Taxes and the Olympics

On March 1, the Commission on the State of U.S. Olympics & Paralympics issued a report: Passing the Torch - Modernizing Olympic, Paralympic, & Grassroots Sports in America. Per the announcement, this commission was directed by Congress to study recent reforms of the U.S. Olympic and Paralympic Committee to improve the organization's "ability to fulfill its mission."

The word "tax" appears 39 times in the report. Tax law changes suggested:

Page 17 - allow taxpayers to deduct the costs for their children to participate in youth sports.

Page 18 - allow taxpayers serving as volunteer coaches for youth sports to deduct out-of-pocket expenses.

Page 18 - to help support youth and grassroots sports, consider new revenue sources such as from an excise tax on legal sports betting and a voluntary checkbox on income tax forms for donations

The report notes the 2016 tax law change to add an exclusion from income for the value of the metal in gold and silver prize medals and bonuses winners receive (unless the taxpayer has AGI determined with the value of Olympic winnings above $1 million - IRC §74(d))

Well, that all sounds good - doesn't it?  But do these proposals meet any of the principles of good tax policy?  I don't think so.  Let's look at a few key principles regarding the deduction proposals.

Equity and fairness: For vertical equity, the deduction for children participating in sports will provide greater tax savings to higher income individuals because they are in a higher tax bracket and are likely to spend more on participation. Some leagues can cost thousands of dollars to join and often there are travel expenses too. If such a proposal were enacted, I suspect it would be an itemized deduction so would not help the majority of taxpayers and likely would have some type of cap.

If there is any money for new deductions, perhaps using that money to instead help fund sports programs at public K-12 schools would be a better way to go.

Convenience of Payment: For families who would most benefit from some assistance to enable their child to participate in local youth sports program, the deduction won't be enough and it won't provide any funds when it is time to sign up and get a uniform and equipment.

Simplicity: Any exception or special rule requires details on what qualifies and what does not. This is where complexity comes into play (see my post of 3/24/24). Principles of good tax policy are best met with a broad tax base and lower rates.

Neutrality: And why only subsidize youth sports via a tax deduction? Why not art and music, visiting museums, etc.? Also, some youth leagues, particularly the high fee ones, would likely increase fees because of the tax break to the payor. More parents might volunteer to coach (which is a good thing, but does violate the principle of neutrality if the tax deduction causes the behavior change). Volunteer coaches give up a lot of their time and some might even reduce work hours to coach - this really can't be compensated via the tax system (and isn't in the proposal) and I suspect most of the dedicated parent coaches don't expect to be compensated via the tax system. 

Minimum Tax Gap: Unfortunately, the deduction likely would be abused. Some individuals would deduct something even if their child did not participate or if they do, would add in some costs not directly related to the sports activity (perhaps more clothes or activities disguised as training). Similarly, some individuals might view themselves as coaches and deduct costs. 

What do you think?

Challenges of Tax Exemptions

One of several features that make tax systems complicated are the numerous exceptions that pull out from taxation something that is part of the tax base for a particular type of tax. It is probably almost impossible to find any federal, state or local tax that doesn't have some type of exception. A list of sales tax exemptions produced by the California Department of Tax and Fee Administration (CDTFA) lists 171 sales tax exemptions. All of them need a definition in the statute and often an explanation from the tax agency. This creates a lot of complexity because it is difficult to define most exemptions. For example, if a state wants to exempt food from sales tax but only healthy food, where does a "protein bar" full of sugar and not a natural item fall?

Our federal income tax law has Code sections 101 through 139I listing items of income, such as certain disaster relief payments, fringe benefits and gifts, that are income, but excluded from the measure of taxable income.

A 2023 ruling in Iowa caught my attention as an example of the complexities of defining exemptions (Sweat Iowa LLC, No. 346007, 11/14/23). Iowa imposes a 6% sales tax on "enumerated services" which includes "all commercial recreation." The term "enumerated services" signals that all potentially taxable services are not subject to sales tax. Generally, because a sales tax is imposed on personal consumption, everything that an individual purchases that is not for business use, should be subject to sales tax. If the law in any state worked that way, the rate would be lower and the tax base broader (and mostly easier to define).

For a sales tax (a tax on personal consumption), the only items that should be exempted medical services provided by a medical professional and tuition for a university or professional/job training.

In the Iowa ruling, the question was whether booking services for saunas with "science-backed technology of infrared (IR) and red light therapy(RLT) to optimize health and wellness" is "commercial recreation."

In the ruling, the Iowa Dept. of Revenue had to review the Code that defines "recreation" and then Black's Law Dictionary on the definition of "pleasure"! Because there was pleasure and promotion of physical fitness involved, the DOR found the sauna service to be taxable. It also noted that even if not recreation, it would fall under the taxable services of Turkish baths and reducing salons.

If the law instead stated that all personal consumption was taxable and only had very few exemptions, it would be a lot simpler for everyone and the rate could be lower.

And there are other reasons for a broader base, not only for sales tax, but often other taxes as well. Often the items that are left out of the base are ones where higher income individuals spend more money so they get the greater savings. This includes food which most states exempt (higher income individuals spend more on food that lower income individuals), entertainment, household services, and even a personal trainer.

A final note, of the 171 sales tax exemptions the CDTFA pub noted earlier, several only apply to businesses so should not even be part of the sales tax base and some major exemptions such as personal services and digital goods are not in the 171 because they are not part of California antiquated sales tax base of tangible personal property (been that way since 1932!).

What do you think?

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!

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

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?

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

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?