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September 2019

Candidate Proposals to Watch

By William Stromsem, J.D., CPA

Assistant Professor of Accounting, George Washington University

 

In an effort to appeal to voters, some of the Democratic primary candidates have proposed major tax law changes. It is always interesting to see how far primary candidates will go in either party to appeal to those who have more extreme views in their party to capture the nomination and then to see how they try to move back to the middle for the general election when they have to appeal to a more moderate majority across party lines. General election candidates like to cite extreme views espoused in the primaries to show that the other candidate is out of touch with the people.

Here are some of the positions recently announced by Democratic primary candidates:

Income Tax Rates—Joe Biden and Amy Klobuchar have proposed raising the top rate to 39.6% from 37%. This is the rate that applied before the Tax Cuts and Jobs Act of 2017. Bernie Sanders proposes a top rate of 70% for income over $10 million.

“Wealth” Tax—Sanders and Elizabeth Warren have proposed a tax on net worth for high-wealth individuals. For those with over $50 million in assets, Warren would assess tax at a rate that would be 2% of net assets and the rate would rise to 3% for those with net worth in excess of $1 billion. Sanders would have a progressive rate starting at 1% on wealth over $32 million and rising to 8% on wealth over $10 billion. These would be annual taxes and could eliminate "excess" wealth over a period of decades if there is no offsetting appreciation. Some believe that this government taking of property would violate the U.S. Constitution.

Estate Tax—TCJA exempts $11.4 million singles; $22.8 million married couples. Sanders would lower the exemption to $3.5 million and raise rates to 45-55% based on estate size, with a high tax on billionaires of $77%. Warren, Cory Booker and Pete Buttigieg would lower the exemption to $3.5 million and set a top rate of 45%.

The proposals above could subject wealthy taxpayers to three levels of tax on the same income: (1) higher income tax rates as it is earned, (2) a new wealth tax once it is accumulated, and (3) a higher tax on distributions when they dispose of their wealth.

Payroll Taxes—Julián Castro would tax income from inherited wealth of $2 million or more and would include this income in assessing payroll taxes as if it were compensation.

Social Security Wage Cap—Klobuchar and Sanders would raise the cap from $132,900 to $250,000, and Beto O’Rourke would raise it to $400,000. Note that this is for payment of the tax, not for computing the benefits that would continue at the old cap.

Capital Gains—Biden would double the capital gains maximum rate to 40%. Castro and Klobuchar would increase the rate for those earning more than $400,000 a year. Most favor taxing capital gains as ordinary income and eliminating the preferential rate for taxing capital gains.

 


How Far Can the IRS Go in Writing Regs to Fill in Blanks in the Underlying Legislation—Billions at Stake!

By William R. Stromsem, J.D., CPA

Assistant Professor of Accountancy, George Washington University School of Business

 

Recently, there has been a division in court opinions on how deductions for equity-based compensation should be allocated for use against U.S. income or foreign countries where the compensated worker provides services. At stake in the controversy are billions of dollars for such large multinational companies as Google, Facebook, Altera, Symantec and others. The court decision could also determine how much the IRS can “fill in the blanks” when the underlying legislation is not specific or clear.

Companies naturally want to allocate these expenses to use against higher U.S. income tax rates (note the case arose before the U.S. lowered the corporate tax rate). The IRS wrote regulations in 2003 that would require these to be allocated to the countries where the compensated employee works. The legislation for allocating these expenses was silent or ambiguous, and the IRS filled in the blanks in a way that was adverse to some very large multinational companies, which now have billions of dollars of extra taxes to pay.

In complex areas, sometimes Congress lacks the tax technical expertise to write the tax law and can ask the IRS to provide the details. Where Congress asks the IRS to write regulations to deal with an issue, without many specifics, the IRS has a fairly free hand to write the law. A classic example is where Congress asked the IRS to write the debt-equity regulations under IRC Section 385 to determine whether a financial instrument was debt, with deductible interest, or equity, with non-deductible dividends. In the past, this was a straightforward choice—stock or bonds. But then came a lot of hybrid financial instruments, debt with a profit-sharing or equity kicker, convertible bonds and debentures, equity with a guaranteed rate of return that looked like interest. Congress could not figure out how to write the law, but wanted the area to be clarified so it directed the IRS to come up with definitions and distinctions. This proved to be a daunting task—although Section 385 was enacted in 1969, final regulations were not published until 2016! Where Congress cedes the authority to the IRS to write the law, the results are legislative regulations and it is then difficult to claim that such regs are not in accordance with congressional intent, because the intent was merely to have the IRS write the law.

But the IRS may not have such blanket authority to write regulations here. The IRS issued regs on allocating equity-based compensation in 2003, and Altera sued in 2012, saying that the IRS did not have authority and have not properly applied an arms-length transaction measurement of compensation and had not followed the requirements of the Administrative Procedures Act in issuing the regs. In 2015, the U.S. Tax Court sided with Altera (which became owned by Intel). An appeals court panel overturned the decision, siding with the IRS. The case is being appealed to the full circuit court and may eventually be decided by the U.S. Supreme Court, which could decide how much the IRS can fill in the blanks when the underlying law is not clear.

http://cdn.ca9.uscourts.gov/datastore/opinions/2019/06/07/16-70496.pdf

 


Surviving Spouses Inheriting an IRA

By Thomas P. Ochsenschlager, JD, CPA

A surviving spouse who inherits an IRA from the deceased spouse has two alternatives to consider:

1. Essentially, continue the deceased spouse’s IRA, albeit entitled under the surviving spouse’s name, or

2. Rollover the inherited IRA into the surviving spouse’s IRA.

Depending on the circumstances, there are advantages and disadvantages to each.

If the surviving spouse is younger than the deceased spouse and does not need the income, then the rollover option would extend the useful life of the IRA and give the surviving spouse the ability to name younger beneficiaries, further extending the life of the IRA.  

If the surviving spouse is less than 59 ½ and needs income, and the deceased spouse was receiving IRA distributions, the first alternative above will permit the surviving spouse to begin receiving the deceased spouse’s distributions without penalty.

If the surviving spouse does not need income, and the deceased spouse was not receiving distributions, the first alternative would require the surviving spouse to begin receiving distributions the year the decedent would have reached 70 ½.

An alternative that in many circumstances would be the best of both worlds is for the surviving spouse to choose the first alternative and receive the same distributions the deceased spouse would have had until the surviving spouse reaches age 59 ½, at which time the surviving spouse can make the rollover election.