Congressman Earl (Buddy) Carter (R-GA) has introduced the FairTax Act of 2023. I generally am hesitant to study proposed tax legislation too hard after a bad experience I had. I intensely studied the proposal that ultimately went into the Tax Reform Act of 1986 and for the next few years had bouts of confusion as I would remember things that did not ultimately end up in the bill. Much of the commentary on the bill, including mine, has been about whether it is a good idea and the politics surrounding its introduction. It has also been tinged by the fact that the concept underlying the tax has been kicking around for a long time. American For Fair Taxation was founded in 1995.
Still I think it might be worthwhile to look at the FairTax Act of 2023 (FTA23) cold and imagine that it was actually just signed into law, unlikely as that may seem. I will do my best to explain the law from a practical compliance point of view and also give you whatever planning ideas I might come up with. Here goes
Big Picture
FTA23 repeals Subtitles A, B, C and H of the Internal Revenue Code of 1986 – income and self-employment taxes, estate and gift taxes and payroll and withholding taxes, financing of Presidential election campaigns. All the other subtitle get moved up a couple notches. And it will now be the Internal Revenue Code of 2023 (IRC 2023) with a new Subtitle A – Sales Tax. The references that will follow will be to the sections of IRC 2023 as opposed to sections of FTA23 (the bill that enacts the new Code).
The effective date is January 1, 2023. I am at a loss as to how that is supposed to work. To stay sane, I will assume that the Sales Tax kicks in and the others go out on January 1, 2025. 2025 is the first year for which a rate is set. If the bill were actually to pass I think there might be a lot more extensive transitional stuff included.
The Sales Tax
Sections 1 and 2 give us principles of interpretation and definitions. We will refer to them as needed. Section 101 imposes the sales tax at a rate of 23% of the gross payments for taxable property or services.
“Gross payment” is the payment for taxable property or services plus the federal taxes (Sec 2(a)(5)). That works out to a conventional sales tax rate of 29.87 % and change- 23 divided by 77. Commentators usually refer to that as 30% which I suppose you might use for planning purposes, but it is not the right number.
23% is the rate for 2025. After 2025 the rate is broken down among general revenue, old-age survivors and disability, and hospital insurance rate. The general revenue rate after 2025 is 14.91%.
The sales tax is on top of any import duties and there will be effort made to collect the two taxes together.
The Taxpayer
The person using or consuming the taxable property or services in the United State has primary liability for the tax (Sec 101(d)(1)). If the consumer pays a seller the tax and receives a proper receipt, they are no longer liable.
Exclusions And Exemptions
Taxable property and services is defined as “any property” (including leaseholds or any term or rents with respect to such property). Excluded from “taxable property and services” are intangible property and used property (Sec 2(a)(14). The exclusion of used property strikes me as a feature of the tax which may give rise to the greatest opportunity for planning particularly in the transition.
No tax is imposed on property or service purchased for a business purpose or an investment purpose (Sec 102(a)). There is an exemption for certain state government functions, but I am not going to discuss the way the tax falls on federal and state government functions, since that is really not a practical concern to you and me.
“Business purposes” requires that there be a trade or business, but is otherwise very broad exempting what is for resale, required to produce, provide, render or sell taxable property or services and “in furtherance” of other bona fide business purpose (Sec 102(b)). This exemption seems to also offer a lot of planning opportunities. There is a rule similar to the current hobby loss provision so that you can’t claim business purpose if you don’t have an actual business (Sec 701). There are special rules for gambling businesses and financial intermediary services.
“Investment purposes” is also very broad. It is property purchased exclusively for purposes of appreciation or the production of income but not entailing more than minor personal efforts Sec 102(c).
Collection
Generally the tax will be collected and remitted by the seller (Sec 103(a)). If property or services purchased outside the United States for use or consumption in the United States, the purchaser remits the tax. A “taxable employer” paying wage for “taxable services” must remit the tax (Sec 103(b)(2)). When it comes to that think Downton Abbey or maybe a live-in nanny. Then there is “converted property”. If property that was purchased for a trade or business starts being used for personal purposes, there is a deemed sale at the fair market value of the property with the person using or consuming the property liable to remit it Sec 103(c). Bartered goods or services require remittance as if the transaction had been for cash Sec 103(d).
Credits And Refunds
There is a credit for business use conversion, intermediate and export sales, an administration credit, a bad debt credit and an insurance proceeds credit Sec 201(a). Only one credit can be taken with respect to any gross payment.
The business use conversion credit credit (Sec 202) applies to property on which the tax has been paid which is converted to be 95% or more used for business. Imagine you bought a pick up truck because you thought it was cool and a couple year later you decide to start a roofing business. The credit is the lesser of the tax rate times the fair market value of the property when it is converted divided by one minus the tax rate or the amount of tax paid with respect to the property. Say you bought your pickup for $50,000. You would have paid $14,935 in tax. If it is worth $30,000 when you convert it your refund is $30,0000*0.23/0.77 $8,961. If it is worth $60,000 your refund is $14,935.
One of the most complicated parts of the new law are the rules governing “mixed use” property i.e. property that is used in business but falls below the 95% threshold.
The intermediate and export sales credit (Sec 203) is the amount of tax paid on property purchased for business use, export or use of consumption outside the United States.
The administrative credit (Sec 204) goes to anyone filing a timely monthly report. The administrative credit is the greater of $200 or 0.25% of the tax remitted. The credit cannot be more than 20% if the tax due to be remitted prior to the application of the credit. So if you are sending in $100,000 in tax you get a credit of $250. If you are sending in $50,000 or $10,000 or $1,000 you get a credit of $200. If you are sending in $500 your credit is $100.
There is a bad debt credit (Sec 205) for people who choose to be on the accrual method, but I find it hard to figure why you would want to do that.
Apparently if you paid tax on an insurance policy you get a credit if the policy pays off. This strikes me as possibly subject to shenanigans in the case of life insurance, but otherwise seems to make sense.
Family Consumption Allowance
A “qualified family” is one or more family members sharing a common residence. Family members are an individual, the individual’s spouse, lineal ancestors or descendants of either of them, legally adopted children and children under legal guardianship. To count as a member of the family they must have a bona fide Social Security number and be a lawful resident of the United States. There are rules about how to count students and children of divorced or separated parents. Incarcerated family members are excluded.
In order to receive the allowance the family must register with the “sales tax administering authority”. That will probably be an agency of a state, but it could be federal if that state decides they don’t want to collect the tax. Registration is not mandatory. You just don’t get the consumption allowance if you don’t register.
The allowance is based on the Health and Human Services Poverty Guideline. Currently in the lower 48, it is $12,880 for a family of 1 and then goes up by $4,540 for each additional person. For purposes of the allowance there is a “marriage penalty elimination amount”. So a household that consisted of just a married couple would be at $25,760. The family consumption allowance is the relevant income level times the tax rate. The Social Security administration will send out a monthly check. For a family of four I make that to be $667.76 per month, but feel free to check my math and mock me if I am wrong. The idea is that the family of four spending $34,840 per year on taxable stuff on net is paying no tax.
Federal And State
FTA23 has a lot about the federal agencies that replace the IRS and how the federal government and states will cooperate in collection the tax. You really can’t tell exactly how it will work from just the statute, so I will not dig into that. We don’t know how many or which states will join in the fun, but it does seem that it will be a little chaotic for a while.
Used Property
It strikes me that “used property” is the most intriguing exclusion from the tax. “Used property” is property on which the sales tax has been paid without anybody claiming a credit for it having been used in a business, held as an investment or written off as a bad debt (Sec 2(a)(16)). Also included in used property is property which was held other than for a business purpose on December 31, 2024.
So imagine you own a vacation home that you have been pretty much renting out. You probably want to convert it to personal use sometime in 2024. Otherwise when you sell it there has to be a 30% tax paid by the buyer if they plan to use it personally. Overall it would seem that “used property” should command a significant premium.
Everything being equal (which granted it never is in the real world) it would seem that if you went into business selling anything you would have a big advantage if you could characterize it as fitting the definition of used. With big ticket items like house, cars and planes there would presumably be good audit trail on whether the property was ever claimed as business property but it is hard to see how that will work with smaller value items.
It seems likely that there will be some sort of regulation to determine when things that are renovated, repaired or reconditioned no longer qualify as being used or something equivalent to the mixed use rules.
The Final Year Of The Income Tax
2024 will be a really interesting year as people strive to defer income and accelerate deductions and position property most favorably under the new tax regime. What will happen to investors who paid for low income housing tax credits that still have years to run on them? A lot of the shenanigans that will likely happen will get by. After September 30, 2027 no money will be appropriated for enforcing the taxes repealed by the act (income, estate, payroll) and all records related to the administration of those taxes are to be destroyed by then except for records related to ongoing litigation. It does strike me as an invitation to go out of compliance, but being a CPA and all I’m not supposed to give that kind of advice.