Never Let a Crisis Go To Waste

As we continue in this economic malaise, we are seeing a great deal more compliance enforcement activity at both the federal and state levels. The coffers are running empty and treasury departments are being aggressive about trying to fill them up. With this in mind, I found this article interesting.


I understand the desire of our elected representatives to “make things easier” for their constituents and certainly having to go to your local tax preparer to get your income taxes prepared can be inconvenient and sometimes expensive. I do think, however, that there is a general benefit to having an independent person helping to prepare your income tax returns. It is the role of the independent tax preparer to review the information received for completeness and accuracy, which I’m sure any IRS created software would do. Although, another function of the independent tax preparer is to suggest areas of tax planning that the typical individual hasn’t considered/thought about. I don’t imagine that any government created tax software is going to suggest ways to minimize the taxes reported.

In my mind, the suggestion that the IRS get into the tax preparation business is a progression of thinking that will ultimately lead to the IRS actually preparing returns for most individuals. The internal revenue code is getting more and more complex and at some point the Treasury department will have a strong case to be made that only they can accurately prepare many individual tax returns. They are already establishing systems that gather the majority of information that is included in the returns.

The following information is currently being gathered or will be in the very near future:

• Wages & Withholding

• Interest Income

• Dividend Income

• State Tax Refunds (Yes these are taxable, if you itemized your prior year deductions)

• Proceeds from Sales of Securities (cost basis reporting to start soon)

• Partnership and S-Corporation Income

• Trust Income

• Social Security Income

• Independent Contractor Income/Commissions

• Mortgage Interest Paid

There are only a few missing pieces in the information that they already collect that would need to be completed and they will have all the information necessary to prepare the vast majority of individual tax returns. I think it is just logical that at some point the IRS will want to control as much of the tax return preparation/filing process as it can and use the information that it is collecting to its fullest potential. What better time than when closing the “Tax Gap” is a priority?

A Rose by Any Other Name…

Recently Business Insider reported on a ranking of the climate for small businesses. Normally, this really wouldn't be worth mentioning, except that at least one of the factors noted that led to some states being highly rated is incorrect or at least not properly understood. The major factor that I'm thinking of is the Corporate Income Tax. Ohio and Texas were in the top 10 with corporate income taxes being listed at 0%. Yes, they don't technically have a corporate "income" tax, but they have other taxes that replace them for the states' purposes. Ohio has a commercial activity tax (CAT) and Texas has a margin tax for businesses. While these aren't "income" taxes, they can be more burdensome (from a compliance perspective) and still extract money from businesses like any income tax would. From a business perspective, what you call it is irrelevant.

Resolutions

It's a new year. It's resolution time. The time when we promise to ourselves that we are going to do all those things that we know are good for us, but that we really don't want to do. We mean it. We are really going to stick to it this year and not fall back into our old habits by the end of March. From a tax perspective, falling back into our old habits can really cost us in the long term.

• No Procrastination – This is one of the (if not the) biggest hurdles for anyone to get over. Humans are pain averse. Rightfully so, but accepting some short term pain can mean avoiding some severe long-term agony in the future.
  
  • Estimated Taxes - Everyone is required to pay estimated taxes through the year. Most people do this through withholding from their paychecks, so it is generally not a concern for them (if you have significant income outside of your paycheck, it should be a concern). However, if you are self-employed or retired you don't likely have the withholding to cover your tax liability, and you will need to consider if it will be necessary to make estimated tax payments to avoid paying penalties and interest on the un-timely paid tax liabilities. The first payment is due in April, so 2011 planning should start now.
    
  • Timely Filing – While most taxpayers are eligible for automatic extensions of time to file their taxes, filing tax returns after the extended due date can be very costly indeed, if you owe money with the return. For individuals, with an amount due to be paid with the return, filing late can cost 5% per month or part of a month (up to 25%) plus .50% per month or part of a month for paying late plus interest. If you've been waiting to file because you didn't have the money to pay the tax liability, it only gets worse the longer you wait to file.
    
  • Tax Reduction – Once a year has ended, it becomes very hard to effectively reduce your tax liability for that year. While there are some things that might be able to be done, they are very few and far between and you may not be eligible to take advantage of them. If you appropriately plan during a year, the full range of options to reduce your tax liability are available to you.
    
• Do It – "Talk is cheap." "Actions speak louder than words." Yes these are clichés, but they have survived the test of time because they are true. All the plans that you can make aren't worth the paper they are written on if you don't do anything with them. If you want to reduce the amount you pay in taxes in 2011, talk to your tax advisor now/soon. When you are taking your 2010 tax information to him/her, make sure they schedule a few minutes to talk with you about 2011. It will be worth your time.
  

Two resolutions shouldn't be too hard to keep and you will be much happier that you did come January, 2012.

Simplification – Oh No, Not Again.

The President's deficit commission called for tax simplification. (It's on page 28.J)

The President has stated that we need to simplify our tax code.

Every few years, the Washington establishment starts to wake up to the fact that the Internal Revenue Code is an overly complicated and inefficient revenue collection vehicle. This is followed-up by the usual crowd calling for the implementation of some "quick and easy solution" like the "Fair Tax" (i.e. a consumption tax) or the "Flat Tax" (i.e. reducing the number of income tax brackets).

"If you follow my 10 step program you can eat all you want and still lose weight."

The "Fair Tax" is for all practical purposes a national sales tax on the sale of every new good and service and would completely replace income, estate, and employment taxes. One of the major selling points is that it would "eliminate" the IRS. The taxes would be collected via the sales tax system already in place in the states. While you might reduce the size of the IRS, there would still be a need on the federal government's part to monitor the sales tax reports, make sure that the proper amounts were remitted by the states, and remit the annual rebate checks (part of the plan). This would certainly be handled by the IRS or whatever its successor would be called. So the IRS wouldn't be eliminated, it just might be called something else. Additionally, this system would rely on the states' departments of revenue as the collector of the tax and first level of review on the tax filings and this could prove to be problematic.

The "Flat Tax" proposals would eliminate most income tax deductions and reduce the number of tax brackets to one. The primary selling point of this proposal is the ability for most people to file their income tax returns on a small "postcard". This sounds great. But most individuals who could file on a postcard can currently file on a one page form, as it is. This wouldn't be big improvement to them. The complexity of our current income tax system doesn't come from itemized deductions or multiple tax brackets. The complexity of the current system comes from determining what income is and, for businesses, what expenses are allowed to off-set their gross income. The "Flat Tax" proposals are very short of detail in this regard.

I'm not opposed to either of these proposals, but their proponents seem to oversell them. I think this becomes problematic in that any flaw in the proposals becomes a convenient excuse for the establishment to continue with the status quo or worse, to find new and different ways to use the tax code for the social engineering that has created the complexity in the first place.

I'm pretty sure we've heard all of this before and I'm not inclined to think that the end results will be any different than they have been in the past. Which means that after the forth coming round of tax simplification attempts we will have an Internal Revenue Code that is twice its current bloated size and three times as complex.

Mind the Gap

Those of you who have traveled to London, England will likely recognize this phrase as a passenger safety warning on the London Underground. However, in the context of US federal income taxation, this phrase has an entirely different meaning.

The US Treasury / IRS keep track of the "Tax Gap", which is a calculation of the difference between the taxes owed and the taxes paid in a timely manner. According to the IRS, this gap was approximately $350 billion in 2001.

Per the IRS website, "The tax gap can be divided into three components: nonfiling, underreporting and underpayment. Nonfiling occurs when taxpayers who are required to file a return do not do so on time. Underreporting of tax occurs when taxpayers either understate their income or overstate their deductions, exemptions and credits on timely filed returns. Underpayment occurs when taxpayers file their return but fail to remit the amount due by the payment due date."

Many of the head scratching proposals, relating to taxes, are an attempt to close this gap. One of the most recent proposals, expanded 1099 reporting, is an attempt to close this gap. Though this isn't meant to close it in the way that many think it is. This proposal isn't meant to capture unreported income of Wal-Mart or Office Depot, entities which would receive 1099s that they previously didn't. This proposal is meant to reduce the amount of "overstated deductions", particularly small business expenses.

There have been some attempts to repeal this requirement and it may not end up going into effect. I hope that it doesn't, but this is an area that will continue to receive scrutiny from the service as it believes that correcting overstated deductions, especially those related to small business, will go a long way toward shrinking the Tax Gap.

Deficit Panal Draft

On Wednesday (November 10th), the "bipartisan" Deficit Reduction Commission released (Wall Street Journal) a preliminary draft of the proposals being considered for inclusion in its final report due on December 1st.  All things considered it may well be a good first step to reducing the federal budget deficit and helping to simplify our overly complex tax code.  We'll see what actually gets included in the final report (having to be approved by 14 members of the 18 member commission).

The draft is being attacked for either overly restricting the ability of the federal government to spend our money (by the left) or not going far enough in reducing the size of government (by the right).  The plan certainly has flaws, but we would be foolish not to expect those in what is going to be a compromise.

Here is what I think is good about the draft proposal:

• Elimination of the AMT
• Lowering of corporate tax rates
• Simplifying the individual tax rate brackets
• Increasing the age at which you get full Social Security (It's not like they proposed raising it immediately and the fact of the matter is that Social Security wasn't designed to provide retirement benefits for decades as it is currently doing for many of its recipients.)
• Reducing some itemized deductions for a much higher standard deduction.
• NO  VALUE ADDED TAX!!!! (My biggest fear with regard to this commission was that it was going to suggest a value added tax as a supplement to the current income tax system, that it wasn't mentioned at all is a huge plus.)

What I don't like:

• Taxing capital gains at ordinary rates
• Means testing social security benefits (You put money into the system and you shouldn't be penalized because you "don't need it".  That wasn't the "agreement" when you started putting money into the system and it shouldn't be able to be changed now.)
• Ensuring permanent deficits (If spending and revenue are capped at the same amount (21% of GDP), you can be assured that the amount to be spent will always reach the cap, but there will be plenty of times when the revenue won't reach the cap.  This ensures that the federal debt will never be paid down.)

Overall, I think the proposal is a good starting point.  It will be interesting to see what actually gets seriously considered by the President and Congress.

Now What?

In January2011, the US House of Representatives will change to republican control. Between now and then, there is going to be a tremendous focus on what will happen in the “Lame Duck” session of congress.


We can hope that some of the items (AMT Patch and tax extenders) that were not addressed before the election will be dealt with. I’m concerned that there isn’t going to be much of an appetite on the part of the departing congresspersons to deal with this. Here is an article from Dean Zerbe (Alliant Group/Forbes.com) where he gives his thoughts and what might happen.

Going forward, I’m concerned that the administration will stand in the way of getting any meaningful extension of the “Bush” tax cuts and that we may be in for a realization of the largest tax hike in history. The administration hasn’t shown a willingness to compromise in many (any?) areas and has already indicated that they will be likely to make liberal use of the veto.