I speak this afternoon at the Iowa Bar Association Bloethe Tax School. I will be talking about “Affordable Healthcare Act for Pass Through Entities” at 3:40. The newly-released proposed regulations on the 3.8% net investment income tax and the .9% Medicare tax will star. If any Tax Update readers are there, please say hello if you get a chance.
Putting the “Net” in the net investment income tax. The Obamacare 3.8% on “net investment income” for higher income taxpayers has a strange feature that is highlighted in the newly-released proposed regulations. The tax applies the tax to “Net” investment income to the extent it increases adjusted gross income — not taxable income — over $200,000 for single taxpayers or $250,000 for joint filers. “Investment Income” for this tax is a new combination of interest, rents, royalties, non-qualified annuities, capital gains and “passive” business income, as from K-1s.
So what does “net” mean? The proposed rules (Proposed Regs. 1.1411-4(f)) say that you reduce income by deductions “allocable” to the investment income. That includes Schedule A deductions for investment expenses, to the extent they exceed the 2% of AGI floor. It also includes state income taxes “allocable” to passive K-1 income and other “investment” income (cites removed for clarity):
In the case of taxes that are deductible… and imposed on both gross income (including net gain)/..and gross income… the portion of the deduction that is properly allocable… may be determined by taxpayers using any reasonable method. For purposes of the prior sentence, an allocation of the deduction based on the ratio of the amount of a taxpayer’s gross income (subject to the tax) to the amount of the taxpayer’s (total) gross income… is an example of a reasonable method.
So even if a taxpayer gets no benefit from a deduction because of alternative minimum tax, it reduces net investment income. Nothing in the regulations incorporates AMT. As long as an itemized deduction is allowed for regular tax, then it reduces investment income. Taxpayers with AMT liability lose the benefit of their state income tax and miscellaneous deductions for most purposes, but not for this silly tax.
By the same token, if a deduction is disallowed for regular tax — by the 2% floor, the passive loss rules, etc. –it does not reduce net investment income. This makes the GOP proposal for a “cap” on itemized deductions that much worse.
Raise rates or limit deductions? Republican Senator Tom Coburn says that he prefers tax rate increases to the deduction cap proposed by some Republicans. From The Hill:
“Personally, I know we have to raise revenue; I don’t really care which way we do it,” Coburn said during an appearance on MSNBC. “Actually, I would rather see the rates go up than do it the other way, because it gives us greater chance to reform the tax code and broaden the base in the future.”
While I am a doubter of the “need” to raise revenue — we don’t need to do that if we would spend at not-insane levels — I agree that if you increase taxes, rate increases are the way to go. It keeps the pain simple and honest. The deduction cap would be much more disruptive to businesses, as owners of pass-through businesses would lose the deduction for much of their state income tax burden. It would greatly complicate tax planning and have unpredictable consequences for business owners, charities and the housing market. It would also be horrible to professional gamblers, whose below-the-line loss deductions would be capped, and to investors with substantial below-the-line investment interest expense. And all just to pretend there is no tax increase.
Of course I have no faith at all that a GOP compromise on tax rates will lead to serious concessions on spending. And the spending is the problem.
Robert D. Flach is not impressed by our leaders:
The continued unmoveable hard line on “resolving” the “fiscal cliff” taken by the two sides is a clear indication that the idiots in Washington do not give a tinker’s damn about the American public.
He’s right. It’s never been about us. It’s about power.
Andrew Lundeen, Fiscal Cliff: Capital Gains and Dividend Tax Increases Pose Greatest Threat to Economy (Tax Policy Blog)
Patrick Temple-West, GOP in a difficult political spot in tax fight, and more (Tax Break)
Howard Gleckman, How to Cut the Charitable Deduction Without Reducing Giving (TaxVox)
David Brunori, Note to Everyone: Business Should Not Pay Sales Tax: (Tax.com)
Only bad things happen when businesses pay sales tax. First, the businesses paying the tax pass the burden on to their customers in the form of higher prices. But the tax is hidden. People do not know they are paying it. Politicians, and perhaps the New York Times, may like that lack of transparency, but it is awful government policy. Second, the higher priced products purchased by consumers are often subject to tax. This gives rise to a tax on a tax. That is awful tax policy. Finally, taxation of business inputs artificially keeps sales tax rates low. People think the sales tax rate is lower than it actually is. None of this is good.
It’s always best to not hide the taxes.
Cara Griffith, New York Times Article Misses the Mark on San Francisco Tax Exemption (Tax.com)
Jana Luttenegger, Last Minute Charitable Gifts. (Davis Brown Tax Law Blog). If they cap itemized deductions, many folks will wish they had given more this year. This post has some good ideas.
Trish McIntire, Education Credits Form Changes
I’m way ahead of the science. Science Says You Should Have Multiple Large Monitors. (Going Concern). Too much is almost enough.
News you can use: Timesheet Wars: Non-Billable Codes Are Orwellian Busywork (Going Concern)