How The Fair Tax Act Of 2023 Might Work

The Readers Digest version of the Fair Tax Act of 2023 is that it replaces the income tax, payroll taxes that fund Social Security and Medicare and transfer (estate and gift) taxes with a very broad sales tax. For 2025 the tax inclusive rate is 23% which translates to an add on rate, as sales tax is usually expressed, of 29.87% and change. After 2025 the tax inclusive rate is 14.91% plus what Social Security Administration actuaries determine the rate to be that will yield what the repealed payroll taxes would have collected.

The Fair Tax enthusiasts paint a “What A Wonderful World” picture of what it will be like as we go from 70,000 pages to 131 and abolish the IRS. I’ve been through the bill numerous times now and will here try to lay out how I think it might work in practice for different sorts of taxpayers when we ring in the jubilee in 2025.

What State Are You In?

If your state gets wise and adopts a “Conforming State Sales Tax” in place of any income tax it has you will get the maximum simplification. If your state keeps it income tax not so much. A lot of state returns fall relatively seamlessly out of the federal income tax return. So it may be possible that you will still have close to the same amount of tsoris, agita and aggravation that you have had every tax season. You can’t blame the Fair Tax enthusiasts for that. They gave your state the opportunity to enact a conforming state sales tax and repeal its income tax.

Now let’s look at how it goes for those in the lucky states.

The W-2 People

If all your income comes from wages and salary, here is what happens in January 2015. Your take-home pay goes up and just about all goods and services you buy are 30% more expensive. The Fair Tax enthusiasts with some justification predict that wringing income and payroll taxes out of the system will lower prices. There is a good chance that they are right, but it seems unlikely that it will happen right away.

You 2014 1040 will be the last one that you file. Some lower income people who generally got “refunds” due to the earned income credit might not be as pleased by that as most other people will be. You will probably want to file the form that qualifies you for a family consumption allowance. It is just names and social security numbers and address of the household and attestations that everybody in the household is a citizen and not currently incarcerated. You don’t have to file the form. The reason you want to is so that you get a monthly check from the Social Security Administration that cancels out the tax for someone at poverty level. I computed it to be about $250 per month for a single person.

So life is somewhat easier not that your 1040 was all that hard to begin with. If you divorce or separate there is still the potential for arguing about who gets credit for the kids for that monthly check.

The 1099 Gigsters

This is people like me who work as independent contractors or free lance. I write for a couple of publications and do a little bit of consulting. And I have other income. My 1040 which I won’t have to file any more is not very hard, but of course I am a CPA and, unlike some of my brethren, keep good records and my covivant has a family and friends tax practice which includes my return. Lots of people I know whose situation is no more complex than mine get overwhelmed by it so wrapping that final 1040 will be a big relief for them. Unfortunately, we have new obligations.

Now I have read the bill at least ten times, but I can’t rule out that I have missed something. Nonetheless, as I read it, I will have to become a registered seller and tack on 29.87% to my invoices. I will have to file monthly to turn the money over. My customers will probably be claiming a credit for the tax that they paid me since my services are mostly business to business. And I will be claiming a credit for the tax on all my business related expenses. I will also get a credit for the work I go through in collecting and paying over the tax. In general that credit is 0.25% of the tax paid. For small fry like me that administrative credit can be the lesser of $200 per month or 20% of the tax that I collected.

I have been futzing with the numbers. It seems that a gigster grossing $40,000 will collect about $12,000 in tax. They should get the $200 per month administrative credit. The 0.25% credit seems to be on your net remittance. You need to be grossing well over $250,000 to get past the $200. I suspect that that credit will be enough to pay for a relatively seamless solution. There will be vendors all over this. When you throw in that you will no longer have to file 1099s on the gigsters who gig for you life may be marginally easier except for figuring your 202 credit.

You are entitled to a business use conversion credit (Section 202) on all goods and services on which you pay the tax and use at least 95% in your business. Then there is mixed use property which is explained in Section 705. Probably the easiest example would be a car. Essentially you would amortize the tax you paid on the car over sixty months and take the amount for that month and multiply by the ratio of business miles to total miles for that month. Real estate is based on floor space. Other tangible property is figured on a calendar year basis.

Computing the mixed used Section 202 credit seems like it might be the most contentious issue for small business people and probably the most complicated.

For Small And Not So Small Businesses

Considering businesses with more than a couple of employees, it strikes me that there will not be that much less accounting to do, but there will be a lot less to worry about. Money can go in and out of the business without worrying about tax consequences. You still need to report your wages to the Social Security Administration, but no longer have payroll withholding. Deal making will end up being free of tax issues that can slow things down. As I understand it this is one of the ways the Fair Tax is supposed to benefit the economy.

Given the level of complexity that current sales tax systems have to cope with I think it is likely that there won’t be any problem modifying existed accounting systems to accommodate the new sales tax. The administrative credit in the aggregate is not much less than is spent on the IRS so you can count on there being lots of vendors chasing that money. Then there will be the ones who offer to take care of it for you at a bargain price and don’t pay the money over. Be careful out there.