Tax Issues

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The Tax Code: More Welfare for the Well Off

May 26, 2011 in Tax Issues by DJ | No comments

Dan4th Nicholas image

A tax client asks,

“Our income for the 1st quarter dropped dramatically. Can I base my estimated payment for the 2nd quarter on actual income, and if so what is the formula?”

The short answer is, yes.  The law requires that a taxpayer pay in 90% of the tax due for the year, or 110% of the tax due for the previous year; either amount will satisfy the requirement.  Except that if the taxpayer earned $150,000 or more, he/she must pay in 100% of the tax due this year.  This is all covered in IRS Publication 505, which for 2011 contains 69 pages explaining how to calculate what you need to pay.

In this taxpayer’s situation, where income is expected to be significantly less than last year, possibly as much as 75% less.  Obviously he wants to pay in based on this year’s tax, whihc will be dramatically less than last year’s.  That means he has to know how much this year’s tax will be.  The first challenge is that both he and his wife are currently unemployed.  He expects to start work again this summer.  He has no idea whether or not his wife will find work.  So he has to make a ballpark guess as to what their income will be before they have made it.

The second challenge is even more formidable: assuming X dollars in income, what will their tax be?  All he has to do is start with his best-guess taxable income, deduct his itemized deductions, and figure in any credits.  Except that last year his itemized deductions were phased out and he was ineligible for any credits.  Looking at last year’s tax return will not help him.  His itemized deductions are likely to be d=significantly different, and he may or may not be eligible for the Child Tax Credit, Higher Education Credits, and/or the Retirement Savings Credit.

In effect, he’s going to have to pay me to prepare a tax return based on fictitious numbers in order to have any idea what his tax liability will be.  Then he’ll have to pay me again when the year is over to prepare a tax return based on the actual numbers.  This by a couple that is currently unemployed.

How can we live with a tax code under which a reasonably intelligent taxpayer has no idea how much he will owe?  We talk about corporate welfare; the tax code is a form of welfare for accountants and lawyers who would otherwise have to find gainful, productive employment.  As an accountant, I am embarrassed to make my living this way.  It isn’t right, and it needs to change.

Of course, with Congress full of lawyers as usual, change isn’t very likely.

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Weird Tax Law

May 20, 2011 in Tax Issues by DJ | No comments

State income tax paid by an individual cannot be considered a business expense (except in very unusual circumstances).  Instead, it is deducted on Schedule A as an itemized deduction.  This means it doesn’t reduce self-employment taxes, and only reduces income taxes if the taxpayer can itemize his/her deductions.  (The tax can be deducted if it is directly attributable to a business, for example in the case of a gross receipts tax like those found in Indiana or on California LLCs.)

But that same state income tax can be considered a business expense for purposes of calculating Net Operating Loss (NOL), which is carried back or forward and used to reduce income taxes for other years.  (See Rev. Rul. 70-40.)  Why?  Because, unlike the law governing business expenses, the law governing NOL doesn’t specifically say it can’t.

Weird, huh?  That’s our tax code in action.

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Californio Absurdum

April 23, 2011 in Tax Issues by DJ | No comments

That California is in deep financial crisis is not news.  However, the desperate measures to which the state is stopping to collect money have passed into the realm of the absurd.

One of my clients has an old tax debt to California that she acknowledges she owes and on which she has been making payments for a number of years.  Recently, the State reviewed her account and assessed her more than $1,000 in retroactive penalties because she failed to make electronic payments.  This is on a balance of about $7,000 – and despite the fact that her payment agreement did not require her to make e-payments.

Another of my clients has me do an annual payroll for him as president of the corporation.  Generally we do this in December, but in 2010 we did it in November.  For federal purposes, he was required to file and pay quarterly.  But for State purposes, he was required to file and pay monthly.  It doesn’t say that on any of the forms involved, one would only know that if they read the entire California Guide to Employers.  Still, the client was assessed a 10% penalty for failing to file monthly.  In most instances, an oversight by a paid professional is reasonable cause for the abatement of any penalty, so I wrote a letter on his behalf arguing that the penalty should be abated because the fault was mine.  Request denied.  The reason?

The employer had a responsibility to select a responsible accountant but did not so so.

Uh-huh. So the employer should have known in advance that the accountant might make a mistake.

(In this instance, I am responsible to pay the penalty.  However, I will be informing the client that I no longer do payroll taxes for California clients.)

California businesses might also wish to be aware that an Annual Statement of Information must be filed for each corporation or LLC.  There is a fee of $25 for filing.  However, the State no longer sends reminder cards, and if you fail to file on time you will be assessed a $200 penalty.

These are policies of a state so desperate for money that it can no longer afford to be reasonable to its taxpayers.  I wonder how long the taxpayers will stand for it.

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Enemy of the State

April 1, 2011 in Tax Issues, US Politics by DJ | 4 comments

United States of Corporate America

I’ve been preparing tax returns for over 20 years.  Throughout that time I have been of the opinion that taxes are a dislikable but necessary burden of a civilized society.  It is our right to take every deduction available so that we do not overpay, but at the same time we must pay what is due.  Render unto Caesar, as it were.

I find myself changing that view.  When huge and profitable companies pay no federal income tax, why should a struggling small business?  When the tax law has been gamed to favor the wealthy such that a taxpayer with $250,000 in income may pay less tax than a taxpayer earning 1/3 of that, why should the latter taxpayer comply?  When the current President and his predecessor have presided over a massive transfer of wealth from individual and government hands into corporate hands, why should Americans give the government more money to be transferred?

I conclude that the taxpayer should not.

If one cannot morally participate in a legally required system, what are the alternatives?  Civil disobedience is one that suggests itself.  In civil disobedience, one publicly refuses to obey the law, and accepts the consequences of that action.  This was the strategy adopted by Dr. Martin Luther King, by Gandhi, and even by many of the early Christians.  It is a moral and patriotic approach, celebrating the right to protest and to determine one’s own destiny.

There is some question, however, about whether this is a valid strategy in all situations, or only when dealing with a moral adversary – and whether the Federal government could possibly be considered a moral adversary.  And, secondary from a moral perspective but more important from a practical perspective, can a person risk themselves in such a way when they have an obligation to support their family?

The alternative would seem to be failing to pay taxes in an act of secrecy – relying on dishonesty and deception.  True, our government has stooped to this level.  But if I adopt their tactics believing that such tactics are abhorrent, am I not at least as evil?

Deception is, from a moral standpoint, an act of violence.  An act of violence against the State is seditious.  Whatever reason I give, if I cheat on my taxes, that makes me an enemy of the state.  At what point is such a course of action justified?

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Why I Don’t Offer E-Filing

March 26, 2011 in Tax Issues by DJ | No comments

The IRS wants us to e-file our tax returns.  In fact, starting this year, a preparer who does more than 100 tax returns is required to e-file.  Next year, a preparer who does more than eleven tax returns will be required to e-file.  But most of my clients could care less about e-filing.  Paper feels much more secure to them, as it does also to me.

Two years ago, I submitted my application to become an e-file provider, complete with fingerprints and background information.  Yes, you have to submit fingerprints to e-file a tax return!

I’m still not set up to e-file.  Every time I try to log into the system (about once a year), I get locked out and have to start over.

Today was a perfect example.  I had two (out of my 93) tax clients ask me about e-filing.  So called to find out what I still had to do to become an e-file preparer.  I need a copy of my acceptance letter, which (because I got it two years ago and don’t know where it is), I can only obtain by logging into the IRS E-Services website.  This requires a username, password, and PIN.  But not just any PIN, this requires a special 5-digit PIN, so it’s not one of the normal numbers I use for my bank or for other IRS websites.

I don’t remember my pin.  After 3 permutations of likely numbers, I got a message telling me I was locked out of their site for an hour.  Brilliant.

An hour later, I was back on the website.  This time I decided to get smart: there’s a link to reset the PIN.  Okay, I can do that.  All I need to provide is my name, social security number, username, and AGI for one of the three previous tax years.  I can do that.

Rather, I thought I could do that.  A cryptic message told me my name did not match my social security  number.  Excuse me?  I tried again… and again.  Then I called the helpline for assistance.  The rep wasn’t able to tell me why I couldn’t log in, but she was able to tell me that I’d been locked out of the site again – this time for 48 hours.

“It didn’t tell me I was locked out,” I complained.  “It just told me there was an error.”

“I don’t know why it does that,” she said.  “But you’re locked out and there’s nothing we can do about it.  Call back on Monday and we’ll help you.”

Monday?  There are 20 days left until April 15.  I won’t come up for air again for another three weeks.

“I’ll try again next year,” I told her.

Now I remember: This is exactly what happened last year, I got locked out for 48 hours and gave up.   For something the IRS mandates must be done, they sure don’t make it easy!  This is a very unfriendly system.

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Lactation Taxation

March 5, 2011 in Tax Issues by DJ | No comments

Wikimedia image: Slovakia folk art

You would think a tax break that promotes breast feeding might be favored by those promoting family values, and vilified by those science-loving progressives. Not this time. As a New York Times article points out, the IRS recently permitted breast pumps and related supplies to be treated as medical equipment, deductible on Schedule A and payable through HSAs and FSAs. For it: Michelle Obama. Against: Michele Bachmann. Go figure.  Perhaps politics is more important than principle.

This tax break only favors those who have HSAs and FSAs, or who file Schedule A to itemize their deductions. So it does nothing for the majority of Americans who don’t have these avenues for savings. It benefits the upper middle class and the wealthy. Nevertheless, it’s a common sense change that might actually save the fed money by reducing its costs for buying baby formula.

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The Absurdity of Our Tax Code

March 1, 2011 in Tax Issues by DJ | No comments

The taxpayer owns a business, converted an IRA to a Roth-IRA, has two children, a mortgage, is subject to the AMT, and lives in a state that also collects income tax.  Still, I can think of no reason an individual ought to have a tax return that is over 3/4″ thick.  Our tax code is absurd.

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Tax Changes for 2011

January 20, 2011 in Tax Issues by DJ | No comments

Il trembla un peu quand la call arriva: elle était bien plus grande que lui
(Pichenettes photo.)

Congress, in its infinite wisdom, decided that the rich should continue to pay less tax in 2011.  Coincidentally, the majority of Senators and Congresspeople will benefit from that decision, but I’m sure that had nothing to do with it.

There were other changes in contained that tax bill.  The Kiplinger Tax Letter summarizes them (Vol. 86 No. 1) – here are a few of the more ridiculous provisions:

  • Social Security taxes will decline for 2011.  That’s right: the same program that is on a path to go broke before I collect from it will now receive less money for 2011 – and there’s no provision to make that shortfall up by finding money elsewhere.  The employee portion of social security tax will fall from 6.2% to 4.2%, putting an extra 2% in the pockets of workers.  The employer portion will not change, making it just as costly to actually hire a worker.  Self employeds will get the same benefit, with their self employment tax rate falling 2% from 15.3% to 13.3% – still a lot of tax for those who work for themselves!
  • The tax credit for saving energy gets chopped by 2/3, dropping from 30% to 10%, with the maximum credits being cut proportionately.  With energy costs rising, it may still make sense to make energy saving home improvements.  But you’ll notice that coal, oil, and natural gas subsidies didn’t get cut while conservation incentives did.
  • Credit and debit card companies will be required to file Forms 1099 to report amounts paid to merchants.  This despite the fact that such payments are made directly to the merchant’s bank account, never in cash.  And 1099 filing for outside contractors, formerly limited to businesses, gets expanded this year to include rental properties owned by individuals.  If Granny owns a rental property, she’s going to have to figure out how to print 1099s.

And if you’ve already talked to your tax preparer about getting your return done early, you’ll know that it’s not possible.  The tax bill passed so late in the year that finalized tax forms are not expected for weeks, and the IRS won’t accept returns until at least mid-Febuary.

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The Tax Code at Work

January 11, 2011 in Small Business, Tax Issues by DJ | No comments

One of my businesses is raising goats and making cheese.  Like every other business, at year-end we have to figure out whether we owe taxes.  For a manufacturing business like ours, that’s not always easy.

During the course of a business year, we paid for cow milk,goat feed, cheese making supplies, and so forth.But we don’t get to deduct the full amount of pour purchases, because some of the cheese we made has not yet been sold.  It remains in inventory.    We are required to count the cheese inventory at year-end, which we did.  We had 1,688 pounds of cheese on hand when we counted.

How much is that cheese worth?  Well, last year it cost us more to produce the cheese than its market value, so we chose a method of inventory called “lower of cost or market.”  That means if the cheese is worth less than it cost, we use the market value; if it cost less than it is worth, we use cost.  So we have to figure out how much the cheese would be valued using each method, and use the lower.

To figure out the market value of the cheese, we tally up the total sales for the year and divide it by the number of pounds sold.  To figure the cost of the cheese, we tally up the costs of the purchases we made to make the cheese and divide that by the total amount produced for the year.  That is the total number sold, plus the total number in inventory, less the total number we had in inventory last year (because that cheese was produced in a prior year, not the year in question).

It turns out that we will be valuing our cheese at cost this year.

We need that number because the deductible amount of the purchases, called Cost of Goods Sold or COGS, is calculated by taking the beginning inventory, adding the purchases, and subtracting the ending inventory.

Are you with me so far?

But here’s where it gets really fun: the federal government has determined that a manufacturing industry must determine how much other expense went into the production of our cheese.  This is Section 263A of the tax code, so these expenses are typically referred to as 263A expenses.  In our case, they include labor, supplies, vehicle expense, security (the livestock guardian dog), equipment rental, repairs, and veterinary expenses.  We add all those up to get the “Total Attributable Expenses.”

Now we find the attribution rate, which is the number of pounds of cheese in the ending inventory, divided by the total number of pounds of cheese produced, rounded to 5 decimal places.  Yes, the tax code says how many decimal places to use.

Take the total attributable expense and multiply it by the attribution rate to get the amount of expense that needs to be capitalized– in other words, expense that isn’t deductible in the current year.

But we’re not done yet: last year we had 263A expense that had to be capitalized.  This year, we take that amount as an expense, while removing the current year number from expense.

So our COGS calculation looks something like this:

Beginning Inventory (last year’s ending inventory)

Add: Last Year’s 263A Expense

Add: Purchases

Subtract: Ending Inventory

Subtract: Current Year 263A Expense

————————————————–

Equals: Cost of Goods Sold

Is it simple?  Not at all.  But the actual tax code, as written by Congress, is worse:

In general
        In the case of any property to which this section applies, any
      costs described in paragraph (2) -
          (A) in the case of property which is inventory in the hands
        of the taxpayer, shall be included in inventory costs, and
          (B) in the case of any other property, shall be capitalized.
      (2) Allocable costs
        The costs described in this paragraph with respect to any
      property are -
          (A) the direct costs of such property, and
          (B) such property's proper share of those indirect costs
        (including taxes) part or all of which are allocable to such
        property.
      Any cost which (but for this subsection) could not be taken into
      account in computing taxable income for any taxable year shall
      not be treated as a cost described in this paragraph.

Excuse me?

It goes on like that for about 3 pages.  Then there are pages more of regulations issued by the Treasury Department on how this rule should be applied.

One thing is for sure: tax code like this ensures that accountants, auditors, and tax attorneys stay gainfully employed– at the expense of the businesses that have to hire them to get these calculations right, and then justify their calculations to the IRS.

My other business is preparing tax returns.  The fact that I make my living from the complexity of government regulation is an embarrassment. I would much rather see a simpler tax code and find another line of work!

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The Tax Bill: The Opposite of What They Promised

December 22, 2010 in Economics, Tax Issues by DJ | No comments

With both parties blaming the other for our financial woes, you might have expected a dose of fiscal responsibility in the latest tax bill to come out of Washington.  You’d be disappointed.

Kiplinger (The Kiplinger Tax Letter 85:25) reports that the “compromise” tax bill includes all the income tax cuts, plus a reduction in Social Security taxes for 2011.  Yes, that same Social Security plan that is desperate for funding will get even less next year– $120 billion less for each year the tax cut remains in place.

And while I can’t argue with extending unemployment benefits, the bill comes through with more expenses and less income than ever.  It’s expected to add $700 billion to the already-bloated deficit.

If I ran my business this way, they’d send me to jail!

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