IRS Tax News – Taxpayers will file QBI deduction computation with IRS next year
The IRS posted a draft of a form that affected taxpayers will submit with their 2019 tax returns showing how they computed their qualified business income (QBI) deduction under Sec. 199A.
Source: IRS Tax News – Taxpayers will file QBI deduction computation with IRS next year
IRS Tax News – Taxpayers will file QBI deduction computation with IRS next year
Tax Policy – Governor Cuomo’s Aggressive Theory of Tax Flight—And Why He’s Wrong About How to Stop It
In New York, Governor Andrew Cuomo (D) is staring down a $2.3 billion shortfall, and he thinks he’s identified the culprit: the state and local tax (SALT) deduction cap. It’s a politically convenient scapegoat, but it misses the point—and more importantly, it misses an opportunity to improve the state’s uncompetitive tax code.
Once a skeptic on tax migration, the idea that people or businesses would move in response to high state tax burdens, Gov. Cuomo has emerged as one of the idea’s most fervent evangelists. “Tax the rich, tax the rich, tax the rich and now what do you? The rich leave,” the governor declared, in the sort of lament not typically associated with Democratic governors of progressive states. Absent a generous federal subsidy for the state’s high taxes, he says, New York is at a “long-term competitive disadvantage” on tax burdens.
Prior to the enactment of the Tax Cuts and Jobs Act of 2017, taxpayers who itemized (about 30 percent of all taxpayers at the time) were able to take an uncapped deduction for their state and local tax payments. Although this benefit was limited or even eliminated for some taxpayers by the Pease limitation and the alternative minimum tax, it represented a particularly attractive benefit to residents of high-tax states and localities, as a significant portion of their state and local tax burden was subsidized by other taxpayers across the country.
That deduction is now capped at $10,000, a change that Gov. Cuomo likens to an “economic civil war” that “literally restructured the economy to help red states at the cost of blue states” in a “diabolical, political maneuver.” In reality, the dividing line cuts much closer to home: the majority of taxpayers in New York itself do not itemize, and non-itemizers tend to have significantly lower income than itemizers. These taxpayers—along with others across the country—are subsidizing the tax burdens of higher earners.
Let’s put a number on that. Imagine two taxpayers living in New York City, one with $50,000 in taxable income and the other $500,000, under the old law (uncapped SALT deduction and a federal top marginal rate of 39.6 percent). For every additional dollar our $50,000 filer earns, she faces a 6.33 percent state marginal rate and a 3.876 percent city marginal rate, for a combined rate of about 10.21 percent. For every additional dollar our $500,000 filer makes, she faces the state’s top marginal rate of 8.82 percent plus the city’s top 3.876 percent rate, for a combined rate of about 12.7 percent.
But wait! Our high earner is an itemizer and gets the benefit of the SALT deduction. (We’ll assume she isn’t subject to the AMT. Some in her income range would be, but not all—and the higher her income, the less likely the AMT is to apply.) She’s getting a reduction of 39.6 cents in her federal tax liability for every additional dollar she owes New York. Functionally, her marginal rate isn’t 12.7 percent, it’s 7.67 percent. That’s way lower than what far less well-off New Yorkers are paying.
That diabolical political maneuver of which Cuomo speaks? It’s no longer making that lower-income New Yorker (or resident of another state) subsidize some of the nation’s top earners. You’d think that would be something a progressive governor would favor.
Of course, we know why Gov. Cuomo and others oppose the SALT deduction cap, even if ideologically they ought to favor it: as Cuomo is quite willing to admit, he’s afraid of tax flight. He’s concerned that wealthy, highly mobile residents aren’t actually willing to face a combined top marginal rate of 12.7 percent, on top of their high property taxes and high cost of living. Yet instead of doing something about it in the statehouse, the governor is doubling down on policies that would actually increase tax burdens for individuals and businesses alike.
In other words, Gov. Cuomo is suddenly highly attuned to the downside of high, uncompetitive taxes, but instead of finding ways to make New York more competitive, he wants an even more aggressive tax regime that makes it harder to do business in the state. His only solution is to call for the federal government to subsidize New York’s high earners again, to soften the blow of the state’s uncompetitive tax code.
Tax flight cannot explain a $2.3 billion budget shortfall. The bottom line is that New York’s estimate was off, while other states, like Connecticut, hit or even exceeded targets with similar demographics and national impacts. Stock market volatility in 2018 undoubtedly led many of New York’s high earners—to say nothing of its professional investor class—to take capital losses at the end of the year, reducing overall collections. Because New York is home to so many high earners, who tend to generate more income from investment, the state is unusually sensitive to stock market fluctuations. If the state underestimated how many high earners would take investment losses in 2018, that could produce a sizable forecasting error.
That said, tax migration is part of it. A few years ago, progressive governors insisted that tax flight was not a real phenomenon. Now, with less of a federal subsidy to ease the burden of their own uncompetitive tax regimes, some regard it as a crisis. The reality has always been somewhere in between, but there can be little doubt that New York’s high taxes are influencing domiciliary choices.
Here, in a nutshell, is the entire theory of tax migration, articulated by Gov. Cuomo: “People are mobile. They will go to a better tax environment. That is not a hypothesis. That is a fact.”
The solution to that problem is a local one. It involves New York getting its own house in order. There’s something particularly ironic about Gov. Cuomo’s preferred solution, which would provide a $670 billion tax cut (over a ten-year budget window) that flows almost exclusively to the top 5 percent of earners—most of whom already received a tax cut under the Tax Cuts and Jobs Act due to lower rates, a higher AMT threshold, and the repeal of the Pease limitation, among other reforms.
Ultimately, the governor is blaming everything but the real culprit: New York’s own tax code. The governor is to be commended for corporate tax reforms undertaken in 2014, but overall, New York still imposes high and poorly-structured taxes, ranking 49th on overall tax structure in our State Business Tax Climate Index. Capping the SALT deduction righted a longstanding wrong in the federal tax code. Instead of railing against a change that increased tax equity, it might be time for New York policymakers to look inward.
Tax Policy – Virginia on the Verge of Approving Its First Local Option Sales Tax
Virginia is on the verge of creating local option sales tax authority for precisely one jurisdiction, and it’s been flying completely under the radar. Halifax County, population 35,000, is about to upend Virginia’s sales tax system and potentially open the door to local option sales taxes across the Commonwealth.
There are already local sales taxes of a sort in Virginia. The state rate is 4.3 percent, with a mandatory 1.0 percent local add-on, administered by the state and disbursed to local governments. A further 0.7 percent is imposed in planning districts that meet certain criteria: a population of 1.5 million or more, at least 1.2 million vehicle registrations, and at least 15 million transit rides per year. That revenue is deposited into local transportation authority funds in the two planning districts which currently qualify, Northern Virginia and Hampton Roads.
A big shift came last year, when the legislature created a new 1.0 percent sales tax for the Historic Triangle, consisting of Williamsburg, James City County, and York County. It, perhaps, could be said to lay the groundwork for what Halifax County is now seeking.
The 1 percent statewide add-on, though distributed to local governments, is not meaningfully local. The 0.7 percent planning district add-on and the 1 percent levy for the Historic Triangle, while local, are not optional. And no local government currently has the authority to impose its own local option sales tax. That, however, would change under HB 1634, which passed the House 74-23 and reported from the Senate Finance Committee on a 9-4 vote with one abstention.
As introduced, the bill would give Halifax County the option of imposing a local sales tax of up to 2 percent. A Senate committee amendment reduced the maximum rate to 1 percent, a discrepancy that would have to be taken up by the House should the bill pass the Senate in that form. Whatever the final rate authorization, the bill seems to be well on its way to passage—and it’s attracted almost no notice.
The tax authority of one small county in Southside Virginia might not seem that pressing an issue, but its consequence could be considerable. If Halifax County can impose its own local sales tax, why not everyone else? (As a Dillon Rule state, localities would still have to rely on the General Assembly to grant them this authority, collectively or individually.)
The Halifax County sales tax is intended to fund the construction of a new high school, no doubt a worthy cause, but it represents a major change in tax policy in Virginia. And with a county property tax rate of 4.8 mills on fair market value, it’s not as if Halifax is maxing out its existing tax authority. By contrast, the rate in Fairfax County, a Northern Virginia jurisdiction, is 11.5 mills, and in Richmond City it’s 12 mills. In fact, Halifax County enjoys some of the lowest effective rates on real property in the Commonwealth. If this is the foot in the door for a local option sales tax, saying no to other localities won’t be easy.
Local sales taxes have their place, and this isn’t the first time they’ve been discussed in Virginia. In the past, however, they’ve generally been talked about in terms of a potential grand bargain to eliminate other, less competitive local taxes (like the BPOL, a local gross receipts tax). With HB 1634, Virginia is on the verge of embracing local option sales taxes, not as a considered alternative to other existing taxes, but as just another revenue option for which local governments can petition Richmond.
Source: Tax Policy – Virginia on the Verge of Approving Its First Local Option Sales Tax
Tax Policy – Ready to go on BEPS 2.0?
Yesterday, the Organisation for Economic Co-operation and Development (OECD) released a consultation document in connection with its continuing efforts under the Base Erosion and Profit Shifting (BEPS) project Action 1 to address the challenges of taxation in the digitalizing economy. The document provides an outline of proposals that the Inclusive Framework (IF) on BEPS (a group of 128 countries) is considering for ways to change international tax rules. This consultation document allows interested parties an opportunity to provide feedback on the policies until March 1. A public consultation on these policies will be held in Paris from March 13-14.
The policy options outlined in the document are motivated by multinational business models and their tax practices that can result in low or no tax liability due to the location of business profits in certain jurisdictions that apply either a very low or zero corporate tax rate. The options are grouped into two pillars and answer two separate policy questions.
The first pillar includes policies to allocate more taxable profits to market countries relative to what results from the current system. The policy question for pillar one is, what profits should be taxable in a market country? If a digital services company has no employees, buildings, or equipment in a country, but has lots of sales generated through marketing efforts over the internet, what profits from those sales should be taxed in the market country? Pillar 1 is mainly, then, about reallocating the tax base among countries using different metrics and methods. The consultation document describes three alternatives that the IF is considering.
- Define the tax base for reallocation by measuring user contributions, then allocate that base to market countries with an allocation metric (potentially revenues).
- Define the tax base for reallocation by assessing marketing intangibles investment, then allocate that base to market countries with an allocation metric (potentially sales or revenues).
- Reallocate the tax base among countries based on a definition of significant economic presence and multi-factor formulary apportionment including sales, assets, employees, and (potentially) users.
The second pillar is a global anti-base erosion proposal that would set a minimum effective tax rate in response to a policy concern that profits from intangible assets are often subject to no or very low rates of taxation. The proposal follows the approach of the U.S. Global Intangible Low Tax Income (GILTI) policy that was part of the U.S. tax reform of 2017. Additionally, the proposal would include a tax on base-eroding payments. Together these would set a minimum tax on income of multinationals. Though the consultation document discusses the mechanics and some ramifications of these proposals, the actual minimum rate is not mentioned.
Pillar 1 Policies
The user contribution approach follows an argument made commonly by the UK government that users of digital services contribute significant value to digital firms and that value creation should give rise to taxing rights in the country that the users are located. The specific business models targeted by this approach are social media platforms, search engines, and online marketplaces. As an example, if a digital company has 100 million users located around the world, but with taxable presence in only the country where the firm is headquartered, this proposal would envision a method of allocating a portion of that company’s profits to the countries where the users are located. This calculation would require multiple assumptions about the value created by the users, and the consultation document admits that:
It could be argued that the value created by user contribution and engagement of users does not constitute value created by the business, and instead constitutes value created by third-parties, that are more akin to suppliers than employees, and are remunerated at arm’s length through the provision of a free service.
The document also notes that the proponents of this option dispute this argument.
The approach to reallocate taxing rights based on marketing intangibles follows a theme that the U.S. Treasury has been arguing recently. Instead of impacting a defined set of business models, this approach would impact a broad range of multinational businesses. Footnote 4 of the consultation document points out that “…marketing intangibles may include, for example, trademarks, trade names, customer lists, customer relationships, and proprietary market and customer data that is used or aids in marketing and selling goods or services to customers.”
The theory behind this approach is that businesses possess brands, customer lists, and customer relationships that are either developed directly in connection with a market or are valuable because of the market. Because of this, the option proposes to allocate some taxable income of multinationals to market countries based on the value derived in the market in the form of marketing intangibles. That tax base would then be divided among countries based on some metric like sales or revenues.
A drawback to this proposal as discussed in the document is that some marketing activities occur outside of market jurisdictions and apply to all sales of a business rather than being designed for specific sales in a specific market. Identifying marketing intangibles directly associated with a market (and resolving disputes over whether an intangible is particular to that market or in general) will likely create difficulties in administering a system that follows this proposal.
Significant Economic Presence
A third approach to allocating taxable income described in the consultation document is to define taxable nexus to include “significant economic presence.” Rather than a physical presence nexus standard where taxing rights might arise due to the presence of physical assets or employees in a jurisdiction, this approach would allocate taxing rights based on a broader set of non-physical items. According to the document, metrics for establishing significant economic presence could include:
- The existence of a user base and the associated data input
- The volume of digital content derived from the jurisdiction
- Billing and collection in local currency or with a local form of payment
- The maintenance of a website in a local language
- Responsibility for the final delivery of goods to customers or the provision by the enterprise of other support services such as after-sales service or repairs and maintenance
- Sustained marketing and sales promotion activities, either online or otherwise, to attract customers
The allocation of profits to an entity with significant economic presence in a jurisdiction would be done in a formulaic manner with attention paid to the global profit rate of the company, and apportionment factors of sales, assets, employees, and (potentially) users.
Each of the Pillar 1 policies would result in a shifting of where and how much taxes are paid by a variety of multinational corporations. However, the details that are left to be worked out could significantly impact how taxing rights are ultimately allocated among countries.
The second policy pillar in the consultation document is a global anti-base erosion proposal that would effectively set a minimum effective tax on profits of multinationals. The policy document assesses the current policy environment as risking “un-coordinated, unilateral action, both to attract more tax base and to protect existing tax base, with adverse consequences for all countries, large and small, developed and developing.” This is a glancing reference not only to tax competition as countries work to improve their tax policies and attract more business investment, but also to policies like digital services taxes and other base expansion regimes that tend toward double taxation. Without specifically mentioning a particular policy, the consultation document is direct in saying, “Unilateral measures…can lead to double taxation and may even result in new forms of protectionism.”
In this context, the document describes both an income inclusion rule and a tax on base-eroding payments. This seems to follow the pairing of the U.S. policies of GILTI and Base Erosion and Anti-Abuse Tax (BEAT) which are both worldwide minimum taxes on different types of income. The income inclusion rule would allow a jurisdiction to tax a foreign subsidiary if that subsidiary’s income is subject to a low effective tax rate. The tax on base-eroding payments would separately deny deductions or treaty relief unless those payments were subject to a minimum effective tax rate.
Altogether, these two proposals would set a floor on tax rates applied to the international income of companies. What is left out of the consultation document is what the minimum rate would be.
The OECD IF has a good deal more work to do to come to a clear, detailed proposal for reallocating taxing rights and applying a minimum tax on the income of multinationals. The consultation period will allow businesses and policy groups to analyze the current proposals from a number of angles including the economic and behavioral effects. The policy options described in the consultation document will impact business decisions in a variety of ways while raising the cost of capital and potentially hurting global capital and trade flows. The Tax Foundation will continue to review this document and will be following up with more analysis of the various options.
Source: Tax Policy – Ready to go on BEPS 2.0?
Tax Policy – Capital Allowances in Europe
Although sometimes overlooked in discussions about corporate taxation, capital allowances play an important role in a country’s corporate tax base and can impact investment decisions—with far-reaching economic consequences. And as today’s map shows, the extent to which businesses can deduct their capital investments varies greatly across European countries.
Businesses determine their profits by subtracting costs (such as wages, raw materials, and equipment) from revenue. However, in most jurisdictions, capital investments are not seen as regular costs that can be subtracted from the revenue in the year of acquisition. Instead, depreciation schedules specify the life span of an asset, which determines the number of years over which an asset must be written off. By the end of the depreciation period, the business would have deducted the total initial dollar cost of the asset.
However, in most cases, these depreciation schedules do not consider the time value of money (a normal return plus inflation). For instance, assume a machine costs $1,000 and is subject to a life span of five years. A business can deduct $200 every year for five years. However, due to the time value of money, a deduction of $200 in later years is not as valuable in real terms. As a result, businesses cannot fully deduct the net present value of capital investment. This inflates taxable profits, which, in turn, increases the cost of capital investment. A higher cost of capital can lead to a decline in business investment and reductions in the productivity of capital and lower wages.
The map reflects the weighted average capital allowances of three asset types: machinery, industrial buildings, and intangibles (patents and “know-how”). Capital allowances are expressed as a percentage of the present value cost that businesses can write off over the life of an asset. The average is weighted by the capital stock’s respective share in an economy (machinery: 44 percent, industrial buildings: 41 percent, and intangibles: 15 percent). For instance, a capital allowance rate of 100 percent represents a business’s ability to fully deduct the cost of an asset (e.g., through full immediate expensing or neutral cost recovery).
Latvia (100 percent), Estonia (100 percent), and Slovakia (78.2 percent) allow for the best treatment of capital investment, while businesses in Spain (54.5 percent), the United Kingdom (57.2 percent), and Poland (59.3 percent) can write off lower shares of investment costs. Estonia and Latvia only tax distributed profits and reinvested earnings are untaxed. This allows for 100 percent of the present value of capital investment to be written off.
On average, businesses in Europe can write off 69.4 percent of the present value cost of their investments in machinery, industrial buildings, and intangibles. By asset category, the highest capital allowances are for machinery (84.2 percent), followed by intangibles (79.5 percent), and industrial buildings (49.9 percent).
The United Kingdom recently improved its place on this measure because the government has adopted a capital allowance for new nonresidential structures and buildings. Previously, UK businesses could not deduct any costs associated with buildings, and the UK weighted average for capital allowances was just 45.7 percent. This new policy would allow businesses to recover 27.9 percent of costs from investments in structures and buildings. This is reflected in the UK’s weighted average of 57.2 percent.
Apart from capital allowances, statutory corporate income tax (CIT) rates significantly determine the amount of corporate taxes businesses are required to pay. One of our previous maps provides an insight into European statutory CIT rates.
Source: Tax Policy – Capital Allowances in Europe
IRS Tax News – Bonus depreciation safe-harbor rules for vehicles issued
The IRS issued a safe-harbor procedure that taxpayers may follow for determining the deduction for depreciating passenger vehicles when they are eligible for 100% bonus depreciation but are also subject to the Sec. 280F limits on deductions for luxury automobiles.
Source: IRS Tax News – Bonus depreciation safe-harbor rules for vehicles issued