Tax Court Judicial Conference Application Deadline Extended to This Friday

Readers may have heard that the Tax Court is holding a judicial conference from Monday evening March 26 to mid-day on Wednesday, March 28, 2018 at Northwestern University Law School. The Tax Court has issued a release about the conference, including information about how to apply to attend.

The Tax Court has extended the deadline to apply, from Wednesday until Friday, November 17.

The Tax Court release discusses the court’s interest in attracting a diverse conference community. The conference will be an opportunity to hear panels on issues of interest to tax litigation as well as give the court a chance to get feedback on ways to improve the tax litigation process. The panels consist of judges, academics, and practitioners from government and the private sector.

Getting together with people who share an interest in the tax litigation process sounds like a great way to spend a few days.

ABA Tax Section Seeking Nominations For Janet Spragens Pro Bono Award

The ABA Tax Section is accepting nominations for its annual award given to an individual or law firm for sustained and outstanding achievements in pro bono activities in the tax law. Nominations will be accepted until December 8th. Information about the straightforward submission process and a listing of the criteria for both firms and individuals can be found here.

The award is named after the late Professor Janet Spragens, who was a pioneer in the tax clinic movement and a mentor to me when I started teaching and directing a tax clinic over 20 years ago.

For those of you who did not have the pleasure of knowing Janet, a wonderful tribute to her from Nancy Abramowitz, her longtime colleague at American University, can be found here. One of my professional highlights was accepting the award on Janet’s behalf when I was able to share with the Tax Section my thoughts on Janet.

I know Janet would be pleased with the work that so many are doing to make the tax system fairer and more accessible.

 

House Republicans Introduce Major Tax Reform Legislation

House House Ways and Means Committee Chairman Kevin Brady (R-TX) introduced the Tax Cuts and Jobs Act, self-described as “bold legislation to overhaul America’s tax code for the first time in 31 years.”

Text of the bill is here; the press release is here.

There is not much in the legislation with a procedural or tax administration focus (with the exception of expanding IRS math error power when there is no SS# accompanying a CTC claim), though the scope of the changes for both individual and business taxpayers portends a major impact on tax administration.

For a summary in table form, see the Tax Foundation twitter post here 

Some of the highlights on the individual side: eliminating the deduction for tax prep advice, alimony and personal casualty losses, and medical expenses. In addition it cuts back the mortgage interest deduction cap (tying it only to principal residence and halving the cap on the deduction), Section 121 exclusion on gain from principal residences (requiring a 5 out of 8 yr use/ownership rather than current 2 out of 5 years) and allows state and local property tax deductions but only up to $10,000.  In addition it boosts the standard deduction and eliminates the dependency exemption deduction (though the definition is still retained for credit purposes).

The Child Tax Credit is increased to $1,600; most of the increase is nonrefundable and the income phase out is also increased so it has little impact on moderate and low income workers, though the $1,000 refundable portion of the CTC is indexed to inflation.

On the pass through income side, an issue we previously discussed, the bill limits the top rate on pass through income to 25%; it has what appears to be a complex anti-abuse provision that is summarized by the Tax Foundation in its review  as follows:

Begins with assumption that 70 percent of income derived from a business is compensation subject to ordinary rates and 30 percent is business income subject to the maximum 25 percent rate for active owners. Businesses can “prove out” of the 70/30 split based on demonstrated return on business capital at the short-term applicable federal rate (AFR) plus 7 percent. Certain specified service industries, like health, law, financial services, professional services, and the performing arts are excluded from the 70/30 split and can only claim the benefit of the lower pass-through rate to the extent that they can “prove out” their business income.

Professor Batchelder on Twitter flags this “prove out” as “the heart of the pass-through loophole for the wealthy” and “great for gaming” and a provision that tax lawyers will “love.”

 

 

Federal Bar Association Tax Section Writing Competition

Last month PT celebrated its 1,000th post and its 2,000th comment. One aspect of the success of the site is that we are occasionally asked to post an announcement because of the number of readers who look at PT. Today, we are happy to comply with a request from the Federal Bar Association Tax Section to publicize its writing competition.

The website for the competition is here. The rules for the competition can be found here and a flyer about the competition can be found here. Effective writing skills will serve any budding tax attorney well. This is a great competition and winning would provide quite an honor (in addition to cash and a trip to D.C.)

We encourage eligible students to write on tax procedures issues and suggest that they can find many good topics from the posts on this blog.

Tax Reform: Some Thoughts on Simplification and Passthrough Income

This past week saw the release of the outline of the next big push for tax reform. Titled a “Unified Framework For Fixing Our Broken Tax Code” the Trump Administration and the majority in the Senate Finance and House Ways and Means Committees discuss in 9 pages basic principles and  major changes, including corporate and individual rate reductions, a new top rate for some passthrough entities lower than the top individual rate, an expansion of the standard deduction, elimination of many personal deductions, and a shift to a territorial system of taxation.

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We try to stay in our lane of tax procedure and tax administration on this blog. I will state the obvious and note that tax reform is a heavy lift, and there is likely to be some serious legislative give and take over the next few months.

Just this past week the National Taxpayer Advocate blogged on her vision of tax reform, in Tax Reform: Hope Springs Eternal This Fall. The NTA, while noting many policy goals around tax reform, picks one issue for emphasis: the need for simplification. Stating that if she had to sum up everything she has learned in her tenure as NTA, it is that the “root of all evil in the tax system is the complexity of the Internal Revenue Code.”  To that end, the NTA discusses sources and effects of complexity and offers a number of suggestions that she has discussed in past reports as a way to meaningfully simplify the Code. Those include streamlining the Code’s myriad savings and education incentives and consolidating civil penalties and family status provisions. As someone who has thought about tax reform for a long time, the NTA makes sensible substantive suggestions that I hope Congress considers as it moves forward.

There have been many articles discussing complexity in the tax system: they often define differing levels of complexity; some suggest that simplification in a meaningful sense is often diametrically opposed to other goals we also care deeply about, like equity (itself a loaded term) and the need for certainty. (For a good example see a 2013 article in the Wyoming Law Review by Jeffrey Partlow). It is easy to see how other goals soon run smack into and conflict with the shared stated goal of simplifying the tax code.

Consider one of the Framework’s proposals: a lowering of the top rate on small and family owned business income from passthroughs to 25%, a rate lower than the top individual rate. Now it does not take a law professor to consider the possibility for mischief from such a proposal: people with labor income will be incentivized to funnel their work into a small business passthrough format to try to game the rate differential. We already see that to an extent in existing law (for much less at stake), as individuals use S Corp structures to try to avoid paying employment taxes on what might otherwise be compensation income.

The proposal addresses that mischief by noting that the framework “contemplates that the committees will adopt measures to prevent the recharacterization of personal income into business income to prevent wealthy individuals from avoiding the top personal tax rate.”

I have not deeply thought through the ways that legislation could achieve that anti-abuse goal, but I suspect that any measure will require greater IRS attention to this structure (already we have discussed in PT the heavy resource lift of IRS  trying to determine on audit whether S Corps are paying shareholders a reasonable compensation). The Center on Budget and Policy Priorities in a report that predates the current proposal discusses some of these challenges, including discussing how some estimate that over 30% of the cost of this change would come from high earners trying to shift income into this structure to game the system and the challenges IRS would likely face in trying to stem the abuse[Ed: note that the CBPP discussion looks at an earlier proposal with an even lower passthrough rate].

Conclusion

It is far too early in the tax reform season to know where things will land. I note that the Trump Administration’s “first principle” of tax reform is to “make the tax code simple, fair and easy to understand.” The passthrough proposal suggests the potential for significant administrative complexity. As IRS struggles with resources (like we learned this week as IRS has confirmed that it has suspended its ASFR program, at least temporarily), Congress should explicitly consider whether it will give the IRS the resources it needs to police a program that at first blush is one that is susceptible to abuse.

 

 

ABA Tax Section Fall Meeting in Austin

Stephen and I are attending the fall ABA Tax Section meeting in Austin. There are panels about important procedural and administrative issues, including the new partnership audit regime (timely as my colleague Marilyn Ames and I are finishing up a chapter on that for the Saltzman/Book treatise), the many changes in Appeals Office procedures, how to navigate cases before the Office of Professional Responsibility, best practices in reading and drafting the various types of tax guidance, and the possible changes arising due to the tax aspects of healthcare reform.

This morning Stephen will be on a panel I am moderating  discussing Section 7434 and the private cause of action that it allows for fraudulently issued information returns. Joining him on the panel is Mandi Matlock, who splits her time between Mondrick & Associates and Texas Rio Grande Legal Aid (and who contributes to the Effectively Representing book and has also blogged for us). There are many interesting issues relating to Section 7434, including whether the statute supports a claim for improperly issued information returns arising in employee misclassification cases, whether a person who did not have a legal obligation to file the information return is potentially liable and how the courts have approached damages in the handful of cases that plaintiffs have won.

 

Review of the Combined Annual Wage Reporting Program

In a recent report, the Treasury Inspector General for Tax Administration (TIGTA) found that the IRS was not using the Combined Annual Wage Reporting (CAWR) Program to the best advantage.  I will talk about the report in some detail but I took from the report that the investigation into CAWR provides a good example of what happens when you grossly underfund the IRS.  Undoubtedly, finding other examples of this would prove easy.  The CAWR program provides a valuable and relatively easy way to reconcile wage reporting and find discrepancies.  If the IRS cannot do anything with the findings, the situation needs correction.

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Employers must report wage and withholding information to both the Social Security Administration and the IRS.  The reported information should reconcile; however, the IRS and SSA learned long ago that it did not and established a program to look into the cases in which it did not.  SSA wants to ensure that employees receive proper credit for working and for covered earnings since the earnings have a direct impact on Social Security benefits based off each person’s highest 35 years of earnings.  Employer mistakes could rob a worker of benefits or keep a worker from receiving the correct amount of benefits if the data reported to SSA does not properly report the worker’s earnings.  Similarly, the IRS wants to make sure that employers report the proper amount of taxes and tax withholding.  The program matches the information reported to the IRS on Forms 1099-R and W-2G (Certain Gambling Winnings) with the Forms W-3, W-2, W-3c (Transmittal of Corrected Wage and Tax Statements), and W-2c (Transmittal of Corrected Wage and Tax Statements) transmitted to SSA.

The CAWR program looks for discrepancies in the reporting information that exceed certain limits – the idea is that the IRS would take action to correct the situation which could result in substantial assessments against the employer whose data does not match.  The program also identifies employers who fail to file employment tax returns with the IRS.  That failure, of course, could result in substantial liabilities and should cause swift action by revenue officers assigned to those accounts.

Looking at the 2013 data (and keeping in mind that CAWRs generally runs a couple of years behind), TIGTA found that the IRS only worked 17% of the discrepancy cases identified.  It estimated that the potential amount of tax underreported was $7 billion and that it would take about 55 IRS employees to work these cases.  It estimated that these 55 employees would cost the government about $2.7 million (with an M not a B).  How many of us would like the opportunity to invest $2.7 million to obtain a return of $7 billion.  I seriously doubt the IRS could collect all of the $7 billion even if it could assess that amount and I also doubt if the 55 employee number considers all of the downstream work that might need to occur in collection and other parts of the IRS to fully recover this amount, but it still seems like an eye popping return on investment opportunity.  While the IRS response gave other reasons for not addressing some of the cases or not prioritizing them as TIGTA might, the IRS pointed to limited resources as a major reason for not going after cases it identified as having discrepancies.

Interestingly, on the SSA side a lawsuit settled in 1990  causes the government to work all of the SSA cases and the IRS can only spend whatever limited resources it has left in working the IRS discrepancy cases.  I suppose that should make those of us hoping for social security benefits feel good, but it also leaves me wonder if someone should bring a lawsuit on behalf of taxpayers to get the same deal for the tax cases.  Here is an example of the government spending the resources necessary to ensure that the benefits side makes out but not spending the resources to ensure that the money is captured that will enable it to pay out the benefits without printing more money.

The report contains detailed statistics for anyone wanting to delve deeper into this topic and one chart shows the types of cases identified.  As with many TIGTA reports, it provides an interesting glimpse into the inner workings of the IRS.  In this case, a discouraging one as well.

 

Summer Reading: Tax Compliance And Small Business Taxpayers

The Wall Street Journal ran an interesting article last week, Number of Americans Caught Underpaying Some Taxes Surges 40% [$]. The main point in the story is that with the increase in the gig economy many more Americans are left on their own to pay estimated taxes. Many are not complying. The WSJ reported that from 2010 to 2015 there was an increase of about 40% in the number of people penalized for underpaying estimated taxes.

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It is easy to understand why. Without the benefit of withholding that comes with traditional paychecks and in many cases also without information reporting that can remind people that Uncle Sam is looking, there are many challenges to staying on the right side of the tax law.

A report last year from the American University Kogod Tax Policy Center called Shortchanged: Tax Compliance Challenges of Small Business Operators Driving the On-Demand Platform Economy gives the issue a deep dive.

The Kogod Report is terrific. It is well researched. It provides background on the rapid growth of this segment of the economy, with companies like Uber, Airbnb, Etsy and many others pushing Americans into the uneasy tax perch of small business owners. One of the main points in the study is that the tax code is a 20th century code poorly matched with the 21st century economy. Add to the mix a 20th century mode of tax administration and many Americans are ill-equipped to keep records and understand how the law applies to their situation. This all leads to a major tax administration headache.

What I found most interesting in the report is the survey it conducted of about 50 small business owners. While the survey is not meant to be a statistically reliable sample (and in fact may reflect a greater sophistication as all responders were in the National Association of Self Employed) it did provides some insight into many challenges this group faces:

At best, these small business owners are shortchanged when filing their taxes; at worst, they fail to file altogether. Approximately one- third of our on-demand platform operator survey respondents didn’t know whether they were required to pay quarterly-estimated payments and almost half were unaware of any available deductions, expenses or credits they could claim to offset their tax liability. These taxpayers face potential audit and penalty exposure for failure to comply with filing rules that are triggered by relatively low amounts of earned income. Compounding this problem is inconsistent reporting rule adoption that results in widespread confusion among taxpayers

I tip my cap to one of the headings in the report (They Got 1099 Problems and Withholding Ain’t One). The Report and the WSJ article tell of one of the main shortfalls in the US tax reporting system for platform players. Essentially reporting is only required if payments are made via credit card or debit card, and the aggregate number of transactions to one service provider exceeds 200 and the payments exceed $20,000. Absent exceeding both requirements then companies that process credit card payments on behalf of individuals in the gig economy are not required to issue a 1099. Of course, the absence of a 1099 does not mean that the service provider does not have to report income but the absence of reporting leads to either mistakes or intentional non reporting.

Some of the platform players in the economy, like Uber, issue a 1099 even if the service provider does not meet both the 200/20K tests (an earlier WSJ article talks about this; see The Blind Spot in a Sharing Economy: Tax Collection $).

As the report discusses, employment and income tax liabilities, with penalties, can snowball. Not surprisingly, the National Taxpayer Advocate has been on this issue; for example, her testimony last year before the House Committee on Small Business touches on these issues, and lots more, including employee classification issues. She also adds a number of proposals to increase compliance, including changing estimated tax and backup withholding rules for taxpayers with poor compliance history and an increase in IRS education efforts to get people on the right path.

Tax administrators, scholars and legislators have taken note. IRS has put up the Sharing Economy Tax Center on its web page, and there are legislative proposals to change the 200/20,000 rule to trigger mandatory reporting at lower thresholds. UC Hastings Law Professor Professor Manoj Viswanathan has a new article called Tax Compliance in a Decentralizing Economy that addresses some of these issues (I have not yet read though am looking forward to it). Our blogging colleague BC Law Prof Diane Ring at Surly Subgroup also discusses the sharing economy in a post today highlighting worker classification issues. With her BC colleague Shu-Yi Oei Diane co-authored Can Sharing Be Taxed, an article that was in Wash U Law Review last year that also looked at the sharing economy, including reviewing some of the compliance problems implicated in today’s post.

As the Kogod Center reports, it is likely that this part of the economy will grow rapidly in the next few years so one can expect a great deal more attention on the issue.