Annette Nellen | TaxConnections

06 Jul 2023

What About Expanding The Qualified Joint Venture Election?

I think to generate simplification ideas, we need to look at every tax rule or calculation and ask at least two questions. First, should this rule even be part of this type of tax? After all, the federal income tax has over 160 “tax expenditures” which are special rules that are not part of the basic income tax structure (see OMB FY2024 report). Next, is there a different way to draft the rule or handle the computation? We get so used to certain rules, forms, and practices that we often act as if that is the only way something can be done.

I want to offer an example of an out of the box idea that does have some basis in an existing tax rule. I recently suggested this in comments I submitted for the written record of a June 7 joint hearing of the Senate Finance Committee and Small Business and Entrepreneurship Committee, on tackling tax complexity for small businesses. Among my suggestions, I offered this:

Allow co-owners of a start-up business to elect qualified joint venture status for the first few years.

IRC Section 761(f) allows a married couple to elect to treat a business they jointly own and operate as a “qualified joint venture” rather than as a partnership. The couple files two matching Schedules C rather than a Form 1065 partnership return. This is simpler for the couple and enables both spouses to pay into the Social Security system. [see IRS information]

Filing two Schedules C is much easier than filing a partnership return including a Schedule K-1 (as well as Schedule K-3) for each partner.
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Written by Annette Nellen | Posted in Qualified Joint Venture Election

13 Jun 2023

Some Tax Figures Should Not Be Adjusted For Inflation

Inflation adjustments to tax rules such as the individual tax brackets and standard deduction make sense to avoid “bracket creep” where inflation might put an employee into a higher bracket despite no increased earning power and ensures an appropriate amount of income is removed from taxation (the role played by the standard deduction and personal and dependent exemptions).

But some figures, such as filing thresholds for information reports such as 1099-INT and 1099-NEC, should not be adjusted for inflation as doing so will increase non-reporting otherwise known as the tax gap (amount of tax owed less what is actually collected). There are often proposals to increase the 1099-NEC filing threshold from $600 which was set in 1954 to its inflation adjusted amount of about $7,000 today. For example, see the proposed Small Business Paperwork Savings Act introduced 6/9/23 to increase the filing threshold for Form 1099-NEC from $600 to $5,000.

According to the IRS, the tax gap is about $500 billion a year. It stems from non-reporting of income and non-payment, as well as various tax errors made in filing. The GAO, IRS and others have known for many years that “compliance is higher when there is a third-party information reporting and withholding” (page 3 of Pub 5364). More specifically, the IRS reports that where income is subject to both information reporting and withholding, the compliance rate is about 99%! In contrast, where there is little to no information reporting or withholding, the compliance rate is about 45%! [page 6 of Pub 5364]

A tax gap means that compliant taxpayers are paying more to cover what non-compliant taxpayers are not paying that they actually owe. Since it has been shown for many years that information reporting reduces the tax gap, raising the filing threshold for Form 1099-NEC will mean far fewer forms will be issued and some taxpayers such as those who keep poor records or think that if they don’t get an information form, the income isn’t taxable, will not report the income – the tax gap will rise. Compliant taxpayers will have to cover more of total taxes.
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Written by Annette Nellen | Posted in TaxConnections • Taxes And Inflation

06 Jun 2023

Bicycling And Tax Breaks

Prior to the Tax Cuts and Jobs Act made some changes to the treatment of qualified transportation fringe benefits (Section 132(f)), primarily making the employer costs non-deductible (Section 274(a)(4)), “qualified bicycle commuting reimbursement” was such a fringe benefit. That benefit was repealed for 8 years for some reason. It is not clear why it was repealed. I don’t believe its temporary repeal generated lots of revenue as it was as small fringe benefit (about $20 per month and only for 15 months per employee) and likely not offered by many employers or used by many employees.

The bicycle benefit covered the reasonable expenses of an employee for purchase of a bicycle, its improvements and repair and storage if regulary used by the employee to get from home to work and back.

Riding a bike to work isn’t an option for many workers who have long distances or unsafe routes or no biking option due to the need to use freeways to get to work. But for workers who can bike to work, isn’t that a benefit to many people? It means fewer cars on the road and less pollution. If there are already bike lanes available, better yet.

If a tax break is to be provided, why not offer a refundable credit for the purchase or a bike with reasonable cost limits and an income phase-out level?
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Written by Annette Nellen | Posted in Bicycling And Tax Breaks

17 May 2023

Professor Annette Nellen Discusses Inequities In The Tax System

Today marks the 16th year after I started this blog in 2007 while I was a fellow with the New America Foundation. My goal with this blog continues to be to analyze proposals and discuss ideas for helping our tax system to reflect how we live and do business today and to meet principles of good tax policy.
There are many inequities in our tax system such as special tax deductions, exclusions and exemptions that provide a larger benefit to higher income taxpayers relative to others. Examples include the mortgage interest deduction, exclusion of gains that exist at death, and the exclusion of employer-provided health insurance subsidies.

I think many of these exist because the vast majority of people don’t understand how they work. Tax literacy is low in the U.S. because we don’t teach about taxes in K-12 and even in college, accounting majors are likely the only ones to take a tax course. And tax and budget policy should be taught along with basics of how taxes work.

Today, let’s look at how the government, via our tax law, provides tax breaks for health insurance. The largest and more favorable tax benefit for obtaining health insurance is the exclusion for employer-provided health insurance. According to OMB and Treasury, the annual cost of this tax break (cost as in tax revenue not collected) is $237 billion for FY2024 (Table 3). At least 57% of individuals get health insurance from an employer. CBO estimates that 58% of employees under age 65 (156 million people) have health insurance from their employer or a family member’s employer.

This health insurance subsidy for employees is very favorable for many reasons:

Written by Annette Nellen | Posted in Tax System Inequities

09 May 2023

Tax Return Preparer Proposal In 118th Congress

The IRS started their return preparer regulation back around 2009. It was severely limited by the DC Court of Appeals 2014 decision in Loving v IRS, No. 13-5061 which concluded that 31 USC 330 did not provide the IRS or Treasury with the authority to regulate return preparers as preparing a return was not representing a taxpayer before the IRS.
Since then there have been proposals to change 31 USC 330 to give the IRS the authority to regulate return preparers. A current version of such as proposal is H.R. 2702 / S. 1209, Tax Refund Protection Act. While this sounds like something else, it would change 31 USC 330 to allow the IRS and Treasury to “certify the practice of tax return preparers” and require preparers to demonstrate competency to advise and assist person in preparing tax returns, claims for refund or other submissions related to Title 26. This should enable the IRS to resume their earlier program of requiring any paid preparer who is not an attorney, CPA or Enrolled Agent to become a registered tax return preparer by passing a test and being required to meet a specified number of hours of continuing education annually before renewing their PTIN. The proposal also specifically allows the IRS to impose an annual fee for the testing and training.

The bill goes further by imposing restrictions on refund anticipation loans and adding a new obligation at Section 7813, Disclosure requirements for tax return preparers, to provide specific information about any RAL offered to the client with a new penalty at Section 6720D, Failure to meet disclosure requirements for tax return preparers.

Why is it taking so long to make this change that has been supported by the Biden* and Trump** administrations, supported by National Taxpayer Advocates Nina Olson and Erin Collins (see background in NTA 2022 Annual Report to Congress noting the NTA recommendation dates back to 2002)?

*FY2024 Greenbook, page 181 includes a proposal to expand and increase penalties for noncompliant return prep and e-filing and authorize IRS oversight of paid preparers.
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Written by Annette Nellen | Posted in 118th Congress • Tax Return Preparer Proposal

25 Apr 2023

Tech Needed To Simplify Energy Credits For Individuals

Special tax rules tend to be complex because they are “special” in that they are not part of the normal tax system and are not intended for all taxpayers and all activities. Drafting legislation and regulations to be sure the credits are used as intended, is challenging. We are seeing this with most of the energy credits added or modified by the Inflation Reducation Act of 2022. The IRS has to define many challenging terms that were not completely spelled out in the legislation, such as the value of critical minerals, battery components, and more.

I have written about some of this before and this blog post of 8/21/22 includes track changs for several of the revised credits such as the two home energy credits and the clean vehicle credit.

For the clean vehicle credit at IRC §30D, the “qualified manufacturer” has to verify most of the difficult provisions to know if the vehicle is “clean” and if it qualifies the buyer for the critical minerals credit of $3,750 and/or the battery components credit of $3,750. The provisions are complex, but some of that complexity is on the manufacturer rather than the buyer (and lots of complexity on the IRS).

For the two revised residential energy credits, the complexity falls on the homeowner (and for some elements of the credits, the tenant if they are incurring the costs). These rules are complex and are with us for the next 10 years to it is worth finding ways to simplify the process for individuals to know if they have purchased the proper property (meets the specified Energy Star or other standard). In addition, for the IRC §25C Energy Efficient Home Improvement Credit, there are different credit limits on doors versus windows versus biomass stoves, etc.

Here is one suggestion for making it simpler for individuals to know if they can qualify for the §25C credit which might also better encourage them to make home improvements that will reduce energy usage.
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Written by Annette Nellen | Posted in TaxConnections

13 Apr 2023

Need For Modernization – Getting Tax Refunds To Taxpayers

Usually around this time of the year – a few days before the filing due date, the IRS issues a news release reminding people who did not file 3 years ago (so for today, their 2019 return) that they need to file by April 15 to get a refund (but due to Covid extensions, they have until July 17 to get their 2019 return filed).

Of course, when some of these people file and report their income, deductions and credits, they might not be eligible for a refund (they might owe tax). But, the news release (IR-2023-79 (4/12/23)) uses the term refund. I conjecture that for many of these individuals and much of the “$1.5 billion in refunds” their only income is wages and too much tax was withheld based on their income. Some may even have been below the filing threshold but unaware that they could only get their overpaid tax (withholding) returned by filing a tax return.

The IRS reports the data on the “$1.5 billion in refunds” by state. I think they know which individuals did not file because the IRS has a document(s) with their SSN and noting how much tax was withhold (the possible refund).

Questions:

1. Why doesn’t the IRS just refund the amount to the taxpayer if based on the W-2 and any other information returns, too much tax was paid? The law doesn’t allow this; you have to file a return.

2. Why is this announcement always close to the end of the statute of limitations period rather than a year before? Yes, this year it is earlier than usual due to the extra filing time we had for 2019 returns.
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Written by Annette Nellen | Posted in Taxpayer Refunds

28 Mar 2023

Disaster Relief And Administrative Convenience

Severe storms have been ongoing in many parts of California since December. I have two family members with severe damage to their homes causing them to have to move out for repairs. And I know many others also suffered significant damage to property.

FEMA and the IRS responded with relief. The IRS has now issued three announcements of which of the 58 counties in California get a postponement of filing and payment and for what periods – generally, if eligible based on county of residence, filing and payment (such as for 2022 returns) is now October 16, 2023.

Each of the three announcements lists mostly the same counties, but the lists are not identical nor the start date. But after these three casualty relief notices, just three of 58 counties in California don’t get filing and payment relief – unless their records are in a county that gets relief and they ask the IRS for the postponed filing and payment date.

Well, California has a population of 39.2 million. The population of the three counties not included in relief are:

Lassen – population 31,000

Modoc – population 8,700

Shasta – population 181,000

These counties represent less than 1% of California’s population.
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Written by Annette Nellen | Posted in Disaster Tax Relief

14 Mar 2023

President Biden’s FY24 Greenbook – Observations On Some Items

On March 9, 2023, President Biden released his FY 2024 budget (and related docs) and Greenbook that describes his tax proposals. It repeats many proposals that were in his FY2022 and/or FY 2023 Greenbooks (see comparison and links here for the FY22 and FY23 plans).

Themes, similar to recent years, include increasing corporate taxes such as increasing the 21% corporate rate to 28%. Unlike a House proposal last year (which was later dropped from Build Back Better), for graduated rates, are not proposed. The proposed 28% flat rate is still below the pre-TCJA maximum of 35%. As noted in President Biden’s recent State of the Union address, he would increase the recently enacted corporate buyback excise tax from 1% to 4%. I believe the logic is to not only raise some revenue, but to address what some corporations do with corporate tax savings and a buyback might be used instead of a taxable dividend payout.

Observation: While individual tax increase proposals continue to be aimed at those with income above $400,000, the corporate tax increase proposal will indirectly affect all individuals. Eventually, all corporate tax is paid by some combination of shareholders, customers and employees. To keep a promise of not increasing taxes on individuals with income below $400,000 (which is about 98% of individuals!), this proposal should be skipped.

There are several proposals to reform international taxation. I’m not an international tax expert so I can’t opine on them, but it does seem that there is a need to revisit the changes by the TCJA, recent changes to foreign tax credit regs that many have noted have problems, and consider what other countries are doing including regarding OECD Pillars I and II.

The Greenbook continues for the third time to call for repeal of all fossil fuel preferences. In 2021 when the House Democrats worked on Build Back Better this was not included. This also needs discussion as it is odd that our tax law has rules that both encourage development and use of carbon-free energy and fossil fuels. Phasing out the 13 preferences for fossil fuels over a period of years would make more sense than outright repeal, and less disruption to the industry.
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Written by Annette Nellen | Posted in President Biden's FY24 Greenbook

07 Mar 2023

Residential Energy Credit Observations And Cautions

First, a policy query: How long should tax incentives be in the law. For example, with the Inflation Reduction Act of 2022, Congress extended the residential energy credits of §25C and §25D through 2032 and 2034, respectively. The §25C credit was first added to the law in 1978 (as §44C by the Energy Tax Act of 1978, P.L. 95-618 (11/9/78)).

Section 25C (originally §44C and then §23) lasted through 1985 and lapsed until reinstated and revised in 2005 by the Energy Policy Act of 2005 (P.L.109-58 (8/8/05)), with §25D added, effective for 2006 and 2007. Subsequent legislation generally continued to extend these provisions (and sometimes modify them) for one to two years at a time.

So, a residential energy credit existed for 1977 through 1985 and for 2006 through 2032 (2034 for §25D). For more on the history, see Congressional Research Service (CRS), Residential Energy Tax Credits: Overview and Analysis, 4/9/18.

How long should these incentives be in the law? Shouldn’t law changes have required new homes to be built with building envelope that is energy efficient and with solar panels? Should a time limit have been given for making older homes energy efficient? Perhaps. Are tax incentives the best way to go forever or should utility companies be incentivized to help customers make improvements?

These credits, particularly §25C, are a bit complex. For example, §25C covers three types of expenditures with details and qualifications for each category. Also, while subtle in the language, you have to read it carefully to know if the expenditure is only for a principal residence you own and use or if it is ok for it to be owned OR used (true for home energy audits), or just has to be a residence (principal or vacation) owned or used (if only has to be used, tenant may claim the credit).

Homeowners should be cautious in using these credits because there are annual limits on, for example, how much you can claim for qualified doors and windows. Spreading the improvements out over a few years can maximize the credit.

Also, there are both ill-informed and unscrupulous sellers and installers who might mislead taxpayers as to how much credit they will get. Some will encourage those with equity in their home to borrow to pay for the energy efficient items and perhaps a lot more that doesn’t generate a credit and might not even be needed. Be cautious and encourage your clients and older family members to be cautious.

For more on these credits, see my 8/21/22 post that also has links to the track changes versions of these credits. These documents also have links to IRS information on the current versions of these credits.

What do you think? Annette Nellen, San Jose State University, San Jose, CA.

Written by Annette Nellen | Posted in Residential Energy Credits

22 Feb 2023

ChatGPT And The Tax Law: Can AI Address Tax Matters?

We all know tax rules are complex. Can artificial intelligence such as used in ChatGPT address tax matters? I gave it a try today while listening to some colleagues deliver an online chat about the abilities and limitations of ChatGPT. I tried two prompts with it which I summarize below with some commentary. Spoiler alert – the 2nd prompt led to a completely wrong answer! I think if there are students using this tool exclusively, they are going to get caught for turning in garbage (and work that is not theirs).

1.I asked a question related to a paper I’m working on that is a continuation of work I have done in the past – what improvements can be made to IRC section 197? ChatGPT mostly gave good information including some that sounded like it was pulled from my past work on this. It also gave me some outdated information on section 197 such as: “The rules for determining useful life under section 197 can be complex and ambiguous, leading to disagreements between taxpayers and the IRS.” Part of this sounds like pre-197 law. My paper though is calling for a legislative change to make it clear that modern intangibles such as domain names and social media assets fall under section 197.

Commentary: Where you know a good amount about the topic, ChatGPT might be a good way to see if there is anything you are overlooking or clarify something worthwhile to explore further. One item that ChatGPT brought up was whether the de minimis safe harbor should be increased to allow expensing of more intangible expenditures thereby avoiding administrative burdens for small businesses.

2. This week my MST research students present on an “important” tax case that stands for a doctrine such as substance over form (Gregory case); they each have different cases. They have already written a case brief, found a case that applied it (and summarized that case), and found and read a journal article that mentions the case. I provide them an example of a case brief I wrote on Eisner v. Macomber, 252 US 189 (1920). The parties involved are taxpayer/shareholder Macomber and IRS Revenue Collector Eisner. Macomber won with the Court finding that a stock dividend is not taxable. Another key point from the case is the realization principle.

Here is the case summary from ChatGBT:
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Written by Annette Nellen | Posted in AI And Tax Matters

08 Feb 2023

More On California Middle Class Tax Refund

Here is my 3rd post on the payments California issued to probably over 90% of Californians per AB 192 (2022) (1/29/23 + 7/10/22). And others have blogged on it as well. On February 3, Procedurally Taxing had a post from Bob Kammen asking why the IRS hasn’t issued guidance. Bob also makes a comment about the high income range of Californians getting AB 192 “relief” payments, with what I think is sarcasm – that $250,000 of income for single or $500,000 if married is “middle class.”

My first post last July raised the issue that some very low income individuals without a filing obligation get no payment if they had not filed a 2020 return by 10/15/21 as required by AB 192 which was enacted in June 2022!

Why would the state provide “relief” to people with income high enough to not need relief while leaving out those who do?

The IRS stated last week that it will try to get guidance out on the taxability of various state payments issued recently. If they can address the California so-called Middle Class Tax Refund (a term used by the FTB), as AB 192 uses the term Better for Families Tax Refund (although AB 192 includes a specific statement that the payments are not income tax refunds). The IRS can clarify to ensure consistent treatment by recipients, although only those who received $600 or more received a 1099-MISC from the FTB.

Some additional observations from me:

AB 192 Has Some Oddities, Such As:

1. It adds section 8161(d) to the Welfare & Institutions Code to say: “The payment authorized by this section shall not be a refund of overpayment of income taxes”. This is likely why FTB is issuing 1099-MISC for payments issued in excess of $600 rather than 1099-G for income tax refunds of $10 or more.
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Written by Annette Nellen | Posted in California • Middle Class Tax Refund