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NC EITC is not the answer

Yesterday, the Progressive Pulse published a blog encouraging the NC Legislature to restore the state Earned Income Tax Credit (EITC) instead of increasing the standard deduction. Their argument is that a NC EITC will help more working poor than increasing the standard deduction. That is correct as far as it goes. Many of the poor in NC owe little or no state income tax so increasing the standard deduction will result in no or little tax savings. On the other hand, an NC EITC would be available to many workers earning less than the standard deduction but still have some earned income.

Some background

The federal EITC was added in 1975 and expanded quite a bit in 1986. For those not old enough to recall, Gerald Ford (R) was president in 1975 and Ronald Reagan (R) was president in 1986. The EITC was expanded and changed by other presidents, most recently during Barack Obama’s terms as president in 2009, 2010, 2013, 2014 and 2015. Quite a few changes for Mr. Obama. It seems the Feds cannot leave the rules alone when it comes to the EITC.

The EITC is designed to encourage people to work by providing a credit for those earning less than a certain amount. The certain amount varies based on the number of children, if any, and marital status. The law is quite complex with many other requirements I will not get into here. The maximum credit for 2015 is $6,242 for a married couple filing a joint return with three children. That is a nice chunk of change for someone earning between $13,850 and $23,649. A married couple with that income and three qualifying children probably owes no federal income tax so they get all their federal income tax withheld back plus another $6,242. In addition, they could also receive up to $3,000 for having three qualifying children under the age of 17.

You can see why a couple with three children making under $23,650 needs other resources to cover their living expenses. Of course they do not even receive all their gross wages as they have to pay Social Security and Medicare taxes of as much as $1,809. Without the EITC, the fear is they would quit and go on welfare. In effect, the EITC is a reward for not being on welfare. Some argue that the EITC itself is a form of welfare run through the tax code. I am not here to argue that point.

NC EITC better?

So is an NC EITC better at getting money to the working poor than a larger standard deduction? A couple with three children under 17 could make a little over $21,800 in NC and owe no NC income tax. The first $15,000 is tax-free due to the NC married filing jointly standard deduction and the $374 of tax on the next $6,800 ($21,800 – $15,000 standard deduction) is offset by the $375 child credit. In this example, increasing the standard deduction by $2,000 saves this couple no NC income tax. Even at $23,649, the extra $2,000 in standard deduction only saves $102.

If NC adds an EITC of 5% of the federal then our couple with three kids gets $312. Much more than $102 and even more than the nothing a couple with $21,800 in income receives. So NC Policy Watch is correct, an NC EITC will provide more money to more people. The results are even more dramatic if NC makes the credit equal to 10% of the federal and NC Policy Watch suggest.

Why could an NC EITC be a bad idea?

After all that, an NC EITC sounds good if you want to encourage the poor to work. Several possible problems:

  1. Does up to $312 annually, tip the scales in favor of working versus welfare for a family of five making as little as $13,850? I really doubt it. On the other hand, they can sure use the $312 which seems to be the argument of those in favor of an NC EITC.
  2. To be revenue neutral, someone has to pay more tax to cover the NC EITC. This money does not materialize from thin air. So some other taxpayer has to pay more to cover the credit. On the other hand, if the option is to add a $2,000 standard deduction then someone has to pay the extra tax of as much as $110 ($2,000 * .05499).
  3. The big problem with an NC EITC is it encourages fraud. Basing NC’s credit on the federal means NC pays as many fraudulent claims as the Feds. In December 2014, TIGTA estimated that 24% of federal claims were fraudulent or otherwise improper. Human error due to the complexity of the law is probably the largest cause outside of fraud. So if NC sets aside $205 million, as NC Policy Watch suggests, NC will pay out more than $49 million in improper claims. The error rate in the food stamp program was estimated at 4.07% according to this December 2013 NY Times article. Not great but a heck of a lot better than 24%.

Conclusion

Until the federal government gets its act together and brings the improper payment percentage to a reasonable level, how can anyone promote the EITC as a cost-effective way to fight poverty? What do you think?

Filed Under: Tax

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Change in W-2 due date for 2015

The NC Legislature, without much warning or lead time, changed the W-2 due date for NC employers. The old W-2 due date was the end of February. Now employers must send the the employer copy to the NC Department of Revenue by January 31, 2016. This W-2 due date change is also tied into a new mandatory electronic filing of W-2s effective for 2015 forms.

NC now requires Electronic Filing

The Legislature, as is true of most elected bodies, lacks many people with practical real world experience. On September 23, 2015, the Legislature passed H.B. 117 (PDF) requiring the new due date. But that was not enough for our Legislature, they decided to also require that all W-2s for 2015 be filed electronically. The only exceptions were for those employers requesting a hardship extension. Really? A little less than 3 1/2 months to get an entire new system setup.

For large employers and those using large payroll processing firms, the electronic requirement is no big deal. They had already invested in software for electronically filing W-2s. Their adjustment is to the new due date only. Smaller employers did not often have the capability to electronically file W-2s with NC. In addition, many of the payroll software vendors catering to small businesses did not have this capability. Even last year I saw handwritten W-2s from some small employers. The Legislature’s solution was to require the NC Department of Revenue to provide an online filing process.

Just this Monday (January 25th) , the NC Department of Revenue finished their programming to allow a simple method for electronically filing W-2s. Fortunately, the Department exercised its authority to grant hardship waivers without making employers apply. You can see their notice here. Basically, small employers can still file paper W-2s for 2015. Find more information on NC electronic filing here.

2015 W-2 form

NC W-2 Due Date change

NC employers had until the end of February 2015 to file W-2s with NC. This would allow employers to provide the W-2s to their employees by the end of January. Then if an employee had needed a correction, the employer had time. For example, if the Social Security Number, the employee’s name or address were wrong things could be fixed before the forms went to the government. No such option now.

Reason for the change

The stated reason is to help prevent identity theft. If NC is able to match the electronically filed W-2s to the individual returns before issuing a refund this should help a lot with identity theft. Considering the short time the Legislature gave to the Department of Revenue, I expect there will be problems this year.

Future Federal W-2 due date change

In December, Congress changed the due dates for 2016 W-2 forms due in early 2017. Congress also made the change to combat identity theft. At least Congress is giving employers time to adjust. The employer will have to file 2016 and future W-2s by the end of the following January. In years past employers who electronically transmitted forms W-2s received an extra month to file them with the government. Instead of the general end of February W-2 due date, electronic filers had until the end of March. No more!

Conclusion

Employers need to adjust their payroll processes to comply with the new due dates. Late filers will owe penalties. NC charges $50 per late W-2. IRS charges up to $100 per W-2 for 2015 W-2s and up to $260 for 2016 W-2s. Penalties are just money down the drain. Taxpayers cannot even deduct the penalty to reduce their income taxes.

So file those NC W-2s before the end of January!

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Tax Extenders revived by PATH

On December 18, Congress and the President finally dealt with the tax extenders. Congress named the new act the “Protecting Americans from Tax Hikes Act of 2015” or PATH. Congress likes cute acronyms. This is an annual exercise to revive dead or almost dead tax provisions. You can read about 2014’s efforts here and here. Short term tax provisions are Congress’ and the President’s way of making the increase in the deficit look better. After all, the provisions expire so the extra cost only last so long, wink wink.

By George Redgrave, Creative Commons license, Flickr

Congress likes to pretend, for budgeting reasons, that they will not renew the tax extenders. Future deficit projections ignore the tax extender costs once they expire. Few of the extenders ever really expire.

Since most of the tax extenders have risen from the dead repeatedly, Congress is lying to taxpayers about how much they are increasing the national debt. For a change, this time Congress actually made some of the extenders permanent.

Selected tax extenders made permanent

  • Enhanced child tax credit – allowing a larger refundable credit for lower-income taxpayers.
  • American opportunity credit – increased the old Hope education credit from a maximum of $1,800 each for two years to a maximum of $2,500 each for four years.
  • Enhanced earned income tax credit increased for three or more children. Credit phases-out at a higher income.
  • Teacher deduction – had expired in 2014, now permanent. Allows elementary and secondary teachers to deduct up to $250 in eligible classroom expenses. Now include professional education costs. Wouldn’t giving the teachers enough money to cover needed classroom supplies and education be a better option?
  • Option to deduct sales taxes instead of state income taxes. This really helps taxpayers in the states without a state income tax.
  • Tax free distributions from IRAs – taxpayers 70 1/2 or older can exclude up to $100,000 distributed from their IRAs to qualified charities.
  • Modified research credit.
  • Modified employer wage credit for employees on active duty (e.g. National Guard and Reserve called up).
  • 15-year straight-line depreciation of qualified leasehold, retail improvements, and restaurant buildings and improvements. If not renewed, these assets were generally deductible over 39 years.
  • Increased Section 179 of $500,000, was to drop to $25,000.
  • Made permanent the five-year waiting period to avoid paying tax on converting to an S corporation from a C corporation. It was ten years before the temporary decrease to five.

Temporary extensions through 2019

  • Work Opportunity tax credit for hiring long-term unemployed.
  • Bonus depreciation is modified to allow 50% for 2015 to 2017, 40% for 2018 and 30% for 2019.

Temporary extensions through 2016

  • Tax-free discharge of qualified principal residence debt.
  • Allow deduction of qualified mortgage insurance premiums as interest.
  • Tuition deduction of up to $4,000.
  • Mine safety equipment deduction and mine rescue training credit. Why do we have to pay mine owners to do the right thing?
  • Allow shorter 7 year depreciation for motor sports. Really, NASCAR is in financial difficulty?
  • Non-business (residential) energy credit for qualified energy-saving expenses, limited to $500 lifetime.

Other notable changes

  • Employer must send 2016 W-2s to Social Security by January 31st. Previously, employers had until March 31st if they electronically filed. The idea is to allow IRS to verify wages and withholding earlier to prevent fraud.
  • Prohibit taxpayers who did not have a qualifying Social Security number or ITIN from amending returns once they get the appropriate ID number to claim:
    • Thee earned income tax credit.
    • The child tax credit.
    • The American opportunity tax credit.
  • Beginning for 2016, taxpayer must have a Form 1098-T to claim education costs.
  • Allowing rollovers from other employer retirement plans to SIMPLE IRAs.
  • Codified taxpayers’ bill of rights.
  • Allow IRS to say when more employers can truncate Social Security numbers on W-2s.

The Congressional Budget Office estimates the ten-year cost at about $680 billion. Source: CBO (see PDF on the linked page for data)

What do you think? Are these tax cuts and credits worth the $680 billion they add to the deficit?

Filed Under: Tax

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Repair and capitalization relief!

On November 25, 2015 IRS provided small businesses and landlords with repair and capitalization relief. Please see Notice 2015-82 (PDF). The 2013 regulations provided guidance on what is a repair and what had to be capitalized. Bullet point four of this post mentions the 2013 changes.  The regulations allowed businesses to treat amounts up to $500 as supplies. Previously, taxpayers would have had to justify deducting new property costing under $500. The new notice changes the amount from $500 to $2,500.

Looks like this car requires more than $500 in work!

Kaz Andrew, 1976 Lincoln Town Coupe, under Creative Commons license, on Flickr

Some background

Tangible property is just what it sounds like. It is property you can touch. Intangible property – such as a patent – cannot be touched. The copyright document can be touched but not the actual idea. For a long time, taxpayers and IRS have argued about whether or not a piece of tangible property is a repair or subject to capitalization. The distinction matters because businesses can immediately deduct repair and maintenance costs, with some exceptions. On the other hand, something that has to be capitalized is typically depreciated over anywhere from a few years to 40 years.

Depreciation is a method of claiming part of the cost of the capitalized asset each year for several years.

  • Repair = 100% deducted in year one (there are some exceptions which are beyond the scope of this post)
  • Capitalized = deduct as little as 2.5% of the cost each year for 40 years, sometimes even less per year.

Qualifying taxpayers

Taxpayers that have an applicable financial statement got a $5,000 safe harbor in the 2013 regulations. Taxpayers without an applicable financial statement (AFS) only received the $500 safe harbor. An AFS is one that is audited or required to be filed with a regulatory agency. If the only reason for audited AFS was to get the $5,000 safe harbor then the taxpayer was still stuck with the $500 safe harbor.

An example

XYZ Company built a $2,500 storage shed. Prior to the 2013 regulations, IRS would have wanted the taxpayer to deduct an average of $65 a year for the next 39 years. Assume XYZ Company has an AFS. If the shed was constructed in 2014 or after, then XYZ could claim the entire $2,500 as a supply deduction in the year built.

Assume ABC Company does not have an applicable financial statement and it builds the $2,500 shed in 2014.  Under the 2013 regulations, ABC was stuck with claiming an average of $65 a year for 39 years. Notice 2015-82 changes this for 2016 (and for many also for 2015). If ABC builds a new shed in 2016 for $2,500, it can claim a supply deduction in 2016 of $2,500. A much better deduction than $65 a year for 39 years.

Repair and capitalization relief for 2015?

The notice states it “is effective for costs incurred during taxable years beginning on or after January 1, 2016.” This seems to say no businesses qualify for the $2,500 safe harbor under the notice until 2016. However, the notice goes on to say

AUDIT PROTECTION

For taxable years beginning before January 1, 2016, the IRS will not raise upon examination the issue of whether a taxpayer without an [applicable financial statement] can utilize the de minimis safe harbor … for an amount not to exceed $2,500 per invoice (or per item as substantiated by invoice) if the taxpayer otherwise satisfies the requirements ….

IRS is saying that if a taxpayer uses the $2,500 safe harbor in 2015, then IRS will not deny the supply deduction as long as it is less than or equal to $2,500. The taxpayer still has to meet all the other requirements that existed when the amount was $500.

How is this for some repair and capitalization relief? Audit protection, nice.

 

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Mileage rates released for 2016

IRS and Congress were both busy in December. I will start the new year with the new 2016 mileage rates released on December 17, 2015 by IRS. The official release is Notice 2016-01 (PDF).

2013 Ford Taurus SHO by That Hartford Guy, on Flickr, under Creative Commons license, on Flickr

The mileage rates are:

2016:

  1. Business    54 cents per mile
  2. Charitable    14 cents per mile
  3. Medical     19 cents per mile

2015:

  1. Business    57.5 cents per mile
  2. Charitable    14 cents per mile
  3. Medical     23 cents per mile

Congress sets charitable mileage rate

Notice that the rate for using a vehicle to provide charitable services did not change. We can thank Congress for that as the amount is included in the actual law and IRS has no authority to change it based upon market conditions. Considering the drop in gas prices in 2015 compared to 2014, the declines should not be a surprise.

Mileage record keeping rules

You can read about the record keeping rules in this post – Business mileage deduction vs. commuting. You can learn about an app to track mileage from this post – Mileage logs stink – try an app. Keeping the required records can be a pain but failure to do so means you lose the deduction. Without the records, IRS is required by law to disallow the deduction.

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State Business Taxes report

The Council On State Taxation (COST) recently released its 13th annual study of state and local business taxes. The full report is available as a PDF towards the bottom of the news release. While the report refers to state and local business taxes, this post will refer to them as state business taxes.

Total Effective Business Tax Rate (TEBTR) as % of private sector Gross State Product (GSP), on (PDF) Council On State Taxation

What is different in this report?

Many state business tax rankings use only income tax rates. The COST report uses the actual total of taxes paid as a percent of the total state business taxes paid. What does this mean? The report includes not only business income taxes but also individual income taxes paid on business income, sales tax on business expenditures, business property taxes, licenses, unemployment taxes, excise taxes, severance taxes (on minerals, oil, etc.), and other business taxes.

Why does this matter?

Does a business really care what kind of tax they pay? Is it more important to pay little or no income tax at the cost of very high sales tax? Of course not. Total tax is what comes out of the business’ pocket not just one type of tax. For example, Nevada has no state individual or business income tax. So NV’s income tax rate is considered zero which would rank it at the top of any state tax ranking based solely upon rates. North Carolina has individual and corporate income taxes. However, NV businesses pay 53% of all state and local taxes while NC businesses pay only 38.8% of all state and local taxes. Further, the Total Effective Business Tax Rate (TEBTR) in NV is 5.9% while in NC it is 4.3%.

All other things being equal, even though NC has an income tax and NV does not, on average a business should prefer NC business taxes to NV business taxes.

Is COST the best state business taxes ranking?

Of course not. Every business is different and every state’s tax laws are different. Property taxes and general sales and use tax on inputs are the two largest components of state and local business taxes. However, many service business (like CPAs) have very little in property so their property taxes are low. For these businesses, income and payroll taxes become a much larger concern.

On the other hand, the rankings solely based upon income tax rates are not the best either.

What do you think, are state business taxes as a % of income a better measurement than a tax rate ranking? Please comment below.