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Sunday, February 19, 2017

California proposal to convert vacation home subsidy to low-income housing one

AB 71 introduced in California for the 2016-2017 session, proposes to repeal the deduction for mortgage interest on a second home (usually a vacation home) and use the savings (and apparently other funds) for low-income housing.

Some people may be surprised to learn that you can deduct interest on a mortgage on a second home. We can find some logic, perhaps, in deducting interest on a mortgage on your principal residence because we think the tax law is encouraging home ownership. But, why would it subsidize/encourage debt on a second home?

The "logic" is mainly historical. Back in 1913 when our modern federal income tax began, all interest expense was deductible. In 1986/1987, to help pay for lower rates, Congress repealed the deduction for personal interest (such as on credit card debt), and limited the mortgage interest deduction to just two home (principal and second) and limited the debt to $1.1 million (which is a lot of debt, even today in California).

Most states follow the federal rules.

The deduction is only available if you itemize your deductions. Only about 30% of individual itemize.  At the federal level, the "cost" of the mortgage interest deduction is about $80 billion per year! (of course, most of this cost is for the deduction related to mortgages on principal residences, not vacation homes).  That is one of the largest costing tax breaks, yet only benefits less than 30% of individuals (not all itemizers have a mortgage).  This is more than the federal government spends on low-income housing.

Several principles of good tax policy support repeal of the interest deduction on a second home. First, equity. This deduction is mostly claimed by higher income individuals (see April 2013 paper of Eric Toder). After all, who can afford a second home (although some use it to buy an RV)? Why subsidize this non-necessity?  Neutrality and economic efficiency are also violated.  The mortgage interest deductions has been shown to result in higher income individuals buying a more expensive home. Thus, the deduction favors housing investment rather than investment in other areas, such as businesses.

So, interesting proposal.  I would suggest a few changes though:

  1. Instead of outright repeal, phase-out the deduction over two to three years to address the issue that many of the borrowers made decisions assuming they would get a tax deduction.
  2. Do not earmark the savings from elimination of the deduction for interest on a second home. That just ties the hands of the lawmakers. The funds should go to the General Fund to be used for various state needs - including low-income housing.
One more area where lawmakers can help low-income housing ... Federal tax reform will most likely include repeal of the low-income housing credit to help pay for lower tax rates. Well, state and local governments are indirect beneficiaries of this tax credit. They should ask Congress to use some of the tax savings as a transfer to state and local governments for low-income housing projects.

What do you think?

Wednesday, February 15, 2017

Tax filings for same-sex couples

Married couples files as married for federal and state tax purposes. If they are in a civil union or registered domestic partnership, the couple is not considered married for federal tax purposes, but may be for state purposes (check state law).  Here is a recent article by Tracy Byrnes with TheStreet on the topic with some reminders.

Saturday, February 11, 2017

More than one way to tax consumption

In the US, the consumption taxes we are most familiar with are the sales tax and some excise taxes, such as on gasoline, alcohol and tobacco. We typically think of these taxes as having to be imposed at the point of purchase.  There is an advantage to this because you'll know at that time if you can afford to pay the tax. Disadvantages to this approach include that the vendor has additional compliance to collect and remit the tax (and penalties if done wrong) and the rate can't be adjusted for the income level of the buyer (although I understand many might not view this as a disadvantage).

Another form of consumption tax that has been around in proposals and policy books and reports for a few decades is the formula approach or consumed income tax. If we consider that one's income is saved and spent, we have this formula:

     Income = savings + consumption

Simple algebra converts this formula to a consumption tax:

     Consumption = income - savings

We know how to measure income, but how do we measure savings? We can look at beginning bank balances and cash stored up (in case that's a lot; a few bucks in your wallet can be ignored). To that we add increases to savings and saving spending (such as purchase of stock). Debt must also be factored in. It might get a bit complicated, but can be managed with software and good records.

Two colleagues (Drs. Foldvary and Haight, economists) and I wrote a paper on how a sales tax might be converted to a formula approach consumption tax, how to do it and the advantages and disadvantages. One advantage is that it would remove the sales tax from businesses (they would not pay it or collect it). Another advantage is that low-income/low-wealth taxpayers can be exempt. Also, the calculation can be done as a form attached to an existing income tax return. And, as noted earlier, a progressive rate structure is possible. Disadvantages include that it won't get at the underground economy and visitors to the state won't pay the tax. Partial solutions to these problems is to retain the sales tax for vehicles (cars and boards). Also, the state could add a small tax to hotel stays, perhaps collected by cities that already impose such a tax.

Another challenges is that without a sales tax, local governments, at least in California, lose a significant tax source. So, a system of sharing state revenues with local governments would be needed. That won't be popular with local governments. It can be done to have the local governmetns share in the state income tax which would align both levels of government to want high paying jobs in the state (today, local governments benefit more from big box retailers in their cities because of the sales tax generated).

The paper is posted here. Yes, it is long, but 2/3 of it are appendices should you seek more background information.

What do you think?

Thursday, February 9, 2017

Extended due date for calendar year corp - what?

In 2015, Congress changed the due date for several types of entities as well as for the FBAR (for foreign financial accounts). The AICPA has a wonderful chart with all of the new dates noted.

When Congress made the changes for C corporations, they apparently had a concern with a change that would move a due date from one government fiscal year into the next fiscal year. The federal government's fiscal year ends September 30.  Prior to the due date changes, we had these due dates:

Calendar year corporation - due March 15, extend to September 15
June 30 corporation - due September 15, extend to March 15

You can see that the extended due date for calendar year and original due date for June 30 corporations crosses the government's fiscal year end if one more month is added to these due dates.

So, Congress said that for the next ten years (2016 through 2025), the extended due date for calendar year corporations would remain at September 15 and the original due date for June 30 corporations would remain the same.  But, the other due dates would have one month added (so calendar year returns due April 15 and June 30 extended return due April 15). After 2025, the due dates would be 3 1/2 months after year end + 6 months extension.

This makes sense (I'm being generous) for the June 30 corporation because its taxes are due on September 15. If that got changed to October 15, it pushes revenue into the next fiscal year. But this isn't the case for the extended due date for calendar year corporations because tax is always due by the normal (unextended) due date.

Well, the IRS recently told us via instructions to Form 7004 and a statement on their website (dated 2/7/17), that it will give calendar year corporations a 6 month extension to October 15 now, even though Congress said September 15 through 2015 and only October 15 after 2025. This is a logical answer, but many practitioners already learned that it was September 15.  Not the end of the world, but one more example of little items that can add up to some confusion.

What do you think? Did IRS make it simpler or more complicated?

Thursday, February 2, 2017

States need to get ready for federal tax reform

There is lots of talk about federal tax reform. We are likely to see some legislative language from the House in spring, according to Speaker of the House Paul Ryan (see Jeremy Quittner, "Paul Ryan Says Tax Reform Won't Happen Any Time Soon," Fortune, 2/2/17).

Federal tax reform presents opportunities and challenges for states. I've got an article in State Tax Notes on suggestions for state governments to consider.  For example, to lower federal tax rates, the base will be broadened and most credits will go away.  One of those credits is the low-income housing credit. State and local governments are indirect beneficiaries of this credit.  State governments should consider asking Congress to give some of those dollars to the states rather than using them all for rate reductions.

I hope you'll take a look - Time to Really Get Ready for Federal Tax Reform.

What do you think?