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Sunday, March 17, 2024

American Opportunity Tax Credit Issues

Over the years, I have heard individuals and tax professionals raise various questions on the operation of the American Opportunity Tax Credit (AOTC at IRC 25A). This is the credit that for the past many years provides up to a $2,500 credit for each of the first four years of higher education at a college or university.  It started in the early 1990s as the Hope Scholarship credit for a lower amount and only the first two years of college.

There are numerous other tax breaks for higher education including an exclusion for scholarships, a limited above-the-line deduction for student loan interest, the Lifetime Learning Credit, an exclusion for interest on education savings bonds, 529 accounts, and more.

Some of the issues I have heard for the AOTC include:

  • Do years at a community college count as part of the four years? I believe they do, but what if the student isn't, at least at first, pursuing a degree?
  • What are all of the expenses that qualify?
  • What if the 1098-T received (and required to claim the credit) is incorrect in terms of the year or amount?
  • Why does it only cover college or university programs rather than also trade schools and similar?
I'm working on a paper of these and a few other administrative and legislative issues about the AOTC. If you have questions or issues you've encountered or wondered about, I would greatly appreciate you posting them in a comment here.  Thank you!

Sunday, March 3, 2024

Why increase the 1099 filing threshold (why increase the tax gap)?

1099-NEC

Over the years there have been proposals to increase the filing threshold under IRC §6041 for 1099-MISC and 1099-NEC which has been $600 since 1954. But, as I've posted about before (see for example my 6/11/23 post), increasing the threshold at which an issuer needs to issue one of these forms results in more individuals not reporting their income.

H.R. 7024 passed in the House on 1/31/24 with an important change to delay capitalization of R&D, includes increasing the $600 issuer filing threshold at §6041 from $600 to $1,000 and then adjusting it for inflation annually.  This means that businesses could change their record sorting so they only issue a 1099-NEC if they paid a contractor $1,000 or more during the year rather than $600 or more. 

The Joint Committee on Taxation estimates that this change will cost (meaning reduce tax revenues) by $1.5 billion over 10 years. The income the contractors earn is still taxable. The revenue loss is because some people who earn income but don't receive a 1099 do not report it. I think the reasons are due to either poor recordkeeping or an erroneously - but widely held belief, that if no 1099 or W-2 is received, the income is not taxable. A 2019 TIGTA report (and other government reports) state that if there is no information reporting, the compliance rate is only 37%! That report also indicates that the compliance rate is 93% when there is information reporting.

Why not reduce the cost of H.R. 7024 and remove the change to §6041? This would help it meet principles of good tax policy to not increase the tax gap and to consider transparency (that taxpayers can better understand the tax system (increasing the 1099 filing threshold sends a confusing message to the recipients of these forms and other taxpayers)).

Why not use the $1.5 billion over 10 years to provide education and grants for recordkeeping software to help small businesses implement recordkeeping to track all of their income and expenses and that will also help them reconcile any 1099s, including 1099-Ks they get to they don't overreport income (1099-Ks report gross receipts which might include fees such that a gig platform charges and should be backed out as an operating expense).

What do you think?


Tuesday, February 13, 2024

Important Effective Date Item in Preamble to Digital Asset Broker Reporting Prop. Regs.

stacks of coins to represent bitcoin
The proposed regulations on broker reporting of digital assets released August 29, 2023 (REG-122793-19) included more than guidance under IRC section 6045. They also included related proposed regulations under section 1001 on amount realized and section 1012 on basis. I think that generally, the 1001 and 1012 proposed regulations are fairly straightforward and tie to the general rules at these provisions.  

One clarification they offer is that in a transaction where a taxpayer exchanges, for example, X coin for Y coin and pays a transaction fee, 50% of the transaction fee is treated as a reduction to the amount realized for the disposition of X coin and 50% is added to the basis of the Y coin acquired.

Unlike the virtual currency FAQs #39 - #41, Prop. Reg. 1.1012-1(j) provides that in applying the specific identification method to know which digital asset was disposed of (when the taxpayer has more than one unit or code representing their digital assets), the taxpayer must apply specific identification on a wallet by wallet or exchange by exchange system. In contrast, the FAQs allow (or at least do not disallow) use of a universal tracking approach where the taxpayer transferring, for example, 2 Xcoin out of wallet 1 to buy goods, could specifically identify to say they used the basis of 2 Xcoin in T's wallet 2. This would not be allowed under the proposed regulations. The long list of questions in the proposed regulations include though, whether there are alternatives to this approach (questions 44 & 45 at page 59616 in the Fed. Register).

Prop. Reg. 1.1001-7(c) and 1.1012-1(j)(6) provide that these proposed regulations are effective on the January 1 following when final regulations are published. However, page 59616 in the Fed. Register states that the 1001/1012 proposed regulations are reliance regulations. That is, per the preamble, taxpayers "may rely on these proposed regulations under sections 1001 and 1012 for dispositions in taxable years ending on or after August 29, 2023, provided the taxpayer consistently follows the proposed regulations under sections 1001 and 1012 in their entirety and in a consistent manner for all taxable years through the applicability date of the final regulations."

Since the broker reporting regs under section 6045 won't be effective for reporting of gross proceeds until sales on or after January 1, 2025 (basis reporting for sales on or after January 1, 2026), if a taxpayer follows the date of the proposed 1001/1012 regulations starting for 2023, they would also do so for 2024.

But, I don't think most taxpayers can follow the 1001/1012 proposed regulations until the 6045 regulations are effective because taxpayers might not be able to get the exchanges they use to help them with the specific identification called for in the proposed regulations.

But, practitioners need to present the effective date choice to clients because the decision is theirs to make. But before making it they should check if any exchange they use will allow them to specifically identify the digital asset they are transferring at the time of the transfer and document that for them (and apply FIFO if they do not give the exchange specific identification information at the time of a transfer). For unhosted wallets, the taxpayer handles that specific identification on their own, likely by sending themselves an email to document what they are doing and have the date verification from the email.

Also, would be a good idea to let your client know that the final regulations might have a different approach then tracking basis wallet by wallet and exchange by exchange. 

Not sure why the 1001/1012 proposed regulations were offered as reliance regs when there are reasons it is either impossible or unwise for taxpayers to start applying them for 2023 and 2024. Also, given the latitude in the virtual currency FAQs, if a taxpayer were tracking on a universal approach, they should be able to change going forward to wallet by wallet and exchange by exchange (with no need to get help from the exchange for that until the regs are finalized). The IRS notes in the preamble to the regs 
(page 59611 of the Federal Register) and at Prop. Reg. 1.1012-1(j)(4) that such a change is not a method of accounting as the method is still specific identification.

So, something to think about and find a way to present to your clients with digital assets so they can make the decision the IRS offers all taxpayers regarding the effective date of the 1001 and 1012 proposed regulations.

What do you think?

Sunday, January 28, 2024

EITC Awareness Day and Week Hopefully Also Can Focus on Needed Improvements

EITC reminder

The Earned Income Tax Credit (EITC) was added to the law in 1975 (Tax Reduction Act of 1975 (P.L. 94-12, SEC. 204; 3/29/75). So, the first note I'd like to make is that March 29, 2025 will be the 50th anniversary of the EITC. The Congressional Research Service has a nice report on the history of the EITC (4/28/22 version).

There is a federal annual EITC Awareness Day, which was January 26, 2024 (IR-2024-22).

Employers have federal (and perhaps state) obligations to tell employees about the EITC. Law changes in California in 2023 require employers to notify employees of the EITC (and a few other items such as CalFile and VITA) twice per year rather than only once per year (SB 131, Chapter 55 (7/10/23)). AB 1355 (Chapter 277 (9/30/23)) allows the notification to be emailed to employees, within specified parameters. The California EDD provides information on the notification and sample language.

On January 27, 2024, California Governor Newsom issued a proclamation that January 26 to February 2, 2024 is CalEITC Awareness Week. 

For many reasons, it seems that a week is certainly needed for EITC awareness and better yet, some way to more frequently help taxpayers be aware of the EITC and the benefits to eligible taxpayers and their communities of making sure it is claimed. Data from the IRS indicates that about 24% of eligible workers do not claim the EITC. The IRS tracks this data by state and you can find it here. CA R&T §19851 states that "hundreds of millions of federal dollars go unclaimed by the working poor in California."

How does this happen? The Tax Policy Center notes that about 5 million eligible individuals do not claim the credit leaving about $7 billion of benefits unclaimed!  These funds certainly could help low-income workers. The Center suggests that reasons for not claiming the EITC include its complexity causing some to not be sure if they qualify, and having income below the filing threshold so they do not file. For the non-filers, perhaps they did not have federal or state income tax withholding, so they are not filing to get those taxes refunded. 

A good portion of the EITC represents a refund of employments taxes withheld or paid by the employer for the employees wages. This illustrates a fundamental problem with the credit in that it is making taxpayers pay taxes they don't owe and then having to file to get the refund and perhaps, depending on earned income and family size, getting an additional amount via the EITC. Why not design the system to not have the EITC-eligible worker not pay the tax in the first place (and that would also provide the benefit per paycheck rather than when the return is filed).

I had the opportunity to suggest such a change back in 2001 in a paper included in the JCT's Study of the Overall State of the Federal Tax System and Recommendations for Simplification, as required by the Tax Reform Act of 1986 (summary at page 7 and full text at page 205). I think others have made similar suggestions over the years. 

Basically, federal income tax withholding could be changed to only start once an employee has earned a certain amount of income. All employees could have, say the first $15,000 of wages not subject to Social Security taxes with an increase in the wage base to address this. Or the change could only be made for workers paid at minimum wage or perhaps 1.10% of minimum wage. 

There used to be an advanced EITC system where the worker applied and the employer would not withhold certain taxes. It was repealed several years ago because there was almost no one using it. Perhaps there is a way to bring that back with better use of technology to help low-income workers get the funds for sure and get them more evenly throughout the year. For example, use of the IRS website to help with the calculations and any form to be completed for the employer (as part of the W-4 for example).

Here is an excerpt of what I wrote over 20 years ago (and I had a lot of background info and data on the EITC in the report too, and I had forgotten that something I've been suggesting in more recent years, I suggested back in this 2001 report - moving to a return-free tax system!).  

    "The EITC could be restructured to be an immediate offset of payroll taxes in more than one way. For example, all employees could have an exemption from Social Security (FICA) and Medicare taxes (referred to in this paper as “payroll taxes”) on a specified amount of wages. Of course, to offset the reduction in tax collections, the tax rates and maximum amount of earned income subject to payroll taxes would need to be adjusted. Another alternative would be to have payroll taxes computed on a graduated rate basis tied to the worker’s wage base (similar to how federal income tax withholding is computed). Because the current EITC structure can result in refunds greater than the worker’s payroll tax amount, additional changes would be needed to maintain the current level of benefit provided by the EITC to taxpayers with one or more qualifying children. These changes might be achieved through increased dependency exemptions or child credits for individuals with specified amounts of earned income. 

     Beyond simplification, an additional potential benefit of an alternative structure and simplification of qualifying status requirements would be that it might make it easier to move to a return-free tax system. Structural changes as described above would also serve to provide the EITC benefit to low-income taxpayers in each paycheck without a need for individuals to apply to receive an advance EITC.  In addition, these structural changes could be implemented in a manner so as to reduce the current high marginal tax rates that result from the phase-out provision of the EITC."

This proposal reminds me of a similar suggestion that I and two SJSU econ professors wrote about a few years ago. To better target sales tax exemptions such as on food and infant diapers and to more easily have the sales tax apply to more types of personal consumption, convert the sales tax to a formula calculation (personal consumption = income less savings), because one benefit is that instead of providing a food exemption that primarily benefits higher income individuals because they spend more on food, you could exempt low-income individuals from all sales tax by exempting them from the calculation if their income is below a specified level. And the benefit could continue for income levels by use of a graduated rate structure based on income. I just note this because it is another example where it might be easier to just not collect a tax in the first place rather than structure a tax credit or use inequitable exemptions to help lower-income taxpayers. This sales tax paper can be found here and there are additional benefits of it in that businesses would no longer pay or have to collect sales tax (there would need to be a transition phase-in as revenues adjusted).

But back to the EITC ... perhaps the upcoming 50th anniversary calls for efforts to examine how it can be simplified and all eligible individuals can readily obtain its benefits.

What do you think?

Monday, January 1, 2024

Fewer Clean Vehicles Qualify for Federal Tax Credit in 2024

The §30D Clean Vehicle Credit that was greatly modified for 2023 through 2032 by the Inflation Reduction Act of 2022 has increasingly strict qualifications each year. Per the IRS and Dept. of Energy list of qualifying vehicles, there is a drop for 2024. For clean vehicles purchased from April 18, 2023 through December 31, 2023, 27 vehicles qualified an eligible buyer for a $7,500 credit and 16 for a $3,750 credit.

As of today (1/1/24), the list for 2024 includes just 10 vehicles for the $7,500 credit and 9 for the $3,750 credit. The drop is due to a combination of no longer meeting the higher critical minerals or battery component requirement or involving parts of assembly by a "foreign entity of concern" such as China.

I suspect that more vehicles will be added during the year, but this drop will likely continue annually for the next several years.  If you're looking for a good deal on a clean vehicle, likely that happens the last week or so of the year when dealers are eager to sell eligible vehicles that won't be eligible the next year.

And new starting in 2024 is the ability of buyers to transfer their credit to the dealer (if registered) so the customer/taxpayer can get the value up front rather than waiting to when they file their return.

There is more information at:

  • IRS Clean Vehicle Tax Credits website
  • FAQs in Fact Sheet 2023-29 (12/26/23) (but always check for the latest fact sheet)
  • Pub 5866, New Clean Vehicle Tax Credit Checklist