Thursday November 21, 2019
April 16 is Tax Freedom Day
Tax Freedom Day is determined by a simple division of all federal, state and local taxes by the nation's income. The government revenue is from individual, corporate, property, sales and excise taxes.
The total amount of federal tax that Americans will pay this year is $3.4 trillion. State and local taxes will total $1.8 trillion. The combined total is $5.2 trillion, which is 29% of the nation's income. Federal and state taxes this year are the same as 2018, due in part to the Tax Cuts and Jobs Act.
The total taxes of $5.2 trillion that Americans will pay this year exceeds the $5.1 trillion that Americans will pay for food, shelter and clothing. Americans are expected to spend $2 trillion for food, $300 billion for clothing and $2.8 trillion for housing this year.
If the federal deficit is included in the calculation, Tax Freedom Day is extended 22 days to May 8. This is 17 days earlier than the latest spending and deficit Tax Freedom Day in U.S. history, which was May 25, 1945. This day reflected higher spending during World War II.
Tax Freedom Day may also be calculated for high and low tax states. The dates for high-tax states are May 3 in New York, April 30 in New Jersey and April 25 in Connecticut. Tax Freedom Day for the lowest tax states are March 25 in Alaska, March 30 in Oklahoma and April 4 in Florida and Louisiana.
Editor's Note: Tax Freedom Day has been calculated each year for several decades. It provides a comparison of government spending for different years. Other Washington organizations have suggested an expanded calculation to determine Tax Freedom Day by taxpayer income levels. If other organizations report Tax Freedom Day by income levels, your editor will publish that data.
Representative Opposes SALT Charitable Deduction Limit
On April 1, 2019, Rep. Josh Gottheimer (D-NJ) sent an open letter to IRS Commissioner Chuck Rettig. Gottheimer opposed the IRS limits on state tax credits for charitable gifts.
In REG-112176-18 (effective August 27, 2018), the Service published Proposed Regulations to limit the benefits of state tax credits for charitable gifts. The Tax Cuts and Jobs Act limited state and local tax (SALT) deductions to $10,000. Sec. 164(b)(6). Because several states with higher tax rates had many affected taxpayers, a number of states passed new tax credit plans in an attempt to replace the lost SALT deductions.
Under the proposed regulations, a state tax credit is "quid pro quo" and reduces the federal charitable deduction by the amount of any state or local tax credit received for the donation. Thus, if a state resident gives $20,000 to a state charity and receives a $20,000 state tax credit, the federal charitable deduction is zero. Prop. Reg. 1.170A-1(h)(3)(i).
The "reduce the federal deduction" rule also applies to a state deduction that exceeds the charitable gift amount. An exception applies for a state tax credit that is not more than 15% of the gifted amount. Prop. Reg. 1.170A-1(h)(3)(vi). Gifts with a state credit at or below 15% qualify for a full federal charitable contribution deduction.
Gottheimer noted that the Tax Cuts and Jobs Act "includes no reference to new limitations on the charitable deduction that you have proposed in this regulation. There are over 100 programs that permit a state tax credit for charitable gifts. Under the proposed regulation, the state tax credits over 15% are considered 'quid pro quo' gifts and reduce the federal deduction. The 'quid pro quo' rule effectively eliminates the benefit for state programs that were designed to bypass the federal $10,000 SALT deduction limit."
The state credits support many social programs, rural hospitals and schools. These charitable programs need support because they are "crucial funding mechanisms for families, entities, and communities. Such a significant change requires explicit congressional action, particularly as this represents a significant tax increase on many Americans in at least thirty-three states."
In the view of Gottheimer, the proposed "quid pro quo" rules are arbitrary and capricious. The IRS "suddenly wants to reverse decades of precedent and court cases."
Editor's Note: Many tax professionals had hoped the IRS would publish final regulations on the charitable deduction limits connected with state credits prior to the April 15 filing deadline. Most tax software companies calculated the charitable deduction using the "quid pro quo" principal specified in the proposed regulations. The tax preparation community awaits the final regulations.
The TCJA and Charitable Remainder Trusts
The Tax Cuts and Jobs Act (TCJA) was the most comprehensive change in tax law since 1986. While there have been voluminous comments and articles on the business and personal tax effects of TCJA, the bill also has potential impact on charitable remainder trust accounting.
In an article titled "Impact of the TCJA on Trust and Estate Income Taxation," American University Professor Donald T. Williamson discussed the potential impact of Sec. 199A and the repeal of miscellaneous tax deductions on charitable remainder trusts (CRTs).
A CRT is generally exempt from income tax. If it has unrelated business income (UBI), 100% of that UBI is forfeited as an excise tax. Sec. 664(c)(2). Therefore, the CRT does not need or qualify for a Sec. 199A deduction. Prop. Reg. 1.199A-6(d)(3)(5).
The accountant for the CRT must track the four-tier amounts for ordinary income, capital gain (with sub-tiers for short term gain, tangible personal property gain, straight line depreciation gain and long term gain), other income (tax-free payments) and return of principal.
However, a CRT beneficiary may qualify for a Sec. 199A deduction. The "taxable recipient of a unitrust or annuity amount from a CRT may take into account the CRT's qualified business income (QBI), real estate investment trust (REIT) dividends and publicly traded partnership (PTP) income to determine the recipient's Section 199A deduction."
Assume a CRT has investment income of $500 and qualified REIT dividends of $1,000. The CRT distributes $1,000 as a unitrust amount to a beneficiary. The $1,000/$1,500 ratio is 66.67%. The beneficiary receives that percentage of income taxed at the same rates, or $333 of investment income and $667 of REIT dividends.
The CRT also distributes a proportionate amount of the Form W-2 wages and unadjusted basis immediately after acquisition (UBIA). If the QBI, REIT dividends or PTP income are unrelated business taxable income (UBTI), they are subject to the 100% excise tax.
TCJA also repealed the miscellaneous deductions for trusts. However, "Sec. 67(e) provides that estate and nongrantor trusts may continue deducting costs which are paid or incurred in connection with the administration of the estate or trust and which would not have been incurred if the property were not held in such trust or estate."
Examples of the deductible fees are fiduciary attorney or accounting fees. Therefore, "all ordinary and necessary expenses attributable to the production of income from real property remain deductible."
Editor's Note: CRTs generally invest in securities with a goal of avoiding UBTI. The combination of the Sec. 664 four-tier and the Sec. 1411 Medicare tax accounting rules create substantial complexity. If the CRT also has QBI that is not UBTI, the process is even more complex. CRT accounting in the future will continue to be a very specialized field.
Applicable Federal Rate of 2.8% for May -- Rev. Rul. 2019-12; 2019-19 IRB 1 (16 Apr 2018)
The IRS has announced the Applicable Federal Rate (AFR) for May of 2019. The AFR under Section 7520 for the month of May is 2.8%. The rates for April of 3.0% or March of 3.2% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2019, pooled income funds in existence less than three tax years must use a 2.2% deemed rate of return.