Archive for the ‘Legislation’ Category

A Retroactive Tax Bill: What Can Go Wrong?

Thursday, February 1st, 2024

Last night, the House of Representatives passed tax legislation that would increase the Child Tax Credit for 2023, allow businesses to expense research and development expenses, tax relief for wildfires and the train derailment in East Palestine, Ohio, and some other provisions.  This legislation is now in the hands of the Senate, and it’s possible it won’t go anywhere (or it could pass tomorrow).  Issues that could derail the bill in the Senate include the SALT cap (the limit of $10,000 deduction on federal tax returns for state taxes paid), election year politics, and the fact that little has come out of the Senate.  And if it gets amended in the Senate, back to the House it goes.

Let’s assume it passes; that would require the IRS to reprogram its computers.  The IRS uses the best of 1959 technology, so this would take a month or so.  Do we file tax returns for individuals (and businesses) impacted by this?  If this passes, impacted individuals (and businesses) who file now might need to amend their returns.  The IRS isn’t expedient in processing amended returns, so that’s not a great option.

Unfortunately, there is no best option.  Each impacted taxpayer is going to have to decide whether or not to file now or extend.  If we get an indication from the Senate whether this bill will pass or not, we may be able to make better decisions. Even though I reside in the capital of gambling and odds, I can’t provide you a quote of the chance this bill passes as written and gets signed into law.

I was hoping for a nice, simple straightforward Tax Season.  Unfortunately, Congress had different ideas.

How High Is Too High?

Tuesday, August 4th, 2020

California, like many states, has financial difficulties because of the Covid pandemic. So is the legislature looking at cutting spending? A little. How about raising taxes? Definitely, especially on the rich.

California’s top marginal tax rate today is 13.3% (on those earning $1 million or more). Proposed legislation would increase the tax rate to 14.3% on those earning more than $1 million, to 16.3% on those earning more than $2 million, and to a whopping 16.8% on those earning more than $5 million.

Today, California gets 40% of its revenues from the top 0.5% of taxpayers. But something lost by the California legislature is what happened after the last tax increase (to 13.3%). As Josuha Rauh notes,

The problem is that high earners do not simply sit there and take it when the state goes after their income.

In a detailed study of the 2012 California ballot measure that raised the top state rate to 13.3 percent, Ryan Shyu and I found that just two years later, the state was only collecting 40 cents of every dollar that it had hoped to raise from the tax increase.

The reason?

High income taxpayers affected by the 2012 tax increase suddenly began to flee the state at higher rates, especially to zero tax states like Nevada, Texas, and Florida.

This is an obvious corollary to the Laffer Curve. Economist Arthur Laffer noted that at 0%, no taxes are collected and that at 100%, no taxes would be collected. So there must be a curve that describes tax collection by tax rate.

The unspoken issue for California is, “Will this increase drive the top 0.5% out of the Golden State?” Mr. Rauh, a Senior Fellow at the Hoover Institution and a Professor of Finance at Stanford, clearly believes the answer is yes. When this measure passes (and given the makeup of the legislature, it will pass), the question is not will top-earners leave, but how many will leave. Alan Greenspan famously said, “Whatever you tax, you get less of.” California is conducting an experiment, and we will find out the results in a year or two. I believe that if you’re a realtor specializing in high-end properties in Nevada, Texas, Florida, or Arizona, you’re about to get more business.

Congress Gets in the Christmas Spirit: Tax Extenders Pass

Friday, December 20th, 2019

“It’s looking a lot like Christmas,” is how one Christmas tune begins. Here in Las Vegas, that means it’s cold (for Las Vegas), and the few deciduous trees in town are now leafless. But Congress got in the Christmas spirit, passing tax extenders. There are a lot of provisions, so let’s get to the ones most likely to impact you.

1. Three ObamaCare taxes are gone: the medical device excise tax, the 40% excise tax on high-cost employer provided health coverage, and the annual fee on health insurance providers. ObamaCare continues to go into the garbage can of history on a piecemeal basis.

2. There are numerous changes to retirement programs. The biggest change is that the age for required minimum distributions has been increased to 72 from 70 1/2. This change is effective for distributions required to be made after December 31, 2019 for employees and IRA owners who attain age 70 1/2 after December 31, 2019.

3. It used to be that if you had cancellation of debt income from your primary residence, you could exclude that from taxation. That vanished–but it’s back! This provision is retroactive to 2018, so if this impacted you an amended return may be in the future. This provision sunsets at the end of 2020 (unless Congress extends it again).

4. Mortgage insurance premiums used to be deductible, but that went away. That’s also back, retroactive to 2018; if this impacts you an amended return may be in your future. This provision sunsets at the end of 2020.

5. The medical expense deduction for 2019 and 2020 returns will be based on 7.5% of AGI, not 10% of AGI.

6. The Tuition and Fees deduction is back for 2018 (retroactive) through 2020.

7. The tax credit for construction of energy efficient homes is back for 2018 (retroactive) through 2020.

Those are just the highlights; there are numerous other provisions. This legislation still must be signed into law by President Trump (he has indicated he will sign it). I would expect tax software companies to have made the appropriate adjustments in their software by the end of January.

An obvious question is whether you should file an amended return if you’re impacted by one of these changes for 2018. The answer will be, “It depends.” The reality is that if the issue is major (you’re a home builder and can take the tax credit for energy efficient homes, or you had large cancellation of debt income from your personal residence) the answer will undoubtedly be yes. However, let’s say you paid $300 of mortgage insurance (and you did itemize) in 2018. Let’s further assume you’re in the 22% tax bracket. That means your potential tax savings are $66. If a tax professional prepares an amended return, he or she will have to charge you. Now, for a change like this the cost will generally be minimal (it should take very little time), but tax professionals must charge for their time. Let’s say the charge is $60. Then you have to add in the cost of postage (all amended returns must be mailed to the IRS) which means certified mail, so that will add in another $6. So you would be spending $66 to save $66 in my hypothetical — a wash. Thus, each individual will need to look at their unique situation.

It would be far better for Congress to drastically simplify the Tax Code or not have extenders; simply pass legislation at the beginning of each year rather than the end of it. The good news for 2020 is we do have certainty on these extenders for next year.

IRS To New York, New Jersey, and California: We Weren’t Kidding

Tuesday, June 11th, 2019

Today the IRS issued rules and guidance on charitable contributions as a workaround to the new limits on state and local taxes. Unsurprisingly, the IRS said exactly what I thought they would: both substance over form and quid pro quo apply.

There’s a fundamental rule in tax: The substance of a transaction determines how it’s taxed, not what it’s labeled. Suppose I pay you to perform services for me, but I send you a Form 1099-INT (for interest income). What I pay you is service income, not interest income, no matter how it’s labeled. Consider state taxes. Suppose a state (say, New York) offers you the ability to contribute to the “Support New York Fund” instead of state taxes. Well, the substance is that you’re paying state taxes by contributing to that fund.

Another issue is “quid pro quo;” that’s Latin for ‘something for something.’ And if you get something for a charitable contribution, that portion isn’t charity. Consider a donation to some foundation for $50 and you receive a blanket worth $10; your charitable contribution (that you can take) is $40. This rule has been around for some time. It applies to these workarounds, too.

Put bluntly, the IRS isn’t amused with the workarounds. The Tax Code is law; until Congress changes it, federal deductions for state and local taxes are limited.

Should I Violate Federal Law or State Law?

Tuesday, August 28th, 2018

Suppose you have a federal license to perform your occupation in your state of residence. That license allowed you to do [whatever it is you do] anywhere in the United States. Now, further suppose your state legislature passed a law specifically overriding that license, and, in fact, making some of [whatever it is you do] illegal under state law. And further suppose that if you obey that new state law you would be violating federal law as you would not be performing [whatever it is you do] properly under federal law. No state legislature could be that stupid uninformed, right?

One should never take a bet against legislatures doing dumb things, and the actions over the past fifteen months of the Nevada legislature demonstrate that. In 2017 the Nevada Legislature passed AB 324 that amended NRS (Nevada Revised Statutes) Chapter 240A; that reclassified Enrolled Agents (what my federal license is) as people who performed “Document preparation services.” We would have to register with the Nevada Secretary of State, post a surety bond, and we would not be able to negotiate with anyone else or communicate to anyone else the position of a client; if we did so, we would be subject to penalties including possible imprisonment. Hmmm, might an Enrolled Agent need to negotiate on behalf of clients with tax agencies such as the IRS and collect confidential information?

The Nevada Society of Enrolled Agents (NVSEA) filed a lawsuit, and in November 2017 had a temporary injunction placed on enforcement of the law. Last month the court heard arguments, and the ruling came out on August 16th.

The Court finds, that as a result of the amendments made to Chapter 240A by AB 324, Nevada Enrolled Agents cannot comply with both federal and state law. Under federal regulations, Nevada Enrolled Agents must provide competent tax advice, must assist clients in preparing accurate tax returns and other forms, must collect documentation which supports a client’s position and must competently and diligently represent taxpayer clients in proceedings before the IRS. Under Chapter 240A as amended, Enrolled Agents in Nevada are prohibited from performing these duties and face civil and criminal liability for violations of the state law.

The Court went on to note why the law is unconstitutional:

This Court finds that Chapter 240A…hinders and obstructs the free use of the Enrolled Agents’ license to practice before the IRS…Pursuant to NRS 240A.240(5), Enrolled Agents are no longer able to “negotiate with another person concerning the rights or responsibilities of a client, communicate the position of a client to another person or convey the position of another person to a client.” This contradicts Section 10.2(4) of Circular 230, which allows agents to “correspond[] and communicat[e] wit hthe Internal Revenue Service” and engage in “matters connected with a presentation to the Internal Revenue Service or any of its officers or employees relating to a taxpayer’s rights, privileges, or liabilities.” The amended law also prohibits an Enrolled Agent from “appear[ing] on behalf of a client in a court proceeding or other formal adjudicative proceeding….” NRS 240A.240(6). This provision conflicts with Section 10.2 of Circular 230, which allows agents to “represent[] a client at conferences, hearings, and meetings.” The amended law prohibits Enrolled Agents from providing “advice, explanation, opinion, or recommendation to a client about possible legal rights, remedies, defenses, options or the selection of documents or strategies….” NRS 240A.240(7) This contradicts Circular 230, which states that Enrolled Agents may give written advice regarding tax matters. 31 C.F.R. §§ 10.2, 10.33, 10.37. Finally, the amended statute contradicts Circular 230 because it requires an Enrolled Agent to provide a copy of a client’s file to government entities. NRS 240A.220(1). Yet, pursuant to IRC §§ 7525, 7216, 6713, Enrolled Agents must keep client information confidential and only share client files when ordered to do by a court…

Accordingly, the Court finds that Chapter 240A of the Nevada Revised Statutes, as amended by A.B. 324, conflicts with federal law to the extent it seeks to regulate Enrolled Agents who are authorized to practice before the Internal Revenue Service. The law is therefore unconstitutional pursuant to the Supremacy Clause of the United States Constitution, Article VI, Clause 2.

The permanent injunction was granted by the Court. While the Nevada Attorney General can appeal (the office has another 20 days or so to do so), it’s not likely; the law is clearly unconstitutional on its face.

There are two points I want to make. First, I didn’t write about this earlier because this law was so stupid it was clear to me that it was going to be found unconstitutional. Even before the temporary injunction was granted the Nevada Secretary of State’s office didn’t enforce the law as it pertained to Enrolled Agents.

The second point is how this law was enacted. The state legislature didn’t contact any tax professionals about the law. There apparently is a problem with some document preparer services, and the Assemblyman who wrote AB 324 made an assumption that Enrolled Agents were part of the problem. We’re actually part of the solution in that we help resolve taxpayer problems, but I digress. I’m a member of the National Association of Enrolled Agents and NVSEA to help with legislative policies vis-a-vis Enrolled Agents. While I don’t agree with all of what the NAEA would like to pass, I agree with most of it. And my dues and contributions to NVSEA helped fight an uninformed law.

No matter your profession, stay informed. Talk to your local legislators. Generally, state legislators are approachable and most want to be informed. I’m making a point of meeting mine later this year, and explaining what Nevada Enrolled Agents do, what we had to do, and why we did what we did. Unfortunately, we remain the Lichtenstein of the tax world.

We’re Not Gonna Take It

Thursday, August 23rd, 2018

The IRS issued proposed regulations today on charitable contributions as it relates to state and local tax credits. Here’s a hint to politicians in Connecticut, New Jersey, and New York. The IRS is telling you:

Here’s an excerpt from the IRS press release:

The proposed regulations issued today are designed to clarify the relationship between state and local tax credits and the federal tax rules for charitable contribution deductions. The proposed regulations are available in the Federal Register.

Under the proposed regulations, a taxpayer who makes payments or transfers property to an entity eligible to receive tax deductible contributions must reduce their charitable deduction by the amount of any state or local tax credit the taxpayer receives or expects to receive.

For example, if a state grants a 70 percent state tax credit and the taxpayer pays $1,000 to an eligible entity, the taxpayer receives a $700 state tax credit. The taxpayer must reduce the $1,000 contribution by the $700 state tax credit, leaving an allowable contribution deduction of $300 on the taxpayer’s federal income tax return. The proposed regulations also apply to payments made by trusts or decedents’ estates in determining the amount of their contribution deduction.

There’s a de minimis exception for tax credits of no more than 15% of the payment amount.

This proposed regulation isn’t a surprise. Indeed, it’s hard to see under the Tax Code how tax credits as charitable contributions would succeed. As for the current lawsuit against the IRS regarding the new tax law, that has even less of a chance of success in my view. But it sounds good, so the lawsuit happened. The idea of a state like New York changing their tax laws to lower their tax rates apparently hasn’t occurred to New York politicians.

We’re Not Gonna Take It…

Saturday, July 21st, 2018

You may have heard that earlier this week four states sued to stop parts of the new tax law from going into effect. The states–New York, New Jersey, Connecticut, and Maryland–don’t like the new $10,000 cap on deducting state and local taxes on federal tax returns. I believe this lawsuit is doomed; there’s no right in the Constitution to allow deducting of such taxes. This isn’t just my opinion; Ilya Somin at the Volokh Conspiracy notes what I think:

They argue not only that the 2017 cap is unconstitutional, but that the federal government has a general obligation to exempt “all or a significant portion of state and local taxes” from the federal income tax. The problem with this argument is simple: nothing in the text or original meaning of the Constitution supports it. To the contrary, the Sixteenth Amendment gives Congress a general power to power “to lay and collect taxes on incomes, from whatever source derived.” There is no mandated exemption for income used to pay state or local taxes. There is also no support for the states’ position in Supreme Court precedent, or in the American constitutional tradition more generally.

The humorous thing (to me) is that blue states normally lead in ‘progressiveness’ of their tax systems (that is, higher rates for individuals earning higher incomes). The cap on deductions will primarily hurt high income individuals. Of course, blue states don’t want out-migration of such high income individuals. Perhaps they might look to lower tax rates. Mr. Somin notes they could remove zoning restrictions. As for this lawsuit, it sounds nice to their constituents but it is almost certainly doomed.

Wayfair and Economic Nexus

Sunday, June 24th, 2018

Last week the Supreme Court ruled in South Dakota v. Wayfair that South Dakota’s law forcing Wayfair, an Internet retailer, to collect (and remit) sales tax to South Dakota (a state that it did not have physical nexus to) was valid. The decision overrides a previous Supreme Court decision called Quill Corp. v. North Dakota). There’s been plenty of excellent coverage on this ruling (see, for example, the Tax Foundation and Kelly Erb). But I’m wondering what this means for income tax and economic nexus.

A few states have passed laws stating that if you have economic nexus to a state you need to file a tax return to that state. California is one such state. Eventually, cases on economic nexus will go through the court system (and with a certainty the US Supreme Court will have the final say). While no one knows how the Court will rule on such cases, there are indications.

From a case called Complete Auto: “The Court will sustain a tax so long as it (1) applies to an activity with a substantial nexus with the taxing State, (2) is fairly apportioned, (3) does not discriminate against interstate commerce, and (4) is fairly related to the services the State provides.” In Wayfair, the Court ruled that “Physical presence is not necessary to create a substantial nexus.”

The key point is noted by Justice Kennedy:

The Court has consistently explained that the Commerce Clause was designed to prevent States from engaging in economic discrimination so they would not divide into isolated, separable units. See Philadelphia v. New Jersey, 437 U. S. 617, 623 (1978). But it is “not the purpose of the [C]ommerce [C]lause to relieve those engaged in interstate commerce from their just share of state tax burden.” Complete Auto, supra, at 288 (internal quotation marks omitted). And it is certainly not the purpose of the Commerce Clause to permit the Judiciary to create market distortions. “If the Commerce Clause was intended to put businesses on an even playing field, the [physical presence] rule is hardly a way to achieve that goal.” Quill, supra, at 329 (opinion of White, J.).

So four questions need to be answered for whether a state can tax a service business conducting no services within that state. Let’s assume there’s a tax preparation business in Nevada that has customers in New York, and New York passes a law saying that if you have any sales to New York residents you must pay New York state income tax and register your business in New York. The questions that must be answered are: Is their substantial nexus to New York, is the tax fairly apportioned, does it discriminate against interstate commerce, and is the tax fairly related to the services that New York provides. We’ll assume the tax is fairly apportioned.

Consider a Nevada tax professional who has one client in New York out of one thousand total clients. Is there substantial nexus? Almost certainly not, and it would be hard to see such a tax passing muster. Thus, some sort of de minimis rule is necessary. Note that in the instant case that the South Dakota law has such a rule.

Consider now a Nevada tax professional who has 200 clients in New York out his one thousand clients. We’ll assume that passes the de minimis hurdle. The two other questions (and I think they’re linked) come into play: Is the tax fairly related to services that New York provides and does it discriminate against interstate commerce?

The first of these questions has two sides. All of the work done here (remember, this is a service business) is being done in Nevada, not New York. That leads to a conclusion that New York income tax is not related to services provided by New York. (However, if New York had a sales tax on services the business would likely need to comply.) On the other hand, the person contracting for the services is a New York resident.

I think the first argument is the better one. The income being earned is based off of work done in Nevada, not New York. Nevada, not New York, has the right to tax its residents on income earned in the state. Because of this, I think that if New York were to tax such income it would discriminate against interstate commerce. (There is an other side to this argument, though. New York can argue that there would be a tax credit available, and that would eliminate the issue. Still, the filing of the return adds to the burden of the Nevada taxpayer, and is an issue.)

That there are two sides to this argument shows that there is no one right answer. In the end, the Courts will end up making the decision about economic nexus and income tax. Indeed, sometime around 2021 I expect a Supreme Court decision on this issue.

Back to the Old Drawing Board

Wednesday, May 23rd, 2018

I’ve written before about certain states’ efforts to get around the new $10,000 cap on state and local taxes that can be deducted on federal tax returns. The IRS announced today they will be proposing regulations later this year on this issue. Here’s an excerpt:

In response to this new limitation, some state legislatures are considering or have adopted legislative proposals that would allow taxpayers to make transfers to funds controlled by state or local governments, or other transferees specified by the state, in exchange for credits against the state or local taxes that the taxpayer is required to pay. The aim of these proposals is to allow taxpayers to characterize such transfers as fully deductible charitable contributions for federal income tax purposes, while using the same transfers to satisfy state or local tax liabilities.

Despite these state efforts to circumvent the new statutory limitation on state and local tax deductions, taxpayers should be mindful that federal law controls the proper characterization of payments for federal income tax purposes.

This is anything but promising for the efforts of California and New York. Words like “circumvent,” “despite,” and “mindful” pretty much tell us how this is going to turn out. If the IRS were going to allow this, the notice would not have such negative words. Instead, it’s all but a certainty that the doctrine of “Substance Over Form” will dictate that these so-called charitable donations are anything but charitable donations and, instead, will be treated as state tax payments on federal tax returns.

The California and New York legislatures would be far better off looking for things to cut in their states’ budgets. I know of a certain railroad in California that could save the state at least $77 billion….

Taxes Matter (2018 Version), Part 1

Thursday, May 3rd, 2018

Those on the left constantly chirp that taxes don’t matter. Those of us who prepare tax returns can state as fact you’re wrong. I moved my business because of taxes and regulations. Here are two other examples from today that illustrate this.

First, the city of Seattle is proposing a new tax on businesses with $20 million in gross receipts (or more): an employee tax of $0.26/employee-hour. Shockingly, Seattle’s largest employer, Amazon.com, has stopped planning on a new 17-story office tower in downtown Seattle. Are the two related? Drew Herdener, an Amazon Vice President told FoxBusiness,

I can confirm that pending the outcome of the head tax vote by City Council, Amazon has paused all construction planning on our Block 18 project in downtown Seattle and is evaluating options to sub-lease all space in our recently leased Rainer Square building.

From the Wall Street Journal comes a headline, “My Clients Are Fleeing NJ Like It’s on Fire.” An excerpt:

That headline arrives via email from a money manager in northern New Jersey. The Garden State already has the third largest overall tax burden and the country’s highest property tax collections per capita. Now that federal reform has limited the deduction for state and local taxes, the price of government is surging again among high-income earners in New Jersey and other blue states. Taxpayers are searching for the exits.

Read the whole thing (note: Pay Link).

For those who say taxes don’t matter, you’re wrong. From small businesses to large taxes absolutely matter.