Tax Fairness is the principle that income should be taxed only when it is received by a taxpayer. Advocates believe it is unfair to impose the income tax on proceeds that are paid to actual expenses by the taxpayer or on “paper” gains that have not been received as income.
Tax Fairness Under Attack
Tax Fairness is under attack. The House Ways and Means Committee is working on legislation that will repeal or restrict business interest deductions and section 1031 of the Internal Revenue Code.
Taxing income and gains that are never realized or received by the taxpayer by repealing business interest deductions and § 1031 would violate the principle of Tax Fairness and cripple our economy.
Business interest deductions and IRC § 1031 have been an important part of the tax code since 1913 and 1921, respectively, and have protected taxpayers from paying taxes on income and gains that are never received or earned. Business interest deductions ensure that a taxpayer only pays tax on the income he earns, not on the interest expense he must pay to a lender. This protects from double taxation since the lender will also pay tax on the interest income received. Eliminating this provision will be devastating to the vast majority of Americans who utilize financing for their operations or to be able to afford to own real estate and will result of a crippling of the economy and the crash of the real estate market.
Section 1031 currently promotes reinvestment in the US real estate and business markets and protects taxpayers who defer their capital gains by exchanging businesses or property held for business or investment purposes for businesses or property of like kind. If this section is repealed, taxpayers will not be able to defer the taxable recognition of their gain through such an exchange despite deferring the realization of that gain in practice. Moreover, most business and real estate sales and transactions that depend on 1031 Exchange will cease to occur, grinding those markets to a halt.
Introducing a tax on unrealized gain violates the principle of Tax Fairness and could set a dangerous precedent that may lead to the taxation of other unrealized gains. The House Ways and Means proposal has resulted in a backlash from voters and there are now several organized movements fighting to keep the tax code fair.
Legal Recognition of Tax Fairness
The principle of Tax Fairness is reflected in the constitutional amendment that grants Congress the power to lay and collect taxes on “incomes” in the first place,1 and is also enshrined in the principle body of statutory tax law in the United States, which says that “…any item of gross income shall be included in the gross income for the taxable year in which received by the taxpayer…” (emphasis added).2 This principle is elaborated on and applied throughout the interlocking sections of the United States Code and the Code of Federal Regulations.3
Current Battlefronts: The Business Interest Deduction and the 1031 Exchange
The fight to preserve and uphold Tax Fairness is currently focused on saving the 1031 Exchange and Business Interest Deductions. In 2014 former House Ways and Means Committee Chairman Dave Camp (R-MI) proposed that a repeal of section 1031 could provide tax revenue to counterbalance a lower corporate income tax rate. In 2015 the Obama administration itself proposed a budget that limits tax deferral for like-kind exchanges. Most recently, Chairman Kevin Brady of the House Ways and Means Committee and his team are actively proposing the elimination of business interest deductions and the 1031 Exchange in favor of a new investment expensing that would primarily benefit the largest corporations and the wealthiest 0.01% at the expense of the majority of Americans.
While the repeal of the business interest expense and 1031 Exchange may seem like it would increase tax revenue, standard economic modeling predicts that it would actually cause GDP to fall considerably and that it could send us back into a very deep recession. Read more about why the business interest deduction and the 1031 Exchange are so important or take action now to help save it!