemptions - yeah! These phase-outs disguise a higher tax rate and make it difficult for affected individuals to know their marginal tax rate.
• Change due dates to enable taxpayers and IRS to get certain information earlier - yeah! It is difficult to file a return with missing K-1s. Also, former Commissioner Shulman's idea to have the IRS take the information returns and prepopulate returns for taxpayers so they know before they file (rather than a few years later) what 1099s and W-2s they have. Click here to see the AICPA proposal on this.
• If the IRS is not successful in its appeal in the Loving case on the paid return preperer system, provide a statutory solution - yeah!  I think there is value in having Circular 230 cover more than attorneys, CPAs and Enrolled Agents. Attorneys and CPAs are already subject to regulation by their licensing bodies.  Why have a system where about 50% of the preparers are not subject to rules of conduct regarding due diligence, return preparation standards, and more. While the preparers are subject to penalties, why not lay out some rules of conduct for them to help them avoid the penalties.
• Revoke or deny passports for individuals who are seriously delinquent - interesting.  If you want someone to do something, consider a carrot or a stick.  If the stick of penalties isn't working, why not deny them something they want. Of course, not everyone wants a passport.

Here are a few I think should be on the committee's list:

• Simplify depreciation rules.  Today, the rules on depreciation are scattered over at least 4 Code sections (167, 168, 179, 280F) and over 60 pages, not counting regulations. Depreciation should not be this difficult.  It is because of special rules, often designed to address some perceived abuse (such as the mid-quarter convention and the limitation on depreciation of passenger cars).  [I have a paper with some ideas on this topic.]
• Remove special rules where divorced parents can decide which parent claims a child as a dependent. Just leave it as going to the parent who has the child residing them with the majority of the time. If the parents want a different financial result, work it out through child support and alimony. The tax law is not intended to solve problems, but to raise revenue for government operations.
• Repeal the kiddie tax.  This is intended to address the situation where parents or someone else gives income-producing assets to a child who is in a lower tax bracket. Well, if it is a valid transfer of assets, let the child pay based on their rate bracket.  Also, if tax reform does result in broadening the base and lowering tax rates, this is not as significant of an issue.
• Repeal the uniform capitalization rules (Section 263A).  Doing so will enable manufacturers and retailers to use their book method for identifying inventoriable costs and save compliance costs due to not requiring a separate set of inventory records and calculations.

I have a few more, but would like to see what you have.  What would you do to simplify the income tax?

Reforms desired by businesses

Recently, the Kogod Tax Center at American University and Bloomberg BNA released the results of a survey where advisers of both small businesses (less than $10 million of gross receipts) and medium-large businesses were asked how they would rate 15 tax reform proposals. The result was that 7 had similar support from both groups. Per the Kogod website: "The findings provide strong evidence that any tax reform bill would have to contain these measures to win the support of businesses."

The seven reforms:

1. 100% expensing of assets
2. a lower tax rate for corporate and passthrough entities
3. reduced payroll taxes for employees
4. elimination of the estate tax
5. clarification of rules on worker classification
6. replace the income tax with a national sales tax or other consumption tax
7. a single, flat rate income tax

Looking at more details of the survey, the top reforms desired by small businesses are not listed above - repeal of the AMT which was tied with lower payroll taxes for employers. The top reform for medium-large businesses was 100% expensing of assets.

I encourage you to read the article on the survey, written by Dave Kautter, managing director of the Kogod Tax Center (and formerly a partner in the Ernst & Young National Tax Practice, and my boss a long time ago.)

Some observations I'd like to make:

• One possible way that has been suggested to pay for a lower corporate tax rate is to change from MACRS depreciation to Alternative Depreciation System (ADS) with longer lives and slower methods. I think this flies in the face of trying to make U.S. firms more competitive internationally (see my article on challenges of reaching a lower corporate tax rate - here). The Kogod/BNA survey indicates that businesses want to move in the other direction - immediate expensing of assets! How will this affect efforts to lower the corporate tax rate in a revenue neutral manner?
• Reform discussions and the realities of finding revenue offsets to extend the 2001/2003 tax cuts for everyone and lower the corporate tax rate likely means that while we might see a lower corporate tax rate in the near future, we will see higher taxes on high income individuals including on qualified dividends. This all makes it difficult to know the tax rate any business is truly taxed at. Why not move to a system where all businesses are taxed the same with elimination of double taxation in the process?
• Why do businesses want lower payroll taxes for employees?  What about future shortfalls in the Social Security Trust Fund and the increase in the number of retirees to workers?
• Replacing the income tax with a consumption tax would be a risky experiment. It also is contrary to international competitiveness in that other countries have a VAT and an income tax.

What do you think?

Small Business Tax Reform

There is a growing number of small businesses. According to the US Census Bureau, in 2002 there were 17,646,062 "non-employer" firms. That is, firms with no employees, such as a sole proprietorship with no employees. In contrast, there were 5,697,759 employer firms. In 2004, the number of non-employer firms had grown by 10.6% while the number of employer firms had dropped by 3.3%.

Per a 12/07 Small Business Administration report (p. 1):

"In 2004, the most recent year for which firm size data are available, small firms with fewer than 500 employees accounted for all of the net new jobs. According to the U.S. Department of Commerce, Bureau of the Census, firms with fewer than 500 employees had a net gain of 1.86 million new jobs, while large firms with 500 or more employees had a net loss of 181,000 jobs. Small firms employed just over half of the private sector work force and generated more than half of nonfarm private gross domestic product. More than 99 percent of American businesses are small, and the average small employer had one location and 10 employees, compared with 62 locations and 3,313 employees in the average large business."

Of course, there are many ways to define small: gross receipts, number of employees, asset size, and capitalization. Also, definitions, such as those used by the SBA, can vary by industry. But, despite the definitional approach, small businesses are viewed as growing and providing employment. So policymakers tend to pay attention to small businesses to see if they can help them to help the economy.

In April 2008, the House Small Business Committee issued a report and held a hearing on ways to modernize the federal tax law to help small businesses to stimulate the economy. There are also several bills to help small businesses with tax compliance. Ideas include:

1. Increasing the IRC Section 179 expensing election.
2. Removing cell phone and laptops from listed property to ease recordkeeping.
3. To increase the meals and entertainment expense deduction in recognition that this is how small businesses generate new business in contrast to large businesses that use fully-deductible advertising.
4. A standard deduction option for the home office deduction and easing of the exclusive use requirement so that more businesses take a deduction that is truly a cost of doing business.
5. Improving health care deductions to make them comparable to corporate employees who treat health insurance contributions on a pre-tax basis.

It is questionable if anything will happen in the remaining days of the 110th Congress. I think the focus on small businesses tax modernization will resurface in the 111th Congress, but most likely in the context of overall reform of the federal tax system. Most of the ideas would help move the tax law into the 21st century. Really - should we have to keep detailed logs on cell phone usage when it has become such a low cost necessity of business people?

For more ideas and information links, I've got a short article on this topic in the August AICPA Corporate Taxation Insider.

What do you think?