Search This Blog

Sunday, October 23, 2016

Tax Reform "Revolution" in 1986 But More Needed Today

Yesterday, October 22, was the 30th anniversary of the Tax Reform Act of 1986 (see 10/18/16 post). My class enjoyed a "Happy anniversary TRA86" cake! 

TRA86 represented a lot of changes that mostly broadened the base and lowered rates. When President Reagan signed the bill, he had lengthy remarks including this statement:

"this tax bill is less a freedom—or a reform, I should say, than a revolution. Millions of working poor will be dropped from the tax rolls altogether, and families will get a long-overdue break with lower rates and an almost doubled personal exemption. We're going to make it economical to raise children again. Flatter rates will mean more reward for that extra effort, and vanishing loopholes and a minimum tax will mean that everybody and every corporation pay their fair share. And that's why I'm certain that the bill I'm signing today is not only an historic overhaul of our tax code and a sweeping victory for fairness, it's also the best antipoverty bill, the best profamily measure, and the best job-creation program ever to come out of the Congress of the United States."

A lot has changed since 1986. Tax rates increased and the base was narrowed by adding over 100 new deductions, exclusions, credits and special lower rates (such as dropping the top capital gain rate from 28% to 0%, 15% or 20%). The income gap has widened, businesses face a more competitive global environment, intangibles are more significant business assets, carbon footprints are more important, and the nature of the workforce and business transactions have changed. Tax reform today needs to recognize these trends.

Also, the growth of special tax rules (ones that are not crucial to the design of an income tax) has budgetary, economic and social effects. Spending in the tax law has grown to equal discretionary spending. But the spending in the tax law is mostly hidden. Recent talks of tax reform though have begun to focus on it. That is important because any effort to broaden our current income tax base to allow for rate reductions will need to get public buy in that that is spending.

For example, the House Republican tax reform blueprint released in June 2016 said this about the spending in the tax system:

"Many of these tax preferences, sometimes referred to as "tax expenditures," are special-interest giveaways that are masked as tax breaks instead of direct grants. For fiscal year 2016, such "spending" through the tax code amounts to more than $1.4 trillion or almost three-fourths of the amount of revenue raised by the entire federal income tax. When Washington picks winners and losers with the tax code, the American people ultimately pay higher tax rates and keep less of their hard-earned money." (p. 9).

But even that problem was noted back in 1984 in efforts that eventually led to TRA86. Senator Bradley and Congressman Gephardt had proposed the "Fair Tax" which was a simpler income tax with fewer special rules and lower rates. In Senator Bradley's book, The Fair Tax, he suggests (page 66) a "unified budget" that "clearly lays out what government spends not only through the authorization and appropriations process, but also through the tax code and off budget. Once all those numbers are laid out, the people could better determine what activities government should increase and reduce."

Under a unified budget, for example, the cost of the American Opportunity and Lifetime Learning Tax Credits (about $20 billion per year) would show up in the same budget as spending on Pell Grants (about $30 billion). A unified budget would help improve budget literacy (awareness) for everyone. It's interesting that it was discussed back in 1984.

So, renewed tax reform efforts today mostly aim to get back to TRA86 days with a broader tax base and lower rates. To get there though, there seem to be a lot more tax provisions that would need to be cut or reduced to get there. We'll see.

What do you think?

Thursday, October 20, 2016

Tax challenges for divorced parents - why?

We get used to certain rules in the tax system and then think they HAVE to be there. But, often, that is not the case. I think the rules related to divorce are good examples.

Alimony is deductible by the payer and taxable to the recipient. This violates the "fruit of the tree" doctrine from the famous 1930 US Supreme Court case, Lucas v Earl. Basically, income is to be taxed to the person who earns it. Our income tax law violates this by letting the alimony payer's income get taxed as if really originally generated by the recipient. If the alimony rules were not in the law, the tax law would be more equitable and simpler. And, the tax consequences can be worked out in the divorce proceedings. The tax law doesn't exist to solve everyone's issues, but to raise revenue for government operations. Former Congressman Camp's Tax Reform Act of 2014 plan (H.R. 1 of 113rd Congress) removed alimony from the income tax rules.

Another oddity and complication is the exception for claiming dependency for divorced parents. The general rule is that children are claimed as dependents by the custodial parent - the one the children live with most of the year. But the tax law, trying to solve issues of divorced parents, adds a rule to allow the custodial parent to file Form 8332 to waive his/her right to the exemption and give it to the non-custodial parent. Again, this issue can be worked out via the amount of alimony and child support the parents agree to.

Every year there are court cases where alimony or Form 8332 are handled incorrectly. I've got a short article in this week's AICPA Tax Insider on a few rulings involving Form 8332 problems that helps illustrate the added complication of trying to help out the divorced parents. [Form 8332 Challenges for Divorced Couples]

What do you think?

Tuesday, October 18, 2016

30th Anniversary TRA86 - 10/22/16

President Reagan signing the Tax Reform Act of 1986 on 10/22/86
[Photo from SSA.]
Despite lots of hearings, reports, proposals and discussion on tax reform, the last major reform to our federal tax system was signed into law as the Tax Reform Act of 1986 on October 22, 1986. Thus, it's 30th anniversary is October 22, 2016!

Rationale for the TRA86 - there was

  1. Sufficient bipartisan and public support for a reformed income tax that was simpler and more supportive of economic growth.
  2. Desire for a system where all taxpayers pay their fair share.
The TRA86 reduced the top corporate and individual tax rates. The top corporate rate dropped from 46% to 34% and the top individual rate dropped from 50% to 28%. Capital gain income and regular income was subject to the same rates.

Subsequent to TRA'86, the top corporate rate increased to 35% and the top individual rate increased to 31% and then to 39.6%. 

After TRA'86 - right after, it was the first time that the corporate rate was higher than the individual rate. There was a significant shift of many corporations into partnerships and S corporations to take advantage of this new rate structure (and avoid double taxation).

I've got an article, co-authored with Jeff Porter, in the Journal of Accountancy this month on the 30th anniversary and what led to the TRA'86 and what happened afterwards - "30 years after the Tax Reform Act: Still aiming for a better tax system."

I'll have more over the next few days on various aspects of TRA'86 including some ideas of former Senator Bill Bradley who along with Congressman Dick Gephardt, had a proposal that helped support efforts that led to TRA'86, and some comments on prospects for tax reform going forward.

What do you think?

Saturday, October 8, 2016

Trump's NOL and the Complexity of Taxation

Lots of news stories and excitement over the first page of three of Trump's state tax returns for 1995 (NY, NJ and CT)! The New York Times broke the story: "Donald Trump Tax Records Show He Could Have Avoided Taxes for Nearly Two Decades, The Times Found," New York Times, 10/1/16. It's a big NOL carryover - over $916 million (almost $1 billion). Several observations:
  • We can't tell a lot from the first page of three state tax returns. Yes, he had a very large loss generated in one or more earlier years. What caused the loss? Likely Trump owns numerous pass-through entities (partnerships, LLCs and S corporations). How many generated losses? How did he have basis to use the losses (cash investments, basis from debt, something else)?
  • How long did it take him to use the NOL carryover and did he get to use it all or did the time limit expire? The NOL may have been reduced if he had cancellation of debt income in a later year. Or, depending on the type of debt (recourse or non-recourse) and how it was cancelled, he might have had large gains in later years that absorbed the NOL.
  • Did any of the NOL carryover go with his wife (Marla) when they divorced? Generally, it goes with the spouse who generated the income. We don't know how various assets and business activities were owned so possibly, some of went to her.
  • State and federal tax laws differ. Perhaps the federal NOL was much larger (might also be smaller, but likely was larger due to federal depreciation rules that are often more favorable than state depreciation rules).
  • For AMT purposes, an NOL can't reduce your AMT income by more than 90%.  So, he should have had AMTI on which he owed federal income taxes in subsequent years.
  • An audit does not mean that a candidate can't release his tax returns. Trump's tax returns are likely quite complex due to the likely numerous entities he has his properties in. But we can still learn a lot from them such as his effective tax rate, types of income, and donation amounts.
Are NOLs legitimate or a loophole? I wrote about this eight years ago when I saw a lawmaker refer to an NOL carryover as a loophole, This is not a loophole. What makes up the NOL might involve overly favorable debt and basis rules that Trump was able to use - that's a different matter. See a 10/3/16 CNN story for some of this background.

The House Republican tax reform blueprint includes a proposal to allow an NOL carryover for an indefinite time period adjusted for the time value of money. However, it would not let taxpayers reduce their taxable income by more than 90% by an NOL carryover, thus ensuring that if you have positive income in a year, you'll pay some tax.  I think given the Trump news, this proposal could easily become law with or without major tax reform.  We'll see.

What do you think?

Saturday, October 1, 2016

Olympic Winnings Exclusion on to the White House - Don't Sign It!

Continuing with a recent theme in this blog - here is an update on federal legislation to not tax winnings of Olympic athletes.  That is, the value of the medal and the cash from the U.S. Olympic Committee will be tax free.  H.R. 5946 has now passed in the House and Senate, so will soon be off to the White House.

Along the way, a major change was made ... If the Olympic medal winner has modified AGI over $1 million, he has to report the winnings!  This amendment addresses the oddity of giving an exclusion to Michael Phelps and the men's basketball team players and other high-income winners.

As noted in my 9/14 post, this bill only results in a revenue loss of about $3 million over ten years. In our trillion dollar budget, this is nothing. But that is no reason to enact this change.  [also see 8/17 post] Additional reasons not to enact this legislation:

  • It is not needed. The winning athletes will have enough money to pay taxes on the winnings because the bulk of the winnings are in cash.
  • Some are likely low income and the bronze or silver prize alone might not be enough to put them into a taxable bracket.
  • The fact that they incur a lot of costs to participate is no reason for the tax break as this is true of many people. For example, college students spend a lot of money to attend college.
  • The fact that they represent the US in the games is a weak justification for the bill. The benefits the athletes receive will benefit them, and the U.S. a lot less (other than from taxes from winnings!)
  • If there is a desire to change the law to help those representing the U.S. why not start with the military?
  • Adding unnecessary rules to the tax law (we have over 200 of them already) just makes the tax system more complex, inefficient and inequitable.
What do  you think?