By Ryan Ellis
This week, the Trump tax plan outline was released. I did a write up on it here.
Like most tax plans, the president’s has one very big drawback–it requires an act of Congress to happen. In case you haven’t noticed, Congress has a hard time agreeing on whether grape jelly is purple these days. So what’s a president who wants to act now to do?
In taxes, sometimes boring wins. In this case, President Trump should use the ample time Congress will take on statutory tax reform to do a little tax reform of his own. How? By using his executive authority to direct the IRS to create new safe harbors and make the existing ones better.
A very aggressive use of safe harbors would probably do as much for small business entrepreneurs, share economy free agents and start ups as whatever Congress ends up agreeing to.
What’s a safe harbor? In the tax world, a safe harbor is a way of calculating a tax benefit in a way that the IRS has said it will accept without question. Probably the most famous safe harbor is the standard mileage rate for automobiles. The IRS has said that if you can document the miles you drove for business, you can simply multiply those miles by $0.54 and relieve yourself of keeping track of gasoline, depreciation, lease payments, insurance premiums, repairs, tires, etc. Another one you’re likely familiar with is the meal per diem for travel. Close enough for government work.
Thinking creatively and with small business owners as partners to get more of these safe harbors going is no one’s idea of flashy. But put a bunch of safe harbors together and you suddenly have a much easier tax code to comply with for entrepreneurs. Here’s a few ideas to get started:
Expand the Schedule C-EZ eligibility. If you’re a sole proprietor or a single member LLC, you are familiar with Form Schedule C. On here, you report your business income and your business expenses by category (e.g. advertising, business meals, business travel, etc.).
The IRS allows business owners with less than $5000 in expenses to report them as a lump sum, without categorization. They do this on the Schedule C-EZ. This is a good first start, but it’s limited.
The $5000 threshold was set early in the George W. Bush administration and hasn’t been updated. It should be increased to $10,000 and indexed to inflation.
There are also limits on who can use the C-EZ form. You’re ineligible if you carry an inventory, if you have a net operating loss, if you’re in a qualified joint venture with a spouse, if you have more than one small business, if you have a home office, or if you use depreciation. Most or all of these vetoes on C-EZ should be done away with.
Make the home office safe harbor more usable. One of the more recent safe harbors the IRS created was for a home office. Business owners are allowed to claim a business deduction for an office in their home which is exclusively business use and is the primary business location.
Let’s say the office is 200 square feet in a 2000 square foot house (10% of the space). A business owner can deduct 10% of the mortgage interest, property taxes, utilities, condo or HOA fees, insurance premiums, repairs, depreciation, cleaning, etc. on the home. Of course, this requires the homeowner to keep good record of all these things.
The IRS has a safe harbor that instead permits the business owner to multiply the square footage by $5, with a limit of 300 square feet and therefore a safe harbor limit of $1500. In higher cost areas of the country or for taxpayers with larger home office areas, this is too skinny to use. They’d rather do it the hard way.
The home office safe harbor should be expanded in two ways. First, the allowable square footage should be increased to 500–no one would argue that a room slightly bigger than 20 feet by 20 feet is lavish.
Second, the dollar figure should be doubled to $10. That would create a home office safe harbor maximum of $5000. The dollar figure should be indexed to inflation. Many, many more taxpayers would claim a home office if it were that easy.
Index the $2500 safe harbor for small equipment. One of the more useful safe harbors the IRS has created has been the $2500 per purchase exclusion from depreciation rules.
A few years ago, if a small business owner bought a Mac Book for $2500, he would have to list it out separately on his tax return–description, date of purchase, cost, and business use percentage. He would have to decide on Section 179 full expensing, bonus depreciation, and/or the depreciation method and convention. What a mess.
Now, the IRS lets that taxpayer simply deduct the cost of the Mac Book without doing any of those things. Any equipment purchase of $2500 or less is eligible. Never again will computers, tablet devices, simple furniture, smart phones, etc. have to be subject to complex depreciation rules.
There are two things the IRS could do to improve this fantastic safe harbor: the first (you guessed it) is to index the $2500 figure to inflation. Second, the IRS should make it clear that they consider these items to be supplies. As it stands, it’s not obvious to tax pros and accountants exactly where to deduct the cost of these safe harbor items. I put them under supplies, but I have no guidance to work from.
Create an equivalent to the Schedule C-EZ for Part Time Renters.There are a host of new part time renters out there thanks to AirBNB and other services. But these “landlords” often find themselves unprepared for the tax consequences.
That rent is taxable, of course. You can deduct rental expenses, but there are complicated rules involving rental vs personal days, material participation, pro-rating areas of the home, etc. That’s to say nothing of keeping track of utilities, taxes, interest, cleaning fees, etc.
The solution is to create a Schedule E-EZ to match the Schedule C-EZ for micro business owners. In this case, allow people to claim a “standard deduction” of $50 per rental day, for all rental activity in their home. Index this to inflation. Simple as that. If you rent out your home for 100 days, that’s a $5000 deduction against the rent you receive. Done and done. You can always do it the long way if you want to.
This is by no means an exhaustive list of safe harbors the IRS can pursue–there are dozens more to be explored. These time and record saving devices might not look like a lot by themselves, but when bunched together they are powerful tax reform in their own right.
And Congress needn’t be bothered.
Read more here.