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Missing From Tax Plans – A “Normal” Personal Income Tax



Missing From Tax Plans - A "Normal" Personal Income Tax

We can gather some general ideas about tax changes in looking at various websites and documents of presidential candidates. This includes the Democratic Party platform for 2020, Republican Party platform for 2016 (it was not updated for 2020, so actually includes pre-TCJA tax ideas), and candidate websites. I recently reviewed these plans for an upcoming webinar. One observation I’ll make about both plans (best I can tell since most details are missing):

Why not fix an outstanding problem with the individual income tax that has worsened with recent law changes and ways people generate additional income and cash flow today? This problem is that expenses of producing taxable income are not allowed unless the activity is a business (other than the business of being an employee). This started with the Tax Reform Act of 1986 and worsened with the TCJA.

The TRA86 added section 67 to treat some miscellaneous itemized deductions as only deductible to the extent they, in aggregate, exceed 2% of one’s AGI. The TCJA disallows this deduction entirely for 2018 through 2025. Thus, no deduction for unreimbursed employee business expenses or expenses of producing income from an activity not engaged in for profit, or expenses of producing investment income. These expenses generally are all limited to the income produced, but not deductible today.

There is a growth in individuals engaged in activities that likely are not a business but that generate income and cash flow. For example, today, technology in the form of apps run by platform companies make it easy to rent out your car or extra space you have, perhaps even a closet (yes, see Neighbor.com for example). While in some cases, this might be a trade or business, it is more often someone trying to monetize extra space or assets they have and not run as a business. The income is taxable, but no expenses are allowed. The main expense incurred is the fee paid for using the platform and likely some insurance. I think this type of income and cash flow generation will continue to become more common.

In its annual tax expenditure report, the Joint Committee on Taxation explains what a tax expenditure is. It is a special tax rule that is not part of the normal tax. They are deductions, special rates and tax credits that are not part of the normal design of the particular tax. For example, a basic or normal personal income tax would not include a mortgage interest deduction or an American Opportunity Tax Credit, among numerous other special provisions. Per the JCT (page 3) though, the normal individual income tax would include “the following major components:

  • one personal exemption for each taxpayer and one for each dependent,
  • the standard deduction,
  • the existing tax rate schedule, and
  • deductions for investment and employee business expenses.

Most other tax benefits for individual taxpayers are classified as exceptions to the normal income tax law.
And the expenses of producing the non-business income should be limited to the income produced and deductible for AGI (not as itemized deductions).

And individuals would need reminders about what is a personal expenditure and not deductible versus is truly an unreimbursed employee business expenses or other expense incurred to produce taxable income.

And more changes would be needed to get closer to the “normal” income tax. Per the presidential plans, we are likely to see more items proposed that continue to move us from that normal tax although some might be variations on the personal exemption and standard deduction noted above.

What do you think? Annette Nellen.

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Annette Nellen, CPA, Esq., is a professor in and director of San Jose State University’s graduate tax program (MST), teaching courses in tax research, accounting methods, property transactions, state taxation, employment tax, ethics, tax policy, tax reform, and high technology tax issues.

Annette is the immediate past chair of the AICPA Individual Taxation Technical Resource Panel and a current member of the Executive Committee of the Tax Section of the California Bar. Annette is a regular contributor to the AICPA Tax Insider and Corporate Taxation Insider e-newsletters. She is the author of BNA Portfolio #533, Amortization of Intangibles.

Annette has testified before the House Ways & Means Committee, Senate Finance Committee, California Assembly Revenue & Taxation Committee, and tax reform commissions and committees on various aspects of federal and state tax reform.

Prior to joining SJSU, Annette was with Ernst & Young and the IRS.

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