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Saturday, August 27, 2016

How many times to tax business income?


A recent post (8/26/16) on the Tax Justice website was titled - Why we must close the pass-through loophole? That caught my attention as I was trying to think what the "loophole" might be?  A loophole is a provision that can be used beyond its intended purpose because the rule is not written specifically enough. When a rule is being used as intended, it is not a loophole. For example, sometimes the mortgage interest deduction is called a loophole, but it is not. People deducting interest on the mortgages on their primary and vacation homes is using the rule as intended.

The "loophole" that was the subject of the blog post is large businesses operating as partnerships rather than as corporations. Partnerships, S corporations and sole proprietors do not pay corporate income tax. Instead, the income is taxed directly to the owners and only one level of income tax is paid at the federal level (and state level). In contrast, C corporations pay the corporate income tax AND when they distribute earnings (dividends) to shareholders, the shareholders pay income tax. Thus, C corporation income is taxed twice.

That just happens to be the way it works in the US tax system. It doesn't have to work that way and not all countries double tax corporate income. In the US, there is some relief in that qualified dividends received by individuals are subject to the lower capital gains tax rate.

Over the years, there have been numerous studies by the government and various organizations on how to integrate the corporate tax meaning have corporate income taxed only once.  There are numerous ways this can be done.  Two easy ones would be to not have a corporate tax (only tax dividends) or not tax dividends (only tax corporate income at that level when earned).  Neither is ideal because not all corporations pay dividends and not all corporate shareholders are taxable (a lot of corporate stock is owned by tax-exempt organizations).

The Tax Reform Act of 1986 called for Treasury to study corporate taxation. This resulted in two reports issued in 1992 on corporate integration (January 1992 and December 1992).  Most recently, Senator Hatch, chair of the Senate Finance Committee reports he is working on a plan for corporate integration and the SFC held two hearings on an approach called the dividends paid deduction model (5/17 and 5/24; also see Joint Committee on Taxation report prepared for the hearings).

Some of the advantages of corporate integration include:

  • Treats all business entities similarly (although this also depends on the corporate versus individual tax rates applicable to business income).
  • Removes or lessens a corporation's tax preference for debt over equity.

So, I ask the question differently from the Tax Justice blog post - why not eliminate double taxation of corporate income and find a way to tax all business entities similarly.  And there are many ways of doing that.  More later on that.

What do you think?

Wednesday, August 17, 2016

Olympic Medal Taxation Craziness

Every four years we usually see at least one bill introduced in Congress to make Olympic medals and related prize winnings (such as cash) non-taxable to the athletes. Why? There is no good reason for excluding this prize income.  All prizes are taxable because they are an accession to wealth which is what our income tax system is based upon. If you win a raffle or win on Jeopardy!, the prizes are taxable. Why should an Olympic medal be different?

Possible reasons offered:
  1. The athletes are representing the U.S. Sounds patriotic but the winnings are still income and we could come up with all kinds of reasons to make all income non-taxable if we tried. For example, people who work in hospitals are helping people, perhaps we should exempt their income from tax?
  2. The athlete might have to sell their medal to pay the tax. This is weak because the metal value is under $1,000. (See Forbes article by DeMarco for the estimate based on the value of gold and silver today.) Also, the U.S. athletes also get cash from the US Olympic Committee, reportedly $25K for gold, $15,000 for silver and $10,000 for bronze.  Not bad. Yes, they incur a lot of costs to prepare, but so do students earning college degrees and their income is taxed.
  3. The athletes are low income.  If they are low income, the tax system will already put them in a zero or very low tax bracket. But they are not all low income. While not all have the estimated $50 million net worth of Michael Phelps (Money magazine article), many do earn a lot of money from sponsorships or employment.
S. 2650 would exempt the value of the medal and cash prizes from the U.S. Olympic Committee. It passed the Senate on July 12 and a version is being considered by the House (H.R. 2628).

California has also joined in this craziness. AB 1944 would exempt the value of Olympic medals and associated cash prizes from California income tax through 2020.

These proposals don't meet most of the principles of good tax policy.  Most importantly, they don't meet the principle of equity and fairness. Olympic medal income is really no different from any other type of taxable income.  There is no reason to exempt it from taxable income.

What do you think?

Sunday, August 14, 2016

PTIN News


A PTIN is a Preparer Tax Identification Number. Paid preparers of most federal returns must have one and include it on the return along with their signature in order to avoid penalties. The IRS can use the PTIN to track returns prepared by particular individuals (years ago they had to use the preparer's SSN). PTINs are part of a system rolled out in 2010 where the IRS planned to regulate all preparers of individual returns and a few others. The system was found contrary to Section 330 of Title 31. Basically, the IRS can't regulate preparers who do not represent clients before the IRS and preparing a return is not considered representation before the IRS. [IRS categories of preparers - here]
Recent news:
  1. The annual fee to obtain or renew a PTIN has been reduced from $50 to $33 starting on September 9, 2016. This likely presents the fact that the IRS doesn't need as much money if it won't be regulating about half of preparers - the roughly 350,000 preparers who are not an attorney, Enrolled Agent or CPA.  [TD 9781 (8/10/16) + IRS preparer stats]
  2. Preparers need to protect their PTIN. On August 11, the IRS alerted people of phishing schemes where someone pretending to be from a tax software company, aiming to get the preparer's PTIN. [IR-2016-103]
More work is needed by the IRS and Congress to get all paid return preparers subject to rules of conduct (beyond penalty provisions of the law). I think that is what most taxpayers expect. The law is complex, even for Form 1040EZ. Preparers need to keep up to date with changes (there were over 120 statutory changes in 2015!).   How this is to be done remains a topic of discussion.

What do you think?

Thursday, August 4, 2016

Tax reform - looking beyond a rate reduction


For the past few years, tax reform discussions have focused on broadening the base and lowering the rate.  We are now hearing a bit more about consumption taxes including in the form of a credit invoice VAT like most of the world uses (in addition to their income taxes).

I like to offer reminders of additional tasks and discussions that should be taking place in addition to the above. For example, how about identifying a goal for tax reform?  That will help in knowing if you're getting there.  Also, it is important for the taxing jurisdiction to know its economic, societal and environmental goals to be sure at least that the tax system is not impeding reaching those goals.

I've got a short article in the AICPA Tax Adviser (July 2016) with a few suggestions for looking beyond a lower tax rate.  I hope you'll take a look.

What do you think?

Tuesday, August 2, 2016

House Republican's Tax Reform Blueprint


On 6/24/16, the House Republican's released as part of their "A Better Way" vision/plan, the last of six parts. That part deals with tax reform.  The plan offers some significant changes including moving business taxation to a consumption tax model at low rates (20% for corporations and a maximum of 25% for flow-throughs).  I have a summary of the plan at "House Republicans Offer "A Better Way" for Taxes" in the AICPA Tax Insider (7/28/16).

I also learned after having this short article published that the House Republican's did some good marketing in calling their plan "a better way."  I received a few emails from readers telling me it was not a better way, as if that was my description of the plan rather than the House Republicans.  While it has some good points, whether it is "a better way" than what we have now or other plans is for discussion.  I think the plan can help us move to reform in how they talk about tax incentives - the numerous special deductions, exclusions, credits and preferential rates in the law. On page 9 of the plan, the House Republicans state:

"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."

I think that angle to describing tax preferences is not only correct, but necessary if tax reform that involves base broadening to allow for lower rates is going to occur.  Lawmakers need to shift taxpayer thinking from these tax preferences being crucial to the system to seeing that they are what supports higher rates, inequities, lack of transparency, complexity and economic inefficiencies.

I assume that the staff of the House Ways and Means is working on legislative language for the plan. Perhaps we'll see a hearing on it after the November election.

What do you think?